Icap ST

CFAP - 6
AUDIT, ASSURANCE AND

RELATED SERVICES
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN i

Fourth edition published by
The Institute of Chartered Accountants of Pakistan
Chartered Accountants Avenue
Clifton
Karachi – 75600 Pakistan
Email: studypacks@icap.org.pk
www.icap.org.pk
© The Institute of Chartered Accountants of Pakistan, January 2022
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Notice
The Institute of Chartered Accountants of Pakistan has made every effort to ensure that at the time of writing, the
contents of this study text are accurate, but neither the Institute of Chartered Accountants of Pakistan nor its directors
or employees shall be under any liability whatsoever for any inaccurate or misleading information this work could
contain.
ii THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN

TABLE OF CONTENTS
CHAPTER PAGE
GUIDANCE FOR OPEN BOOK EXAM 1
Chapter 1 CONCEPT AND NEED FOR ASSURANCE 5
Chapter 2 THE REGULATORY ENVIRONMENT 13
Chapter 3 PROFESSIONAL ETHICS 35
Chapter 4 APPOINTMENT OF AN AUDITOR AND THE PLANNING PHASE 111
Chapter 5 PROFESSIONAL RESPONSIBILITY AND LIABILITY 157
Chapter 6 THE AUDIT APPROACH 189
Chapter 7 UNDERSTANDING THE ENTITY AND THE RISK ASSESSMENT 263
Chapter 8 USING THE WORK OF OTHERS 371
Chapter 9 AUDIT EVIDENCE 419
Chapter 10 AUDIT FINALISATION AND REPORTING 461
Chapter 11 MODIFICATION IN THE AUDIT REPORT 495
Chapter 12 SPECIAL AUDITS 563
Chapter 13 REVIEW ENGAGEMENTS 579
Chapter 14 ASSURANCE AND NON ASSURANCE ENGAGEMENTS 609
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN iii

iv THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN
GUIDANCE FOR OPEN BOOK EXAM
AT A GLANCE
SPOTLIGHT
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 1

GUIDANCE FOR OPEN BOOK EXAM CFAP 6: AARS
1. APPROACH FOR OPEN BOOK EXAM

In the open book mode of examination, students are expected to:
- have a deep knowledge of the standard and simultaneously the student should be able to comprehend the
scenario based questions in exam environment,
- be able to identify the relevant standard involved; and
- finally, should be capable enough to draft a solution in accordance with the requirement of the question and
relevant standard.
As the said approach is a bit different from the conventional way of testing knowledge, a basis guideline for
students has been presented as follow to help students prepare for and attempt exams under open book mode.
It is important to note that there is no absolute guidance for any subject and students may drive their preparation
in any manner deemed necessary for them, suiting their circumstances.
Pillars of the Approach

Following are the seven (07) pillars to the Open Book Approach that are further elaborated in forthcoming
sections:
AT A GLANCE
 Understanding the concepts

 Mind Mapping of the contents
 Skimming of the Standard
 Highlighting and Marking (Building affiliations with standards)
 Basic Self-Assessment
 Advanced Self-Assessment
 Final Mock for Practice from multiple areas
1.1 Understanding the concepts

It is strongly suggested that students must not solely rely on the basic level of knowledge acquired at the CAF
level of the qualification and are encouraged to take guidance from relevant person(s). As this is an open-book
SPOTLIGHT
exam, the practical understanding of concepts would play a vital role in the preparation of the exam. It is also
suggested to follow complete guidelines provided by counsellor to have a composite understanding of the entire
syllabus systematically.
1.2 Mind Mapping of the contents

After you have clarified the concepts given in different standards / topics, this book comes to help you. You may
either consult this book as guideline for preparation of your own mind maps or you may select this book for
building the mind maps of different topics. This book would give you a summary of all the relevant standards
cross-linked with relevant para references etc.
This is important to remember that in the exams you are not expected to find the answers from the bulky book(s)
of Standards. Ideal solution (or a rough sketch) to the case study should strike first in your mind using your mind
mapping skills, you may refer the standard to confirm your understanding. If you are not equipped with Proper
understanding (unit 1.1), open book approach is not going to help you; rather it would simply waste your time
in ICAP exam making the paper more difficult for you under exam pressure.
1.3 Skimming of the Standards

After getting understanding and mapping the things in your study notes and mind, it is important to skim the
contents given in the standards. If you have a previous understanding (unit 1.1) supported by mind mapping
(unit 1.2), reading the original standard would not be a much time consuming element for you. You should skim
the contents of relevant standards in a slightly faster pace identifying the key requirements learned earlier.
2 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN

CFAP 6: AARS GUIDANCE FOR OPEN BOOK EXAM
It would generally take approximately half an hour to read any unit/ standard/topic of this book.
Before starting from the bare standard, it is recommended to quickly skim the relevant area from this book once
again (but with a faster pace this time). After skimming that, start reading and understanding the core paragraphs
of the standard.
After understanding the theme conveyed in core paragraphs, start connecting explanatory paragraphs (having a
prefix of “A”, e.g. A23). These paragraphs can be read at a little faster pace.
1.4 Highlighting and Marking (Building affiliations with the standards)

You should use 2 to 3 colors highlighters during the above reading and skimming phase so that you may highlight
different paragraphs for future reference. In this way you would be making that standard more user friendly for
your revision.
1.5 Basic Self-Assessment

After doing the aforementioned steps for any area or the topic, it’s time to assess your preparation as per the
benchmark of ICAP exams. You should select some of the questions from the practice questions given in each
relevant standard (ideally two-third of the total for that unit). It is important to note that all these practice
questions have been taken from your ICAP examinations (previous attempts of the same subject).
AT A GLANCE
After reading the question, at first stance, let your mind challenge the questions (recall your mind maps, build a
solution in mind and try to find a nearest answer in the standard available with you).
After you have prepared a rough answer in your mind; check the solutions given in the ‘Solution’ section of the
same and rate yourself. Before checking solution you may also look for the tutorial notes that are guiding you
what not to do and some additional points to focus more while developing an answer in mind.
If you are unable to reach at 70%-80% of the solution, it means that any of the starting pillars are not done
properly. If your answer matches substantially with given solution, you are ready for the second last and very
crucial phase of your preparation.
1.6 Advanced Self-Assessment

Select the remaining one-third (1/3rd) questions of each area or topic and write down their answers by yourself
SPOTLIGHT
using your understanding and the mind maps approach. Provide your solutions to any of your peer or senior to
review against the solution given in the book (Get it properly marked). An ideal situation would be two students
cross checking the solutions of each other against same chapter. Scored marks should not be less than 55%. (If
so; repeat all the previous pillars).
1.7 Final Mock for practice from multiple areas

Now when you are comfortable enough with all the topics of the syllabus and have done all previous pillars
individually for all the individual topics of the syllabus; you are required to practice a full length mock of 3 hours
to assess your final preparation and an ability to retrieve the knowledge from your mind maps and the open book
when the relevant area is increased to full syllabus. You may choose latest paper of ICAP exam as this mock.
Giving such mock (or latest paper of ICAP) would assure:
 A good writing practice
 Self-Assessment
 Multi-topic testing
 Practicing time management
 Know your weaknesses at least 2 weeks before exam

GUIDANCE FOR OPEN BOOK EXAM CFAP 6: AARS
AT A GLANCE
SPOTLIGHT

CHAPTER 1
CONCEPT AND NEED

FOR ASSURANCE
AT A GLANCE
IN THIS CHAPTER:
The main objective of an audit is to enable an auditor to convey an
opinion as to whether or not the financial statements of an entity are
AT A GLANCE
prepared according to an applicable financial reporting framework.
SPOTLIGHT The external auditor must be independent from the directors;
AT A GLANCE
otherwise his report will have little value. If he is not independent,
1. The meaning of audit his opinion is likely to be influenced by the directors.
‘Assurance’ means confidence. In an assurance engagement, an
2. The meaning of assurance
‘assurance firm’ is engaged by one party to give an opinion on a piece
of information that has been prepared by another party. The opinion
3. Advantages and limitations of
is an expression of assurance about the information that has been
statutory audits
reviewed. It gives assurance to the party that hired the assurance
firm that the information can be relied on.
An audit provides a high, but not absolute, level of assurance that
the audited information is free from any material misstatement.
This is often referred to as reasonable assurance.
A review in contrast to ‘reasonable’ level of assurance provided by
SPOTLIGHT
an audit, a review into an aspect of the financial statements would
provide only a moderate level of assurance that the information
under review is free of material misstatement. The resulting opinion
is usually (although not always) expressed in the form of negative
assurance.
There are certain advantages and limitations of audit that are also
narrated in this chapter.

CHAPTER 1: CONCEPT AND NEED FOR ASSURANCE CFAP 6: AARS
1. THE MEANING OF AUDIT

1.1 Definition and objective of audit
An audit is an official examination of the accounts (or accounting systems) of an entity (by an auditor).
When an auditor examines the accounts of an entity, what is he looking for?
The main objective of an audit is to enable an auditor to convey an opinion as to whether or not the financial
statements of an entity are prepared according to an applicable financial reporting framework.
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. Financial statements have the following
components (as per IAS-1):
 Statement of Financial Position (Balance Sheet)
 Statement of Profit or Loss and other comprehensive income
 Statement of Changes in Equity
 Cash Flow Statement
AT A GLANCE
 Notes to the Financial Statements

 Comparative information prescribed by the standard
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.
The applicable financial reporting framework is decided by:
 legislative or regulatory environment within each individual country, and
 accounting standards (for example, International Accounting Standards / International Financial
Reporting Standards).
SPOTLIGHT
The auditor seeks to express an opinion as the result of the audit work that he does. The type of work carried out
by an auditor in order to reach his opinion is described in later chapters.
1.2 Concepts of accountability, stewardship and agency

An audit of a company’s accounts is needed because in companies, the owners of the business are often not the
same persons as the individuals who manage and control that business.
 The shareholders own the company.
 The company is managed and controlled by its directors.
The directors have a stewardship role. They look after the assets of the company and manage them on behalf of
the shareholders. In small companies the shareholders may be the same people as the directors. However, in
most large companies, the two groups are different.
The relationship between the shareholders of a company and the board of directors is also an application of the
general legal principle of agency. The concept of agency applies whenever one person or group of individuals
acts as an agent on behalf of someone else (the principal). The agent has a legal duty to act in the best interests
of the principal, and should be accountable to the principal for everything that he does as agent.
As agents for the shareholders, the board of directors should be accountable to the shareholders. In order for the
directors to show their accountability to the shareholders, it is a general principle of company law that the
directors are required to prepare annual financial statements, which are presented to the shareholders for their
approval.

CFAP 6: AARS CHAPTER 1: CONCEPT AND NEED FOR ASSURANCE
1.3 The audit report: independence, materiality and true and fair
Audit has a very long history. The concept of an audit goes back to the times of the Egyptian and Roman empires.
In medieval times, independent auditors were employed by the feudal barons to ensure that the returns from
their stewards and their tenants were accurate.
Over time, the annual audit was developed as a way of adding credibility to the financial statements produced by
management. The statutory audit is now a key feature of company law throughout the world.
An auditor reports to the shareholders on the financial statements produced by a company’s management.
The key features of the audit report are as follows:
AT A GLANCE
 The auditors producing the report are independent from the directors producing the financial
statements.
 The report gives an opinion on whether the financial statements “give a true and fair view”, or “present
fairly” the position and results of the entity.
 The report considers whether the financial statements give a true and fair view in all material respects.
The concept of materiality is applied in reaching an audit opinion.
Independence of the auditor

The external auditor must be independent from the directors; otherwise his report will have little value. If he is
not independent, his opinion is likely to be influenced by the directors.
SPOTLIGHT
In contrast to external auditors, internal auditors may not be fully independent from the directors, although they
may be able to achieve a sufficient degree of independence.
The concept of ‘internal auditors’ shall be described in details in a later chapter.
True and fair view (fair presentation)

The auditor reports on whether (or not) the financial statements give a true and fair view, or present fairly, the
position of the entity as at the end of the financial period and the performance of the entity during the period.
The auditor does not certify or guarantee that the financial statements are correct.
In preparing the financial statements, a large amount of judgement is exercised by the directors. Similarly,
judgement is exercised by the auditor in reaching his opinion. The phrases ‘true and fair view’ and ‘present fairly’
indicate that a judgement is being given that the financial statements can be relied upon and have been properly
prepared in accordance with an appropriate financial reporting framework.
Materiality concept
The auditor reports in accordance with the concept of materiality. He gives an opinion on whether the financial
statements present fairly in all material respects the financial position and performance of the entity.
Information is material if, on the basis of the financial statements, it could influence the economic decisions of
users should it be omitted or misstated.

For example, the shareholders of a company with assets of Rs.1 million will not be interested if petty cash was
miscounted with the result that the amount of petty cash is overstated by Rs.100. This is immaterial. However,
they will be interested if there are receivables in the statement of financial position of Rs. 200,000 which are not
in fact recoverable and which should therefore have been written off as a bad debt.
Applying the concept of materiality means that the auditor will not aim to examine every number in the financial
statements. He will concentrate his efforts on the more significant items in the financial statements, either:
 because of their (high) value, or
 because there is a greater risk that they could be stated incorrectly.
1.4 The statutory requirement for audit

Most countries impose a statutory requirement for an annual (external) audit to be carried out on the financial
statements of most companies.
However, in many countries, smaller companies are exempt from this requirement for an audit. Other entities,
such as sole traders, partnerships, clubs and societies are usually not subject to a statutory audit requirement.
Small companies and these other entities may decide to have a voluntary audit, even though this is not required
by law.
AT A GLANCE
1.5 Responsibility of management and those charged with governance

With respect to the audit and contrary to what many members of the public think, it is management and those
charged with governance which are responsible for:
 Prevention and detection of fraud
 Preparation of the financial statements
 Design and implementation of effective internal controls - for example authorising payments above a
certain amount, monthly bank reconciliation and a monthly trade payables control account
reconciliation.
They are also responsible for:
 Providing the auditor with:
SPOTLIGHT
¯ Access to information relevant to the preparation of the financial statements

¯ Additional information relevant to the audit
¯ Unrestricted access to persons whom the auditor needs access to in order to complete the audit
 Providing written representations to the auditor at the end of the audit (see later chapter for details)

2. THE MEANING OF ASSURANCE

2.1 Definition of assurance
‘Assurance’ means confidence. In an assurance engagement, an ‘assurance firm’ is engaged by one party to give
an opinion on a piece of information that has been prepared by another party. The opinion is an expression of
assurance about the information that has been reviewed. It gives assurance to the party that hired the assurance
firm that the information can be relied on.
Assurance can be provided by:
 audit: this may be external audit, internal audit or a combination of the two.
 review.
A statutory audit is one form of assurance. Without assurance from the auditors, the shareholders may not accept
that the information provided by the financial statements is sufficiently accurate and reliable. The statutory audit
provides assurance as to the quality of the information.
The provision of this assurance should add credibility to the information in the financial statements, making the
information more reliable and therefore more useful to the user.
However, there are differing levels or degrees of assurance. Some assurances are more reliable than others.
AT A GLANCE
2.2 Levels of assurance
The degree of assurance that can be provided about the reliability of the financial statements of a company will
depend on:
 the amount of work performed in carrying out the assurance process, and
 the results of that work.
The resulting assurance falls into one of two categories:
 Reasonable Assurance - A high (but not absolute) level of assurance provided by the practitioner’s
conclusion expressed in a positive form. E.g. “In our opinion the accounts are true and fair”. The objective
of a statutory audit is to provide reasonable assurance.
SPOTLIGHT
 Limited Assurance - A moderate level of assurance provided by the practitioner’s conclusion expressed
in a negative form. E.g. “Based on our review, nothing has come to our attention that causes us to believe
that the accompanying financial statements do not give a true and fair view”. The objective of a review
engagement is often to provide limited assurance.
Assurance provided by audit

An audit provides a high, but not absolute, level of assurance that the audited information is free from any
material misstatement. This is often referred to as reasonable assurance.
The reason why auditor is not expected to provide absolute assurance is that 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 are discussed later in this
chapter.
Assurance provided by review

In contrast to ‘reasonable’ level of assurance provided by an audit, a review into an aspect of the financial
statements would provide only a moderate level of assurance that the information under review is free of
material misstatement. The resulting opinion is usually (although not always) expressed in the form of negative
assurance.
Negative assurance is an opinion that nothing is obviously wrong: in other words, ‘nothing has come to our
attention to suggest that the information is misstated’.

A review does not provide the same amount of assurance as an audit. An external audit provides positive
assurance that, in the opinion of the auditors, the financial statements do present fairly the financial position and
performance of the company.
The higher level of assurance provided by an audit will enhance the credibility provided by the assurance
process, but the audit work is likely to be:
 more time-consuming than a review, and so
 costlier than a review.
2.3 Elements of an assurance engagement

 Definition: Assurance engagement
An engagement in which a practitioner aims to obtain sufficient appropriate evidence in order to
express a conclusion designed to enhance the degree of confidence of the intended users other
than the responsible party about the subject matter information (that is, the outcome of the
measurement or evaluation of an underlying subject matter against criteria).
Source: Handbook of International Quality Control, Auditing, Review, Other Assurance, and
Related Pronouncements
AT A GLANCE
An assurance engagement performed by a practitioner will consist of the following five elements:
 A three party relationship:
¯ Practitioner - the individual providing professional services that will review the subject matter and
provide the assurance. E.g. the audit firm in a statutory audit
¯ Responsible party - the person(s) responsible for the subject matter. E.g. the Directors are
responsible for preparing the financial statements to be audited
¯ Intended users - the person(s) or class of persons for whom the practitioner prepares the
assurance report. E.g. the shareholders in a statutory audit
 Subject matter: This is the data such as the financial statements that have been prepared by the
responsible party for the practitioner to evaluate. Another example might be a cash flow forecast to be
reviewed by the practitioner.
SPOTLIGHT
 Suitable criteria: This can be thought of as ‘the rules’ against which the subject matter is evaluated in
order to reach an opinion. In a statutory audit this would be the applicable reporting framework (e.g.
IFRS and company law).
 Evidence: Information used by the practitioner in arriving at the conclusion on which their opinion is
based. This must be sufficient (enough) and appropriate (relevant).
 Assurance Report: The report (normally written) containing the practitioner’s opinion. This is issued
to the intended user following the collection of evidence.

3. ADVANTAGES AND LIMITATIONS OF STATUTORY AUDITS

3.1 Advantages of statutory audits
An external audit provides the following benefits:
 It increases the credibility of published financial statements.
 It confirms to management that they have performed their statutory duties correctly.
 It provides assurance to management that they have complied with non-statutory requirements, such
as corporate governance requirements (where these are subject to audit or review).
 It provides feedback on the effectiveness of internal controls. Where internal controls are weak or
inadequate, the auditor will give recommendations for improvement. This will assist management in
reducing risk and improving the performance of the company.
Even where a statutory audit is not required, for example due to small company statutory exemption limits (in
some countries), an audit will increase the credibility of published financial statements. This may be important
for potential lenders to the company. Potential lenders, such as banks, may insist on the company having an audit
as a pre-condition for lending money.
3.2 Limitations of statutory audits
AT A GLANCE
The main limitations of an audit are as follows:
 The cost of an audit can be very high. However, if the audit firm is already hired to carry out non-audit
work such as advisory work, the additional cost of an audit may be fairly small.
 The disruption caused to a company’s staff during the audit. The company’s staff may be required to
assist the auditors by answering questions, providing documents and other information.
 Some items in the subject matter might be estimates whose truth and fairness will not be known with
certainty until some point in the future. This means the assurance opinion is ultimately subjective and
judgmental.
 Most fraud will include an attempt to deliberately conceal the truth or misrepresent information.
 In order to balance cost and efficiency the auditor routinely uses sampling rather than tests every item.
SPOTLIGHT
 Irrespective of how robust a client’s systems are, they will always incorporate some degree of inherent
limitation.
 Audit evidence is persuasive rather than conclusive, i.e., they persuade the auditor to believe that a
particular assertion has been justified instead of providing a conclusion.
 Practice Question 01:
You were the engagement partner on the audit of a commercial bank which has a network of
more than 200 branches, across the country. During a recent meeting, a member of the audit
committee referred to an instance of irregularity in a branch, whereby the Branch Manager had
extended credit to a close relative without following the bank’s credit disbursement procedures.
The member criticized the auditors for their failure to highlight such instances.
Required:
As an engagement partner, write a letter to the audit committee explaining your point of view in
detail with specific references to the International Standards on Auditing, wherever applicable.
 Solution:
Views expressed by the Audit Committee Member were not correct due to following reasons:
The objective of an audit of financial statements carried out in accordance with ISA is to obtain
reasonable assurance that the financial statements taken as a whole are free from material
misstatements.

For this purpose, the auditor considers internal control relevant for the preparation and fair
presentation of the financial statements but is not required to express an opinion on the
effectiveness of the entity’s internal control system.
An audit opinion does not assure the future viability of the entity nor the efficiency or
effectiveness with which management has conducted the affairs of the entity.
The audit process is subject to certain limitations which are also recognized by ISA. Such
limitations include:
 use of sampling
 reliance on internal controls which itself is subject to limitations (for example: possibility of
management override or collusion) and
 the fact that most audit evidence is persuasive rather than conclusive.
Moreover, in the context of the specific instance referred by the Audit Committee Member, it may
be possible that the subject branch may not have been selected for the purposes of audit due to
its relative insignificance in relation to the overall financial statements.
Moreover, the fact that credit was granted to close relative of branch manager without following
normal lending procedures, may not necessarily result in material misstatement in the financial
statements.
AT A GLANCE
SPOTLIGHT

CHAPTER 2
THE REGULATORY ENVIRONMENT
AT A GLANCE
IN THIS CHAPTER:
The key reason why audit and assurance services should be
AT A GLANCE regulated is to serve the public interest. Assurance providers give
an impartial, professional view on issues that matter to users of
SPOTLIGHT financial and other information.
International Standards on Auditing (ISAs) are set by the
1. The need for regulation of International Audit and Assurance Standards Board (IAASB), which
audit and assurance services is a part of IFAC.
AT A GLANCE
2. Professional standards The IAASB issues a number of international standards like
- International Standards on Auditing (ISAs)
3. Professional misconduct
- International Standards on Review Engagements (ISREs)
4. Consideration of laws & - International Standards on Assurance Engagements (ISAEs)
regulations in an audit of
financial statements (ISA - International Standards on Related Services (ISRSs)
250) - International Standards on Quality Control (ISQCs)
International standards are drafted to be used internationally and
promote consistency in audit and assurance practice.
SPOTLIGHT
Money laundering can be defined as the process by which criminals
attempt to conceal the true origin and ownership of the proceeds of
their criminal activities.
The requirements of ISA-250 are designed to assist the auditor in
identifying material misstatement of financial statements due to
non-compliance with laws and regulations. However, the auditor is
not responsible for preventing non-compliance and cannot be
expected to detect non-compliance with all laws and regulations.

CHAPTER 2: THE REGULATORY ENVIRONMENT CFAP 6: AARS
1. THE NEED FOR REGULATION OF AUDIT AND ASSURANCE SERVICES

1.1 The public interest
The key reason why audit and assurance services should be regulated is to serve the public interest. Assurance
providers give an impartial, professional view on issues that matter to users of financial and other information.
It is important that this view can be trusted. Therefore, assurance providers need to operate:
 within ethical boundaries
 to consistent standards and
 within the bounds of local laws and regulation.
You know from your previous studies that assurance providers are regulated by:
 the law of the land in which they operate
 the ethical standards of the land and the professional body to which they belong
 the professional standards adopted by their country, for example International Standards on Auditing
(ISAs)
1.2 Ethical regulation

AT A GLANCE
Assurance providers are given ethical guidance by:

 Professional bodies, for example, The Institute of Chartered Accountants of Pakistan (ICAP)
 Law
 International Federation of Accountants (IFAC)
You should already be familiar with some of the ethical guidance relevant to this syllabus from your earlier
studies, which is revised later in Chapter 3.
1.3 Legal regulation

Most countries have legal requirements associated with some assurance providers, particularly auditors.
Examples of these legal requirements in Pakistan can be found, for example, in the Companies Act, 2017, Banking
SPOTLIGHT
Companies Ordinance 1962 and Insurance Companies Ordinance 2000.
1.4 Professional regulation

Auditors are required to carry out audits according to professional standards – International Standards on
Auditing (ISAs) as applicable in Pakistan. Some assurance work is also covered by professional standards,
although this is a developing area and less guidance is available. In many cases, guidance given in auditing
standards can be adapted for use in assurance services where there is no specific guidance for that service.
As assurance provision goes increasingly ‘global’ the harmonisation of such professional guidance has become
necessary.
1.5 Harmonisation of the accountancy and auditing profession

The International Federation of Accountants (IFAC) is an international regulatory body for the profession but
each country has its own regulatory regime for auditing, which may not necessarily apply the same principles of
audit behaviour as those used by IFAC.
The same arguments that have been made in favour of the universal adoption of international accounting
standards can also be made in respect of other regulatory aspects of the auditing and accounting profession.
 These include advantages such as the adoption of global auditing standards, which should improve the
efficiency of the audit process for multinational companies and should improve transparency in audit
reporting.

CFAP 6: AARS CHAPTER 2: THE REGULATORY ENVIRONMENT
 Disadvantages include the problems of getting international agreement on auditing practices, and the
need for many countries to change their local law to bring it in line with the agreed international practice.
A number of initiatives are taking place to harmonise the regulation of the auditing profession internationally.
These include the following:
 Audits of all listed companies in the European Union should now be carried out in accordance with
International Standards on Auditing.
 Moves to establish a more formal, statute-based corporate governance regime (such as Sarbanes-Oxley
in the USA).
 The development of national regulatory models for the profession, headed by a single unified body.
 New requirements across the European Union, in relation to mandatory audit firm rotation for Public
Interest Entities.
AT A GLANCE
SPOTLIGHT

2. PROFESSIONAL STANDARDS
2.1 The international standard-setting process
IFAC
(International Federation of Accountants)
IAASB IESBA
(International Auditing and Assurance (International Ethics Standards Board

Standards Board) for Accountants)
ISAs
International Standards on Auditing (ISAs) are set by the International Audit and Assurance Standards Board
(IAASB), which is a part of IFAC.
A subcommittee of IAASB is asked to write an exposure draft of the new standard when IAASB considers that
AT A GLANCE
one is required. This draft is then ‘exposed’ to interested parties, who comment on the exposure draft. Interested
parties include national standard setters and professional bodies.
The comments are reviewed within the IAASB and the draft is amended as required. Finally, a new ISA is issued.
In addition, the IAASB also publishes:
 International Standards on Review Engagements (ISRE);
 International Standards on Assurance Engagements (ISAE);
 International Standards on Related Services (ISRS);
 International Standard on Quality Control (ISQC); and
 International Auditing Practice Note (IAPNs).
SPOTLIGHT
Code of Ethics for Professional Accountants

IFAC’s Code of Ethics for Professional Accountants is issued by the International Ethics Standards Board for
Accountants (IESBA), which is also a part of IFAC. Similar to many accountancy bodies around the world who
are members of IFAC, ICAP’s code of ethics is based on the IESBA’s Code of Ethics for professional Accountants,
with minor modifications or specific additions for clarification made where necessary, considering the corporate
professional environment of Pakistan.
2.2 The authority of national and international standards

International standards are drafted to be used internationally and promote consistency in audit and assurance
practice. However, situations may arise where the requirements of the international standards clash with
national standards.
In this situation, there are a number of matters that should be considered:
 ISAs are not designed to overrule national requirements, so auditors should follow national
requirements.
 However, as ISAs represent international best practice, countries are encouraged by IFAC to change their
national practice so that ISAs can be followed. For example, in the UK, since December 2004, all financial
statements have been audited using the UK version of ISAs, known as ISAs (UK and Ireland). These are
based on ISAs with any additional, UK-specific, provisions shown in shaded boxes.
 If there is no comparable guidance to the ISA in the country, then individual ISA practice can be adopted
immediately.

2.3 Preface to International Standards on Quality Control, Auditing, Review, Other Assurance and
Related Services
The IAASB issues a number of other international standards, in addition to ISAs. The table below sets out these
standards, including ISAs, and when the preface says they are to be applied.
Type of standard When applied

International Standards on Auditing (ISAs) In the audit of historical financial information
International Standards on Review In the review of historical financial information
Engagements (ISREs)
International Standards on Assurance In assurance engagements other than audits or reviews of
Engagements (ISAEs) historical financial information
International Standards on Related On compilation engagements, engagements to apply agreed
Services (ISRSs) upon procedures to information and other related services
engagements
International Standards on Quality Control For all the above services
(ISQCs)
AT A GLANCE
In addition to this preface, ISQC 1 and certain ISREs, ISAEs, ISRSs are examinable in this paper. These are covered
in later chapters.
As discussed above, the IAASB’s pronouncements do not override local laws or regulations. If local laws or
regulations differ from, or conflict with, the IAASB’s standards then a professional accountant should not state
that they have complied with the IAASB’s standards unless they have fully complied with all of those relevant
to the engagement.
International Standards on Auditing (ISAs)

ISAs are written in the context of an audit of financial statements by an independent auditor. They are to be
adapted as necessary when applied to audits of other historical financial statements.
Each ISA contains:
SPOTLIGHT
 an introduction
 objectives
 definitions (if necessary)
 requirements which are shown by the word ‘shall’ and are to be applied as relevant to the audit
 application and other explanatory material which is for guidance only.
This structure arose out of the work carried out as part of the IAASB’s “Clarity Project” (see below).
International Standards on Quality Control (ISQCs)

ISQCs apply to all services carried out under the IAASB’s engagement standards (ISAs, ISREs, ISAEs and ISRSs).
Other International Standards

The other international standards (ISREs, ISAEs and ISRSs) follow the format of the original ISAs. They contain:
 basic principles and essential procedures (identified in bold type and by the word ‘should’), and
 related guidance in the form of explanatory and other material, including appendices.
The basic principles and procedures must be followed. In exceptional circumstances, a professional accountant
may judge it necessary not to follow a relevant essential procedure in order to achieve their objectives. In these
circumstances, the auditor must be prepared to justify the departure from the requirements of the standard.

Authoritative and non-authoritative material

The IAASB’s preface describes how the above standards (ISAs, ISREs, ISAEs, ISRSs and ISQC1) are ‘authoritative
material’. This means that they MUST be followed when conducting engagements of those types.
The IAASB also publishes ‘non-authoritative’ guidance as follows:
 Consultation Papers – these are used to generate discussion with relevant stakeholders
 Staff Publications – these raise awareness of new and emerging issues
 International Auditing Practice Note (IAPNs) – these provide practical assistance to auditors in applying
the ISAs in performing an audit
Professional judgement
The nature of the international standards requires the professional accountant to exercise professional
judgment in applying them.
2.4 ISA 200: Overall objectives of the independent auditor and the conduct of an audit in accordance
with International Standards on Auditing
The objectives of the auditor as per ISA 200 are:
AT A GLANCE
 to obtain reasonable assurance about whether the financial statements as a whole are free from material
misstatement, whether due to fraud or error. This allows the auditor to give an opinion on whether or
not the financial statements have been prepared in accordance with the applicable financial reporting
framework.
 to report on the financial statements and communicate as required by the ISAs, in accordance with the
auditor’s findings.
Where the auditor is unable to obtain reasonable assurance and a qualified opinion is insufficient, the auditor
must disclaim an opinion or resign. The different types of opinions are covered in a later chapter.
In line with what you should remember from your previous studies, ISA 200 requires the auditor to:
 comply with all ISAs relevant to the audit
SPOTLIGHT
 comply with relevant ethical requirements

 plan and perform an audit with professional skepticism
 exercise professional judgment in planning and performing an audit
 obtain sufficient and appropriate audit evidence to allow them to obtain reasonable assurance.
2.5 Public oversight

The global architecture of standard setting in the field of audit, assurance, ethics and education consists of a
three-tier structure made up of:
 standard setting boards supported by IFAC
 independent oversight by the Public Interest Oversight Board (PIOB)
 accountability to a monitoring body of public authorities (Monitoring Group).
Public Interest Oversight Board (PIOB)

The PIOB is the global independent oversight body that seeks to improve the quality and public interest focus of
the international standards formulated by the Standard Setting Boards supported by IFAC in the areas of audit
and assurance, education and ethics. Through its oversight activities, the PIOB works to bring greater
transparency and integrity to the audit profession, thereby contributing to the enhanced quality of international
financial reporting.

The PIOB provides independent oversight throughout the entire process of standard setting to help ensure that
standards development is fully responsive to stakeholder needs, accountable and transparent. The public
interest responsiveness of standard development requires aligning the priorities of the profession with priorities
of all stakeholders. This is the ultimate objective of the current architecture in place, of which the PIOB is an
essential component.
Independent oversight is necessary for financial markets: investors want to know that the financial information
on which they base their capital allocation decisions is credible and reliable. By overseeing the establishment
and adherence to high-quality professional standards, the PIOB seeks to further the international adoption and
implementation of such standards and improve the comparability of financial statements across the globe.
The Securities and Exchange Commission of Pakistan (SECP)

The Securities and Exchange Commission of Pakistan (SECP) was set up in pursuance of the Securities and
Exchange Commission of Pakistan Act, 1997.
The SECP was initially concerned with the regulation of corporate sector and capital market. Over time, its
mandate has expanded to include supervision and regulation of insurance companies, non-banking finance
companies and private pensions.
The SECP has also been entrusted with oversight of various external service providers to the corporate and
AT A GLANCE
financial sectors, including chartered accountants, credit rating agencies, corporate secretaries, brokers,
surveyors etc.
The SECP’s mission is:
 To develop a fair, efficient and transparent regulatory framework, based on international legal standards
and best practices, for the protection of investors and mitigation of systemic risk aimed at fostering
growth of a robust corporate sector and broad based capital market in Pakistan.
The SECP’s strategy is:
 To develop an efficient and dynamic regulatory body that fosters principles of good governance in the
corporate sector, ensures proper risk management procedures in the capital market, and protects
investors through responsive policy measures and effective enforcement practices.
SPOTLIGHT

3. PROFESSIONAL MISCONDUCT
3.1 Facts, etc., to be laid before the Investigation Committee
The Secretary of the Institute, any member or any aggrieved person may lay before the Investigation Committee
with relevant and necessary facts indicating that-
 A member of the Institute has prima facie been guilty of any professional misconduct specified in
Schedule I or Schedule II; or
 A student has prima facie been guilty of any professional misconduct specified in Schedule III.
3.2 Inquiry by the Investigation Committee

The Investigation Committee is of opinion that such facts or complaint require investigation, it shall after giving
a notice to the member of the Institute or student whose conduct is in question, hold an inquiry by counsel or by
member of institute, provided that opportunity of being heard will be given.
The Investigation Committee shall report the result of the inquiry to the Council after inquiry.
3.3 Member or student not found guilty

AT A GLANCE
If, the member of the Institute or student, is not guilty of any professional misconduct, it shall record its finding
accordingly
3.4 Orders by the Council if member found guilty in Schedule I

If the Council is of the opinion that the member of the Institute has been guilty of any professional misconduct
specified in Schedule I, it may, after giving such member an opportunity of being heard, either personally or
through counsel or another member of the Institute, make any of the following orders, namely:-
 reprimand or warn such member;
 impose such penalty as it may deem necessary not exceeding one thousand rupees; and
 remove the name of such member from the Register for a period not exceeding five years:
SPOTLIGHT
Provided that, where Council is of the opinion that the name of such member is to be removed from the Register
for a period exceeding five years or permanently, it shall not make any order but shall refer the case to the High
Court with its recommendations thereon.
 SCHEDULE 1
Professional misconduct in relation to chartered accountants in practice (Part 1)
A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, if
he-
 allows any person to practice in his name as a chartered accountant, unless such person
is also a chartered accountant in practice and is in partnership with, or employed by,
him;
 pays or allows or agrees to pay or allow, directly or indirectly, any share, commission or
brokerage or the fees or profits of his professional business to any person other than a
member of the Institute or a partner or a retired partner or the legal representative of a
deceased partner.
 Explanation:- In this clause, "partner" includes a person residing outside Pakistan with
whom a Chartered Accountant in practice has entered into partnership which is not in
contravention of clause (4) of this part; accepts or agrees to accept any part of the profits
of the professional work of a lawyer, auctioneer, broker, or other agent who is not a
member of the Institute.

 Places his professional service at the disposal of, or enters into partnership with, an
unqualified person in a position to obtain business of the nature in which chartered
accountants engage by means which are not open to a member of the Institute: Provided
that this paragraph shall not be construed as prohibiting a member from practicing in a
country outside Pakistan in association with a person who is entitled under the laws in
force in that country to perform functions similar to those of a member of the. Institute
is entitled to perform in Pakistan:
 Solicits clients for professional work either directly or indirectly by circular,
advertisement, personal communication or interview or by any other means;
 Advertises his professional attainments or services, or uses any designation or
expression other than chartered accountant on professional documents. Visiting cards,
letter head or sign boards, unless it be a degree of a University established by law in
Pakistan or recognized by the Federal Government or the Council;
 Accepts a position as auditor previously held by another member of the Institute without
first communicating with him in writing;
 accepts appointments as auditor of a company without first ascertaining from it whether
the requirements of sub-section (6) of section 144 of the Companies Act, 1913 (VII of
1913), in respect of such appointment have been duly complied with;
AT A GLANCE
 charges or offers to charge, accepts or offers to accept in respect of any professional
employment fees which are based on a percentage of profits or which are contingent
upon the findings or results of such employment except in cases which are permitted
under any law for the time being in force or by an order of the Government;
 Engages in any business or occupation other than the profession of Chartered
Accountants unless permitted by the Council so to engage; Provided that nothing
contained herein shall disentitle a Chartered Accountant from being a director of a
company unless he or any of his partners is interested in such company as an auditor;
 accepts a position as auditor previously held by some other Chartered Accountant in
such conditions as to constitute undercutting;
 allows a person not being a member of the Institute or a member not being his partner
to sign on his behalf or on behalf of his firm; any balance sheet, profit and loss account,
SPOTLIGHT
report or financial statement; or
 gives estimates of future profits for publication in a prospectus or otherwise or certifies
for publication the statements of average profits over a period of two years or more
without, at the same time, stating the profits or losses for each year separately.
Professional misconduct in relation to members engaged in management consultancy
(Part 2)
A member of Institute engaged in management consultancy shall be deemed to be guilty of
professional misconduct, if he-
 advertises or solicits for work or issues any circular, calendar or publicity material;
 issues brochures, except to existing clients or in response to an unsolicited request;
 uses designatory letters indicating qualifications of the directors and members of the
company on letter head, note-papers, or professional cards excepts as provided in clause
(6) of Part 1 of this Schedule;
 refers to associate firms of Chartered Accountants on his letter head or professional
cards or announcements;
 adopts a name or associates himself as a partner or director of a firm or a company
whose name is indicative of its activities;
 uses the term chartered accountants for his management consultancy firm or company;

 shares profits of remuneration in a manner contrary to clauses (2) and (3) of Part 1 of
this Schedule, except when he associates with non- members as stated in clause (10) of
this part;
 or his partner in any firm accepts auditing, taxation, or other conventional accounting
work from any client introduced to him for management consultancy services by the
client's own professional accountant;
 uses the term "Management Consultant(s)" except in respect of a company engaged in
management consultancy field;
 associates with non-members for the rendering of various management services except
as long as such non-member observes the bye-laws and code of professional ethics of
the Institute;
 does not communicate with the existing professional accountant or consultant, if a
member of the Institute, informing him of the special work he has been asked to
undertake in the event of an introduction for management consultancy work other than
through the existing professional accountant; or
 Under the guise or through the medium of a company or firm does anything which he is
not allowed to do as an individual.
Professional misconduct in relation to members of the Institute in service (Part 3)
AT A GLANCE
A member of the Institute (other than a member in practice) shall be deemed to be guilty of
professional misconduct, if he, being an employee of any company, firm or person:
 pays or allows or agrees to pay directly or indirectly to any person any share in the
emoluments of the employment undertaken by the member;
 accepts or agrees to accept any part of fees, profits or gains from a lawyer, chartered
accountant or broker engaged by such company, firm or person or agent or customer of
such company, firm or person by way of commission or gratification; or
 discloses confidential information acquired in the course of his employment except as
and when required by law or except as permitted by the employer
Professional misconduct in relation to members of the Institute generally (Part 4)
A member of the institute, whether in practice or not, shall be deemed to be guilty of professional
SPOTLIGHT
misconduct, if he-
 includes in any statement, return or form to be submitted to the Institute any particulars
knowing them to be false;
 not being a fellow styles himself as a fellow;
 does not supply the information called for by the Institute or does not comply with the
requirements asked to be complied with or does not comply with any of the directives
issued or pronouncements made by the Council or any of its Standing Committees;
 generally, wilfully maligns the Institute, the Council or its Committee to lower their
prestige, or to interfere with performance of their duties in relation to himself or others;
 has been guilty of any act or default discreditable to a member of the Institute; or
 contravenes any of the provisions of the Ordinance or the bye-laws made there under.
3.5 Orders by the Council if member found guilty in Schedule II

If the Council is of opinion that the member of the Institute is guilty of professional misconduct specified in
Schedule II, it shall refer the case to the High Court with its recommendations thereon.
High court can take following actions:
 direct that the proceedings be filed, or dismiss the complaint, as the case may be;
 reprimand such member;

 remove him from membership of the Institute either permanently or for such period as it may deem fit;
or
 refer the case to the Council for further inquiry and report.
Return of certificate
If name of a member of the Institute is removed from the Register, whether for a specified period or permanently,
every certificate of membership or practice held by such member shall deemed to be stand cancelled from the
date of the order for the said period or, as the case may be, permanently.
 SCHEDULE II
Professional misconduct in relation to chartered accountants in practice requiring action
by a High Court (Part 1)
A chartered Accountant in practice shall be deemed to be guilty of Professional misconduct, if he-
 discloses information acquired in the course of his professional engagement to any
person other than his client, without the consent of his client or otherwise than as
required by any law for the time being in force;
 certifies or submits in his name or in the name of his firm a report of a examination of
AT A GLANCE
financial statement unless the examination of such statements and the related records
has been made by him or by a partner or an employee in his firm or by another chartered
accountant in practice;
 permits his name or the name of his firm to be used in connection with any estimates of
earnings contingent upon future transactions in a manner which may lead to the belief
that he vouches for the accuracy of the forecast;
 expresses his opinion on financial statements of any business or any enterprise in which
he, his firm or a partner in his firm has a substantial interest, unless he discloses his
interest in his report;
 fails to disclose a material fact known to him which is not disclosed in a financial
statement, but disclosure of which is necessary to ensure that the financial statement is
not misleading;
SPOTLIGHT
 fails to report a material misstatement known to him to appear in a financial statement
with which he is concerned in a professional capacity;
 is grossly negligent in the conduct of his professional duties;
 fails to obtain sufficient information to warrant the expression of an opinion or his
exceptions are sufficiently material to negate the expression of an opinion; or
 fails to keep moneys of his client in a separate banking account or fails to use such
moneys for purposes for which they are intended.
Professional misconduct in relation to members engaged in management consultancy
requiring action by a High Court (PART 2)
A member engaged in management consultancy shall be deemed to be guilty of professional
misconduct, if he-
 discloses information acquired in the course of his professional engagements to any
person other than his client, without the consent of his client or otherwise than as
required by any law for the time being in force;
 is grossly negligent in the conduct of his professional duties; or
 fails to keep moneys of his client in a separate banking account or fails to use such
moneys for purposes to which they are intended.

3.6 Orders by the Council If student found guilty-

If Council is of opinion that the student is guilty of any professional misconduct specified in Schedule III, it shall,
after giving such student an opportunity of being heard, either personally or through a counselor a member of
the Institute, make any of the following orders, namely:-
 Reprimand or warn the student; or
 Suspend the student from training, or extend the period of training of the student, for such period as it
may deem fit; or
 Debar the student from training.
 SCHEDULE III
Professional misconduct in relation to the students of the Institute
A student of the Institute shall be deemed to be guilty of professional misconduct if he-
 contravenes any of the provisions of the Ordinance or the bye-laws made there under;
 does not supply the information called for by the Institute;
 does not comply with any requirements which he is asked by the Institute to comply
with;
AT A GLANCE
 does not comply with any of the directives issued by the Council or any of its committees;
 discloses confidential information acquired in the course of his training except as and
when required by law or except as permitted by his principal;
 includes in any statement or form to be submitted to the Institute, any particulars
knowing them to be false; or
 has been guilty of any act or omission discreditable to a student of the Institute.
3.7 Publication of findings and decisions

Where a member of the Institute or a student is found guilty, the Council shall publish the findings and decisions
in the official Gazette or journals as the Council may deem fit:
However, it may omit the name of such member or student from publication, if required.
SPOTLIGHT
3.8 Appeal and revision

Any aggrieved member of the Institute may file an appeal within sixty days of the date of communication of such
order to him, to the High Court.
The High Court may-
 confirm, modify or set aside the order;
 impose any penalty or set aside, reduce, confirm or enhance the penalty imposed by the order;
 remit the case to the Council for such further inquiry as the High Court may consider proper in the
circumstances of the case; or
 pass such other order as it may deem fit:
3.9 Powers of a civil court

The Council and the Investigation Committee shall deemed to be a civil court and shall have the same powers as
of a civil court like:
 summoning and enforcing the attendance of any person and examining him on oath;
 the discovery and production of any document; and
 receiving evidence on affidavits.

4. CONSIDERATION OF LAWS & REGULATIONS IN AN AUDIT OF FINANCIAL

STATEMENTS (ISA 250)
This ISA distinguishes auditor’s responsibilities in relation to compliance with two different categories of laws
and regulations as follows:
 Provisions of laws and regulations normally having a direct effect on determination of material amounts
and disclosures in financial statements (e.g. tax and pension laws etc); and
 Other laws and regulations that do not have such a direct effect, but compliance with which may be
fundamental to operating aspects of business, ability to continue its business, or to avoid material
penalties (e.g. compliance with terms of operating license or compliance with environmental
regulations).
Nature and circumstances of entity may impact whether relevant laws and regulations are within the first or
second category.
4.1 Responsibility for Compliance with Laws and Regulations (Ref: 3-9, A1-A8)
 It is responsibility of management, with oversight of those charged with governance, to ensure that
operations are conducted in accordance with provisions of laws and regulations, including compliance
with the provisions of laws and regulations determining amounts and disclosures in financial
AT A GLANCE
statements.
 Auditor is not responsible for preventing or detecting all non-compliances.
 This ISA assist auditor in identifying material misstatement of financial statements due to non-
compliance.
 Detection of non-compliance, regardless of materiality, may also affect other aspects of the audit
including, for example, consideration of the integrity of management or employees.
 Definition: Non-compliance
Acts of omission or commission intentional or unintentional committed by the entity, or by
those charged with governance, by management or by other individuals working for or under
the direction of the entity, which are contrary to the prevailing laws or regulations. Non-
SPOTLIGHT
compliance does not in0clude personal misconduct (unrelated to business activities of the
entity).
4.2 Consideration of Compliance with Laws and Regulations (Ref: 13-18, A11-A16)
As part of obtaining understanding of entity, auditor shall obtain general understanding of:
 Legal & regulatory framework applicable to entity and industry in which it operates; and
 How the entity is complying with that framework.
Auditor shall obtain sufficient appropriate audit evidence regarding compliance with the provisions of those
laws and regulations, generally recognized, to have a direct effect on financial statements. They could
include those that relate to, for example:
 The form and content of financial statements;
 Industry-specific financial reporting issues;
 Accounting for transactions under government contracts; or
 The accrual or recognition of expenses for income tax or pension costs.
Some provisions in those laws and regulations may be directly relevant to specific assertions (e.g.
completeness of income tax provisions), while others may be directly relevant to financial statements as
a whole (e.g. required statements constituting a complete set of financial statements).
Non-compliance with other provisions of such laws etc may result in fines, litigation or other consequences
for the entity, the costs of which may need to be provided for in the financial statements.

4.3 Procedures to Identify Instances of Non-Compliance (Ref: 15-16, A13-A15)

Auditor shall perform the following audit procedures to help identify such instances:
 Inquiring of management and, where appropriate, those charged with governance, as to whether the
entity is in compliance with such laws and regulations; and
 Inspecting correspondence, if any, with the relevant licensing or regulatory authorities.
During audit, auditor shall remain alert to the possibility that other audit procedures applied may bring
instances of non-compliance or suspected non-compliance to auditor’s attention. (e.g. reading minutes,
inquiring legal counsel or performing substantive test of details etc.)
4.4 Written Representations (Ref: 17-18, A16)

Request management and where appropriate, those charged with governance, to provide written representations
that all known instances of non-compliance or suspected non-compliance with laws and regulations, whose
effects should be considered when preparing financial statements, have been disclosed to auditor.
4.5 Audit Procedures When Non-Compliance Is Identified or Suspected (Ref: 19-22, A17-A25)
If the auditor becomes aware of information concerning an instance of non- compliance or suspected non-
compliance with laws and regulations, the auditor shall obtain:
AT A GLANCE
 An understanding of nature of the act and the circumstances in which it has occurred; and
 Further information to evaluate the possible effect on the financial statements including:
¯ The potential financial consequences of non-compliance on financial statements
¯ (e.g. imposition of fines, penalties and enforced discontinuation of operations etc.)
¯ Whether it requires disclosure
¯ Whether these are so serious as to call into question the fair presentation of the financial statements
 Indications of Non-Compliance with Laws and Regulations (Examples)
 Investigations by regulatory organizations and Govt. departments or payment of fines
or penalties.
 Payments for unspecified services or loans to consultants, related parties or government
SPOTLIGHT
employees.
 Sales commissions or agent’s fees that appear excessive in relation to those ordinarily
paid by the entity.
 Purchasing at prices significantly above or below market price.
 Unusual payments in cash, purchases in form of bearer cheques or transfers to
numbered bank accounts.
 Unusual transactions with companies registered in tax havens.
 Payments for goods or services made other than to the country from which goods or
services originated.
 Payments without proper exchange control documentation.
 Unauthorized transactions or improperly recorded transactions.
 Adverse media comment.
If the auditor suspects that there may be non-compliance:
 Auditor shall discuss matter with management (unless prohibited by law or regulation)
 Where appropriate, auditor may discuss the findings with those charged with governance where they may
be able to provide additional audit evidence
 If management/those charged with governance do not provide sufficient information that supports the
compliance and in the auditor’s judgment, the effect of the suspected non-compliance may be material
to the financial statements, the auditor shall consider the need to obtain legal advice.

Auditor shall evaluate implications of non-compliance for other aspects of audit, including risk assessment and
reliability of written representations, and shall take appropriate action.
In certain cases, auditor may consider withdrawal from engagement when management or those charged
with governance do not take the remedial action or where identified or suspected noncompliance raises
questions about their integrity, even when non-compliance is not material to the financial statements.
Auditor may consider appropriate to take legal advice to determine whether withdrawal is appropriate. Even after
withdrawing, he is not relieved of complying with other responsibilities under law, regulation or relevant ethical
requirements to respond to noncompliance.
4.6 Communication and Reporting Identified or Suspected Non-Compliance with those charged with
governance (Ref: 23-25)
 Unless all those charged with governance are involved in management of entity, auditor shall
communicate with those charged with governance (unless prohibited by law or regulation) significant
matters involving non- compliance that come to auditor’s attention during the course of the audit.
 If, in the auditor’s judgment, the non-compliance is believed to be intentional and material, auditor shall
communicate the matter with those charged with governance as soon as practicable.
 If auditor suspects that management or those charged with governance are involved in non-compliance,
AT A GLANCE
the auditor shall communicate the matter to the next higher level of authority at the entity, if it exists.
(e.g. audit committee).
 Auditor shall consider the need to obtain legal advice:
¯ Where no higher authority exists;
¯ If the auditor believes that the communication may not be acted upon; or
¯ If the auditor is unsure as to the person to whom to report.
4.7 Implications on Auditor’s Report (Ref: 26-28, A26-A27)

 If auditor concludes that the non-compliance has a material effect on the financial statements, and has
not been adequately reflected in financial statements, auditor shall express a qualified or an adverse
opinion.
SPOTLIGHT
 If auditor is precluded by management or those charged with governance from obtaining sufficient
appropriate audit evidence to evaluate whether non-compliance that may be material to the financial
statements has, or is likely to have, occurred, auditor shall express a qualified opinion or disclaim
opinion.
 If auditor is unable to determine whether non-compliance has occurred because of limitations imposed
by the circumstances rather than by management or those charged with governance, auditor shall
evaluate the effect on the auditor’s opinion in accordance with ISA 705.
Law or regulation may preclude public disclosure by either management, those charged with governance or
auditor about a specific matter (e.g. a communication, or other action, that might prejudice an investigation by
an appropriate authority, as it may alert the entity). Auditor may consider obtaining legal advice to determine
the appropriate course of action.
You are the manager incharge responsible for the audit of Day Pharma Limited, a subsidiary of a
multinational pharmaceutical company. One of the drugs being imported/marketed by the
company is VITABE. It was introduced a few months back but contributes significantly to the
company’s revenues. While the audit was in progress, you came across a news item in a well-
known publication, according to which the authorities in many countries have banned the use of
VITABE as some of its ingredients were considered dangerous for human health and required
further testing. While going through some files you have discovered that the parent company had
informed Day Pharma Limited about the harmful effects of the drug. However, it had not given
any further instruction in this regard. You have discussed this matter with the CEO who has

informed you that the company had not called off the medicine nor has it provided any
information in this regard to the users of the drug or the general public as the management is of
the view that there is very limited risk of any harm being caused by the drug. However, you had
discussed this matter with a senior physician who believes that these types of products are also
banned in Pakistan.
Required:
Assess the above situation and describe what measures the auditor should take in such
circumstances.
 Solution:
Auditor should perform audit procedures to further confirm this noncompliance of health/safety
regulation. That is:
 Inquiring from the original manufacturer of the product.
 Requesting assistance from the audit firm’s branches or associates in the countries
where authorities have banned the product.
If it is probable that the product is harmful or there is potential noncompliance with health and
safety regulations, the auditors should consider the following actions:
AT A GLANCE
i. Communicate with those charged with governance/ audit committee/ supervisory

board about the potential noncompliance with the safety regulations.
ii. With the permission of client, seek legal opinion from company’s lawyer.
iii. Encourage the management of Day Pharma Limited to announce the problem publicly.
There will obviously be reluctance to do this. However, the auditors should try to explain
and hopefully convince the management that this would be the ethically correct way to
proceed.
iv. Consider the impact of the above situation on the financial statements related audit
procedures and on the auditor’s report specially with respect to the following:
¯ Any hazardous inventory that would need to be written off.
¯ Provisions that may become necessary for refund of returned products, when
SPOTLIGHT
the matter becomes known.

¯ Disclosures relating to contingent liabilities that may need to be recognized in
respect of damages that may be claimed by the customers.
v. If the auditor concludes that the noncompliance has a material effect on the financial
statements, which has not been properly reflected in the financial statements, the
auditor should express a qualified or an adverse opinion.
vi. If the company refuses to disclose the matter itself the auditor should consider whether
it need to communicate with regulatory and enforcement authorities. While making such
a decision, disclosure should not be made without proper and specific authority to do so,
or unless there is a legal or professional right or duty to disclose.
vii. The auditor may need to seek legal advice in such circumstances, giving due
consideration to the auditor’s responsibility to the public interest.
viii. Obtain clarification on view of parent company.
ix. The auditor may conclude that withdrawal from the engagement is necessary if the
entity does not take the remedial action that the auditor considers necessary in the
circumstances. Factors that would affect the auditor’s decision in this regard, include the
following:
¯ implications on the integrity of the highest authority within the entity which may
affect the reliability of management representations;
¯ the effects on the auditor, of continuing association with the entity.

If the firm finally decides to resign, it may circularize a ‘statement of circumstances’ which would
describe the reason for the resignation. However, in reaching such a conclusion, the auditor
would ordinarily seek legal advice.
The following matters relating to different clients are under the consideration of Mr. Jameel, who
is the engagement partner:
The management of Muneer Limited had been illegally dumping its chemical waste in the
neighboring plot of land. When confronted, the chief financial officer, instead of providing an
assurance to address the issue, informed the audit senior that the management is least bothered
about the minor fines that may be levied by the regulatory agencies.
Required:
Evaluate each of the above situations and briefly describe what course of action the engagement
partner would be expected to adopt.
Tutorial Notes:
The students should fully mention the illegal act of the company and its implications. Auditor’s
response should also be given in case those charged with governance failed to take appropriate
AT A GLANCE
action. Some issues should also be considered while answering the question like cleaning costs
and their provision, possibility of a major disaster in case the non-compliance continues and its
repercussions and the careless attitude of the management which raises questions on the quality
of management controls, systems and procedures.
 Solution:
Dumping of waste
 The fines levied by the regulatory authority maybe immaterial but the same could have
significant implications on ML as any mishap may lead to severe legal action especially
in case a mishap occurs.
 The engagement partner should discuss the matter with those charged with Governance
and advise them to take necessary steps to avoid future non- compliances.
SPOTLIGHT
 The engagement partner should consult the legal advisor about the laws and regulations
and the possible impact of the non-compliance on the client. If engagement partner is
not satisfied with the opinion of ML’s legal advisor it should consult with its own lawyer,
relating to possible legal consequences.
 If those charged with governance agree to rectify the situation, the auditor need to
consider the cost of cleaning up the site and ask the client to make necessary provision.
If necessary, the partner may ask ML to obtain opinion from the relevant expert as
regards the present condition of the plot and the cost of the measures necessary to clean-
up the site in accordance with the requirements of law.
 The partner should consider the possibility of similar non-compliance in other areas.
 In case no action is taken by those charged with governance, the partner must consider:
¯ The impact on the audit report.
¯ Withdrawing from the engagement now or not accepting the assignment for the
next year, as may be appropriate.
 The engagement partner should consider the legal responsibilities to report to the
authorities.


During the audit of Leather Goods Limited (LGL), it came to the knowledge of the audit team that
LGL has been dumping its chemical waste in an open area outside the city, without proper
treatment as per the required standards. When confronted, the Chief Financial Officer did not
consider it a serious issue and informed that LGL has managed to receive the required certificate
from the relevant regulatory authority.
Required:
Evaluate the above situation and explain what course of action the auditor would need to take.
Tutorial Notes:
Main point of concern for auditor should be assessing the attitude of management towards
compliance of laws and regulations, necessary for conduct of business which entailed a big
question mark on the management’s concern for ethical values and also indicated a fraud risk
factor. This, in turn, required a review of the audit approach with regard to nature, timing and
extent of audit procedures. Possibility of similar non-compliances and unexplained cash
payments needed to be critically inspected also.
 Solution:
Evaluation of the situation:
AT A GLANCE
Even though LGL manages to get its required certificate, the same could have significant
implications on LGL as any mishap may lead to severe legal action in future. Furthermore,
violation of laws and regulations is a fraud risk factor and also brings in doubt the ethical values
and the attitude of the management towards the conduct of business.
Course of action:
i. Auditor should inquire how the management has obtained the certificate despite not
disposing the waste as per the required standards and consider the possibility that the
certificate was obtained illegally.
ii. Audit team should critically inspect cash payments and any unexplained payments made
during the year.
iii. Auditor should assess the risk of material misstatement due to fraud and its implication
on nature, timing and extent of audit procedures.
SPOTLIGHT
iv. Due to the non-compliance of laws and regulation and the attitude of management
towards its compliance, auditor should also consider the reliability of written
representation provided by the management.
v. Auditor should discuss the matter with those charged with governance and advise them
to take necessary steps to avoid future non-compliances.
vi. Auditor should consult the legal advisor about the laws and regulations and the possible
impact of the non-compliance on the client. If auditor is not satisfied with the opinion of
LGL’s legal advisor it should consult with its own lawyer, relating to possible legal
consequences.
vii. If those charged with governance agree to rectify the situation, the auditor need to
consider:
¯ the cost of cleaning up the site and ask the client to make necessary provision.
¯ the possibility of similar non-compliance in other areas.
viii. In case no action is taken by those charged with governance, the partner must consider:
¯ the impact on the audit report.
¯ withdrawing from the engagement.
¯ including a key audit matter section regarding the risk of fraud, bribery and
corruption.
ix. Auditor should consider the legal responsibilities to report the non-compliance to the
authorities.


You are the manager responsible for the audit of Hafiz Limited (HL), a listed company, whose
fieldwork in respect of the statutory audit is in progress. You are reviewing the following issues
which were brought to your attention by the audit team:
HL has paid a substantial amount of consultancy fee to a firm in another foreign country. The
management of HL is unable to provide a convincing explanation for such a payment. An
employee of HL has unofficially informed the audit senior that the amount was paid to avoid
paying a fine. However, the management has denied this allegation.
Required:
Discuss how would you deal with each of the above issues and what may be the implications
thereof on your audit report.
Tutorial Notes:
Some important matters students should consider in addition to regular procedures are:
 Explanation of the payment made in a foreign country.
 Impact on initial risk assessment and to revise the audit procedures accordingly.
AT A GLANCE
 Potential financial consequences of the non-compliance on the financial statements
including, the imposition of fines and penalties and the impact thereof on the Company’s
ability to carry out its business.
 Reporting the matter to the concerned authorities.
 Solution:
 Evaluate the reasons provided by the management for making this payment, to assess
whether the amount paid in the circumstances was reasonable.
 If the management is unable to provide satisfactory explanation, it may be indicative of
the following:
SPOTLIGHT
¯ That the amount paid was not for the purposes of the company’s business.
¯ There was a non-compliance with a law as has been unofficially claimed by an
employee.
 In either case, the auditor should consider the impact thereof on his initial risk
assessment and to revise the audit procedures accordingly.
The indication of non-compliance with laws and regulations may require the auditor to
consider the potential financial consequences of the non-compliance, on the financial
statements including, the imposition of fines and penalties and the impact thereof on the
company’s ability to carry out its business. The auditor may discuss his findings with
those charged with governance if the auditor considers that they will be able to provide
with additional audit evidence in relation to the transaction.
 If management or those charged with governance do not provide sufficient appropriate
audit information to the auditor, the auditor may consider it appropriate to consult with
the entity’s legal counsel or auditor’s own legal counsel if the auditor is not satisfied with
the entity’s legal counsel.
 The auditor may also consider whether it is necessary for him under the relevant laws
and regulations to report the matter to the concerned authorities.

Impact on Audit Report

If the auditor concludes that the non-compliance has a material effect on the financial statements
which has not been adequately reflected therein, the auditor shall express a qualified opinion or
an adverse opinion.
If the auditor concludes that the expenditure incurred is not for the purpose of the business, the
auditor shall express a qualified opinion or an adverse opinion depending upon the materiality
of the transaction.
If the auditor is precluded by management or those charged with governance from obtaining
sufficient appropriate audit evidence to evaluate whether non-compliance that may be material
to the financial statements has, or is likely to have occurred, the auditor shall express a qualified
opinion or disclaim an opinion on account of scope limitation.
The following situations have arisen at different audit clients of your firm. The year-end in each
case is 31 March 2019:
Afzal Limited is a listed company. During its audit of financial statements, the provincial sales tax
authority has seized the accounting records of the company on the charges of tax evasion.
AT A GLANCE
Required:
Discuss your firm’s course of action along with the implications on the audit report.
Tutorial Notes:
Along with other procedures, students should pay attention to the fact that what should be the
course of action if the integrity of the management was doubtful.
 Solution:
Since the records of a significant portion of revenue have been seized by the tax authorities in
order to probe an allegation of tax evasion, the auditor will consider the scope limitation imposed
by circumstances beyond management control on the sufficiency and appropriateness of audit
SPOTLIGHT
evidence.
We will consider the possible effect on audit report in the form of a qualified or disclaimer of
opinion depending upon the materiality and pervasiveness of the issue.
Furthermore, we will also evaluate whether management has adequately disclosed the
contingency or recorded additional taxes and fines that the entity may face as a result of probe
by involving our own tax expert and by contacting the company’s legal advisor. In case
appropriate accounting/disclosures have not been made, we will have to express a qualified
opinion.
The auditor should also consider whether the tax evasion was intentional. If it is determined that
the evasion was intentional, the auditor should consider its earlier assessment regarding
integrity of the management and consider informing the fact to those charged with governance.
Auditor should also consider resigning from the assignment and obtain legal opinion in this
regard and shall determine whether there is a responsibility to report to the regulatory
authorities.
4.8 Reporting Non-Compliance to appropriate authority outside entity (Ref: 29, A28-A34)
If the auditor has identified or suspects non-compliance with laws and regulations, auditor shall determine
whether law, regulation or relevant ethical requirements:
 Require the auditor to report to an appropriate authority outside the entity.
(e.g. statutory requirements of a financial institution may require to report occurrence, or suspected
occurrence, of non-compliance to supervisory authority)

 Establish responsibilities under which reporting to an appropriate authority outside the entity may be
appropriate in the circumstances, such as:
¯ Auditor has determined that it is in accordance with relevant ethical requirements; or (e.g. IESBA
Code requires auditor to take steps to respond to such non-compliance and determine whether
further action is needed including reporting to outside authority).
¯ Law, regulation or relevant ethical requirements provide auditor with right to do so (e.g. when
auditing financial statements of financial institutions, auditor may have legal right to discuss matters
such as identified or suspected non-compliance with a supervisory authority).
4.9 Documentation (Ref: 30, A35-A36)

Auditor shall include:
 Identified or suspected non-compliance with laws and regulations;
 Procedures performed, significant professional judgments made and conclusions reached;
 Discussions of significant matters related to non-compliance with management, those charged with
governance and others, including how they responded to the matter.
Law, regulation or relevant ethical requirements may also set out additional documentation requirements
AT A GLANCE
regarding identified or suspected non-compliance with laws and regulations.
SPOTLIGHT

AT A GLANCE
SPOTLIGHT

CHAPTER 3
PROFESSIONAL ETHICS
AT A GLANCE
IN THIS CHAPTER: The application of the fundamental principles in the Code of
Ethics is considered within a conceptual framework. This
AT A GLANCE framework, applies to chartered accountants in business and in
practice and acknowledges that the fundamental principles may
SPOTLIGHT be threatened in a broad range of circumstances.
Chartered accountant shall apply the conceptual framework to:
1. The fundamental principles a) Identify threats to compliance with fundamental principles;
b) Evaluate the threats identified; and
2. Integrity, objectivity and
AT A GLANCE
independence c) Address the threats by eliminating or reducing them to an
acceptable level.
3. Confidentiality and conflicts of Although ICAP Code provides a conceptual framework, which
interest recognises that it is impossible to define every situation that
creates threats and specify the appropriate safeguards, specific
4. Corporate financial advice guidance is provided in some of the following key areas:
- Fees
5. Responding to non- - Compensation and Evaluation Policies
compliance with laws and - Gifts and Hospitality
regulations
- Actual or Threatened Litigation
6. PAIB requirements for - Financial Interests
- Loans and Guarantees
SPOTLIGHT
Chartered accountants in
practice - Business Relationships
- Family and Personal Relationships
- Recent Service with an Audit Client
- Serving as a Director or Officer of an Audit Client
- Employment with an Audit Client
- Temporary Personnel Assignments
- Long Association of Personnel
- Provision of Non-Assurance Services to an Audit Client
* Accounting and Bookkeeping Services
* Administrative Services
* Valuation Services
* Tax Services
* Internal Audit Services
* Information Technology Systems Services
* Litigation Support Services
* Legal Services
* Recruiting Services
* Corporate Finance Services

CHAPTER 3: PROFESSIONAL ETHICS CFAP 6: AARS
1 THE FUNDAMENTAL PRINCIPLES

1.1 Introduction: rules of conduct for professional accountants
The professional bodies that regulate the auditing profession set high standards of behaviour for their members
(including students). Their codes of practice apply to all members, whether in public practice or not. The
detailed rules of conduct vary between the professional bodies, but all the major bodies have codes that are
broadly similar.
In setting a code of practice, each professional body is complying with one of its regulatory functions, which is
to ensure that professional services related to accountancy and audit are performed only by ‘fit and proper’
persons who act with professional integrity and perform quality work.
ICAP has adopted the IESBA’s Code of Ethics into its own localised code called ‘The ICAP Code of Ethics for
Chartered Accountants’ (the Code). The Code’s substance remains largely unchanged from the IESBA’s original
code.
The Code must be followed by all members (including students) whether they are working in professional
practice (such as providing external audit or advisory services), or professional accountants in business (such
as working in the finance department or internal audit). The Code also applies to the staff of an ICAP practice,
regardless of whether they are members of ICAP or any other professional body.
AT A GLANCE
1.2 The fundamental principles of the ICAP Code of Ethics

A chartered accountant shall comply with each of the five fundamental principles of the Code set out below:
Principle Explanation
Integrity A professional accountant should be straightforward and honest in all professional
and business relationships.
Objectivity A professional accountant should not allow bias, conflict of interest or undue
influence of others to override his or her professional or business judgements.
Professional A professional accountant has a continuing duty to maintain professional knowledge
SPOTLIGHT
competence and and skill at the level required to ensure that a client or employer receives competent
due care professional service based on current technical and professional standards and
relevant legislation. A professional accountant should act diligently and in
accordance with applicable technical and professional standards when providing
professional services or working for an employer.
Confidentiality A professional accountant should respect the confidentiality of information acquired
as a result of professional or business relationships and should not disclose any such
information to third parties without proper and specific authority unless there is a
legal or professional right or duty to disclose. Confidential information should not be
used for the personal advantage of the professional accountant or third parties.
Professional A professional accountant should comply with relevant laws and regulations and
behaviour should avoid any action or conduct which discredits the profession.
You need to know these five fundamental principles and what each of them means. An exam question may
require you to discuss the relevance of the five fundamental principles to a particular situation in a case study.
1.3 The conceptual framework

The application of the fundamental principles set out above is considered by the ICAP Code within a conceptual
framework. This framework, applies to chartered accountants in business and in practice, acknowledges that
these principles may be threatened in a broad range of circumstances.

CFAP 6: AARS CHAPTER 3: PROFESSIONAL ETHICS
A chartered accountant shall apply this conceptual framework 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.
Exercise of Professional Judgment
CAs are required to exercise professional judgement in undertaking all professional activities. In exercising
professional judgement, CAs apply their relevant training, professional knowledge, skill and experience. CAs
might consider below factors in exercising professional judgement:
 Reason to be concerned that potentially relevant information might be missing from the known facts
and circumstances
 Inconsistency between the known facts and circumstances and CAs’ expectations.
 Whether CAs’ expertise and experience are sufficient to reach a conclusion.
 Need to consult with others with relevant expertise or experience.
 The information provides a reasonable basis on which to reach a conclusion.
 Preconception or bias might affect the exercise of professional judgment.
AT A GLANCE
 Other reasonable conclusions could be reached from the available information.
Threats to the fundamental principles fall into one or more of the following categories:
 Self-interest threat. This arises when the accountant or the audit firm has a financial interest or other
interest in a matter. Typically, this means that the accountant’s decisions may be influenced by self-
interest and the accountant will therefore not act with objectivity and independence e.g. if the auditor
earns a large proportion of their revenue from a particular client they may be unwilling to upset that
client by issuing an unfavorable audit report.
Circumstances that could give rise to self-interest threats for CAs in:
Business Practice
SPOTLIGHT
 financial interests, loans or guarantees  direct financial interest in a client.
from the employer.  accept new engagement with a low fee that deters
 incentive-based compensation offered quality of professional services.
by the employer.  close business relationship with a client.
 inappropriate personal use of corporate  access to confidential information for personal
assets. gain.
 offered a gift or special treatment from  a CA discovering a significant error when
a supplier. evaluating the results of a previous professional
 concern over employment security. service performed by CA’s firm.
 commercial pressure from outside the  contingent fee arrangements.
employing organization.  close personal or business relationships.
 holding a financial interest in a client or jointly
holding a financial interest with a client.
 undue dependence on fees from a client.
 Self-review threat. This occurs when an accountant is required to review or re-evaluate (for a
different purpose) a previous judgement they have made or action that they have taken. Self-review
threats can also apply to audit firms. For example, if an audit firm prepared the financial statements for
a client company and then acted as auditor, it would be reviewing its own work and would be reluctant
to criticise or question it. This would be a threat to objectivity and independence.

Business Practice
 determining the appropriate accounting  providing assurance on the operation of
treatment for a business combination after financial systems after being involved in
performing the feasibility study supporting their design or implementation.
the purchase decision.  a CA prepared the original data used to
 business decisions or data being reviewed generate records that are the subject matter
by the same person who made those of the assurance engagement.
decisions or prepared that data.  a member of the assurance team being, or
 being in a position to exert direct and having recently been, employed by the client
significant influence over an entity’s in a position to exert direct and significant
financial reports. influence over the subject matter of the
 the discovery of a significant error during a engagement.
re-evaluation of the work undertaken by the  performing a service for a client that directly
member. affects the subject matter of an assurance
engagement.
AT A GLANCE
 Advocacy threat. This occurs when the accountant is in a position where they are expected to defend
or justify the position of the client, and act as an ‘advocate’ for the client’s position or point of view, for
example in a legal case. This would be a threat to objectivity and independence.
Business Practice
 opportunity to manipulate information in a  promoting shares in a listed company
prospectus in order to obtain favorable financing. which is also an audit client.
 commenting publicly on future events.  acting as an advocate for an audit client
 situations where information is incomplete or in litigation or dispute with third
where the argument being supported is against parties.
the law.  lobbying in favor of legislation on
SPOTLIGHT
behalf of an audit client.

 Intimidation threat. This occurs when the accountant is deterred from acting with objectivity due to
threats against them or their firm. The nature of the threat may be a threat by the client that it will take
work away from the audit firm unless it agrees with the point of view of the client management.
Another example might be a strong finance director intimidating junior members of the audit team and
persuading them not to report errors found during their testing.
Business Practice
 threat of dismissal or replacement of the  the threat of dismissal because a disagreement
member, or a close family member, over about a professional matter.
a disagreement about the application of  pressured to agree with a judgement because
an accounting principle or the way in the audit client has more expertise on the matter
which information is to be reported. in question.
 a dominant personality attempting to  informing a CA that a planned promotion will
influence the member’s decisions e.g. not occur unless a CA agrees with an
regarding the awarding of contracts or inappropriate accounting matter.
the application of accounting principles.
 accepted a significant gift from a client and being
threatened that acceptance of this gift will be
made public.

 Familiarity threat. This occurs when the accountant becomes too sympathetic with the client’s position
due to close relationships, for example due to a long association over many years in carrying out the
annual audit.
Business Practice
 A CA is responsible for the financial  having a close or immediate family member who
reporting when an immediate or close is a director or officer of the client
family member in the organization  over-familiarity with the management of the
makes decisions that affect the financial organisation such that professional judgment
reporting. could be compromised.
 long association with business contacts  a former partner of the firm being a director or
influencing business decisions. officer of the client or an employee being in a
position to exert direct and significant influence
over the subject matter of the engagement.
 An audit team member having a long association
with the audit client.
AT A GLANCE
Members are required to identify, evaluate and respond to such threats. If identified threats are anything but
clearly insignificant, members must implement safeguards to eliminate the threats or reduce them to an
acceptable level so that compliance with the fundamental principles is not compromised.
CAs shall do so by:
i. Eliminating the circumstances, including interests or relationships, that are creating the threats;
ii. Applying safeguards, where available and capable of being applied, to reduce the threats to an
acceptable level; or
iii. Declining or ending the specific professional activity.
EXAM TECHNIQUE POINT: In any scenario-based question regarding the five fundamental principles or any of
the situations causing the five threats to independence, it is important that don’t only state the basic
requirements of the code that are being breached but also relate them to the given scenario.
SPOTLIGHT
Also, it helps to give some commentary in relation to the significance of a threat i.e. if the situation relates to a
more senior person on the audit firm (such as the Engagement Partner) the threat is likely to be significant,
with no safeguards being able to eliminate or reduce it to acceptable levels.
Mr. Omar is incharge of the quality control department of an audit firm. While reviewing the
working papers relating to some audit engagements of the firm he came across the following
situations:
i. The spouse of a partner in the firm is a legal consultant and is assisting an audit client
of that firm in filing its tax return.
ii. The audit manager engaged on the audit of a company has been offered a job by that
company. He has been asked to join on March 1, 2010 when the current CFO would
retire. The audit is expected to be completed on December 15, 2009.
iii. A meeting of the CEO of ABC & Company Limited and the audit engagement partner
was held to discuss the draft financial statements of the company for the year ended
September 30, 2009. Serious difference emerged between the two sides on the
accounting treatment and the disclosures of certain items and consequently the CEO
informed the engagement partner that unless the auditors agree to the company’s point
of view, they would not be reappointed for the next year.

iv. The engagement partner on the audit of XYZ Limited has been its engagement partner
for the past six years.
Required:
Identify the category of threat involved in each of the situations described above and explain
how would it affect the objectivity and independence of the auditor. Also explain the
responsibility (if any) of the firm and the concerned member of the audit team.
 Solution:
i. This situation does not contain any threat.
ii. Self-Interest Threat: Subsequent employment with the assurance client is of personal
interest to the audit manager which will impair. Moreover, if the company is listed, then
as per Code of Corporate Governance (CCG) it shall not appoint any member of the audit
engagement team or his close relative as its CEO/CFO/Internal auditor/director at any
time during the next 2 years of his/her involvement in the audit. In case it’s not a listed
company, manager shall immediately inform the engagement partner about his
intentions and the firm should arrange proper replacements.
iii. Intimidation Threat: The CEO of the client has actually threatened of replacement in
case there is a disagreement by the auditor over the issues. Partner should discuss the
AT A GLANCE
issue with the other partners in the firm. Disclose to the audit committee or others
charged with governance and may decide to withdraw from the current year
engagement.
iv. Familiarity Threat: The prolonged period of time during which partner has been the
engagement partner could lead to a close relationship with the company. This could
affect his objectivity as he may decide not to discuss contentious matters with the
management, to maintain good relationship. If the company is listed the firm is
required by CCG to rotate the partner incharge after 5 years. If it is a non-listed
company this approach may be followed as best practice to avoid familiarity threat.
SPOTLIGHT

2 INTEGRITY, OBJECTIVITY AND INDEPENDENCE

Introduction
The revised ICAP code contains “International Independence Standards” (parts 4A and 4B). The discussion
below is relating to part 4A that relate to independence for audit and review engagements.
2.1 The requirement for independence

Independence is required by the ICAP Code and it is in the public interest that CAs in public practice and their
firms are independent when performing audit, review and other assurance engagements.
Independence comprises:
Independence of mind Independence in appearance
(Actual independence) (Perceived independence)
The auditor is free from bias, influence or How others view the auditor in concluding whether the
pressure from others when making decisions, auditor’s integrity, objectivity or professional skepticism
thereby acting with integrity, and exercise has been compromised.
objectivity and professional skepticism.
AT A GLANCE
For an audit report to be of value, the auditor:
 must be independent, and also
 must be seen to be independent.
These principles of both being and being seen to be independent are at the centre of the role played by
independence in auditing.
The opinion of an auditor must be an independent opinion given by a professional person with appropriate
skills in audit work, and the opinion must not be influenced by anyone else, and in particular must not be
influenced by the opinions and views of the management of the company whose financial statements have been
audited.
SPOTLIGHT
 Illustration: Independence of mind and independence in appearance
Independence of mind describes a state of mind that permits the auditor to express a conclusion
without being affected by influences or prejudices that compromise their professional
judgment. This allows the auditor to act with integrity and exercise objectivity and professional
scepticism.
Independence of appearance means the avoidance of facts and circumstances that are so
significant that a reasonable and informed third party, having knowledge of all relevant
information (including any safeguards applied) would reasonably conclude that a firm’s, or a
member of the assurance team’s, integrity, objectivity or professional scepticism has been
compromised. For example, if an auditor owned shares in an audit client then a reasonably
informed third party could safely assume that the auditor will not be truly objective as they
would not want to see the value of their investment in the client reduced.
The presumption is that if an auditor is not independent in appearance then they cannot
possibly think with objectivity (i.e. be independent of mind). Even if this may not technically be
true it is a presumption that must be held in order to protect the reputation of auditors.
Independence of the auditor is a matter of public confidence in the audit process.
 Auditors need to be fully aware of situations that may impair their independence and objectivity. Such
situations are referred to as threats to auditor independence.
 Any threats to independence may be mitigated by safeguards that are implemented by an audit practice
(audit firm).

The ICAP Code takes the form of guidance on independence, rather than specific rules. It is left to the individual
member to apply judgement about how the guidelines should be applied in practice.
The guidance sets out a number of general categories of threat to independence, and then goes on to list specific
threats and associated guidance.
Professional Skepticism
Exercising professional skepticism is at the heart of the auditing profession. Standards require CAs to exercise
professional skepticism when planning and performing audits, reviews and other assurance engagements. In
an audit of financial statements, compliance with the fundamental principles, individually and collectively,
supports the exercise of professional skepticism.
2.2 Threats to independence – key areas

Threats to the fundamental principles are matters that could result in the Chartered Accountant or audit firm
acting with compromised integrity, without considering competence, without ensuring confidentiality or in a
way that may discredit the profession. However, threats to the fundamental principles are largely threats to the
independence and objectivity of the Chartered Accountant or the audit firm.
Although the ICAP Code provides a conceptual framework, which recognises that it is impossible to define every
AT A GLANCE
situation that creates threats and specify the appropriate safeguards, specific guidance is provided in a number
of key areas where independence may be under threat, or may be seen to be under threat.
The main areas are discussed below.
2.3 Fees (s410)

The nature and level of fees or other types of remuneration might create a self-interest or intimidation threat.
Relative size of fees

Where the total fees generated from an audit client represent a large proportion of either an audit firm’s total
fees or an individual audit partner or one office of the firm, the dependence on that client and concern about
the possibility of losing that client may create a self-interest or intimidation threat.
SPOTLIGHT
Specific safeguards might include:

 increasing the client base in the firm or for the partner to reduce dependence on the audit client
 taking steps to reduce dependency on that client (for example, by refusing lucrative non-audit services
or taking those on and resigning as auditor)
 having external quality control reviews
 consulting a third party, such as ICAP or another professional accountant.
It may be particularly difficult for new audit practices to mitigate the above threats; therefore, particular care
on independence is required.
For public interest entities (such listed entities in Pakistan), if the total fees from the client and its related
entities represent more than 15% of the total fees received by the firm expressing the opinion on the financial
statements of the client for two consecutive years, the firm is required to:
 Disclose the fact and fees to those charged with governance;
 Arrange a chartered accountant, who is not a member of the firm or a professional body to perform:
¯ ‘pre-issuance quality control review’ before issuing the audit opinion on the second year’s financial
statement.
¯ ‘post-issuance quality control review’ after issuing the audit opinion on the second year’s financial
statements but before issuing the opinion on the third year.

ICAP directive 4.23

ICAP has issued a directive in 2019 recommending reference fees for certain types of entities. In the directive it
states that “in best public interest, development of the audit profession and taking into account the above factors
the Council has approved the Schedule of Audit Fee for members in practice as recommended reference fee.”
Overdue fees
If fees from an audit client remain unpaid for a long time, a self-interest threat may arise. This will certainly
be the case if a significant part of the overdue amount is not paid before the next year’s report is issued. If the
fees are unpaid for a long period of time, overdue fees might be equivalent to a loan to the client.
The Code therefore recommends that payment of such fees should be required before the report is issued.
Other safeguards might include:
 discussing the level of outstanding fees with the audit committee or other appropriate persons at the
client.
 obtaining partial payment of the overdue fee.
 involving an additional chartered accountant who did not take part in the assurance engagement to
provide advice or to review the work performed.
AT A GLANCE
You are the quality control partner of Lotus & Co. Chartered Accountants. You have been
assigned additional responsibilities for assessment of risks associated with the firm’s clients.
At present, the following matters are under your consideration:
Clean Limited (CL) has failed to pay the fee for review of its half yearly accounts for the six
month ended 30 June 2017. The issue was discussed with the management in the planning
meeting for the audit of the year ending 31 December 2017. The management has assured that
the amount would be paid in about 30 days. During the discussion, the audit manager was also
informed that CL has been facing liquidity issues and it has closed two of its plants. The
management has also requested for a reduction in the audit fee for the year ending 31 December
2018 because of the decline in the volume of business. Further, the management has requested
SPOTLIGHT
the firm to consider some relief as regards audit fee for the current year.
Required:
Discuss the categories of threats involved in above situation and advise the possible course of
action that may be followed.
Tutorial Notes:
Appropriate comments on some of the main issues must be given while answering:
 With regard to non-payment of audit fee, do specify the important step that the auditor
should bring the matter to the knowledge of the audit committee and/or to those
charged with governance.
 Discussion on significance of the threat also would be appreciated and is normally
expected by examiner, even when not expressly asked. The allocated marks normally
also suggest the same.
 Reduction in fee due to work reduction as a result of closure of plants.
 Solution:
The discussion in the meeting with the management of Clover Limited (CL) highlights two
aspects which would have an impact on the ethical considerations:
i. Outstanding fee
ii. Reduction in fee

i. Outstanding fee:
A self-interest threat may be created if fees due from an audit client remain unpaid for
a long-time, especially if the review fee is not paid before the issuance of the audit
report for the year ended 31 December 2017.
Our firm should ensure that the outstanding fee is received as early as possible to avoid
the above threat. In this regard we should consider discussing this matter with the
audit committee or those charged with governance.
If the fee remains unpaid, the existence and significance of any threat shall be evaluated
and safeguards applied when necessary to eliminate the threat or reduce it to an
acceptable level. Such a safeguard is, having an additional chartered accountant who
did not take part in the audit engagement provide advice or review the work
performed.
According to Code of Ethics, the overdue fee might even be regarded as being
equivalent to a loan to the client and in case the amount is considered significant, we
may consider whether it is appropriate to continue the audit engagement.
ii. Reduction in fee:
AT A GLANCE
A self-interest threat to professional competence and due care is created if the fee
quoted is so low that it may be difficult to perform the engagement with applicable
technical and professional standards in that price.
Even though CL has closed one of its major product lines, it does not necessarily mean
that quantum of work will materially differ from the quantum of work carried out by
us previously. Instead, because of the weak financial position of the company, we may
encounter more challenging audit areas that would require additional work and more
extensive areas of professional judgement and greater skepticism such as for
determining impairment of assets and going concern, etc.
In view of the above, we may agree to a reduction in fee only if we are satisfied that we
would be able to perform all the necessary procedures and there would be no undue
pressure in this regard because of the reduction in fee.
SPOTLIGHT
Moreover, regardless of the audit fee, we should ensure that:

 adequate time is spent on the assignment; and
 audit personnel with sufficient expertise and experience are assigned to the job.
We should only accept management’s request of a reduction in fee, if we are able to
ascertain that the quantum of work will reduce accordingly.
XYZ Limited has been an audit client of your firm for the last several years. The engagement has
been assigned to you and you have received the following briefing from the engagement
partner:
i. The recovery of fee on this client has become very low over the years.
ii. In the past few years, audit managers have been rotated twice on the request of the
client.
iii. Over the years, several significant decisions were taken by the company which were
communicated to audit teams at the time of finalisation of audits.
Required:
As the audit manager what will be your strategy to improve the relationship at this client?

Tutorial Notes:
The main mistake to be avoided is focusing on the independence issues and on suggestions for
improving the performance of the audit team, whereas it is more of a client issue.
Other common mistakes may be:
 Misunderstanding of the scenario as if the fee was actually not being received by the
firm.
 Not mentioning a need for discussing the matter with the client (CFO, CEO, Audit
Committee, Board of Directors etc.).
 Solution:
My strategy for improving relationship at client, would be as follows:
 Discuss with the partner, the reasons for changes of audit managers and address the
issues appropriately.
 Arrange meeting between the partner and CEO well before the start of the audit for
discussing business issues/ challenges and developments during the current year.
Highlight the potential audit issues and make specific inquiry regarding expected dates
of finalisation of audit.
AT A GLANCE
 Have meeting with the finance department well before the start of the audit and obtain
understanding of their processes and controls including any changes introduced during
the year and the issues that were faced in the previous audit and identify root causes
for the issues.
 Send and discuss the Audit plan to the Board/Audit Committee for clear
communication of issues. The business issues and developments and their potential
audit impacts and audit strategy needs to be discussed in order for the Board/Audit
Committee to acknowledge the efforts of auditor.
 Float the list of requirements for audit on a timely basis.
 Conduct frequent meetings with client’s staff and give input on timely basis in order to
smooth out the client relationship.
 Ensure that the field work is completed on a timely basis.
SPOTLIGHT
 Perform timely review, ensure timely involvement of engagement partner and timely
submission of client deliverables for onward submission to Board/Audit Committee.
 Write a memo to the Board/Audit Committee in which the issues faced during the audit
and foreseeable reasons thereof may be identified.
 Once this has been done, discuss with the Board/Audit Committee regarding
enhancement of fees.
Pricing
When an assurance firm obtains an assurance engagement at a significantly lower level than that charged by
the previous firm, or quoted by other firms (known as “low-balling”) a self-interest threat arises. This threat
will not be reduced to an acceptable level unless:
 the firm is able to demonstrate that appropriate time and qualified staff are available, and
 all applicable assurance standards and quality control procedures are being complied with.
Identify and evaluate the threats involved and explain how these threats can be reduced to an
acceptable level, in each of the following situation:
A limited assurance engagement has been accepted at a fee which is lower than the fee charged
by the predecessor auditor.

 Solution:
By agreeing to perform the engagement at a lower fee than that charged by the predecessor
firm, or quoted by other firms, a self-interest threat has been created.
Safeguards:
The self-interest threat created may be reduced to an acceptable level if the firm is able to
demonstrate that:
 Appropriate time and qualified staff are assigned to the task.
 All applicable assurance standards, guidelines and quality control procedure are being
complied with.
Contingent fees
Contingent fees (direct or indirect) are fees that are calculated on a pre-determined basis, relating to the
outcome or result of a transaction or the work performed. A contingent fee charged through an intermediary is
an example of an indirect contingent fee. A contingent fee may be an engagement on a ‘no win no fee’ basis, or
on the basis that the audit firm will receive a percentage amount of the money it succeeds in saving or making
for the client.
AT A GLANCE
Clearly a contingent fee creates self-interest threat. The threat is considered insurmountable and therefore
the Code does not allow contingent fee arrangements.
For example, if an audit firm is asked to provide an assurance report in support of a loan application, it may be
offered a fee which is only payable by the client if the application is successful. This would be a contingent fee
and this fee arrangement must be refused.
Similarly, a fee for taxation services that will be calculated as a percentage of the tax saved for the client would
be a contingent fee and is not permissible.
Fees should be charged on the basis of the experience of the person doing the auditor assurance work and the
time spent on the work.
SPOTLIGHT
You are the quality control partner of Lotus & Co. Chartered Accountants. You have been
assigned additional responsibilities for assessment of risks associated with the firm’s clients.
At present, the following matters are under your consideration:
During the review of working papers of Daffodil Limited (DL), the engagement manager came
to know that a large consignment of import of raw material is stuck with the custom authorities.
On his query he was informed that the DL’s clearing agent was unable to resolve the matter.
However, now DL has approached another custom clearing agent for clearing the said
consignment and the matter with the custom authorities would be resolved shortly. DL has
agreed to pay 1.4% of the value of consignment to the clearing agent. A junior member of the
team has informed the engagement manager that clearing agent appointed by DL is the brother
of the audit senior.
Required:
Discuss the categories of threats involved in above situation and advise the possible course of
action that may be followed.
Tutorial Notes:
Please read tutorial notes to this question only after attempting this question in writing.
Some of the common issues identified by examiner in the relevant examiner comments to this
questions are reproduced here.

“According to this scenario, a client which was in a weak financial position had failed to pay the
audit fee for review of half yearly accounts and the management had also requested the audit
firm to give some relief as regards audit fee of current year.
The performance remained below average mainly because the students could not give
appropriate comments on some of the main issues as discussed below:
 With regard to non-payment of audit fee, the candidates generally could not specify an
important step that the auditor should bring the matter to the knowledge of the audit
committee and/or those charged with governance. Moreover, it was also important to
assess the significance of the threat which was also missed by the majority.
Furthermore, many candidates mentioned about declining the engagement whereas
according to the scenario it had already been accepted.
 With regard to reduction in fee, many students did not make any comment on the
management’s contention that work would reduce as a result of closure of plants. On
the other hand, many students were completely in agreement with the management’s
view in this regard. They did not consider the other aspect of the situation i.e. closure
of factories is also an indication of weakening financial position because of which the
auditor may have to face more challenges such as risk of intentional misstatement and
more issues involving professional judgment, such as impairment of assets and going
AT A GLANCE
concern and therefore it was not necessary that closure of plants may result in
reduction in work.
 A large number of students were of the incorrect view that audit fee cannot be reduced
under any circumstances.”
 Solution:
Self-interest threat or intimidation threat may be created due to a close business relationship
between a member of the audit team’s immediate family and the audit client. The relationship
of the audit senior and the clearing agent comes under the definition of close family member
instead of immediate family member. However, the code recognizes the fact that it is impossible
to define every situation, and there could be many variations in circumstances that create
threats to independence and can deter a Chartered Accountant from concluding that a situation
SPOTLIGHT
is permitted if it is not specifically prohibited.
Therefore, even though the clearing agent is not an immediate family member of the audit
senior, our firm should consider the possibility and significance of threats to the independence
of the audit senior.
Depending upon the significance, we may also consider:
 Removing the audit senior from the engagement team.
 Having a chartered accountant review the work of the audit senior.
You are the partner in charge of your Firm’s risk management department and in the said
capacity your responsibilities include advising the firm’s engagement partners /managers on
different aspects of the assurance and non-assurance services, in accordance with the applicable
regulatory and independence framework. You have been requested for guidance on the
following issues:
Olive Limited has approached your firm to act as their advisors to the first public issue of the
company which shall be used to finance a new project. Your responsibilities would include
drafting the prospectus, assistance in completing listing formalities and negotiations with and
appointment of Bankers to the issue. Previously you have also carried out a due diligence
exercise in respect of the said project. Olive limited has suggested different fee levels
corresponding to the amount of eventual subscription received.

Required:
a) Advise the concerned partners/managers as regards the acceptance of the above
assignments.
b) Suggest possible modification in the scope or terms of engagement or possible
safeguards, if any, to avail the opportunities within permissible limits.
 Solution:
a)
 Since Olive Limited is not an audit client, therefore the requested services may be
provided.
 In term of the Chartered Accountants Ordinance, 1961 and the code of ethics a
member should not enter into any contingent or conditional fee arrangement and
the member is guilty of professional misconduct if he/she enters into such
arrangement. Hence, fee based on amount of subscription received should not be
agreed upon.
b) An appropriate caveat should be built in the engagement letter wherein we should
describe the management’s responsibility and disassociate the firm from the
responsibility of taking management decisions on behalf of the client. The fee
AT A GLANCE
arrangement should be reconsidered and brought in line with permissible mode like
fixed fee or hours charged basis.
a) MF Momin, Shams & Company is a firm of chartered accountants (the firm) which was
initially registered with two partners namely Momin and Shams, in the year 2011 with
offices in Karachi and Islamabad. In 2020, the firm got affiliation with a reputed
international firm namely Missouri Fox (MF) which resulted in increase in clientele of
the firm especially in the province of Punjab. As a result, the firm has established its
new office in Lahore.
You are the quality control partner in the firm. While reviewing the annual revenue
earned by the firm for the year ended 31 December 2020, you have extracted the
SPOTLIGHT
following information from the firm’s books of accounts:

Firm’s offices Firm’s partners
Clients Karachi Islamabad Lahore Momin Shams Others
--------------- Rs. in ‘000 ---------------
Audit and assurance services
Pervez Limited (PL) 2,730 - - - 2,730 -
Amin (Pvt) Ltd (APL) - - 1,680 - - 1,680
Salman Limited (SL) - 4,000 - 4,000 - -
Tania Limited (TL) 1,100 - - - 1,100 -
Other clients 3,800 3,000 6,000 3,000 1,800 8,000
Consultancy and other services
Pervez Limited (PL) 500 2,000 500 - - 3,000
Amin (Pvt) Ltd (APL) - - 1,480 - - 1,480
Salman Limited (SL) 1,500 - 1,300 - - 2,800
Tania Limited (TL) 200 - - - 200 -
Other clients 4,170 6,000 2,040 3,000 3,170 6,040
14,000 15,000 13,000 10,000 9,000 23,000

Other information:
i. PL, SL and TL are listed companies whereas APL is the first multinational client of the
firm.
ii. All the clients have already re-appointed the firm for their subsequent statutory audit.
iii. Shams is also entitled to 20% additional commission of the total fees earned from PL.
Required:
(a) In the light of ICAP’s Code of Ethics for Chartered Accountants, evaluate the
implications of revenue earned from PL, APL, SL and TL on the firm and suggest the
safeguard(s), if any, available to the firm and partners.
b) Other clients in (a) include Hafiz Limited (HL) and Chand Limited (CL) which have not
yet paid the audit fees for the year ended 30 June 2020. The audit report for HL was
issued three months ago but HL has still not paid the balance 50% of audit fee, while
the audit report for CL has not been issued due to certain pending issues.
Required:
Discuss the course of action available to the firm in the above situation.
AT A GLANCE
 Solution:
a) When the total fees generated from an audit client by the firm expressing the audit
opinion represent a large proportion of the total fees of that firm, the dependence on
that client and concern about losing the client create a self-interest or intimidation
threat.
Pervez Limited (PL):
Revenue earned from PL is 30.3% of Shams’s revenue and 23% of Karachi office. It
represents a large proportion of the revenue from one partner and one office of the
firm. The significance is further increased as Shams is also entitled to earn additional
20% commission on total revenue of Rs. 5.73 million generated from PL so his
objectivity might be compromised.
SPOTLIGHT
Even though the revenue from PL is still below 15% of the firm’s total revenue given in
the code, it needs to be under consideration that any further increase in the fee charged
to PL or any additional assignment may make it above the 15% threshold.
Safeguard available to the firm
The firm should consider increasing the client base of Shams to mitigate the risk and
reduce the dependence on the audit client.
The firm should also consider rotating this client to some other partner.
Shams should reduce dependency on PL by refusing other assignments or rotate it to
some other partner when providing those services.
An appropriate review should also be conducted by a reviewer who does not take part
in the engagement review process.
Amin (Pvt.) Limited (APL):
The revenue earned from APL is 24.3% of Lahore revenue which represents a large
proportion of the revenue of one office of the firm. The significance is further increased
as APL is the first multinational client of the firm so it is qualitatively significant to the
firm. It further increases the significance as Lahore office is also a newly established
office.


Although Lahore office is a newly established office, the client base will eventually grow
and the office dependence on APL might further decrease in future. In the meantime,
the firm should consider to increase client base of the office by assigning other
assignments. The firm may also consider assigning the other assignments of PL to
Lahore office if acceptable to the client.
Salman Limited (SL):
The revenue earned from SL is 16% of firm’s total revenue which exceeds 15%
threshold given in the Code. The significance is further increased as revenue earned
from SL is 26.7% of Islamabad office revenue and 40% of Momin’s revenue which
represents a large portion of the Islamabad office and Momin’s Revenue.
The firm shall disclose the fact to those charged with governance that the total of such
fees represents more than 15% of the total fees received by the firm.
Prior to the audit opinion being issued on the financial statements, a chartered
accountant, who is not a member of the firm expressing the opinion on the financial
AT A GLANCE
statements, performs an engagement quality control review of that engagement; or a

professional body performs a review of that engagement that is equivalent to an
engagement quality control review (“a pre-issuance review”).
After the audit opinion on the financial statements has been issued, and before the audit
opinion being issued on the next year’s financial statements, a chartered accountant,
who is not a member of the firm expressing the opinion on the financial statements, or
a professional body performs a review of the second year’s audit that is equivalent to
an engagement quality control review (“a post-issuance review”).
Tania Limited (TL):
The revenue earned from TL does not represent a large proportion of the revenue of
the firm or Karachi office. Since it is 14.4% of Sham’s total revenue, therefore it needs
SPOTLIGHT
to be considered that any further increase in revenue or any additional assignment may
make it large proportion for Shams’ revenue.
Firm should closely monitor any additional billing to TL so that it remains within the
prescribed limits.
b) Hafiz Limited (HL):
Even though 50% of the fees has been received from HL, a significant part is still
outstanding for last three months. The firm shall:
 determine whether it is appropriate for the firm to be re-appointed or continue
the audit engagement.
 consider whether the overdue fees might be equivalent to a loan to the client.
If the outstanding fees is not paid before next year’s report, the firm shall discuss with
the audit committee and those charged with governance to pay the fee at earliest.
Chand Limited (CL):
Since the audit report of CL has not been issued due to some pending matters, the firm
should ask the client to pay audit firm a significant part of the fees.


 The firm should also appoint an appropriate reviewer who did not take part in
the audit engagement.
 If the outstanding fees is not paid before next year’s report, the firm shall discuss
with the audit committee and those charged with governance to pay the fee at
earliest.
2.4 Compensation and Evaluation Policies (s411)

A firm’s evaluation or compensation policies might create a self-interest threat.
Selling non-assurance services

When an audit team member is compensated (such as commission or bonus) or the performance is evaluated
for selling non-assurance services to the audit client, the level of the self-interest threat will depend on:
 materiality of the compensation
 seniority of the audit team member
 whether its influences promotion decisions
AT A GLANCE
Safeguards to reduce the threat include:
 removing the person from the audit team
 appropriate review of the work performed by the audit team member
Key audit partner is prohibited from being evaluated or compensated based on selling non-assurance services
to the audit client.
2.5 Gifts and hospitality (s420)

Accepting gifts or hospitality from an audit client might create a self-interest, familiarity or intimidation threat.
The Code specifies that gifts or hospitality shall only be accepted where the value is clearly trivial and
inconsequential.
Those in a position to influence the conduct and outcome of the audit and immediate family members of such
SPOTLIGHT
persons shall not accept hospitality from the audited entity, unless it is reasonable in terms of its frequency,
nature and cost.
Accept or offering gifts and hospitality to/from an audit client a where the intent is to improperly influence
behavior is not allowed even if the value is trivial and inconsequential.
It may be noted that what constitutes trivial and/or reasonable gift and hospitality could vary across cultures.
Question in the exam in relation to gifts and hospitality usually require candidates to apply professional
judgment and discuss in detail the consequences on either party involved in addition to the impact there could
be on stakeholders.
2.6 Actual and threatened litigation (s430)

When litigation with an audit client occurs, or appears likely, self-interest and intimidation threats are created.
In some cases, a client entity (or some of its shareholders) may threaten the audit firm with litigation as a result
of something the audit firm, or a member of the audit team, has (or has not) done. The significance of the threat
will depend on the materiality of the litigation, the nature of the engagement and whether the litigation relates
to a prior audit engagement.
Safeguards should include:
 if the litigation involves a member of the audit team, removing that individual from the audit team.
 appointing a professional to review the work done and assess the nature of the litigation threat.
If such safeguards do not reduce the threats to an acceptable level, the only appropriate action is to withdraw
from, or decline, the audit engagement.

2.7 Financial interests (s510)

Holding a financial interest in an audit client might create a self-interest threat.
A financial interest in an audit client exists where shares or debt instruments are held either directly or
indirectly. A direct financial interest is one held by an individual or the firm or by a collective investment
vehicle (such a trust or estate) controlled by them. An indirect financial interest is one held by an individual
or the assurance firm via a collective investment vehicle not controlled by them.
The following shall not hold financial interest or a material indirect financial interest in an audit client:
 the firm
 audit team member or their immediate family
 other partners in the office where an engagement partner practices or their immediate family
 other partners or managers who provide non-audit services to the audit client or their immediate
family, except where the involvement is minimal
 firm, audit team members and their immediate family members hold financial interest or a material
indirect financial interest in an entity which has a controlling interest in the audit client
Furthermore, firm, audit team members and their immediate family members should not hold financial
interest or a material indirect financial interest in an entity which has a controlling interest in the audit
AT A GLANCE
client.
Therefore, the only safeguards would be to:
 dispose of any direct financial interest
 dispose of any indirect financial interest or reduce the holding to such a level that it is no longer
material
 remove the individual from the assurance team
 resign from the audit.
If holdings are acquired by an individual or immediate family members as a gift or inherited or as employment
rights (employee share options):
 they should be disposed of as soon as practicable, or
SPOTLIGHT
 the individual should be removed from the assurance team.
Other situations
 A self-interest is created when firm, audit team members and their immediate family members hold
financial interest or a material indirect financial interest in an entity where the audit client also holds
a financial interest.
 A self-interest, familiarity, or intimidation threat is created when firm, audit team members and their
immediate family members hold financial interest or a material indirect financial interest in an entity
where a director, officer or controlling owner of the audit client also hold a financial interest.
 A self-interest threat is created if an audit team member knows that a close family member has a direct
financial interest or a material indirect financial interest in the audit client.
 A self-interest threat is created if an audit team member knows that a financial interest in the audit
client is held by either other partners and professional employees of the firm or individuals with a close
personal relationship with an audit team member.
The safeguards would be to:
 dispose of the interest or reduce it to a level it becomes immaterial
 remove the individual from the audit team
 have an appropriate reviewer review the work of the audit team member
 ensure audit client or director/officer cannot exercise significant influence over the entity

If a retirement benefit plan of a firm (such as pension scheme) holds a direct or material indirect financial
interest in an audit client, appropriate safeguards should be applied to reduce self-interest threat.
Mr. Mahmood is the engagement partner for the audit of Khyber Limited (KL), a listed company.
In a meeting of the partners of the firm he had declared that Better Life Trust (BLT), in which
he is a trustee, intends to purchase fifty thousand shares of KL from the open market.
Required:
a) State how should the firm deal with the above situation.
b) What would the firm’s response be if Mr. Mahmood inadvertently fails to disclose the
above fact before the purchase of shares and it comes to the knowledge of the firm after
the shares have been purchased?
 Solution:
a) Circumstances in which the shares of KL can be purchased by BLT:
If BLT makes investment in shares of KL Mr. Mahmood may continue to act as the audit
engagement partner of KL as well as a Trustee in BLT, if:
 Mr. Mahmood or any of his immediate family members is not a beneficiary of
AT A GLANCE
the trust;
 The value of shares purchased is not material to BLT (Trust);
 Even after purchase of shares, BLT will not be able to exercise significant
influence over the assurance client; and
 Mr. Mahmood and the firm does not have significant influence over any
investment decision involving a financial interest in KL.
In case the answer to any of the above is in negative, the firm shall require that the
shares held by the Trust are disposed of or shall have to change the engagement
partner.
b) Circumstances and Actions:
If Mr. Mahmood has inadvertently not disclosed the fact about purchasing shares of KL
SPOTLIGHT
and the shares are subsequently purchased, the firm should take the following steps in
order to ensure that the independence of the firm is not impaired:
 In case where Mr. Mahmood discloses the fact regarding purchase of shares to
the firm immediately after the purchase of shares, the firm should require him
to either ensure that the shares are sold by the Trust immediately. If that is not
possible, he should be removed from the engagement team.
 In case where Mr. Mahmood does not disclose the fact regarding purchase of
shares to the firm immediately after the purchase of shares, the firm should
consider involving an additional chartered accountant who did not take part
in the assurance engagement to review the work done by Mr. Mahmood.
You are the quality control partner of Nasir and Company, Chartered Accountants (NCC) and
presently following matters are under your consideration:
While appreciating the services rendered by your firm, the managing director of a client has
informed the engagement partner that an audit trainee has helped him in the purchase of a plot
of land. On investigation, the engagement partner was able to establish that the trainee works
part-time in an estate agency and receives 0.5%commission on all deals.
Required:
Identify and evaluate the threats involved and explain what actions you would take in the above
circumstances including the steps required, if any, to reduce the risks to an acceptable level.

Tutorial Notes:
Apart from mentioning self-interest threat, other important issues to be discussed are
materiality and significance of the financial interest involved and whether the trainee’s conduct
was in accordance with the firm’s policies.
 Solution:
A close business relationship between a member of assurance team and the management of the
client will involve a common financial interest and may create self-interest threat.
The materiality and significance of the financial interest, needs to be evaluated. If the financial
interest is immaterial or relationship is clearly insignificant then the audit trainee may be
allowed to work on that client, otherwise only safeguard available is to not to allocate that audit
trainee on the client.
If the conduct of the trainee is not in accordance with the firm’s policies, appropriate action may
be taken.
You are the manager in Quality and Risk Management department in a firm of Chartered
Accountants. A partner of the firm has informed you about the following:
AT A GLANCE
Audit of Nadir Limited (NL), a non-listed company, is in the finalization stage as almost 85%
of the field work has been completed. NL has acquired 51% holding in Hamid Limited (HL),
a listed company, few days ago. A partner of the firm holds 500,000 shares valuing Rs. 20
million in HL. The partner has agreed to sell the shares; however, it would take some time as
the shares of HL are not actively traded.
Required:
Give your views on above situation with regard to Code of Ethics.
Tutorial Notes:
Important point to be considered is that 85% of the work had been completed.
SPOTLIGHT
 Solution:
After the acquisition, HL has become related entity of NL and as per the Code of Ethics, reference
to Audit Client includes reference to its related entities. Therefore, after the acquisition, the
partner holds direct financial interest in a related entity and it would create a self-interest
threat.
As the amount of holding is material to the partner and NL can exercise significant influence
over HL, the self-interest threat created would be so significant that no safeguards could reduce
the threat to an acceptable level.
However, as 85% of the audit work has been completed, the remaining work can be completed
in a short period of time and, in such case if those charged with governance request the firm to
complete the audit without disposing off the interest, the firm can continue the engagement,
provided that the firm:
 discusses the evaluation of threat with those charged with governance.
 ensures that relevant partner is not the member of the audit team nor the partner
responsible for engagement quality control review.
 has deputed a Chartered Accountant to review the audit work.
 has deputed another Chartered Accountant, other than the members of the audit team,
to perform a review that is equivalent to engagement quality control review.


You are the partner in a firm of Chartered Accountants having three partners. Presently,
following matters are under your consideration:
Your firm has been approached by Javed Limited for advice regarding investment in Kamran
Limited (KL). The spouse of a partner of the firm holds 500,000 shares in KL.
Required:
Evaluate threats involved in the above situations and suggest related safeguard(s), if any.
 Solution:
The interest of relevant partner and Javed Limited, with respect to Kamran Limited are in
conflict and it will create a threat to objectivity. The firm is required to evaluate:
 the significance of relevant interest or relationships.
 the significance of the threats created by performing the professional services.
The following safeguards shall be applied to reduce the threats to an acceptable level:
 Closely monitor the implementation of policies within the firm with regard to
AT A GLANCE
procedures to limit access to client files, the use of confidentiality agreements and/or
the physical and electronic separation of confidential information.
 Regular review of the application of safeguards by a senior individual not involved with
the client engagement(s).
 Having a chartered accountant who is not involved in providing the service or
otherwise affected by the conflict, review the work performed to assess whether the
key judgments and conclusions are appropriate.
 Consulting with third parties, such as a professional body, legal counsel or another
chartered accountant.
Nisar Khalid & Co. Chartered Accountants (NKC) has been approached by Hector Limited (HL)
SPOTLIGHT
a listed company, for appointment as HL’s auditors for the year ending 30 April 2019.
The core departments of NKC along with the names of the partners are as follows:
Assurance Department Quality Control Tax & Corporate Advisory
Department Department
Nisar Ali Khalid
Hashmat Usman Ovais
Moin Hasan
Rashid
Arif
NKC intends to appoint Rashid as the engagement partner. As part of the client acceptance
procedures, an email was circulated to all the staff of the firm to disclose any investment in HL
and its related parties by any partner/employee or their family member(s).
A summary of response of Rashid and his staff is as follows:
 Rashid has confirmed that he does not hold any shares in HL although his wife has
invested Rs. 2 million in a mutual fund. The mutual fund has invested 14% of its total
investment in shares of HL.
 Zahid has been working as an audit manager with Rashid. Zahid has disclosed that he
has invested Rs. 50,000 in the shares of Troy Limited (TL). HL owns 20% shareholding
in TL.

Response by other partners of the firm are as follows:

 Ali has invested Rs. 45,000 in the shares of Achilles Limited, which is the holding
company of HL.
 Ovais has confirmed that his son has invested Rs. 500,000 in the debentures issued by
HL.
Response by other staff of the firm:
 Some of the junior audit staff who are not working with Rashid and the staff of the firm’s
accounts department have confirmed holding in shares of HL of nominal amounts
ranging from Rs. 5,000 to Rs. 60,000.
Required:
In the light of Code of Ethics for Chartered Accountants, evaluate the above situation and discuss
the threats (if any) in each case along with the available safeguards, if NKC decides to accept the
assignment.
Tutorial Notes:
AT A GLANCE
questions are reproduced as follows:
“Majority of the students were only able to obtain a few marks on the basis of their comments
on shareholding of the engagement partner’s wife’s. Most of the candidates tried to give
generalised comments on the scenario as a whole instead of analyzing each situation separately.
Many students did not consider the partners giving non-audit services as part of audit team and
hence made incorrect conclusions. Similarly, only a few students touched on the threats arising
due to holdings of other employees as majority concluded that no threats would arise due to
holdings of other employees”
 Solution:
Holding a financial interest in an audit client may create a self-interest threat. However, the
SPOTLIGHT
significance of the threat may vary in different circumstances, each of which is discussed below:
Rashid
Even though Rashid does not have any financial interest in HL. However, his wife being an
immediate family member holds an indirect financial interest, since she beneficially owns
shares in HL through a collective investment trust.
It needs to be assessed whether the amount invested in the mutual fund is material to her. If
yes, a self-interest threat would be created. Then the firm should not accept the assignment
unless the units of mutual fund are disposed of or a sufficient amount is disposed of so that the
remaining amount is no longer material.
Zahid
Since HL owns 20% shares in TL, HL can exercise significant influence over TL. However, the
materiality of the interest both for HL in TL and Zahid in TL needs to be evaluated. In case the
financial interest is material to any of the parties the threat created would be so significant that
it can only be reduced if Zahid disposes of his entire shareholding or reduces it to such an extent
that it no longer remains material.
Ali & Ovais:
Persons performing quality control for the engagement or providing consultation regarding
technical issues for the engagement are also included in the audit team.

A self-interest threat may be created due to Ali’s holding of shares in the holding company of
HL if the investment in HL is material to AL. If the investment is material to AL, then firm should
not appoint Ali as the engagement quality control partner unless he disposes of his entire
investment.
If Ovais’s son is not dependent on him, then NKC can accept the assignment. However, if Ovais
is to be considered as the tax advisory partner, then his son being a close family member, would
have to dispose of all of his holding or a sufficient amount is disposed of so that the remaining
amount is no longer material, even if he is not dependent on Ovais. However, if his son intends
to retain the investment, then NKC should consider to have a chartered accountant review the
work performed by Ovais or remove Ovais from the team.
If Ovais’s son is dependent on him, then it would be a direct investment in an audit client by an
immediate family member and NKC could not accept the assignment, unless he disposes of all
his investment.
Other employees:
Self-interest threat may be created, but it’s significance would depend on whether any of these
individuals have any relationship with the audit team and the firm’s organizational, operating
and reporting structure.
AT A GLANCE
Depending upon the significance of the threat, NKC may:
 remove any audit team member who have any relationship with such an employee;
 exclude any such employee from any significant decision making; or
 have a chartered accountant review the work of such member of the audit team
2.8 Loans and guarantees (s511)

A loan or a guarantee of a loan with an audit client might create a self-interest threat.
If the audit client is a bank or similar institution, no threat to independence is created where the loan is made
on normal terms to the audit firm or a member of the audit team.
If the audit client is a not a bank or similar institution the self-interest threat would be so great that no
SPOTLIGHT
safeguard could reduce the threat to an acceptable level, unless the loan is immaterial to both the firm/member
and the client.
2.9 Business Relationships (s520)

A commercial or common financial interest between an audit firm or a member of the audit team and a client
or its management may create a self-interest and intimidation threat. The Code gives the following examples
of such relationships:
 A material financial interest in a joint venture with the audit client or its senior management.
 Arrangements to combine services or products, marketed with reference to both parties.
 The firm acting as a distributor or marketer of the client’s products or services or vice versa.
If the relationship relates to the audit firm, unless the financial interest is immaterial and the relationship
clearly insignificant to the firm, the Code states that there are no safeguards which could reduce the threat to
an acceptable level. Therefore, the only possible courses of action are to:
 terminate the Business Relationship,
 reduce the level of the relationship so that the financial interest becomes immaterial and the
relationship insignificant, or
 refuse the assurance engagement.

If the relationship relates to a member of the audit team, as opposed to the firm, unless the financial interest
is immaterial and the relationship clearly insignificant to the individual, the only appropriate safeguard would
be to remove the individual from the assurance team.
The purchase of goods and services from an audit client by the firm or a member of the audit team would not
generally create a threat to independence provided:
 the transaction is in the normal course of business, and
 on an arm’s length.
However, the nature or number of such transactions could create a self-interest threat and safeguards would
need to be applied such as:
 eliminating or reducing the transactions
 removing the individual from the assurance team
For example, a new member of an audit team may have bought goods or services from the audit client in the
past, on normal commercial terms and at normal prices. This does not create any problem. However, if the audit
team member intends to continue using the goods or services of the client to a significant extent, there may be
some threat of a loss of independence. If so, the individual should be asked not to buy from the client entity in
the future; if the individual does not wish to do this, he or she should probably be taken off the audit team.
AT A GLANCE
 Example: commercial transaction with an audit team member

An audit firm has a client company, Zoomco, which operates a motor racing circuit. The audit
firm has discovered that the audit manager for the Zoomco audit keeps a racing car at Zoomco’s
circuit and uses the race track regularly. Because they are the audit manager, Zoomco allows
them 50% off normal charges for garaging the car and for use of the race track.
What is the ethical position and what measures should the audit firm take to deal with this
situation?
 Answer
The transaction between Zoomco and the audit manager is a normal commercial transaction for
Zoomco, but it is not at arm’s length because the audit manager gets 50% off normal prices. The
SPOTLIGHT
transaction may not be material for Zoomco, but it is likely to be material for the audit manager.
Consequently, there has been a breach of the ethical code by the audit manager. The audit
manager has created a self-interest threat (and possibly a familiarity threat) by entering into
the transaction with Zoomco.
 The ethics partner of the audit firm should be consulted and asked to assess the
materiality of the transaction between Zoomco and the audit manager and to consider
whether disciplinary action is appropriate.
 The audit manager should be removed immediately from the Zoomco audit team and
replaced by someone else.
 In view of the threat to the objectivity and independence of the former audit manager,
the audit plan for the Zoomco audit should be reviewed and amended if this is
considered necessary.
The ethics partner may also wish to check whether the former audit manager has entered into
commercial arrangements on favourable terms with any other audit client.
2.10 Family and personal relationships (s521)

Family and personal relationships between a member of the audit team and a director, officer or certain
employees (depending on their role) of the audit client may create a self-interest, familiarity or intimidation
threat, depending on the specific circumstances. The significance of these threats will depend on:

 the individual’s responsibilities on the audit team,

 the closeness of the relationship, and
 the role of the family member or other individual within the client.
Clearly, a greater threat will exist where, say, the wife of one of the partners at the assurance firm is the finance
director at a client then if, say, an audit junior’s sister is the receivables ledger clerk at a client.
Where an immediate family member (i.e. spouse or dependent) of a member of the audit team is:
 a director, officer or employee of the audit client, and
 is in a position to exercise direct and significant influence over the subject matter of the audit
engagement or was in such a position during any period covered by the engagement or the financial
statements. then the only appropriate safeguard is to remove the individual from the audit team.
So, in the example above, that particular partner should have no involvement with the assurance engagement
at his wife’s company. Even then, this may not be a sufficient safeguard if all the partners enjoy a close
relationship and the only safe approach may be not to take on that company as a client at all.
For a close family member (parent, non-dependent child, brother or sister) in the same position safeguards
might include:
AT A GLANCE
 removing the individual from the audit team.
 where possible, structuring the responsibilities of the audit team in such a way that the member of the
audit team does not deal with matters which are the responsibility of the family member (so, in the
example above, the audit junior would not be assigned to the receivables section of the audit).
 putting in place policies and procedures to allow audit staff to communicate to senior staff at the audit
firm any independence issues which concern them.
Threats are not restricted to the family relationships defined above. It is the audit firm’s responsibility to
consider any other personal relationships which might have a bearing on independence and consider what
safeguards need to be put in place.
You are the audit manager in Farhad and Company, Chartered Accountants. You have specific
SPOTLIGHT
responsibility for assessing the risks associated with the firm’s existing and proposed listed
clients. Presently, the following matters are under your consideration:
Sherbano Limited (SL) has requested your firm to provide a consent letter for acting as its
auditors. The wife of a partner in your firm is the Director Marketing in SL.
Required:
Discuss the categories of threats involved in each of the above situations and advise the partners
as regards the possible course of action that may be followed.
 Solution:
Sher Bano Limited:
 Family and personal relationships between a member of the assurance team and SBL
Director Marketing may create:
- threat to independence;
- self-interest threat;
- familiarity threat; or
- intimidation threat
 The significance of the above threat should be evaluated and the following safeguards
should be considered to reduce the threat to an acceptable level:
- Removing the individual from the assurance team;

- Where possible, structuring the responsibilities of the assurance team so that the
professional does not deal with matters that are within the responsibility of the
immediate family member;
- Policies and procedures to empower staff to communicate to senior levels within the
firm any issue of independence and objectivity that concerns them.
ABC and Company, Chartered Accountants, have been requested to give their consent for
appointment as the auditor of Sindh Limited (SL), in place of XYZ and Company, Chartered
Accountants. The matter of appointment of ABC and Company is to be placed in the annual
general meeting of SL.
Required:
i. Explain the responsibility of ABC and Company and the steps that it needs to take
before acceptance of the audit.
ii. What would be the retiring auditor’s responsibilities with respect to the above and the
responsibility of ABC and Company, in case the retiring auditor does not fulfil its
responsibility?
AT A GLANCE
 Solution:
i. New Auditor’s (ABC and Company) responsibility before acceptance of audit:
 ABC and Company should consider whether the acceptance of new client would
create any threats to compliance with fundamental principles.
 Evaluate significance of threats before accepting the audit engagement. If the
threats are other than clearly insignificant, safeguards should be considered and
applied as necessary, to eliminate them or reduce them to an acceptable level.
 Communicate with the retiring auditor to establish the facts and circumstances
behind the proposed change, however, before communicating it shall seek
permission of the client for such communication.
 Comply with relevant legal and other regulations in communicating with retiring
SPOTLIGHT
auditor.
ii. Retiring Auditor’s responsibility:
Retiring auditor is responsible to respond to any communication by the incoming
auditor. However, before giving any information about the client, he should seek
client’s permission.
While communicating with the auditor, the retiring auditor need to meet the legal and
ethical requirements related to such communication and disclosure.
The retiring auditor should promptly transfer to the new auditor all books and papers
related to SL, which may be held after the appointment has been effected and should
also advise SL accordingly.
Incoming Auditor’s Course of action if SL and retiring auditor do not fulfil their
responsibility:
In case ABC and Company is unable to communicate with the retiring auditor due to
any reason, it should try to obtain information about any possible threats by other
means such as inquiries from third parties or background investigation of senior
management or those charged with governance.
If unable to reduce threats through alternative procedures, it may decline the
engagement.


You are the partner incharge of quality control department of Mian and Company,
Chartered Accountants. The following independent matter is under your consideration:
Engagement partner’s brother-in-law has joined as CFO on an audit client.
Required:
Identify and evaluate the threats involved (if any), in above situation and explain the actions
which should be taken as regards the above matters.
 Solution:
Partner’s brother in law has joined as CFO:
 Partner’s brother in law does not come under the definition of close or immediate family
member.
 However, this may be perceived as a close personal relationship in our society and it would
threaten the perceived independence (independence in appearance) of the engagement
partner.
 The close relationship between engagement partner and CFO may give rise to self-interest,
familiarity and intimidation threats.
 The appropriate safeguard would be to rotate the partner and do not allow him to involve
AT A GLANCE
in any matter pertaining to that client.
 In case no other partner is available then it would be better to withdraw from the
engagement.
You are the partner in a firm of Chartered Accountants having three partners. Presently,
Your firm is conducting the audit of Tahir Limited (TL). A partner in your firm is a close friend
of Kashif, who is the financial controller in TL
Required:
Evaluate threats involved in the above situations and suggest related safeguard(s), if any.
SPOTLIGHT
 Solution:
Self-interest, familiarity or intimidation threats may be created due to a personal relationship
between the partner and the finance controller of TL.
The existence and significance of any threat will depend on factors such as:
 The nature of the relationship between the partner and the finance controller;
 The interaction of the partner with the assurance team;
The significance of any threat shall be evaluated and safeguards applied when necessary to
eliminate the threat or reduce it to an acceptable level. Examples of such safeguards include:
 Structuring the partner's responsibilities to reduce any potential influence of the partner
over the assurance engagement; or engagement team.
 Having a chartered accountant review the relevant assurance work performed.
Sameer works as manager assurance in your firm. He has close personal relationship with Saqib,
who is the CFO at one of your audit clients. However, you haven’t assigned that client to Sameer.
Required:
Evaluate the above situation and identify threat(s), if any, and related safeguards.
Tutorial Notes:
Sameer’s close relationship with Saqib and their managerial positions both should be discussed.
Be sure to give relevant safeguards as well.

 Solution:
Due to close personal relationship between Sameer and Saqib, self-interest, familiarity and
intimidation threats may be created.
The threats are significant due to close personal relationship and managerial positions of Saqib
and Sameer. The significance will also depend on the interaction of Sameer with the assurance
team;
Safeguards may include:
 structuring Sameer’s responsibilities to reduce any potential influence over the assurance
engagement; or
 having the relevant assurance work reviewed by a chartered accountant.
2.11 Recent service with an audit client (s522)

If a former director, officer or employee of an audit client becomes a member of the audit team there may be a
self-interest, self-review or familiarity threat. This will particularly be the case if, as a member of the audit
team, the individual has to report on work they carried out. They may also be reluctant to criticise the work of
former colleagues.
The Code specifies that individuals who worked for an audit client as a director, officer or employee in a position
AT A GLANCE
to exert a significant influence over the preparation of the client's accounting records or the financial statements
on which the firm will express an opinion, the threat created would be so significant that no safeguards could
reduce the threat to an acceptable level. Consequently, such individuals shall not be assigned to the audit team.
Threats are also created if the services were prior to period covered by the audit report. For example, a threat
would be created if a decision made or work performed by the individual in the prior period, while employed
by the client, is to be evaluated in the current period as part of the current audit engagement.
The existence and significance of any threat will depend on factors such as:
 the length of time elapsed,
 the individual’s position with the client,
 the role of the individual on the audit team.
SPOTLIGHT
Safeguards might include conducting a review of the work done by the individual as a member of audit team.
 Example: recent service with an audit client
Sadeeq served as the finance director of Ramble, an audit client for three years prior to joining
Ramble’s auditors, Tahir & Co., in March 2015 as a partner.
Sadeeq is prohibited from being a member of the audit team for Ramble’s 2015 statutory audit
because he was employed at the audit client (Ramble) in a position to exert direct and significant
influence over the subject matter during the period under review.
2.12 Serving as a Director or Officer of an Audit Client (s523)

Serving as a director or officer of an audit client creates self-review and self-interest threats.
It is prohibited for a partner or employee of the audit firm to serve as a director or employee of an audit client.
The threats created would be so significant that no safeguards could reduce the threat to an acceptable level.
A partner or employee of the firm may serve as a company secretary for an audit client if:
 this is allowed under the legislation,
 management makes all decisions, and
 the function is routine and administrative in nature (such as preparing minutes and maintaining
statutory returns).


2.13 Employment with an Audit Client (s524)

Employment relationships with an audit client might create a self-interest, familiarity or intimidation threat.
Individuals who have previously been on the audit team could leave the audit firm to work for the audit client.
A significant familiarity or intimidation threat could arise depending on:
 the seniority of the individual when they were on the audit team.
 the position they have taken up at the client i.e. whether they can exert significant influence over the
preparation of the financial statements subject to the audit.
 the amount of future involvement they will have with the audit team (as a member of the client’s staff).
 the length of time that has passed since they were on the audit team.
This will be the case particularly if strong personal or financial links remain between the individual and the
remaining members of the audit team or the audit firm.
The Code specifies that:
 the individual concerned must not be entitled to any benefits or payments from the firm, unless these
are fixed, pre-determined arrangements.
 any amounts owed to the individual (for example, in the case of an ex-partner) must not be so
AT A GLANCE
significant that they could threaten independence.
 the individual must no longer take part (or appear to take part) in the firm’s business.
Other safeguards might include:
 modifying the audit plan (perhaps to increase the amount of work on the area the ex-team member will
be involved with).
 assigning an audit team of sufficient expertise compared to the individual who has left (i.e. a team which
will not be intimidated by the ex-team member).
 arranging for an additional chartered accountant to review the work done.
 carrying out a quality control review of the engagement.
For Public interest entities:
SPOTLIGHT
 No public interest entities shall appoint a person as a director or officer (such as CEO), or as an
employee in a position to exert significant influence over the financial statements preparation (such as
the CFO) who was a partner of the firm of its external auditors (or an employee involved in the audit of
the public interest entity).
 Independence would be deemed to be compromised unless, subsequent to the partner ceasing to be a
key audit partner, the public interest entity had issued audited financial statements covering a period
of not less than twelve months and the partner was not a member of the audit team with respect to the
audit of those financial statements.
Only exception to the previous paragraphs is where the circumstances has arisen as a result of a business
combination, and there are not outstanding benefits or payments due to the former partner or amounts owed
are immaterial, the former partner does not participate in the firm’s activities and position was not taken in
contemplation of the business combination.
Similar threats could also arise where a member of the audit team knows they are to join the client in the future
or has entered negotiations to do so. If the individual were to remain on the audit team, objectivity could be
impaired as the individual might be keen not to upset their potential future employer (self-interest threat).
Safeguards would include:
 the firm having policies and procedures in place to require individuals to notify the firm when they are
entering into such negotiations with an audit client
 removing the individual from the audit team

 having an appropriate reviewer review any significant judgments made by that individual while on the
team
2.14 Temporary personnel assignments (s525)

The loan of personnel to an audit client might create a self-review, advocacy or familiarity threat.
When the firm becomes too closely aligned with the views and interests of management of the audit client,
safeguards are often not available.
A firm shall not loan personnel to an audit client unless:
 assistance is provided only for a short period of time.
 prohibited non-assurance services are not performed.
 management responsibilities are not assumed, and the audit client is responsible for directing and
supervising the activities of the personnel.
Other safeguards include:
 conduct an additional review of the work performed by the loaned personnel.
 exclude the loaned personnel from the audit team.
 do not give the loaned personnel audit responsibility for any function or activity that the personnel
AT A GLANCE
performed during the assignment.
2.15 Long association of senior personnel (Including Partner Rotation) with an audit client (s540)
Using the same individual on an audit engagement over a long period of time may create a familiarity and self-
interest threat.
A self-interest threat might be created as a result of an individual’s concern about losing a longstanding client
or an interest in maintaining a close personal relationship with a member of senior management or those
The significance of threats will depend upon in relation to the individual:
 the length of individual’s relationship with the client including if relationship existed while the
individual was at a prior firm.
SPOTLIGHT
 how long the individual has been on the audit team?

 the role of the individual on the audit team and extent of the work reviewed or supervised.
 the extent to which the individual can influence the outcome of the audit.
 the closeness of the individual’s personal relationship with senior management or those charged with
governance.
 the nature and frequency of the individual’s interaction with the senior management or those charged
with governance.
The significance of threats will depend upon in relation to the audit client:
 the nature and complexity of audit client’s accounting and reporting issues.
 whether the client's management team has changed.
 whether there have been any structural changes in the client’s organization impacting interactions
between the individual and senior management of those charged with governance.
Safeguards might include:
 rotating senior staff of the audit team; for example, changing the audit engagement partner every five
years.
 arranging for a chartered accountant to review the work done by the senior staff.
 regular independent internal or external quality reviews of the engagement.


You are the quality control partner in a medium size audit firm and have been asked to give your
views on the following situations:
One of your firm’s large clients, a listed company, has requested that the current year’s audit
should be carried out by the same team which audited the last year’s financial statements. The
request has been justified on the grounds that the accounts department is extremely busy on a
special assignment and a new team would take a lot of their time. You have also been informed
that Mr. Shams has been the manager in charge of that audit during the last three years.
Required:
Discuss the category of threat involved in each of the above situations. Also explain the
safeguards available with the firm which may eliminate or reduce the threat to an acceptable
level.
 Solution:
Client’s request for certain staffs
The audit firm should assess whether the reason given by the client is valid under the
circumstances because if there is any other reason, it may affect the independence of the audit.
Moreover, as a matter of principle, the audit firm should not encourage such requests from the
AT A GLANCE
client.
Long association of Mr. Shams
i. Using the same senior personnel on an assurance engagement over a long period of time
may create a familiarity threat.
ii. The significance of the threat should be evaluated and, if the threat is other than clearly
insignificant, safeguards should be considered and applied to reduce the threat to an
acceptable level. Such safeguards might include:
 Rotating the senior personnel (other than the audit team)
 Involving an additional chartered accountant who was not a member of the assurance
team to review the work done by the senior personnel or otherwise advise as
necessary;
SPOTLIGHT
 Independent internal quality reviews.
You are the partner in a firm of Chartered Accountants and presently following matters are
under your consideration:
Annual audit of Kamran Limited (KL) for the year ending 31 December 2016 is due to commence
in a few weeks. Jamal has been an audit team member for eleven years; two years as the job
incharge, three years as manager and six years as partner.
KL was listed on the Pakistan Stock Exchange in July 2016.
Required:
i. Identify the threats in the above situation and discuss the significance thereof.
ii. Discuss the need for rotation of engagement partner in each of the following situations:
 The firm has adequate resources and personnel who can replace Jamal as
engagement partner but Jamal does not want to leave this assignment.
 The firm is unable to find a suitable replacement.
Tutorial Notes:
Point of confusion was that the company had been listed during the current year only and hence
the rotation of the partner was not necessary under the given circumstances.

 Solution:
(i) As Jamal is associated with KL since last eleven years it will create a familiarity and self-
interest threats.
The threats created are significant as:
 association of Jamal with KL is of 11 years;
 Jamal has a key/main role in the audit engagement of KL, being the engagement
partner; and
 the engagement is a statutory audit.
Other factors on which the significance of threats will depend are:
 Structure of the firm;
 Whether the client’s management team has changed;
 Whether the nature or complexity of the client’s accounting and reporting issues has
been changed.
(ii) As Jamal has served the audit client for six or more years when the KL becomes a listed
company, however as per the requirements of Code of Ethics Jamal can still continue to
serve as an engagement partner for a maximum of two additional years.
AT A GLANCE
Further, Jamal can continue to serve as an engagement partner for more than the period
specified, provided an independent regulator has provided an exemption from partner
rotation. If such an exemption is not provided, then the auditor should leave the audit
engagement.
Alpha Textile Limited (ATL) is a long standing listed audit client of your firm. Haris has been the
audit engagement partner of ATL for the last five years. The firm is considering to appoint Munir
as ATL’s engagement partner and Haris either as ATL’s quality control review partner or client
relationship partner.
Required:
In the light of Listed Companies (Code of Corporate Governance) Regulation, 2017 and ICAP’s
SPOTLIGHT
Code of Ethics, discuss the validity of Haris’s appointment either as ‘quality control review
partner’ or ‘client relationship partner’.
Tutorial Notes:
Linking the requirements of Code of Corporate Governance (CCG) and Code of Ethics (CE) is
required rather than providing two separate conclusions i.e. one under CCG and other under CE.
 Solution:
Code of ethics requires that an individual shall not be a key audit partner for more than seven
years unless the law prescribes a shorter period. Since Pakistan law i.e. code of corporate
governance requires rotation of engagement partner after 5 years, the requirements of Pakistan
law will apply.
Code of ethics also requires that after such time, the individual shall not be a member of the
engagement team or be a key audit partner for the client for two years. The code defines key
audit partner as the engagement partner, individual responsible for engagement quality control
review partner and other partners who make key decision or judgements on significant matters
with respect to the audit of the financial statements.
Considering the above, Haris cannot be appointed as engagement partner or quality control
partner.

Appointment as Client Relationship Partner

If Haris would be in a high level contact with the management or the audit committee, there is
a possibility that he would be able to directly influence the outcome of the engagement. In such
a case he could not be appointed as client relationship partner.
However, code of ethics allows an additional year to a key audit partner only in rare
circumstances outside the firms’ control whose continuity is especially important as long as the
threat to independence can be eliminated or reduced to an acceptable level by applying
safeguards.
Salman Qasim is an audit senior of Ibrahim & Company, Chartered Accountants. He joined the
ongoing audit of Kalam Limited (KL) which was under completion stage. During the audit, he
came to know that the newly appointed Chief Financial Officer (CFO) is a close friend of the audit
manager which was not disclosed by him to the firm. He decided to disclose this matter to the
engagement partner; however, he came to know that the engagement partner has been out of
country for last one month and has not yet discussed the progress of the audit with the audit
team. He then wrote an email to the firm’s quality control partner and brought all such
observations in his knowledge.
Required:
AT A GLANCE
Discuss the professional and ethical issues arising in the above situation and advise the course
of action that the firm’s quality control partner should take.
Tutorial Notes:
Points to be focused are:
 The fact that no review or discussion was made by the engagement partner regarding the
progress of the audit and the implications related to its ethical and professional issues.
 Matters which need to be discussed with those charged with governance when a breach has
been identified.
 Engagement shall only be continued when concurrence of those charged with governance
has been taken.
SPOTLIGHT
 Solution:
No discussion on the progress of the audit work by the engagement partner indicates that
elements of ISA 220 related to review of the engagement have been breached.
ISA 220 states that reviews should happen on a timely basis throughout the audit to enable
problems to be resolved at an appropriate time. Further, ISA 220 also state that the audit
partner need not review all audit documentation, but no discussion with the audit team indicate
that areas of risk or critical judgement have not been reviewed.
Reviews should also be hierarchical and it appears that the audit partner has not reviewed the
work of the audit manager. The significance of this issue is further increased because the audit
manager is close friend of the CFO which is not disclosed by him to the firm. Therefore, a very
thorough review could have been performed by the engagement partner of the work of the audit
manager.
Audit manager being the close friend of CFO created familiarity, self-interest and intimidation
threat. Therefore, the audit manager not disclosing his friendship with the CFO is a breach of
the provision of ICAP code of ethics. The firm should immediately remove him as the audit
manager and perform an independent quality control review. However, when a breach is
identified, the firm shall discuss the breach and the action as soon as possible, with those
charged with governance. The matters to be discussed shall include:
 The significance of the breach, including its nature and duration;
 How the breach occurred and how it was identified;

 The action taken or proposed to be taken and the firm's rationale for why the action
will satisfactorily address the consequences of the breach and enable it to issue an audit
report;
 The conclusion that, in the firm's professional judgment, objectivity has not been
compromised and the rationale for that conclusion; and
 Any steps that the firm has taken or proposes to take to reduce or avoid the risk of
further breaches occurring.
Firm shall only continue with the engagement if they obtain the concurrence of those charged
with governance that action can be, or has been, taken to satisfactorily address the
consequences of the breach.
Public interest entities
The individual shall not act as an engagement partner, or quality reviewer, or other key partner role for a period
of more than seven years unless local prescribes a shorter period. After the time-on period, a cooling off period
of five consecutive years applies.
Where the individual has been appointed as responsible for the engagement quality control review and has
acted in that capacity for seven cumulative years, the cooling-off period shall be three consecutive years.
If the individual has acted as a key audit partner other than in the capacities of key audit partner or quality
reviewer for seven cumulative years, the cooling-off period shall be two consecutive years.
AT A GLANCE
 Example: cooling off period

An individual who served as engagement partner for four years followed by three years off can
only act thereafter as a key audit partner on the same audit engagement for three further years
(making a total of seven cumulative years). Thereafter, that individual is required to cool off as
per the requirements of the Code.
However, because the threat could be so great for an audit client, the Code specifies the following for the audit
of listed clients (as required by the Pakistan Securities and Exchanges Commission’s Code of Corporate
Governance):
 All banks and development finance institutions (DFIs) are required to ensure that the external auditors
are rotated on expiration of five years. In case of banks / DFIs having two audit firms jointly auditing
their accounts and both of them complete their five years’ period at the same time, one of them will be
SPOTLIGHT
rotated on completion of five years and the other one in the next year.
 All listed companies in the financial sector shall change their auditors every five years. Financial sector
for this purpose means Non-Banking Finance Companies (NBFCs), Modarabas and Insurance
Companies.
 All listed companies other than those mentioned above shall at a minimum rotate the engagement
partner after every five years.
 A partner rotating after five years should not resume the lead engagement partner role until a further
period of time, normally two years, has elapsed.
2.16 Provision of non-assurance services to an Audit Client (s600-610)

The provision of non-assurance services is now common among audit firms of all sizes, consistent with
members’ skills and expertise. Most audit firms recognise the potential threat to compliance with the
fundamental principles and their independence and they try to deal with threats through their internal
organisational structure.
 Larger firms will operate in a number of separate departments, each with its own partners and
members of staff. By dividing the work of the audit firm into different functions, employees involved in
audit work will not be the same as those involved in providing, say, consultancy advice to the same
client.
 In some of the largest practices, the consultancy department has been legally separated from the
accounting/auditing arm of the firm as a further step towards preserving auditor objectivity and
independence.

 A similar approach is often taken by smaller audit firms. Although these firms may not be large enough
to be organised in separate departments, efforts are usually made to ensure that different members of
staff and partners are responsible for different services provided to clients.
 Example: non-audit work and safeguards
An audit firm has completed the annual audit for a client company and the audit team has
identified a number of weaknesses in internal controls that have been notified to the client’s
management. As a result, the client has asked the firm to carry out a review of its financial IT
systems.
What are the ethical issues to consider in this situation and how might the problems be dealt
with?
 Answer
The engagement would involve non-audit work. The audit firm can accept this engagement
subject to certain conditions:
 The management of the client company must recognise that they have the
responsibility for internal controls in the company. This responsibility cannot be
passed on to the auditors.
AT A GLANCE
 The engagement team will not be required to act in a management capacity in any way.
For example, they must not be given any responsibility for the implementation of any
improvements in internal control that they recommend.
 There must be sufficient controls against a self-review threat. For example, the
individuals assigned to the engagement team to do the work should not include anyone
who will also be a member of the audit team.
The ICAP Code recognises that the independence of an audit firm may be threatened when the firm carries out
either a material non-assurance work or multiple non-assurance services for an entity that is also its audit client.
 The non-assurance work may provide a large amount of income that makes the audit firm economically
dependent on the company (self-interest threat).
 In addition, employees of the audit firm who carry out the audit may be required to audit the work that
SPOTLIGHT
has been done for the company by colleagues in the audit firm. It might be difficult for them to find
faults with the work that has been done by other employees of the firm (self-review threat).
 Moreover, the firm may present its client’s case in front of tax commissioner (Advocacy threat)
New business practices, the evolution of financial markets and changes in information technology, are among
the developments that make it impossible to draw up an all-inclusive list of non-assurance services that might
be provided to an audit client. However, the ICAP Code considers various categories of non-assurance work,
including the following which is not an exhaustive list of all non-assurance services:
 Accounting and bookkeeping services
 Administrative services
 Valuation services
 Tax services
 Internal audit services
 IT systems services
 Litigation support services
 Legal services
 Recruiting services
 Corporate finance services

General guidance on non-assurance services

Although non-assurance services are generally considered acceptable, subject to appropriate safeguards, the
following activities are prohibited by the Code:
 Authorising, executing or completing a transaction.
 Directing and taking responsibility for the actions of employees in relation to the employees’ work for
the entity.
 Deciding which recommendation of the firm should be implemented.
 Reporting, in a management role, to senior management of the client.
 Setting policies and strategic direction.
 Hiring or dismissing employees.
 Controlling or managing bank accounts or investments.
 Taking responsibility for the preparation of financial statements and designing, implementing,
monitoring or maintaining internal controls.
Any of the above would involve the firm acting in a management capacity and therefore constitute a threat to
the firm’s objectivity for which no safeguards are available to mitigate threats.
AT A GLANCE
Appropriate safeguards for other activities would include the following:

 The firm having policies and procedures such that an individual is prevented from making any
management decision on behalf of the client.
 Discussing independence issues with the audit committee or senior management at the client.
 The firm having policies covering oversight responsibility for the provision of other work to audit
clients.
 Involving an additional chartered accountant in a review of independence or an aspect of the
engagement.
 The client acknowledging responsibility for the results of the work performed by the firm.
 Disclosing to the audit committee or similar body the nature and extent of fees charged.
SPOTLIGHT
 Personnel carrying out the non-assurance services not taking part in the audit engagement.
An audit manager of the firm has effectively negotiated a non-assurance assignment with an
audit client. Such deals are usually considered in the annual appraisal of the managers.
Required:
 Solution:
A self-interest threat is created when a member of the audit team is evaluated on or
compensated for selling non-assurance services to the audit client.
The significance of the threat will depend on:
 The proportion of the individual’s compensation or performance evaluation that is
based on the sale of such services;
 The role of the individual on the audit team; and
 Whether promotion decisions are influenced by the sale of such services.

The significance of the threat shall be evaluated and, if the threat cannot be reduced to an
acceptable level, the firm shall either revise the compensation plan or evaluation process for
that individual or apply safeguards to eliminate the threat or reduce it to an acceptable level.
Examples of such safeguards include:
 Removing such members from the audit team; or
 Having a Chartered Accountant review the work of the member of the audit team.
Accounting and booking keeping services

Providing accounting and bookkeeping services to an audit client might create a self-review threat. These
services comprise a broad range including but not limited to preparing financial statements, recording
transactions and payroll services.
In providing such services, firms must not make management decisions such as:
 determining accounting policies and the accounting treatment in accordance with those policies
 deciding on or changing journal entries without the client’s approval
 authorising or approving transactions
 preparing source documents or originating data (including decisions on valuation assumptions).
AT A GLANCE
The audit process also necessitates dialogue between the firm and management regarding above e.g. proposing
adjustments as a result of the audit which is considered to be a normal part of the audit process, as long as client
makes the decision. Furthermore, the provision of advice on accounting principles and presentation in the
financial statements given during the course of an audit is also considered to be part of the normal audit process.
For audit clients that are not public interest entities, accounting or book-keeping services, including payroll
services, of a routine or mechanical nature may be provided with appropriate safeguards such as:
 the service not being performed by a member of the audit team
 the firm having policies and procedures such that an individual is prevented from making any
management decision on behalf of the client
 requiring the source data for accounting entries to be originated by the client
SPOTLIGHT
 requiring the underlying assumptions to be originated and approved by the client
 obtaining the client’s approval for any changes to the financial statements.
You are a chartered accountant in practice. The following situations have arisen in connection
with two of your clients:
Your firm is the external auditor of a listed company. Recently the management of the company
has requested your firm to provide the following services:
(i) Reconciling the creditors’ ledger with the statements submitted by the suppliers.
(ii) Estimating the compensation payable to the employees who were seriously injured while
carrying out the trial run of the plant.
Required:
Explain the threats involved in accepting the above assignments and identify the steps the firm
should take to fulfill its professional responsibilities and obligations.
 Solution:
(i)
 Preparation of such reconciliations may be used by the client as base document of
accounting entries. Therefore, it may create a self-review threat when the financial
statements are subsequently audited by the firm.

 While providing such assistance, the auditor should not involve in making management
decision which include:
- Determining or changing journal entries, or the classifications for accounts or
transaction or other accounting records.
- Authorizing or approving transactions; and
- Preparing source documents or originating data or making changes to such documents
or data.
 The significance of any threat created should be evaluated and, if the threat is other than
clearly insignificant, safeguards should be considered and applied as necessary to reduce
the threat to an acceptable level. Such safeguards might include:
- Making arrangements so such services are not performed by a member of the
assurance team;
- Implementing policies and procedures to prohibit the individual providing such
services from assisting in preparation of accounting records and making any
managerial decisions on behalf of the audit client;
(ii)
The estimation of compensation may be used by the client as a basis for making provisions in
the accounts. Therefore, it may create a self-review threat. The significance of threat will depend
AT A GLANCE
upon the following factors:

- The materiality of the amounts involved;
- The degree of subjectivity inherent in the matter concerned; and
- The nature of the engagement i.e. the purpose and objective of estimation.
The firm should evaluate the significance of threat and if it is significant then apply the
necessary procedures to eliminate the threat or reduce it to an acceptable level. Such safeguards
may include:
- Policies and procedures to prohibit individuals assisting the audit client from making
managerial decisions on behalf of the client.
- Using professional who are not members of the assurance team to perform the service;
- The involvement of others such as independent experts.
SPOTLIGHT

You are the quality control partner in a firm of chartered accountants. The following
independent situations are under your consideration.
The client has written a letter of appreciation showing their gratitude for the involvement and
guidance provided by an audit manager on various issues regarding application of accounting
standards.
Required:
Identify and evaluate the threats involved and explain what actions should be taken in the above
 Solution:
Involvement of audit personnel and guidance to client on accounting principles are an
appropriate means to promote the fair presentation of financial statements and the audit
process routinely requires dialogue between the firm and management of the audit client and
such types of activities are considered to be a normal part of the audit process and do not,
generally, create threats to independence
Self-review threat will be involved in above situation, if the auditor assumes management
responsibility while providing guidance to the client’s management. Safeguards should be
applied to prevent the auditor from assuming management responsibility when providing
advice. Safeguards could include:

 Obtaining acknowledgement of responsibility from the client for any actions or decisions
made.
 Evaluating the ultimate decision of the client and ensuring that the reasons for their
decisions are self-determined
 The risk is further reduced when the firm gives the client the opportunity to make
judgments and decisions based on an objective and transparent analysis and presentation
of the issues.
Chartered Accountants. The following independent matter is under your consideration:
On an unlisted audit client, the audit engagement team prepares financial statements from the
trial balance and proposes adjusting entries.
Required:
which should be taken as regards the above matter.
 Solution:
AT A GLANCE
The following safeguards can be applied to reduce the threat to an acceptable level: it may
 Obtaining client approval for any proposed adjustments/ avoid managerial decision
making.
 Requiring the underlying assumptions / source data for accounting to be originated
and approved by the audit client.
 Having a qualified person, who is not a member of the audit team, take responsibility
for performing the non-audit services
 Establishing procedures and policies to guide persons performing such services
Your firm, Hatim Manzoor and Company, Chartered Accountants is the auditor of Paints Limited
SPOTLIGHT
(PL) for the year ending 31 December 2019. On 1 December 2019, PL has acquired controlling
interest in Brush Limited (BL). Your firm also has a contract with BL for providing accounting
and bookkeeping services until 31 December 2020. BL has requested your firm to keep
providing the services until an alternate solution is worked out.
Required:
Evaluate the threat(s) in the above scenario and discuss whether the firm can continue
providing the services to both the clients till conclusion of the audit.
Tutorial Notes:
Following points should not be missed:
 Discussing with those charged with governance why the interest cannot reasonably be
terminated by the effective date of the acquisition.
 Engaging another firm to evaluate the results of non-assurance service
 Engaging another firm to re-perform the non-assurance service to the extent necessary
to enable it to take the responsibility.
 Solution:
Since such a current interest or relationship cannot reasonably be terminated by the effective
date of the acquisition, the firm shall evaluate the self-review threat.
The financial statements of BL and PL would be consolidated and the firm would have to review
its own work. Furthermore, PL and BL would now be related entities and the restriction
imposed by the code of ethics on PL would also be applicable on BL.

The firm shall discuss with those charged with governance the reasons why the interest cannot
reasonably be terminated by the effective date of the acquisition and the evaluation of the
significance of the threat.
If those charged with governance request the firm to continue as an auditor, the firm shall do
so only if:
 the interest or relationship will be terminated as soon as reasonably possible and in all
cases within six months of the effective date of the acquisition.
 any individual who performed that non-assurance service should not be made part of
the audit team.
 a chartered accountant reviews the audit work as appropriate.
 a chartered accountant, who is not a member of the firm expressing the opinion on the
financial statements, perform a review that is equivalent to an engagement quality
control review.
 another firm is engaged to evaluate the results of the non-assurance service or another
firm is engaged to reproduce the non-assurance service to the extent necessary to
enable it to take responsibility of the service.
For audit clients that are public interest entities, accounting or book-keeping services of a routine or
AT A GLANCE
mechanical nature may only be provided to the divisions or related entities of the public interest entity where
the divisions or related entities for which the service is provided are collectively immaterial to the financial
statements.
Administrative services
Providing administrative services, such as assisting clients with their routine or mechanical tasks within the
normal course of operations, to an audit client does not usually create a threat. Example of such services include:
 Word processing services
 Preparing administrative or statutory forms for client approval.
 Submitting such forms as instructed by the client.
SPOTLIGHT
 Monitoring statutory filing dates, and advising an audit client of those dates.
Valuation services
A self-review or advocacy threat might arise where an audit firm performs a valuation of an item which is to
be included in the financial statements to be audited. Therefore, audit firms should not provide valuation
services where:
 the matter is material to the financial statements, and
 involves a significant degree of subjectivity.
In other cases, appropriate safeguards might include:
 the client acknowledging responsibility for the results of the work.
 having a professional who was not involved in providing the valuation services review the audit or
valuation work performed.
 the client confirming their understanding of and approving the underlying assumptions and
methodologies used.
 the individuals carrying out the work not being involved in the audit.
clients. Presently the following matters are under your consideration:

Romeo Supermarket Limited (RSL), a large chain of super markets, has approached your firm
to perform financial due diligence of one of your audit client, Juliet Limited (JL), which is a listed
company. RSL intends to acquire 80% shareholding in JL.
Required:
Discuss the categories of threats involved in above situations and advise the partners as regards
the possible course of action that may be followed.
 Solution:
Romeo Supermarket Limited:
Providing due diligence services to the client (RSL) whose interests are in conflict with your
other assurance client (Juliet Limited) in relation to the transaction in question may create a
self-review threat or threat to objectivity or confidentiality or professional behavior.
However, the firm can provide such services provided it notifies JL of the firm’s business interest
or activities that may represent a conflict of interest, and obtains its consent for accepting the
assignment. In such case the following safeguards should also be considered:
 The use of separate engagement teams;

AT A GLANCE
Additional procedures to restrict access to confidential information to concerned
personnel only;
 Clear guidelines to members of the engagement team on issues of security and
confidentiality;
 The use of confidentiality agreements signed by employees and partners of the firm
and;
 Regular review of the application of safeguards by a senior individual not involved in
relevant client engagements.
You are the quality control partner in Pirzada and Company, Chartered Accountants. The
SPOTLIGHT
Your firm has been approached for appointment as external auditors of Watto Limited (WL), a
listed company. Your firm has been providing valuation services to WL.
Required:
Identify and evaluate the threats involved and explain what action would you take in the above
circumstances including the steps required, if any, to reduce the risk to an acceptable level.
Tutorial Notes:
The students are expected to know that the response of the firm would be different depending
upon whether the items being valued were material to the financial statements or involved
subjectivity or not.
 Solution:
Watto Limited
a) A self-review threat may be created if the results of the valuation carried out by the
firm are required to be incorporated in the client’s financial statements.
b) If the firm has carried out valuation of items material to the financial statements or the
valuation involves a significant degree of subjectivity, the firm would not be in a
position to reduce the self-review threat to an acceptable level by the application of any
safeguard, and should not accept the audit engagement.

c) If the valuation services are not material either separately or in aggregate, or if they do
not involve a significant degree of subjectivity, the following actions may be taken to
reduce the self-review threat to an acceptable level:
 Involve another chartered accountant who will not be a member of the assurance
team, to review the work done or provide necessary advice.
 Obtain confirmation from the audit client about their understanding of the
underlying assumptions of the valuation and the methodology being used for
valuation
 Obtain approval of the client regarding use of the methodology and assumptions
in the valuation.
 Obtain the client’s acknowledgement of responsibility for the results of valuation
services performed by the firm.
 Ensure that personnel who had been providing such services do not participate
in the audit engagement.
You are the quality control partner in Wiew and Company, Chartered Accountants. You have
been assigned additional responsibilities for assessment of risks associated with the firm’s
AT A GLANCE
existing and proposed clients. At present, the following matters are under your consideration:
The government has invited ‘expression of interest’ for selling its strategic shares in Iqbal
Limited (IL). One of your clients’ Zain Limited is interested in the deal and has requested your
firm to carry out a due diligence exercise. Mian Limited has also approached your firm for
carrying out a business valuation of IL.
Required:
Discuss the categories of threats involved in above situation and advise the partners as regards
Tutorial Notes:
The firm is serving two different clients with conflicting interest.
SPOTLIGHT
 Solution:
Iqbal Limited:
i. A threat to objectivity or confidentiality may be created when a Chartered Accountant
in practice performs services for clients whose interests are in conflict.
ii. The above threat may be reduced to an acceptable level by taking the following steps:
 Notifying both the parties that we are acting for both of them, and obtaining their
consent to so act;
 Procedures to prevent access to information (e.g., strict physical separation of
such teams, confidential and secure data filing);
 Clear guidelines for members of the engagement team on issues of security and
confidentiality;
 The use of confidentiality agreements signed by employees and partners of the
firm; and
 Regular review of the application of safeguard by a senior individual not involved
with relevant client engagements.


a) An audit client has approached your firm for advice on various issues concerning a
financing arrangement. The client has provided you information regarding terms of
financing offered by three different financial institutions including draft agreements
which the client may be required to sign.
Required:
Identify threats involved in the above case and also suggest related safeguards, if any.
b) Assuming that two of the above financial institutions are audit clients of your firm,
explain whether such situation would result in a conflict of interest, under the Code of
Ethics for Chartered Accountants.
 Solution:
a) Threats:
The firm should ensure that while giving advice to the audit client, it does not commit
the client to the terms of the transaction or consummate transaction on behalf of a
client. If the advice to the client involves any of the above acts, then the firm should not
accept such an engagement, because accepting such an engagement would create a
AT A GLANCE
threat to independence that are so significant that no safeguard could reduce the threat
to an acceptable level.
After considering the above, if the assignment relating to the advice on the financing
arrangement is accepted then it would still create threats to advocacy and self-review
threat.
Safeguards that should be considered include:
 Policies and procedures to prohibit individuals assisting the assurance client from
making managerial decision on behalf of the client;
 Using professionals who are not members of the assurance team to provide the
service; and
SPOTLIGHT
b) If the audit client intends to enter into financing arrangement with the financial
institutions which are also your audit clients, this will not create any conflict of interest
as obtaining loan from bank does not produce any apparent conflict of interest between
the client and the bank.
A conflict of interest might exist between two financial institutions, which are providing
the finance, but as your firm is not providing the said service to these institutions, hence
no threat will be created and this assignment can be accepted. However, the
confidentiality requirements and relevant safeguards should be considered while
carrying out the said assignment.
You are the quality control partner in a firm of chartered accountants. Your firm has been
approached by Beta (Private) Limited (BPL) for appointment as the auditors for the year ending
30 June 2019.
Your firm was also hired by BPL for valuation of its investment in an unlisted company on
August 2018. The valuation engagement had concluded in September 2018 and the amount of
investment is material to BPL’s financial statements.
Required:
Being the quality control partner, advise whether the audit of BPL could be accepted by the firm.
Also discuss the relevant threats, if any.

Tutorial Notes:
Majority of the students may not pay attention to the fact that valuation service was provided
prior to appointment as auditor so the appointment could have been accepted. Consequently,
the correct safeguards may be missed.
 Solution:
Under the code of ethics, the firm could not have accepted the valuation service, had the
valuation service been requested after the appointment as auditors, However, since the
valuation service was provided prior to appointment as auditors, the audit engagement could
be accepted.
A self-review threat would be created because the amount is material to the financial
statements, is highly subjective and is included in the financial statements of the period which
the firm will subsequently audit.
In order to reduce the threat to an acceptable level the following safeguards should be applied:
 Not including personnel who provided the non-assurance service in the audit team.
 Having a chartered accountant to review the audit and the valuation as appropriate
 Engaging another firm to evaluate the results of the valuation engagement or having
AT A GLANCE
another firm to re-perform the non-assurance service to the extent necessary to enable
it to take responsibility for the service.
Chartered Accountants. The following independent matters are under your consideration:
Your firm has been asked to verify the results of an award competition being organized by an
audit client.
Required:
SPOTLIGHT
which should be taken as regards the above matters.

 Solution:
Verify results of award competition
 If the award competition materially affects the information/results of financial
statements, self-review threat may be created.
 Significance of threat need to be evaluated that whether the award competition is
material to the audit client and to what extent affects the figures appearing in the
financial statements.
If the threat is significant then the assignment should be declined. The threat involved in this
situation is self-review threat.
Tax services
Taxation services comprise a broad range of services, including:
 Tax return preparation;
 Tax calculations for the purpose of preparing the accounting entries;
 Tax planning and other tax advisory services; and
 Assistance in the resolution of tax disputes.

While taxation services provided by a firm to an audit client are addressed separately under each of these broad
headings; in practice, these activities are often interrelated.
Performing certain tax services create a self-review or advocacy threat. The existence and significance of any
threats will depend on factors such as:
 The system by which the tax authorities assess and administer the tax in question and the role of the
firm in that process;
 The complexity of the relevant tax regime and the degree of judgment necessary in applying it;
 The particular characteristics of the engagement; and
 The level of tax expertise of the client's employees.
Tax Return Preparation

Providing such services does not generally create a threat to independence if management takes responsibility
for the returns including any significant judgments made.
Tax Calculations for the Purpose of Preparing Accounting Entries Audit clients that are not public interest
entities.
Preparing calculations of current and deferred tax liabilities (or assets) for an audit client for the purpose of
AT A GLANCE
preparing accounting entries that will be subsequently audited by the firm creates a self-review threat. The
significance of the threat will depend on:
 The complexity of the relevant tax law and regulation and the degree of judgment necessary in applying
them;
 The level of tax expertise of the client's personnel; and
 The materiality of the amounts to the financial statements.
Safeguards shall be applied when necessary to eliminate the threat or reduce it to an acceptable level.
 Using professionals who are not members of the audit team to perform the service;
 If the service is performed by a member of the audit team, using a partner or senior staff member with
SPOTLIGHT
appropriate expertise who is not a member of the audit team to review the tax calculations; or
 Obtaining advice on the service from an external tax professional.
Audit clients that are public interest entities

 Except in emergency situations, in the case of an audit client that is a public interest entity, a firm shall
not prepare tax calculations of current and deferred tax liabilities (or assets) for the purpose of
preparing accounting entries that are material to the financial statements on which the firm will
express an opinion.
Tax Planning and Other Tax Advisory Services

A self-review threat may be created where the advice will affect matters to be reflected in the financial
statements.
Assistance in the Resolution of Tax Disputes

An advocacy or self-review threat may be created when the firm represents an audit client in the resolution of
a tax dispute once the tax authorities have notified the client that they have rejected the client's arguments on
a particular issue and either the tax authority or the client is referring the matter for determination in a formal
proceeding, for example before a tribunal or court. The existence and significance of any threat will depend on
factors such as:
 Whether the firm has provided the advice which is the subject of the tax dispute;

 The extent to which the outcome of the dispute will have a material effect on the financial statements
on which the firm will express an opinion;
 The extent to which the matter is supported by tax law or regulation, other precedent, or established
practice;
 Whether the proceedings are conducted in public; and
 The role management plays in the resolution of the dispute.
The significance of any threat created shall be evaluated and safeguards applied when necessary to eliminate
the threat or reduce it to an acceptable level.
 Using professionals who are not members of the audit team to perform the service;
 Having a tax professional, who was not involved in providing the tax service, advise the audit team on
the services and review the financial statement treatment; or
 Obtaining advice on the service from an external tax professional.
Where the taxation services involve acting as an advocate for an audit client before a public tribunal or court in
the resolution of a tax matter and the amounts involved are material to the financial statements on which the
firm will express an opinion, the advocacy threat created would be so significant that no safeguards could
AT A GLANCE
eliminate or reduce the threat to an acceptable level. Therefore, the firm shall not perform this type of service
for an audit client. What constitutes a "public tribunal or court" shall be determined according to how tax
proceedings are heard in the particular jurisdiction.
You are the quality control partner of Nasir and Company, Chartered Accountants (NCC)and
presently following matters are under your consideration:
Your firm has issued an unmodified opinion on the financial statements of Salim Limited (SL)
for the year ended 31 December 2012. The tax authorities have recently launched an
investigation against SL, alleging that SL has under declared its income for the year ended 31
December 2012. NCC is also acting as the tax advisor of SL.
Required:
SPOTLIGHT
Tutorial Notes:
Most of the students may discuss the issue of permissible and non-permissible services under
the Code of Ethics. However, some important considerations also could be what else can go
wrong in the given situation, such as possibility of misstatements in the financial statements or
misstatement in tax returns. Obviously, misstatement in either or both of the above documents
would warrant various actions by the auditors.
 Solution:
(a) Investigation by tax authorities
 The tax authorities have launched an investigation against SL on suspicion of under-
declaring income. This implies one of the following:
- The financial statements are materially misstated.
- The tax return is misstated.
- The tax official’s suspicions are unjustified.
 The quality control partner may engage another chartered accountant to review the
financial statements as well as the tax return to investigate the allegations leveled against
the client.

 If Financial Statements are Misstated:

- Quality control partner may ask the engagement partner to review the situation and
establish whether the financial statements need to be revised.
- Quality Control Partner may like to know whether the mistake could have been avoided
if the Quality control policies of the firm had been followed.
- If there is a lapse on the part of the firm’s employees, appropriate action would be taken
and the capacity of the reviewer would also be questioned.
- If the mistake was such that it could not have been detected using the standard audit
procedures of the firm, the firm’s policies and procedures may be reviewed to ensure
that weaknesses, if any, are properly addressed.
 If Tax Return are Misstated:
- If it is established that tax returns filed by NCC on behalf of the client are materially
misstated, then NCC should ensure that proper remedial actions (such as revision of
tax returns etc.) are followed subsequent to the discovery of misstatement.
- If the above actions are not taken by the client, the auditor should consider the firm’s
legal responsibilities.
 In the case of error in the financial statement or the tax return, quality control partner
would need to assess whether the error was made intentionally by the management.
AT A GLANCE
- If it is established that the misstatement was made intentionally the auditor would
need to review whether it would be appropriate to discontinue its relationship with
the client.
Internal audit services

A self-review threat might arise where an audit firm provides internal audit services to an audit client. The
following safeguards must be applied:
 the client being responsible for the internal audit activities (using a designated, preferably senior
management, employee) and acknowledging its responsibility for the system of internal controls.
 the client and audit committee approving the scope, risk and frequency of the work.
 the client being responsible for evaluating recommendations and deciding which are to be
SPOTLIGHT
implemented.
 the client evaluating the adequacy of the procedures performed.
 the findings and recommendations being reported to the audit committee or similar body.
In addition, the firm should consider whether such services should only be provided by individuals not involved
in the audit.
In the case of an audit client that is a public interest entity, a firm shall not provide internal audit services that
relate to:
 A significant part of the internal controls over financial reporting;
 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.
You are the partner in a firm of Chartered Accountants and presently following matters are
under your consideration:
Your firm has received request from a listed audit client to assess the quality of the internal
audit function and give recommendations as regards improving the structure of the internal
audit department and the quality of its staff.

Required:
Evaluate the above situation and identify threats, if any and related safeguards.
Tutorial Notes:
This is important to appreciate that since the work did not involve any management decision or
taking management responsibility, therefore it comes under the purview of allowed services under
the code of ethics and listing regulations.
 Solution:
Since the services comprise of reviews and recommendations (as quality assessment) for
improvement of the client's Internal Audit function and giving recommendations with respect
to improving the structure of the internal audit department and the quality of its staff, does not
seem to involve any management decision or taking management responsibility, therefore
these are the allowed services under code of ethics and listing regulations.
However, if it appears that the recommendations are binding on management which may be the
case if the management is not competent to evaluate the recommendations or exercise its own
judgment, then these services cannot be performed,
AT A GLANCE
An audit client of Akbar Ali & Co. has approached your firm for appointment as internal auditor.
Your firm and Akbar Ali & Co. Chartered Accountants have a common quality control
department and share common quality control policies and procedures.
Required:
Discuss the above scenario in the light of Code of Ethics assuming the said client is a public
interest entity.
Tutorial Notes:
Important point is to consider that the two firms were network firms and therefore each firm
would be subject to the same independence requirement while accepting an assignment involving
clients of the network firms, as would be applicable in case of its own clients.
SPOTLIGHT
 Solution:
Our firm and Akbar Ali and Company are Network firms due to common quality control
department and common quality control policies and procedures.
The firm shall be independent of the audit client of the network firms, also.
Therefore, the provision of internal audit services will create a self-review threat to
independence, in the same manner, as if the assignment was taken by the firm itself.
Since our client is a public interest entity, we shall not provide the internal audit services
relating to the following:
 A significant part of the internal controls over financial reporting.
 Financial accounting systems that generate information that is significant to the client’s
accounting records or financial statements on which the firm will express an opinion:
or
 Amounts or disclosures that are material to the financial statements on which the firm
will express an opinion.
The firm may accept the engagement except for the above mentioned internal audit service but
it should ensure that it does not get involved in management decision making.
If the firm gets involved in management decision making, the threat created would be so
significant that no safeguards would reduce the threat to an acceptable level.


Eagle Limited (EL) is an unlisted company and operates a chain of 30 restaurants. The
management has established effective internal controls especially over cash receipts and
payments to employees and suppliers. The internal audit department of EL has been playing an
important role in continuous evaluation and monitoring of these internal controls. However,
the chief internal auditor (CIA) has recently resigned along with his two assistants.
Your firm has been the auditor of Eagle Limited (EL) for the last many years. The CEO of EL has
approached your firm for help in resolving the situation and has proposed the following
alternatives:
i. EL would outsource its internal audit department to your firm.
ii. Your firm would recruit an individual for the position of CIA to fill the vacancy.
Inconsideration, EL would pay a fee equivalent to two months’ gross salary of the CIA.
iii. EL would recruit the CIA and your firm would provide audit staff on secondment for six
months to assist the CIA in understanding and accomplishing the tasks. The CEO has
showed his inclination to hire Mr. Kiwi, the manager responsible for the audit of EL.
Required:
AT A GLANCE
Comment on each of the above alternatives as follows:
Discuss the threat involved and explain the safeguards, if any, available to the firm which may
eliminate or reduce the threat to an acceptable level.
 Solution:
Alternative 1: Outsourcing of Internal Audit Department
A self-review threat may be created when a firm provides internal audit services to a financial
statement audit client.
When the firm undertakes the outsourcing of internal audit activities, any self-review threat
created may be reduced to an acceptable level by ensuring that there is a clear separation
between the management and control of the internal audit by client management and the
SPOTLIGHT
internal audit activities themselves.
The firm may accept this alternative if appropriate safeguards are put in place to reduce the
threat to an acceptable level. The safeguard may include the following:
i. The audit client is responsible for internal audit activities and acknowledges its
responsibility for establishing, maintaining and monitoring the system of internal
controls;
ii. The audit client designates a competent employee, preferably within senior
management, to be responsible for internal audit activities;
iii. The audit client, the audit committee or supervisory body approves the scope, risk and
frequency of internal audit work;
iv. The audit client is responsible for evaluating and determining which recommendations
of the firm should be implemented;
v. The audit client evaluates the adequacy of the internal audit procedures performed and
the findings resulting from the performance of those procedures by, among other
things, obtaining and acting on reports from the firm; and
vi. The findings and recommendations resulting from the internal audit activities are
reported appropriately to the audit committee or supervisory body.
vii. Internal audit services should be provided only by personnel not involved in the
financial statement audit engagement and with different reporting lines within the
firm.

Alternative 2: Recruitment of CIA on EL’s behalf

The recruitment of senior management for an assurance client, such as those in a position to
affect the subject matter information of the assurance engagement, may create current or future
self-interest, familiarity, and intimidation threats.
In any case, the firm should not make management decisions and the decision as to whom to
hire should be left to the client.
However, the firm could provide such services as:
i. Reviewing the professional qualifications of a number of applicants and providing
advice on their suitability for the post.
ii. producing a short-list of candidates for interview, provided it has been drawn up using
criteria specified by the assurance client.
However, a contingent fee charged by a firm creates self-interest and advocacy threats that
cannot be reduced to an acceptable level by the application of any safeguard. Accordingly, the
firm should not enter into any such fee arrangement.
Alternative 3: Providing audit staff on secondment to assist CIA
A self-review threat may be created when a firm provides internal audit services to a financial
AT A GLANCE
statement audit client. The firm can provide its staff on secondment to the client subject to the
application of safeguards given in alternative 1.
IT systems services
Where such services provided by the audit firm involve the design and implementation of Financial Information
Technology Systems (FITS) a self-review threat might arise. Without the following safeguards the Code
considers that this threat will probably be too significant for the work to be accepted:
 The client acknowledging its responsibility for the system of internal controls.
 The client designating a competent employee, preferably senior management, to be responsible for
management decisions in respect of the design and implementation of the system.
 The client making all such management decisions.
SPOTLIGHT
 The client evaluating the adequacy and results of the design and implementation of the system.
 The client being responsible for the operation of the system and the data generated by it.
In the case of an audit client that is a public interest entity, a firm shall not provide services involving the design
or implementation of IT systems that:
 form a significant part of the internal control over financial reporting; or
 generate information that is significant to the client's accounting records or financial statements on
which the firm will express an opinion.
You are the partner in charge of your Firm’s risk management department and in the said
capacity your responsibilities interlaid include advising the firm’s engagement partners
/managers on different aspects of the assurance and non-assurance services, in accordance with
the applicable regulatory and independence framework. You have been requested for guidance
on the following issues:
Crimson Limited, an unlisted audit client has engaged a software company to automate its
accounting and finance functions. The company wants to engage your firm to help in the
implementation of the system.
Required:
a) Advise the concerned partners/managers as regards the acceptance of the above
assignment.

b) Suggest possible modification in the scope or terms of engagement or possible

safeguards, if any, to avail the opportunities within permissible limits.
 Solution:
a) Since the company is unlisted, therefore accepting such an assignment is not altogether
restricted by ICAP’s code of ethics. However, provision of such services may create self-
review threat.
b) In order to address the issue of self-review threat the auditor should apply appropriate
safeguards i.e. ensure that:
 The client acknowledges its responsibility for establishing and monitoring the
system of internal controls.
 The client makes all management decisions with respect to the design and
implementation process.
 The client evaluates the adequacy and results of the design and implementation
of the system.
 The client is responsible for the operation of the system (hardware or software)
and the data used or generated by the system.
AT A GLANCE
 The team engaged on the assignment should be different from the team employed
on the audit engagement.
To evaluate the network security system of Babar Limited (BL), your firm had acquired the
services of a Systems Auditor. The Finance Director of BL has accused the Systems Auditor for
compromising information relating to the company’s customers and providing their contact
details to a competitor.
Required:
SPOTLIGHT
Tutorial Notes:
It is pertinent to remember that the allegation may or may not be true. Consequently, a
structured response is required assuming both alternates.
 Solution:
If the allegation by the client that the Systems Auditor has compromised the information
relating to the company’s customers is correct, retaining the employee would pose similar
threat at other clients also.
Therefore, we should immediately take the following actions:
a) Remove the Systems Auditor from all jobs till the matter is investigated and the
allegation is confirmed or refuted.
b) If the System Auditor is found guilty, he shall be dismissed immediately.
c) The above situation casts doubt about the firm’s recruitment and training policies.
These would need to be reviewed and re-evaluated.


Your firm has received a proposal from an audit client for implementation of a new IT system
which the company has acquired.
Required:
Tutorial Notes:
The fact to be remember is that the listed companies’ regulations clearly stipulate that
prohibited services include financial information technology system design and
implementation and such services can only be undertaken if the auditor conclude that it is not
significant to overall financial statements.
 Solution:
The listing regulations clearly stipulate that prohibited services by the auditors include financial
AT A GLANCE
information technology system design and implementation, significant to overall financial

statements.
However, if the auditor concludes that it is not significant to overall financial statements and is
therefore permissible under the listing regulations, the situation would need to be assessed
from the point of view of Code of Ethics, which states that:
The provision of services involving design and implementation of information systems that are
used to generate information forming part of financial statements may create a self-review
threat.
The self-review threat is likely to be too significant to allow the provision of such services to a
financial statement audit client unless appropriate safeguards are put in place ensuring that;
 The audit client acknowledges its responsibility for establishing and monitoring the
SPOTLIGHT
system of internal controls;

 The audit client designates a competent employee preferably in the senior
management cadre, with the responsibility to make all management decisions with
respect to the design and implementation of the hardware or software system;
 The audit client evaluates the adequacy and result of the design and implementation of
the system; and
 The audit client is responsible for the operation of the system (hardware or software)
and the data used or generated by the system.
Consideration should also be given to whether such non-assurance services should be provided
only by personnel not involved in the financial statement audit engagement and with different
reporting lines within the firm.
Litigation support services

Such services may include:
 acting as an expert witness
 calculating estimated damages
 assistance with document management and retrieval
and could create a self-review or advocacy threat, depending on the materiality of the amounts involved and
the subjectivity of the matter concerned.

Safeguards might include:

 the service not being performed by a member of the audit team
 the firm having policies and procedures such that an individual is prevented from making any
management decision on behalf of the client
 the involvement of independent experts.
You are the quality control partner in Wiew and Company, Chartered Accountants. You have
been assigned additional responsibilities for assessment of risks associated with the firm’s
existing and proposed clients. At present, the following matters are under your consideration:
JKL Limited, a listed audit client of your firm, has been in dispute with a supplier. JKL is of the
view that it has suffered losses on account of breach of contract by that supplier. JKL intends to
file a suit in a civil court and has asked you to estimate the amount of damages that may be
claimed and provide a detailed calculation thereof.
Required:
Discuss the categories of threats involved in above situation and advise the partners as regards
AT A GLANCE
Tutorial Notes:
A demarcation should be understood between litigation support services and legal services
before attempting this question.
 Solution:
JKL Limited:
i. A self-review threat may be created when the litigation support services provided to a
financial statement audit client include the estimation of the possible outcome and
thereby affects the amounts or disclosures to be reflected in the financial statements.
The significance of any threat created will depend on:
 The materiality of the amounts involved:
 The degree of subjectivity inherent in the matter concerned;
SPOTLIGHT
ii. Wiew and Company, should evaluate the significance of any threat created and, if the
threat is other than clearly insignificant, it should:
 Inform JKL that the decision with regard to the filing of suit and all allied
matters is at the sole discretion of its management.
 The employees on the assignment should be clearly advised, not to participate
in any managerial decision making.
 The professional on this assignment should not be involved in the assurance
engagement.
 The involvement of others, such as independent experts should be considered,
if necessary
Legal services
The threat will depend on the nature of the service, whether the provider is also a member of the assurance
team and the materiality of the matter. Safeguards are likely to include those listed under general non-audit
services above.
Acting for an audit client in the resolution of a dispute or litigation where the amounts involved are material
to the financial statements creates such significant an advocacy or self-review threat that the work should
not be taken on.
A partner or employee of the firm or the network firm shall not serve as General Counsel for legal affairs of an
audit client

Recruitment services
The recruitment services for an audit client may create a self-interest, familiarity or intimidation threat. The
level of the threat will depend on the role of the person to be recruited and the type of assistance sought. The
firm is prohibited from acting as a negotiator on the client’s behalf.
The firm is prohibited from providing recruitment services in relation to a director or senior management (such
as CFO) in a position to exert significant influence over the preparation of the financial statements.
For other roles, the firm may review CVs and draw up a short-list of candidates for interview but the decision
as to who is hired, determining salary and benefits must be made by the client.
You are the quality control partner in a medium size audit firm and have been asked to give your
views on the following situations:
Pentagon Limited, an unlisted assurance client, has requested your firm to assist them in the
recruitment of the Chief Financial Officer (CFO) of the company. While shortlisting the
candidates, it was found that the applicants include CFOs of two of your existing assurance
clients.
Required:
AT A GLANCE
Discuss the category of threat involved in above situation. Also explain the safeguards available
with the firm which may eliminate or reduce the threat to an acceptable level.
 Solution:
i. Recruitment of senior management may create current or future self-interest,
familiarity and intimidation threats.
ii. Applications from CFOs of existing assurance clients has also created a threat to
objectivity, as we perform services for these clients whose interests will be in conflict
with Pentagon in respect of appointment of CFO.
iii. The significance of the threat created should be evaluated and, if the threat is other than
clearly insignificant, safeguards should be considered and applied as necessary to
SPOTLIGHT
reduce the threat to an acceptable level.

iv. The safeguards available to the engagement partner are the following:
 The firm should not make management decisions and engagement should be
restricted to advising suitable qualification and making a list of suitable
candidates. The decision as to whom to hire should be left to the client.
 The use of separate engagement team
confidentiality.
You are the quality control partner of Nasir and Company, Chartered Accountants (NCC)and
presently following matter is under your consideration:
Josh Limited (JL), an unlisted audit client of your firm has approached your firm to recruit a
chartered accountant for the position of finance director in JL. In response to an advertisement
published in the newspaper, NCC received various applications which include individuals
working at some of your clients and some of your ex-employees.
Required:

Tutorial Notes:
Following points may be inadvertently missed while answering this question:
 Use of separate teams for audit and recruitment procedures.
 Confidentiality of the assignment and procedures to prevent access to confidential
information.
 Solution:
The recruitment of finance director for JL may result in self-interest, familiarity and intimidation
threat. The service to be provided shall not involve making management decision and the
decision as to whom to hire should be left to JL.
A threat to Objectivity will be created, because the recruitment team may become biased while
dealing with the applications of their former colleagues or if the recruitment team members
know the employees of the clients who have applied for the job.
Significance of threat should be evaluated and if the threat is other than clearly insignificant,
safeguards should be considered, which may include:
Use of separate engagement teams for the audit and recruitment procedure.
Procedures to prevent access to information (e.g. strict physical separation of audit and
AT A GLANCE
recruitment teams, confidential and secure data filing); and
Clear guidelines for members of the engagement team and recruitment teams on issues of
objectivity, confidentiality. The use of confidentiality agreements to be signed by employees and
partners of the firm
Kamal, a manager in the firm is assigned on deputation for training of the newly hired staff in
the accounts department of a brokerage house. The brokerage house is also an audit client of
your firm.
SPOTLIGHT
Required:
 Solution:
Supervising employees of assurance client in the performance of their normal recurring
activities may create self-review or self-interest threats.
The significance of threats should be evaluated and if the threat is other than clearly
insignificant, safeguards should be considered and applied as necessary to eliminate the threat
or reduce to an acceptable level. Such safeguards might include:
 Making arrangement so that personnel providing such services do not participate in
the assurance engagement;
 Involving an additional chartered accountant to advise on the potential impact of the
activities on the independence of the firm and the assurance team;
Corporate finance services

Certain types of corporate finance services may create such significant an advocacy or self-review threat that
the work should not be taken on. Audit firms should not:
 promote, deal in or underwrite an audit client’s shares
 commit an audit client to the terms of a transaction or complete a transaction on an audit client’s behalf

 provide advice which depends on a particular accounting treatment or presentation in the financial
statements (having a material impact) on which the firm will express an opinion
In other cases, safeguards, such as not making management decisions and using individuals who are not
members of the assurance team, should be considered.
You are a chartered accountant in practice. The following situations have arisen in connection
with two of your clients:
A multinational company (MNC) which is planning to establish a place of business in Pakistan
by forming a public limited company under the Companies Ordinance, 1984, has requested your
firm to provide the following services:
i. Receive the funds remitted by the MNC.
ii. Make disbursements in accordance with the instructions of the MNC.
Required:
Explain how you would meet your professional obligations and responsibilities while
carrying out the above assignment.
AT A GLANCE
 Solution:
i. While taking up the assignment, we should keep in mind the following:
 A chartered accountant in practice should not assume custody of client’s monies
unless permitted to do so by law.
 It creates a self-interest threat to professional behavior and may be a self-interest
threat to objectivity.
 To safeguard against such threats, we would:
¯ keep such monies separately from firm’s assets.
¯ use such money only for the purpose for which they are intended;
¯ at all times, be ready to account for these assets, and any income, dividends or
SPOTLIGHT
gains generated, to any persons entitled to such accounting.

¯ comply with all relevant laws and regulations relevant to the holding of and
accounting for such assets
 We should be aware of threats to compliance with the fundamental principles
through association of such assets. For example, money derived from illegal
activities. In order to safeguard against these threats, we should:
¯ make appropriate inquires about the source of such assets;
¯ consider their legal and regulatory obligations.
¯ seek legal advice.
ii. There is no bar to accepting this business as MNC is not our financial statements audit
client.
Your firm has been appointed as an advisor to Jupiter Limited (JL) an unlisted public company,
which is an assurance client of your firm. JL wants to dispose of its shares in Pluto Limited, to a
foreign buyer. As part of the assignment, your firm is required to act as an intermediary between
the foreign buyer and JL, negotiate the payment terms, receive payments on behalf of JL and
ultimately make disbursement to JL after the transfer of shares.
Required:
Identify the nature of threat(s) involved and explain how you would meet your professional
obligations and responsibilities while carrying out the above assignment.

Tutorial Notes:
“This question required the students to identify the threats involved when a chartered
accountant in practice acts as an intermediary between prospective buyers and the client,
negotiating payment terms, securing payments, etc. The students were expected to identify the
two main aspects giving rise to the threats, namely, the provision of advisory services (that may
result in self-review threat and threat to independence), and having custody of assets (resulting
in self-interest threats to professional behavior and objectivity).
There was a mixed response from students with some identifying both aspects and the related
threats and others identifying only one. However, almost all those who identified the threats
correctly were also able to state the professional responsibilities and procedures required from
the auditor.
Some students did not segregate their answers amongst the two issues and tried to provide a
combined answer which resulted in various errors and omissions”
 Solution:
AT A GLANCE
Acting as an intermediary between the perspective buyer and the client negotiating the
payment terms, making arrangements for securing payments and ultimately making
disbursements to the group of shareholders to a non-audit assurance client, will involve two
aspects, i.e.
i. Provision of advisory services
ii. Having custody of JL Assets
i. Provision of advisory services
Self-review threat and threat to independence would arise if services performed by
your firm affect the subject matter information of assurance engagement performed by
your firm.
SPOTLIGHT
The significance of threats created should be evaluated and if the threat is other than
clearly insignificant, safeguards should be considered and applied as necessary to
reduce it to an acceptable level, which may include:
 Policies and procedures to prohibit professional staff from making management
decision or assuming management responsibility for such decision.
 Discussing independence issues related to the provision of non-assurance
services and nature and extent of fees charged, with those charged with
governance, such as audit committee.
 Policies within the assurance client regarding the oversight responsibility for
provision of non-assurance services by the firm.
 Involving an additional chartered accountant to advice on the potential impact of
the non-assurance engagement on the independence of the member of the
assurance team.
 Involving an additional chartered accountant outside of the firm to provide
assurance on a discrete aspect of the assurance engagement.
 Obtaining the assurance client’s acknowledgement of responsibility for the
results of the work performed by the firm.
 Making arrangements so that personnel providing non-assurance services do not
participate in the assurance engagement.

ii. Having custody of JL Assets

While taking up the assignment, we should consider whether taking custody of client’s
assets is permitted by law. Even if the law allows, it will still create a self-interest threat
to professional behavior and may be a self-interest threat to objectivity.
To safeguard against the threats identified, we should,
 keep such money separately from firm assets;
 use such money only for the purpose for which they are intended;
 at all times, be ready to account for the money received, and any income, dividends
or gains generated, to any persons entitled to such accounting;
 comply with all relevant laws and regulations relevant to the holding of and
accounting for such assets.
We should be aware of threats to compliance with the fundamental principles through
association of such assets. For example, money derived from illegal activities. In order
to safeguard against these threats, we should:
 make appropriate inquiries about the source of such assets;
 consider their legal and regulatory obligations.
AT A GLANCE
 seek legal advice.
2.17 Safeguarding independence

The responsibility for safeguarding independence is shared between:
 the individual auditor (or audit practice) and
 the profession as a whole.
The responsibilities of individual auditors and audit practices
There should be a culture of independence and a belief in auditors’ independence that is shared by all partners
and employees in an audit firm.
SPOTLIGHT
Where possible, there should be rotation of the engagement partner (the partner in charge of the audit) and of
senior staff. Rotation means that an individual should not be involved in the annual audit of the same client
company for more than a maximum number of years.
In addition, an audit firm should have the following procedures in place:
 Appropriate training, including training in how to maintain an independent opinion during audit work.
 Quality control procedures. A firm should have procedures for quality control to ensure that
independence is considered in respect of all work undertaken by the audit firm.
 Consultation procedures. A firm should have internal procedures for consultation, whereby questions
arising in relation to independence can be discussed.
 If an auditor becomes aware of a situation that may be seen to threaten their independence,
appropriate action should be taken to resolve the issue. The action to be taken will depend on the
circumstances, but might include any of the following:
 It may be possible to remove the threat to independence by a simple action, such as not accepting an
offered gift or for an audit partner to dispose of shares that they hold in a client company, and so on.
 Sometimes, it may be necessary to reject a proposed appointment as auditor. For example, an audit
firm may have to reject its appointment as auditor of a new client company where the guidance on fee
income level would be breached (because the fee income from the client would exceed the maximum
limits established by the professional guidelines).
 With an existing client, if an independence issue cannot be resolved, the ultimate action is to resign
from the audit of the client.

The responsibilities of the profession

Professional bodies expect their members to comply with codes of conduct relating to independence and will
take disciplinary action as appropriate. Such action might lead to a fine, reprimand or exclusion from
membership.
The profession and other interested parties regularly suggest new practices and procedures designed to
improve auditor independence. Suggestions include:
 the regular rotation of auditors, to avoid too close a relationship developing between the auditor and
the client over a long period of time.
 the use of audit committees.
The responsibility for safeguarding independence is seen as shared between the individual auditor (or audit
practice) and the profession as a whole.
2.18 Period During which Independence is Required

Independence shall be maintained during both:
 The engagement period, which starts when the audit team begins to perform the audit; and
 The period covered by the financial statements.
AT A GLANCE
For recurring audits, independence is required until the notification by either party that the professional
relationship has ended or the issuance of the final audit report.
 Example: Period of independence
ZH Chartered Accountants have just accepted an audit of FMC Limited for 31 December 2020
and signed the audit acceptance in October 2020. The firm previously provided tax advice to
FMC on a tax matter in June 2020 and also seconded an advisory staff to their finance team for
a period of 4 months from April – July 2020.
This situation presents threats to independence (self-interest and self-review) due to provision
of non-assurance services to FMC during the period covered by the financial statements
(January – December 2020). Hence, appropriate safeguards, such as ensuring team members
SPOTLIGHT
provided non-assurance services are not part of the audit team, should be applied to mitigate
underlying threats.
2.19 Mergers and Acquisitions

In the current economic climate and due to continuing globalization, mergers and acquisitions are very
common. However, independence is threatened when an entity become a related entity of an audit client
because of a merger or acquisition. Threats are largely due to previous or current interests or relationships
between the firm and such a related entity. The firm is required to end any interests or relationships that are
not permitted by the Code, effective from the date of merger or acquisition.
However, as an exception, those charged with governance may allow the firm to continue with such interests
or relationships, subject to applying appropriate safeguards, but the interest or relationship must end no later
than six months from the merger or acquisition. Safeguards in this situation include:
 Require a CA to review the audit or non-assurance work as appropriate.
 Require an engagement quality control review from a CA independent of the firm.
 Engage another firm to evaluate the results of the non-assurance service or having another firm re-
perform the non-assurance service to the extent necessary to enable the other firm to take
responsibility for the service.


Identify and evaluate the threats involved and explain how these threats can be reduced to an
acceptable level, in following situation:
During the year, Jamil Limited (JL) had acquired Sarfraz Limited (SL) and the companies were
subsequently merged. The due diligence exercise for the acquisition was performed by the same
firm which carries out the annual audit of JL. At the time of planning, the auditor found that a
significant provision has been made against SL’s inventories and accounts receivables. The
management informed the auditor that the fact that the value of these assets was impaired came
to its knowledge after taking control of SL. JL and SL are unlisted public companies.
Tutorial Notes:
Be sure to also consider the advocacy threat and its impact.
 Solution:
Threats Faced:
i. Self-Review Threat:
Since judgments and conclusions reached during the due diligence exercise needs to be
AT A GLANCE
reviewed again for the purpose of the audit, there exists a self-review threat.
The situation is all the more complex on account of the fact that impairment in the value of
these assets could not be identified during the due diligence exercised.
ii. Advocacy Threat:
The auditor has an interest in concluding that no impairment has taken place and the
previous valuation (as per the due diligence exercise) was correct. Hence there is an
advocacy threat.
Safeguards:
On account of above threats, the staff who had participated in the due diligence work
should not be made part of the audit team.
SPOTLIGHT
Even if the audit is carried out by staff other than the staff who carried out the due diligence
exercise, the firm may take the following safeguards:
 Involve an additional chartered accountant to review the work done or otherwise
advise as necessary.
 Consult an independent third party such as a professional regulatory body.
 Involve another firm to perform or re-perform part of the engagement.
If the firm still wants to include the same team members, then besides the above
safeguards the following additional safeguards would be advisable:
 Not assigning work to team members (who had participated in the earlier
assignment) in the audit areas, which were connected with the due diligence
work.
 Reviewing their work carefully.
 Keeping the audit committee or those charged with governance of KL informed
about the inclusion of the members in the audit team that were involved in due
diligence.
 Assigning more senior staff to audit team than would be required if no such
impairment in the value of assets had occurred.


Zaheer Limited has approached your firm for transaction advisory services related to
acquisition of Javed Limited, which is your audit client.
Required:
 Solution:
Accepting of assignment from Zaheer Limited will result in conflict of interest, which will result
in threat to objectivity.
Significance of threat need to be evaluated and relevant safeguards should be applied to reduce
the threats to an acceptable level. Such safeguards may include:
 Implementing mechanisms to prevent unauthorized disclosure of confidential
information as the interests of the two clients may be are in conflict. This could include:
¯ Using separate engagement teams who are provided with clear policies and
procedures on maintaining confidentiality.
AT A GLANCE
¯ Creating separate areas of practice for separate functions within the firm, which
may act as a barrier to passing of confidential client information from one practice
area to another within a firm.
¯ Establishing policies and procedures to limit access to client files, the use of
confidentiality agreements signed by employees and partners of the firm and/or
the physical and electronic separation of confidential information.
 Obtaining consent from Javed Limited, relating to acceptance of assignment from ZL.
 Regular review of the application of safeguards by a senior individual not involved with
the two engagements.
 Requiring a chartered accountant who is not involved in providing the services or
otherwise affected by the conflict, to review the work performed to assess whether the
key judgments and conclusions are appropriate.
SPOTLIGHT
 Consulting with third parties, such as a professional body, legal counsel or another
Chartered Accountant.
2.20 Making referrals

An audit firm may enter into an arrangement with another entity, whereby the other entity agrees to pay a fee
to the audit firm for referring clients. For example, a software company may specialise in selling accounting
software packages or writing bespoke accounting software. It may enter into an arrangement with an audit firm
whereby the audit firm will receive a fee every time it refers a client to the software firm with a view to buying
a software package or software services.
This type of arrangement could create a self-interest threat for the audit firm. However, it is permissible,
provided that suitable safeguards are in place. Suitable safeguards might include the following:
 When making a referral, the audit firm should notify the client that it will receive a fee for the referral.
This means that the client will be made fully aware of the financial benefit for the audit firm.
 The audit firm should monitor the quality of the products or services provided. In the case of referrals
to a software company, this means having to keep the quality of the software packages and services
under review, to make sure that they meet appropriate standards. (It is important that audit clients
should not be referred to someone who provides poor-quality goods or services.)
 The firm should also obtain verification from all staff involved with the audit of a client who is referred,
that they do not personally have any financial interest in the company or other entity to which the
referrals are made.

Furthermore, a Chartered Accountant in public practice may purchase all or part of another firm on the basis
that payments will be made to individuals formerly owning the firm or to their heirs or estates. Such payments
are not generally regarded as commissions or referral fees.
clients. Presently the following matters are under your consideration:
One of your assurance clients has requested your firm to provide consultancy services in
relation to a proposed transaction with a company based in Singapore. As your firm does not
have the expertise to undertake that assignment, it is considering to refer the assignment to
Marvi & Company, Chartered Accountants. It is expected that your firm would receive a
commission of15% of the assignment fee from Marvi & Company.
Required:
Discuss the categories of threats involved in the above situation and advise the partners as
regards the possible course of action that may be followed.
 Solution:
AT A GLANCE
 The payment of such referral fee create a:

¯ self-interest threat to objectivity; and
¯ Self-interest threat to professional competence and due care.
 Before referring the assignment, your firm should disclose to the client about the
arrangement to receive a referral fee from Marvi & Company.
Your finance department has issued an invoice to Qamar Software Services (QSS) against
referral fees for recommending services of QSS to an assurance and a non-assurance client. Your
SPOTLIGHT
permission has been sought before sending the bill to QSS.

Required:
 Solution:
Qamar Software Services:
a) Receiving of a referral fees for referring the services of QSS to clients may create a self-
interest threat to objectivity, professional competence and due care.
b) (It should be ensured that the arrangement between Pirzada and Company, Chartered
Accountants and QSS, regarding referral fees, is fully disclosed to the clients.
2.21 Mini case studies

 Case study 1: Tahir and Shafique
A Pakistani audit firm, Tahir and Shafique, is faced with the following situations:
Situation 1
Mr Tahir is one of the audit firm’s partners. He and his wife have been invited by the managing
director of a private company, Entity X, to a weekend of celebrations in Dubai to mark the 20 th
anniversary of the incorporation of Entity X. Mr Tahir has been the engagement partner
throughout this time

Situation 2
The firm has been approached by the directors of Entity Y, with a view to being appointed as
auditors. One of the firm’s audit managers, Mr Kashif, is a company secretary of Entity Y,
although he takes no part in its management. His parents are the sole directors and
shareholders of Entity Y.
Situation 3
The finance director of Entity Z, a private limited company, has requested that only certain staff
are to be included on the audit team to prevent unnecessary interruption to the entity’s
accounting department during the audit. In particular, he has requested that Dawood, who has
been the accountant in charge of the audit for the last two years, be assigned to the audit and
that the team contain no new trainees.
Required
What threats to objectivity are present in each of these situations and how should the audit firm
deal with them?
 Answer
Situation 1
AT A GLANCE
The fact that Mr Tahir and his wife have been invited to a ‘free’ weekend in Dubai represents a
threat to the firm’s independence, because it would be perceived that they are too close to Entity
X and therefore not truly independent.
The offer should be refused as goods, services or hospitality should only be accepted when the
value is clearly insignificant, which it is not to Mr Tahir and his wife in this case.
Even if the invitation is declined, there is a potential problem with regard to the length of time
that Mr Tahir has been the engagement partner – 20 years. He is by now likely to be over-
familiar with the client, and may be too trusting and/or sympathetic. The firm should strongly
consider safeguards to independence in this situation such as rotating Mr Tahir away from this
engagement.
SPOTLIGHT
Situation 2
Mr Kashif takes no part in the management of Entity Y. However, if he is involved with the audit
there may be actual or perceived threats to his objectivity as his immediate family members, his
parents, are the directors of Entity Y.
The firm must ensure that Mr Kashif is not part of the audit team and is not in a position to
influence any members of the audit team. If this cannot be demonstrated, then the firm should
not accept the audit engagement.
Situation 3
The key ethical issues that arise in this situation are familiarity and possible intimidation.
There is a risk that if Dawood is assigned to the audit over too long a period he might become
unduly familiar with the client and its staff and lose his objectivity in relation to the assignment.
The finance director’s request could amount to intimidation if there is any question that the
audit would be withdrawn if the request was not complied with. Best practice is that audit firms
should not allow clients to dictate staffing issues as it is important that audit firms staff their
teams in the most appropriate way in terms of safeguarding against ethical threats, quality
control on the audit and technical expertise.
If the firm considers it not appropriate to comply with the finance director’s request, they
should not do so, while assuring them that if different staff are assigned, they are required by
professional standards to have obtained a good knowledge of the business and to be directed,
supervised and reviewed well, hopefully therefore causing minimum disruption to operations.

 Case study 2: Happy Days

Your firm is the auditor of Happy Days, an entity which provides hospitality packages at
racecourses around a single country. The managing director of Happy Days has suggested the
following to your managing partner:
 All members of the audit team are to be offered two free tickets to a major event at the
racecourse of their choice.
 Last year’s audit senior should be seconded to the organisation for a six-month period.
The current year’s audit is not yet underway.
Required
Discuss which, if any, of the above proposals would be acceptable to your firm (and if not state
why not), and set out the main safeguards, if any, which would be required.
 Answer
Free tickets – not acceptable. The ICAP Code states that gifts or hospitality should only be
accepted where the value is clearly insignificant (self-interest threat). This would be likely to be
a considerable “perk” for audit team members and, in any case, would not give an appearance
of independence.
AT A GLANCE
Secondment – acceptable with the following safeguards.

 The senior should not be involved in future audits (as there would be self-review and
familiarity threats) and also shouldn’t be involved with the results of the previous
audit.
 The composition of the current year’s audit team should be reviewed to ensure that the
secondee would not be likely to have significant influence over the members of that
team (through personal relationships) (familiarity and intimation threats).
 The secondee should not be in a position to influence management decisions and
management must take responsibility for all such decisions.
SPOTLIGHT

3 CONFIDENTIALITY AND CONFLICTS OF INTEREST

3.1 The basic principle
The ICAP Code of Conduct applies IFAC’s Code of Ethics regarding confidentiality. In both codes the duty of
confidentiality is a fundamental principle of professional behaviour that information obtained in the course of
professional work should not be disclosed to others or used unless:
 disclosure is permitted by law and consent has been obtained from the party to whom the duty of
confidentiality is owed; or
 disclosure is required by law; or
 there is a professional duty or right to disclose, when not prohibited by law.
Part of the rationale behind this requirement is that auditors need full and frank disclosure of information from
a client in order to carry out their duties. If the client is not assured of confidentiality of this information, they
may be unwilling to provide all relevant information to the auditor.
Each of these three situations is discussed in more detail below.
3.2 Recognised exceptions to the duty of confidentiality
AT A GLANCE
Disclosure permitted by law and authorised by the client or employer
 For example:
 when an auditor is asked to report to a bank in relation to compliance with a loan
covenant the auditor will seek the client’s authorisation before disclosing confidential
information to the bank;
 when an auditor is asked to report to a listing authority (stock exchange) in relation to
listing rules, again the auditor will seek the client’s authorisation before disclosing
confidential information to the listing authority.
Disclosure required by law
SPOTLIGHT
An ICAP member may be required by law to disclose confidential information to an appropriate legal authority.
In such circumstances the requirements of the law override the duty of confidentiality.
The ICAP Code of Conduct provides the following illustrations of when disclosure is required:
 Producing documents or other evidence in the course of legal proceedings; or
 Disclosure to the appropriate public authorities of infringements of the law that come to light.
One specific example is, where an ICAP member is required by law to make disclosure to the relevant legal
authorities if they know, or have reason to suspect that a client has committed money laundering.
Professional duty or right to disclose, when not prohibited by law

Disclosure of confidential information is also permitted when an accountant has a professional duty or right to
disclose, when not prohibited by law.
The ICAP Code of Conduct gives a number of illustrations of when this applies:
 To comply with the quality review of a member body or professional body.
 To respond to an inquiry or investigation by a member body or regulatory body.
 To protect the professional interests of a Chartered Accountant in legal proceedings (for example when
it is reasonably necessary to protect the interests of the member in making a defence against an official
accusation of professional negligence).
 To comply with technical standards and ethics requirements.

Other considerations
In deciding whether or not to disclose confidential information, Chartered Accountants should consider the
following points:
 Whether the interests of all parties, including third parties whose interests may be affected, could be
harmed if the client or employer consents to the disclosure of information by the Chartered Accountant;
 Whether all the relevant information is known and substantiated, to the extent that it is practicable;
when the situation involves unsubstantiated facts, incomplete information or unsubstantiated
conclusions, professional judgment should be used in determining the type of disclosure to be made, if
any; and
 The type of communication that is expected and to whom it is addressed; in particular, Chartered
Accountants should be satisfied that the parties to whom the communication is addressed are
appropriate recipients.
It is possible that a member may be in doubt as to whether they have a right or duty to disclose information.
Under such a circumstance they should seek legal advice or consult with ICAP for advice.
3.3 Improper use of information

An ICAP member should not use, or appear to use, confidential information gained in the course of professional
AT A GLANCE
work for their personal advantage or for the advantage of a third party.
 For example:
 A member should not deal in the shares of a client company in such a way that it might
seem that information obtained in a professional capacity has been used for their
personal advantage (so-called ‘insider dealing’).
 Where a member has confidential information from Client 1, which affects an assurance
report on Client 2, they cannot provide an opinion on Client 2 that they already know,
from this other source, to be untrue. If the member is to continue as auditor to Client 2,
they must carry out normal audit procedures to enable the same information to be
obtained from another source. Under no circumstances should there be any disclosure
of confidential information outside the firm. Ultimately the auditor may have to resign.
SPOTLIGHT
3.4 Confidentiality of working papers

An accountant’s working papers, which contain confidential client information, are the property of the
accountant and should not normally be made available to outside parties.
However, situations may arise where government agencies (for example, tax authorities) ask to see the
accountant’s working papers relating to a particular client. In such situations, the accountant should act in the
best interests of their client. If they feel that releasing the papers is in the best interests of their client, and the
client has no objections, then the papers should be made available. Ultimately, the tax authorities are likely to
have legislative powers to obtain the papers. Any lack of co-operation on behalf of the auditor or their client
may add to any existing suspicions.
Occasionally, the authorities may ask to see a sample of working papers from a firm of accountants but not in
relation to any particular client. This may occur when the authorities have doubts about the quality of the work
performed by that practice. Again, a ‘best interest’ approach should be adopted, allowing the authorities to
review the papers if the accountant judges that this is in the best interests of the practice and its clients.
An appropriate practical compromise may be achieved in this situation by arranging for an independent
accountant to review the work and issue a report to the authorities.
You have worked as a job in charge on the audit of financial statements of a multinational listed
company, engaged in pharmaceutical business. During the course of your audit, you became
aware of various facts and details about the company.

It was a long engagement for which you had to move out of the city of your residence.
Consequently, a number of people around you, including family, friends and colleagues, are
aware of the fact that you were job in charge on the said audit. Some of them are interested in
having certain information as discussed below:
a) One of your close relative has got an offer for appointment as director marketing of the said
client. He wants to be aware of the levels of remuneration at comparable positions in order
to negotiate his remuneration properly.
b) A manager in your firm (other than the engagement manager for the said client) has
inquired about the internal controls in place, in respect of a specific process. Assuming that
the same would be effective, he intends to recommend the same as best practice to a local
pharmaceutical client.
c) Your sister has asked you about the ingredients of a specialized nutritional product for
children, being marketed by the company, which she is using for her child. You are aware
of all the details about the said product, as you got the opportunity to perform tests on the
costing of that product.
d) One of your friends is working in the Ministry of Health, Government of Pakistan. He has
asked you as to whether the company has complied with certain statutory requirements.
You are aware of the fact that the company is not complying with the same and you have
already included the matter in the management letter. With reference to specific provisions
AT A GLANCE
of law, he has convinced you that it is his duty to enquire about the same, and you are
responsible to disclose the relevant information to the Ministry. He has also informed you
that in case of no response, you may be served with a legal notice.
e) Your younger brother intends to commence distribution business. He has asked you about
the rate of commission and volume rebates being allowed by the said client to its
distributors, as he wants to work out the feasibility of business.
f) Your father invests his surplus funds in the capital market. Being aware of the fact that
companies like that always have a five to ten year’s plan in place. He has asked you about
the trend of earnings per share of the said company for the last five years, and the expected
growth in the net profits for the next five years.
Required:
Discuss each situation to conclude as to whether or not you can provide the requisite
SPOTLIGHT
information and the extent to which the same can be disclosed without compromising the
professional ethics. Support your conclusions, with appropriate arguments.
 Solution:
a) Information requested can be disclosed, to the extent of the remuneration of the chief
executive, because in case of a public listed entity, it is public information.
b) The information related to executive directors is disclosed in the financial statements
on aggregate basis, hence it is not public and it would not be appropriate to disclose the
same.
c) You cannot provide him the information directly about his question, as according to the
code of ethics, the confidentiality is applicable even in case of colleagues within the
firm.
d) However, code of ethics does not restrict the professional accountant to use his/her
prior knowledge and experience, even on a new job. Accordingly, you can use your
knowledge as benchmarks, if you form your independent view that these are
appropriate for consideration as benchmarks.
e) Information can be disclosed to the extent to which the details are made public by the
company, which is a common practice and requirement of law in the nutrition sector.
f) According to the Code of Ethics, a professional accountant may be required to disclose
confidential information when:
 disclosure is permitted by law and is authorized by the client or the employer.

 disclosure is required by law. (For example in the course of legal proceedings

or disclosure to appropriate public authorities if infringement of law is
discovered.)
In case a written notice is received from the Ministry of Health, the relevant information
may be provided after ensuring that it is actually required by law. However, even in
such case, the client should at least be informed before sending the information.
g) You cannot provide any information.
h) Past information of earnings per share may be disclosed; as the same is public
information but future projections should not be disclosed as it is confidential
information of the entity.
3.5 Conflicts of interest
Conflicts between members and clients

ICAP members or firms should not accept or continue an engagement where there is a conflict of interest
between the member or firm and its client. The test is whether or not a “reasonable and informed third party”
would consider the conflict of interest as likely to affect the judgement of the member or the firm.
AT A GLANCE
Examples of this might be:

 when a CA is acting for two or more clients whose interests in relation to the matter are in conflict, such
as:
¯ acting for seller and buyer relating to same transaction
¯ representing two clients in the same legal matter
¯ preparing valuation for two parties who are in adversarial position with respect to the asset
 when a CA competes with the client i.e. interests relating to the matter are in conflict
 providing advice to an entity seeking to acquire an audit client, where the firm is privy to confidential
information during the audit relevant to the transaction
 advising a client to invest in a business in which the spouse of the CA has a financial interest
SPOTLIGHT
 advising a client on acquiring a business which the firm is also interested in acquiring
 the receipt of commission from a third party for the introduction of a client (for example, an accounting
firm may be paid a commission by another entity, such as a firm of brokers, for introducing the entity
to its client companies).
Safeguards
Accountant should have procedures in place to:
 identify possible conflict of interest situations
 evaluate the possible problem, and
 where necessary, take action to manage or avoid the conflict.
Possible procedures include the following:
 Review relationships with all clients on a regular basis.
 Take care to consider potential conflicts of interest when deciding whether or not to take on new
clients.
 If a potential conflict is identified, decide on an appropriate course of action. An appropriate course of
action may be any of the following:
¯ Notify the clients involved and discuss the matter with them.
¯ Set up ‘Chinese walls’ to manage the problem. A Chinese wall is set up by using different members
of staff on the assignments for each of the clients and locating them in different offices. The two
groups of staff act independently of each other and do not communicate with each other except in
an official capacity.

¯ Consider resigning (or declining the new engagement offered) in respect of one of the two
competing clients.
Conflicts between competing clients

A firm might act for two clients that are in direct competition with each other.
The firm has a professional duty of confidentiality and so will not disclose confidential information about one
client company to its competitor. Again, the test is whether a “reasonable and informed third party” would
consider the conflict of interest as likely to affect the judgement of the firm.
The approach that the accounting firm should take will be a matter of judgement and should reflect the
circumstances of the case. Where the acceptance or continuance of an engagement would materially prejudice
the interests of any client, the appointment should not be accepted or continued.
In other cases, possible safeguards might include the following:
 Giving careful consideration to whether or not it is appropriate to accept an assurance engagement
from a new client that is in direct competition with an existing client, it may be appropriate to decline
the offer from the potential new client.
 Careful management of the clients, for example by ensuring that different members of staff are used on
AT A GLANCE
the two engagements.
 Full and frank disclosure to the clients of the potential conflict, together with suitable steps by the firm
to manage the potential conflict of interest.
 Procedures to prevent access to information (such as physical separation of the teams and confidential
and secure data filing). Such an approach is known as creating “Chinese walls”.
 Establishing clear guidelines on security and confidentiality and the use of confidentiality agreements.
 Regular review of safeguards in place.
 Advising one or both clients to seek additional independent advice.
Disclosure and consent
SPOTLIGHT
A CA is required to exercise professional judgement to determine whether specific disclosure and explicit
consent are necessary to mitigate the threat created by the conflict of interest. Disclosures might be “General”,
such as a common commercial practice by the CA or “Specific”, such as only to the affected clients of the
circumstances of the particular conflict.
Members are encouraged to make disclosure or consent in writing. However, if these are not in writing, a CA
should sufficiently document the nature of the circumstances, safeguards applied, and consents obtained.
For situations where the client refuses to provide explicit consent to the CA to provide services, the professional
services or relevant relationships should be ended.
A CA shall remain alert to confidentiality when making disclosures or sharing information within the firm.
Confidentiality might be breached when seeking consent to perform:
 A transaction-related service for a client in a hostile takeover of another client of the firm.
 A forensic investigation for a client regarding a suspected fraud, where the firm has confidential
information from its work for another client who might be involved in the fraud.
When confidentially is breached, the firm shall only accept or continue an engagement if:
 The firm does not act in an advocacy role for any one client
 Adhere confidentiality between the engagement teams serving the two clients


You are the statutory auditor of two listed companies, Alpha Limited and Gama Limited. Both
the companies are in conflict with each other and involved in two major litigations.
Required:
Identify the threats involved in the above situation and also suggest related safeguards, if any.
 Solution:
A threat to objectivity or confidentiality may be created when a chartered accountant in practice
performs services for clients that are in dispute with each other.
Following safeguards should be considered and applied as necessary to eliminate or reduce the
threats to an acceptable level:
 The use of separate engagement teams.
 Procedures to prevent access to information (e.g., strict physical separation of such
teams, confidential and secure data filing).
 The use of confidentiality agreements signed by employees and partners of the firm.
 Regular review of the application of safeguards by a senior individual not involved with
relevant client engagement.
AT A GLANCE
 Having a chartered accountant who is not involved in providing the service review the
work performed to assess whether the key judgements and conclusions are
appropriate.
 Consulting with third parties, such as professional body, legal counsel, etc.
 Disclose the nature of conflict of interest and the related safeguards to the clients in
litigation.
 Where a conflict of interest poses a threat to one or more of the fundamental principles,
including objectivity, confidentiality or professional behavior, that cannot be
eliminated or reduced to an acceptable level through the application of safeguards, the
chartered accountant may withdraw from the engagement.
SPOTLIGHT
(a) Dynamic (Private) Limited (DPL) is a client of your firm. At the finalization stage of annual
audit, it was discovered that a senior member of the assurance team is the co-owner of a
property, for the possession of which DPL has filed a legal case. On investigation, the
member informed that the said case is pending for the last three years and he did not
consider necessary to disclose it at the time of commencement of audit.
Required:
Discuss the matters that should be considered and the course of action which may be
followed in the above situation.
(b) Murree Limited (ML) and Bhurban Limited (BL) are listed assurance clients of your firm. BL
has filed a claim of Rs. 50 million in the court in respect of low quality of goods delivered by
ML. Upto last year ML had not acknowledged the claim of BL. However, in the planning
phase, you were informed by ML’s management that in order to avoid bad reputation in the
market and to continue its business relationship with BL, ML intends to settle the dispute
by making a payment of Rs. 20 million to BL. The debt of Rs. 50 million is fully provided in
the books of BL.
Required:
Being the auditor of both the companies, identify and evaluate the threats for the firm and
explain how these can be reduced to an acceptable level.

Tutorial Notes:
a) According to the situation given in this part, litigation between the client and a senior
assurance team member was discovered during finalization stage of the audit. On
inquiry, the concerned member had informed that he knew of the litigation but did not
consider it necessary to disclose it. The candidates were required to discuss the matter
and specify the course of action that the firm may adopt.
Most of the students were able to identify the related threats, discuss the significance
of the threat and the measures to mitigate such threat. However, very few of them could
look beyond that. They did not realize that the possible reason for failure of the
assurance team member to disclose the fact was important. His statement that he didn’t
felt the need to disclose this information was indicative of the fact that the firm had no
policy in this regard or this policy was not clearly stated or communicated to the staff.
This aspect was not covered by majority of the students.
b) According to the situation given in this part of the question, a firm was the auditor of
AT A GLANCE
two listed companies. One of the companies had filed a claim of Rs. 50 million against
the other company for supply of low quality products.
The performance in this part was good as majority of the candidates were able to fulfil
the requirement of identifying the related threats and the measures to mitigate such
threats. Many candidates secured full marks also.
 Solution:
a) When litigation takes place, or appears likely, between the firm or a member of the
assurance team and the assurance client, a self-interest or intimidation threat may be
created. The significance of the threat created will depend upon materiality of the
litigation. In this regard, the following steps may be undertaken:
 Disclosing to the audit committee or others charged with governance, the extent
SPOTLIGHT
and nature of litigation.
 Involving an additional chartered accountant in the firm who was not a member
of the assurance team to review the work done or otherwise advise as necessary.
If the assurance team member knew about the suit filed and he does not disclose the
fact to the firm then, it raises questions related to independence and integrity of the
assurance team member, and possible course of action, in additions to the steps taken
above may include:
 If the employee avoided declaring his interest by making an incorrect declaration,
appropriate action should be taken against him as per the firm’s policies.
 If no such declaration is required under the firm’s policies, then the QCR policies
of the firm need to be reviewed and revised appropriately.
 Assurance member’s argument that he did not consider it necessary to disclose
the matter is indicative of deficiency in the training program of the firm and needs
improvement.
b) A threat to objectivity or confidentiality may be created when a chartered accountant
in practice performs services for clients that are in dispute with each other. Significance
of threats should be evaluated, if threats are other than clearly insignificant, following
safeguards should be considered and applied as necessary to eliminate them or reduce
them to an acceptable level:

 Notifying the client of the firm’s business interest or activities that may represent
a conflict of interest and obtaining their consent to act in such circumstances;
 Notifying all known relevant parties that the chartered accountant in practice is
acting for two parties in respect of a matter where their respective interests are
in conflict, and obtaining their consent to do so;
 Notifying the client that the chartered accountant in practice does not act
exclusively for any one client in the provision of proposed services and obtaining
their consent to so act;
confidentiality;
 The use of confidentiality agreements signed by employees and partners of the
firm;
AT A GLANCE
 Regular review of the application of safeguards by a senior individual not involved

with relevant client engagement.
 Where a conflict of interest poses a threat to one or more of the fundamental
principles, including objectivity, confidentiality or professional behavior, that
cannot be eliminated or reduced to an acceptable level through the application of
safeguards, the chartered accountant may resign from the engagement.
SPOTLIGHT

4 CORPORATE FINANCIAL ADVICE

4.1 Advising clients involved in take-over bids or share issues
Auditors are often asked to give corporate finance advice. However, as you saw earlier, certain types of
corporate finance services may create such significant advocacy and self-review threats that the work should
not be taken on, such as:
 promoting, dealing in or underwriting an assurance client’s shares
 committing an assurance client to the terms of a transaction or completing a transaction on an
assurance client’s behalf.
Where clients are involved in a contested take-over bid, the auditors could find themselves in a position where
they are potentially acting for both parties.
In this situation:
 there is a danger that the firm cannot give objective professional advice in the best interests of both
parties (a possible lack of independence)
 the firm may be in possession of confidential information relating to each party, with a risk that the
information may inadvertently become available to the other party (a possible breach of
AT A GLANCE
confidentiality).
 Guidelines in this area are as follows:
 There is no reason, in principle, why firms should not act for both parties when a contested takeover
bid occurs. However, a firm should not be the sole or main advisor to both parties.
 If the accountants are in possession of material confidential information and feel that their position in
this respect is questionable, they should take advice from the appropriate financial regulatory authority
(for example, the stock exchange involved in the take-over or the national regulator of the financial
markets).
Similar conflicts of interest may arise in connection with issues of shares to the public, because the accountants
may be advising both the company issuing the shares and potential investors (such as companies interested in
buying an investment in the shares or investment institutions).
SPOTLIGHT

5 RESPONDING TO NON-COMPLIANCE WITH LAWS AND REGULATIONS

Non-compliance with laws and regulations (NOCLAR) comprises acts of omission or commission, intentional or
unintentional, which are contrary to the prevailing laws or regulations committed by the entity’s
management/directors/those charged with governance.
A chartered accountant might encounter or be made aware of non- compliance or suspected non-compliance
when providing a professional service to a client. A self-interest or intimidation threat to compliance with
the principles of integrity and professional behavior is created when a CA becomes aware of non-compliance or
suspected non-compliance with laws and regulations.
Laws and regulations that a CA is required to consider are:
 Those laws and regulations that have a direct effect on the determination of material amounts and
disclosures in the client’s financial statements; and
 Other laws and regulations whose compliance is fundamental to the operating aspects of the client’s
business, or to its ability to continue its business, or to avoid material penalties.
5.1 Actual or suspected non-compliance

If during an audit a CA becomes aware of NOCLAR issue (actual or suspected), the CA should obtain an
AT A GLANCE
understanding of the nature and circumstances in which the non-compliance (actual or suspected) has occurred
or might occur. While a CA is expected to apply knowledge and expertise and exercise professional judgement,
whether an act constitutes a NOCLAR is ultimately a matter to be determined by a court or other appropriate
adjudicative body.
A CA can follow steps when actual or suspect non-compliance has or might occur:
 Consult, on a confidential basis, with others within the firm (quality and risk staff), with ICAP, or with
legal counsel.
 Discuss the matter with the appropriate level of management (usually at least one level above the
individual or individuals involved or potentially involved in the matter) and those charged with
governance.
 Discuss the matter with internal auditors or risk managers, where appropriate.
SPOTLIGHT
5.2 Management’s action

Management and those charged with governance are responsible to take appropriate and timely action in
responding to the non-compliance. A CA shall assess the appropriateness of the response of management and
those charged with governance in dealing with the non-compliance.
In situations where a CA has no confidence in the integrity of management and those charged with governance
(such as when management is involved or had knowledge of non-compliance and did not take any action), the
member should:
 Disclose the matter to an appropriate authority even when there is no legal or regulatory requirement
to do so.
 Withdraw from the engagement and the professional relationship, where permitted by law or
regulation.
The Code permits the predecessor auditor to provide all relevant facts and other information concerning the
identified or suspected non-compliance to the incoming auditor even where the client fails or refuses to grant
the predecessor accountant permission to discuss the client’s affairs with the proposed auditor, unless
prohibited by law or regulation.

5.3 Disclosure of non-compliance

A CA should determine whether to disclose the matter to an appropriate authority. This determination depends
on the nature and extent of the actual or potential harm that is or might be caused by the matter to investors,
creditors, employees, or the general public. Disclosure may be warranted in situations such as:
 The entity is engaged in bribery
 The entity is regulated, and the matter is of such significance as to threaten its license to operate
 The entity is listed, and non-compliance might result in adverse consequences to trading
 The entity may sell harmful products to public
 The entity is involved in evading taxes
The fundamental principle of confidentiality prohibits disclosure of confidential information acquired as a
result of professional and business relationships outside the firm without proper and specific authority, unless
there is a legal or professional duty or right to disclose. However, in situations where a CA determines that
disclosure of the non-compliance to an appropriate authority is an appropriate course of action, that disclosure
is permitted pursuant to the confidentiality requirements of the Code. When making such disclosure, the CA
shall:
 act in good faith
AT A GLANCE
 exercise caution when making statements and assertions
 consider whether it is appropriate to inform the client before disclosing the matter.
 Linking ethical code with the ISAs
It is vital to consider the requirements of ISA 250 “Consideration of Laws and Regulations in an
Audit of Financial Statements” to understand what the auditor’s duty in regard to laws and
regulations relevant to the financial statements audit. Furthermore, it is also important to
consider the requirements of ISA 260 “Communication with Those Charged with Governance” to
establish when and what matters are required to be communicated to directors and those
charged with governance, including actual or suspected instances of non-compliance.
SPOTLIGHT

6 PAIB REQUIREMENTS FOR CHARTERED ACCOUNTANTS IN PRACTICE

The Code prescribes Professional Accountants in Business (PAIB) ethical requirements to those chartered
accountants working in public practice/audit firms in the capacity of employees. Examples of situations in
which PAIB provisions in the Code apply to a chartered accountant in practice include:
 Facing a conflict of interest when being responsible for selecting a vendor for the firm when an
immediate family member of the accountant might benefit financially from the contract. The
requirements and application material relating to conflict (s210) of interest apply in these
circumstances.
 Preparing or presenting financial information for the accountant’s client or firm. The requirements and
application material relating to preparing and presentation of financial statements (s220) apply in
these circumstances.
 Being offered an inducement such as being regularly offered complimentary tickets to attend sporting
events by a supplier of the firm. The requirements and application material relating to inducements,
including gifts and hospitality (s250) apply in these circumstances.
Facing pressure from an engagement partner to report chargeable hours inaccurately for a client engagement.
The requirements and application material relating to pressure to breach the fundamental principles (s270)
apply in these circumstances.
AT A GLANCE
SPOTLIGHT

CHAPTER 4
APPOINTMENT OF AN AUDITOR AND

THE PLANNING PHASE
AT A GLANCE
IN THIS CHAPTER: ISA-210 deals with the auditor’s responsibilities in agreeing the
terms of the audit engagement with management and those
AT A GLANCE charged with governance, including establishing that certain
preconditions for an audit, responsibility for which rests with
SPOTLIGHT management and those charged with governance, are present.
AT A GLANCE
ISA-220 deals with the specific responsibilities of the auditor
1. Agreeing the Terms of Audit regarding quality control procedures for an audit of financial
Engagements (ISA 210) statements. It also addresses, where applicable, responsibilities
of the engagement quality control reviewer
2. Quality Control for an Audit of
Financial Statements (ISA 220) ISQC 1 deals with a firm’s responsibilities for its system of
quality control for audits and reviews of financial statements,
3. Quality Control for Firms and other assurance and related services engagements.
(ISQC-1) IAASB developed the Framework for Audit Quality which it
launched in February 2014. The Framework describes in a
4. The IAASB’s Framework for holistic manner the different elements that create the
Audit Quality environment for audit quality at the engagement, firm, and
SPOTLIGHT
national levels, as well as relevant interactions and contextual
5. Quality Control Review (QCR) factors
Framework by ICAP
ISA-300 deals with the auditor’s responsibility to plan an audit
6. Planning an Audit of Financial of financial statements. This ISA is written in the context of
Statements (ISA 300) recurring audits. Additional considerations in an initial audit
engagement are separately identified.
7. Changes in a professional This chapter also deals with the situations where a Chartered
appointment Accountant is asked to assume a position that was being held by
another existing Chartered Accountant in an entity and
8. Obtaining and charging for encompasses the communication between these accountants as
professional work per Code of Ethics 2019.

CHAPTER 4: APPOINTMENT OF AN AUDITOR AND THE PLANNING PHASE CFAP 6: AARS
1. AGREEING THE TERMS OF AUDIT ENGAGEMENTS (ISA 210)

1.1 Preconditions for an Audit (Ref: 6-8, A2-A21)
a) Determine whether financial reporting framework to be applied in the preparation of the financial
statements is acceptable; and
Factors relevant to auditor's determination of acceptability of financial reporting framework are:
 Nature of entity (e.g. business enterprise or not-for-profit)
 Purpose of financial statements (e.g. General purpose financial statements or Special Purpose financial
statements)
 Nature of financial statements (e.g. complete set of financial statements or a single financial statements);
and
 Whether law or regulation prescribes applicable financial reporting framework.
Deficiencies in applicable financial reporting framework may be encountered after acceptance of audit
engagement. Management may decide to adopt another framework that is acceptable.
 Jurisdictions not having standards setting organizations or prescribed financial reporting framework
AT A GLANCE
(Appendix 2)
 When these accounting conventions are widely used in that particular jurisdiction,
accounting profession in that jurisdiction may consider acceptability of financial
reporting framework on behalf of the auditors.
 Auditor may also make determination by considering whether accounting conventions
exhibit following attributes:
¯ Relevance
¯ Completeness
¯ Reliability
¯ Neutrality
SPOTLIGHT
¯ Understandability
 Auditor may also compare accounting conventions with an existing acceptable financial
reporting framework (e.g. IFRS)
 Collection of accounting conventions devised to suit individual preferences is not an
acceptable financial reporting framework for general purpose financial statements.
 Compliance framework will not be an acceptable financial reporting framework, unless
it is generally accepted in particular jurisdictions by preparers and users.
You are a partner in a firm of chartered accountants. Your firm has recently been approached by
an off-shore entity incorporated in British Virgin Island for appointment as an auditor for the
year ending 30 September 2019. The entity is following locally developed accounting standards
in the preparation of its financial statements.
On your query regarding availability of records and information, the entity has informed you that
they will electronically send the scanned copies of the records/information required for the audit
purpose.
Required:
Discuss the matters that your firm should consider before accepting the above audit engagement.

CFAP 6: AARS CHAPTER 4: APPOINTMENT OF AN AUDITOR AND THE PLANNING PHASE
Tutorial Notes:
 The answer to this question should comprise of three main components which are client
acceptance procedure, acceptability of financial reporting framework and
appropriateness of audit evidence in electronic form. A typical mistake could be focusing
on one aspect of the question and ignoring the rest.
 Answering that the framework is acceptable without discussing how to assess its
acceptability would not be a right course of action.
 Solution:
The firm needs to consider the following before accepting the appointment as the auditor of an
off-shore entity:
Client acceptance procedures:
 Consider whether local laws allow to audit an off-shore entity.
 Consider whether laws of BVI permits audit by an auditor registered outside BVI.
 Inquire from the prospective client the reasons for not appointing an auditor from BVI.
 Perform the following client screening procedures:
¯ Determine whether acceptance would create any threats to compliance with the
AT A GLANCE
fundamental principles. Potential threats to integrity or professional behavior may
be created from, for example, questionable issues associated with the client (its
owners, management or activities), client involvement in illegal activities (such as
money laundering), dishonesty or questionable financial reporting practices.
¯ Consider whether the audit team will have sufficient knowledge of the applicable
financial reporting framework and the laws and regulation of BVI. A self-interest
threat to professional competence and due care is created if the engagement team
does not possess, or cannot acquire, the competencies necessary to properly carry
out the engagement.
 Obtain professional clearance letter from the predecessor auditor.
Acceptability of financial reporting framework:
Consider the following for determining the acceptability of the financial reporting framework:
SPOTLIGHT
 Nature of the entity
 Purpose of the financial statements
 Nature of the financial statements
 Whether law or regulation prescribes the applicable financial reporting framework.
 Whether it is a general purpose financial statements or special purpose financial
statements.
 Whether it is a compliance framework or fair presentation framework
The framework/accounting conventions being used by the entity needs to be sorted out for
relevance, completeness, reliability, neutrality and understandability.
The accounting conventions used by the entity may be compared with the requirements of an
existing financial reporting framework considered to be acceptable such as IFRS. If there are
differences identified in accounting conventions being used and an acceptable reporting
framework, the reasons of differences need to be analyzed and assess whether application of
accounting conventions as reporting framework would make financial statements misleading.
Sufficiency and appropriateness of audit evidence in electronic form:
In order to undertake the audit, the firm will ensure that sufficient and appropriate audit
evidence can be obtained through application of audit procedures designed. ISA 500 on audit
evidence specifies that evidence obtained through original documents is more reliable than
provided by photocopies or otherwise transformed into electronic form.

Furthermore, all audit evidence cannot be obtained from scanned copies of documents. For some
of the audit procedures physical presence is required, such as for procedures related to
inspection, observation, etc.
b) Agreement of responsibilities of management (premise)

If premise is not present, auditor will be unable to obtain sufficient appropriate audit evidence. Auditor may need
to explain the importance of these matters, and implications for auditor's report.
1. Preparation of financial statements in accordance with the applicable financial reporting framework.
Preparation includes presentation.
2. As accounting books and records are an integral part of internal control as defined in ISA 315, no specific
reference is made to them. To avoid misunderstanding, it may be appropriate for auditor to explain to
management scope of this responsibility.
3. To provide the auditor with:
 Access to all information;
 Additional information that the auditor may request
 Unrestricted access to persons within the entity
4. If preconditions are not present, auditor shall discuss the matter with management.
AT A GLANCE
5. Auditor shall not accept audit engagement, unless required by law or regulation to do so.
6. If management/those charged with governance impose a scope limitation of pervasive nature (requiring
to disclaim opinion), auditor shall not accept engagement, unless required by law or regulation to do so.
1.2 Agreement on Audit Engagement Terms (Ref: 9-12, A22-A29)
Principal contents:
1. Objective and scope of audit;
2. Responsibilities of the auditor;
3. Responsibilities of management;
4. Identification of the applicable financial reporting framework for the preparation of financial
SPOTLIGHT
statements; and
5. Reference to expected form and content of any reports to be issued by auditor and a statement that
deviations may be expected from its expected form and content.
Optional Contents – Judgment required

1. Elaboration of scope of audit + reference to applicable legislation, regulations, ISAs etc.
2. Form of any other communication of results.
3. Requirements for the auditor to communicate Key Audit Matters (KAM) as per ISA-701
4. Fact that because of inherent limitations of audit & internal control, there is risk that some
misstatements may not be detected, even though audit is properly planned & performed
5. Arrangements regarding planning and performance of audit, team including composition
6. Expectation that management will provide written representation
7. Agreement of management to make available to auditor draft financial statements and any
accompanying other information on timely basis.
8. Agreement of management to inform auditor of facts that may affect financial statements during date of
auditor's report to date of issuance of financial statements
9. Basis on which fees are computed and any billing arrangements.
10. Request for management to acknowledge receipt of audit engagement letter and agree.

Additional Contents (If relevant)

1. Arrangements about involvement of other auditors and experts.
2. Arrangements concerning the involvement of internal auditors and other staff of the entity.
3. Arrangements to be made with predecessor auditor (initial audit)
4. Any restriction of auditor's liability when such possibility exists.
5. A reference to any further agreements between auditor and entity
6. Any obligations to provide audit working papers to other parties.
AUDITS OF COMPONENTS
When auditor of a parent entity is also auditor of a component, the factors that may influence the decision
whether to send a separate audit engagement letter to component include the following:
1. Who appoints the component auditor;
2. Whether a separate auditor's report is to be issued on component;
3. Legal requirements in relation to audit appointments;
4. Degree of ownership by parent; and
5. Degree of independence of component management from parent.
AT A GLANCE
1.3 Recurring Audits (Ref: 13, A30)
Auditor may decide not to send a new audit engagement letter or other written agreement each period. However,
following factors may make it appropriate to revise terms or to remind the entity:
1. Any indication that entity misunderstands the scope of audit.
2. Any revised or special terms of the engagement.
3. A recent change of senior management.
4. A significant change in ownership.
5. A significant change in nature or size of entity's business.
6. A change in legal or regulatory requirements.
SPOTLIGHT
7. A change in the financial reporting framework adopted in preparation of financial statements.
8. A change in other reporting requirements.
1.4 Acceptance of a Change in the Terms of the Audit Engagement (Ref: 14-17, A31-A35)
Request to Change the Terms of the Audit Engagement

1. Such request may result from a:
 Change in circumstances affecting the need for the service;
 A misunderstanding as to nature of an audit as originally requested; or
 A restriction on scope of the audit.
2. Auditor shall not agree to such change where there is no reasonable justification for such.
3. Reason 1 & 2 may be considered a reasonable basis.
4. Not be considered reasonable if change relates to incorrect or unsatisfactory information.
Request to Change to a Review or a Related Service

1. Auditor shall determine whether there is reasonable justification.
2. Auditor may need to assess any legal or contractual implications.

3. Audit work performed till date of change may be relevant to new engagement. But changed report would
not include reference to:
 Original audit engagement; or
 Any procedures till date, except where audit is changed to agreed-upon procedures.
4. Auditor and management shall agree on and record new terms of engagement.
5. If auditor is unable to agree and is not permitted to continue the audit, auditor shall:
 Withdraw from audit engagement, where possible under applicable law or regulation.
 Determine whether there is any obligation to report the circumstances to other parties e.g.
those charged with governance/owners/regulators.
1.5 Additional Considerations in Engagement Acceptance (Ref: 18-21, A36-A39)
Financial Reporting Standards Supplemented by Law/Regulation

1. Auditor shall determine whether there are any conflicts between standards and the requirements of
Law.
2. If conflict exist, auditor shall agree with management whether:
 Additional requirements can be met through additional disclosures in financial statements; or
AT A GLANCE
 Description of applicable financial reporting framework in financial statements can be amended

accordingly.
3. If neither of the above actions is possible, auditor shall determine implications of ISA 705.
A regulatory body has recently revised certain requirements pertaining to the information to be
disclosed in the financial statements of one of your existing clients. These requirements may be
in conflict with the financial reporting framework being followed by the client.
You have informed the client that in view of the possible conflict, the audit report may require a
modification. However, the client has expressed its reservations over the issue and requested
you to avoid modifying the report.
SPOTLIGHT
Required:
Based on the requirements of the relevant International Standards on Auditing draft an
appropriate response to the client, explaining the possible reasons for modification and the
circumstances in which such a modification may be avoided.
Tutorial Notes:
Students should have a sound grip on the concept of framework. Presentation and writing skills
are much needed in answering this question. Students should use the suggested answers to really
understand as to how such questions are required to be dealt with. The primary requisite is the
knowledge of the related standard whereas good presentation and writing skills are also
essential in answering such questions.
 Solution:
Dear Sir,
If there is a conflict between the new requirements introduced by the regulatory body and the
existing financial reporting framework we will have to assess the situation and proceed in the
following manner:
a) If the compliance with additional requirements can be met through additional
disclosures, you shall be required to incorporate the additional disclosures in the

b) as the external auditor we shall ensure the adequacy of the disclosures.

c) If the additional requirements cannot be met with the additional disclosures, you will
need to amend the description of applicable financial reporting framework mentioned
in the Statement of Compliance in Policy notes of the financial statements
d) In case you don’t agree with incorporating additional disclosures or the amendment of
the description of the applicable financial reporting framework, then in this case we may
require modifying our opinion in accordance with the applicable International Standard
on Auditing.
We hope that the above points will clarify your concerns relating to the compliance with the
additional requirements, introduced by the regulatory body and the possible reasons due to
which we may need to modify our opinion.
Yours faithfully,
XYZ and Company, Chartered Accountants
Financial reporting framework Prescribed by Law or Regulation

1. If auditor determine that such framework would be unacceptable, but as it is prescribed by law, auditor
shall accept audit engagement only if the following conditions are present:
AT A GLANCE
 Management agrees to provide additional disclosures to avoid financial statements being
misleading; and
 It is recognized in terms of the audit engagement that:
¯ Report will have an “Emphasis of Matter paragraph” referring additional disclosures.
¯ Opinion will not include phrases like "present fairly, in all material respects," or "give a true
and fair view" in accordance with applicable financial reporting framework
2. If above 2 conditions are not present auditor shall:
 Evaluate the effect of the misleading nature of financial statements on the auditor's report; and
 Include appropriate reference to this matter in the terms of the audit engagement.
SPOTLIGHT
Auditor's Report Prescribed by Law or Regulation
1. If wording of report is significantly different from requirements of ISAs, auditor shall evaluate:
 Whether users might misunderstand the assurance obtained from audit and, if so,
 Whether additional explanation in report can mitigate possible misunderstanding.
2. If auditor concludes that additional explanation cannot mitigate possible misunderstanding, auditor
shall not accept the engagement, unless required by law or regulation.
3. Such an audit does not comply with ISAs. Accordingly, auditor shall not include any reference to audit
having been conducted in accordance with ISAs.
 Appendix 1 - Example of an Audit Engagement Letter
To the appropriate representative of management or those charged with governance of ABC
Company:
[The objective and scope of the audit]
You have requested that we audit the financial statements of ABC Company, which comprise the
balance sheet as at December 31, 20X1, and the income statement, statement of changes in equity
and cash flow statement for the year then ended, and a summary of significant accounting
policies and other explanatory information. We are pleased to confirm our acceptance and our
understanding of this audit engagement by means of this letter. Our audit will be conducted with
the objective of our expressing an opinion on the financial statements.

[The responsibilities of the auditor]

We will conduct our audit in accordance with International Standards on Auditing (ISAs). Those
standards require that we comply with ethical requirements and plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free from material
misstatement. An audit involves performing procedures to obtain audit evidence about the
amounts and disclosures in the financial statements. The procedures selected depend on the
auditor’s judgment, including the assessment of the risks of material misstatement of the
financial statements, whether due to fraud or error. An audit also includes evaluating the
appropriateness of accounting policies used and the reasonableness of accounting estimates
made by management, as well as evaluating the overall presentation of the financial statements.
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 ISAs.
In making our risk assessments, we consider internal control relevant to the entity’s preparation
of the financial statements 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
entity’s internal control. However, we will communicate to you in writing concerning any
significant deficiencies in internal control relevant to the audit of the financial statements that
AT A GLANCE
we have identified during the audit.

[The responsibilities of management and identification of the applicable financial reporting
framework (for purposes of this example it is assumed that the auditor has not determined that
the law or regulation prescribes those responsibilities in appropriate terms; the descriptions in
paragraph 6(b) of this ISA are therefore used).]
Our audit will be conducted on the basis that [management and, where appropriate, those
charged with governance] acknowledge and understand that they have responsibility:
a) For the preparation and fair presentation of the financial statements in accordance with
International Financial Reporting Standards;
b) For such internal control as [management] determines is necessary to enable the
SPOTLIGHT
preparation of financial statements that are free from material misstatement, whether due
to fraud or error; and
c) To provide us with:
i. Access to all information of which [management] is aware that is relevant to the
preparation of the financial statements such as records, documentation and other
matters;
ii. Additional information that we may request from [management] for the purpose of
the audit; and
iii. Unrestricted access to persons within the entity from whom we determine it
necessary to obtain audit evidence.
As part of our audit process, we will request from [management and, where appropriate, those
charged with governance], written confirmation concerning representations made to us in
connection with the audit.
We look forward to full cooperation from your staff during our audit.
[Other relevant information]
[Insert other information, such as fee arrangements, billings and other specific terms, as
appropriate.]
[Reporting]
[Insert appropriate reference to the expected form and content of the auditor’s report.]

The form and content of our report may need to be amended in the light of our audit findings.
Please sign and return the attached copy of this letter to indicate your acknowledgement of, and
agreement with, the arrangements for our audit of the financial statements including our
respective responsibilities.
XYZ & Co.
Acknowledged and agreed on behalf of ABC Company by
(signed)
Name and Title
Date
1.6 Tutorial note

The important paragraphs of the standard, to be focused more by the students are:
Core Paragraphs: 6, 10, 17 to 21
Explanatory Paragraphs: A4, A8, A23, A24, A25, A28 and A33
AT A GLANCE
SPOTLIGHT

2. QUALITY CONTROL FOR AN AUDIT OF FINANCIAL STATEMENTS (ISA 220)

2.1 Leadership Responsibilities for Quality on Audits (Ref: 8, A3)
Engagement partner shall take responsibility for overall quality on each of his audit engagement, emphasizing
the fact that quality is essential for audit and the importance to audit quality of:
1. Performing work that complies with professional standards and legal & regulatory requirement
2. Complying with firm's quality control policies and procedures, as applicable
3. Issuing auditor's reports that are appropriate in circumstances
4. Engagement team's ability to raise concerns without fear of reprisals
2.2 Relevant Ethical Requirements (Ref: 9-11, A4-A7)

Throughout audit, engagement partner shall remain alert, through observation and making inquiries for
evidence of non-compliance with relevant ethical requirements by team members. Fundamental principles of
professional ethics include Integrity, Objectivity, Professional competence & due care, Confidentiality and
Professional behavior.
INDEPENDENCE
AT A GLANCE
Engagement partner shall:

1. Obtain relevant information from the firm (& network firms) to identify and evaluate situations that
create threat to independence.
2. Evaluate information on identified breaches of the firm's independence policies and procedures.
3. Apply safeguards to eliminate or reduce such threats or to withdraw from engagement.
4. Promptly report to the firm any inability to resolve matter.
2.3 Acceptance and Continuance of Client Relationships and Audit Engagements (Ref: 12-13, A8-A10)
Engagement partner shall be satisfied that appropriate procedures regarding acceptance and continuance have
been followed.
SPOTLIGHT
Following information assists engagement partner in determining so:

 Integrity of principal owners, key management and those charged with governance;
 Whether engagement team is competent to perform the audit and has necessary capabilities, including
time and resources;
 Whether firm and engagement team can comply with relevant ethical requirements; and
 Significant matters arisen during current/previous audit & their implications on continuance.
If engagement partner obtains information causing firm to decline the audit (if had received earlier), engagement
partner shall communicate promptly to firm for necessary actions.
Beta Construction Company Limited (BCCL) is involved in the construction of large buildings and
shopping plazas. The company commenced its business in 2004 by establishing an office in
Karachi and has grown rapidly. It currently has offices in five major cities of the country and as
many as 25 projects are in various stages of execution.
A substantial portion of the work is done through sub-contractors. Payment to subcontractors is
based on certificate of work completion which is issued by the supervisor incharge of each
project. The certificate is sent through email to the finance department. The payment is credited
directly into the bank accounts of the sub-contractors.

Recently, the management has discovered that the project supervisor of a large project had
issued a fraudulent work completion certificate. The preliminary investigation indicated that
some other sub-contractors have also been paid fraudulently in the past and the practice was
ongoing for the past two years.
The management of BCCL has asked your audit firm to conduct an investigation into the matter.
Your initial discussion with the client has revealed the following:
i. For the past four years the external auditors of the company are Alpha & Co.
Chartered Accountants. They had issued unqualified audit reports for all those years
and had not reported any internal control weakness in their management letters.
ii. Prior to approaching your firm, BCCL wanted to give this assignment to Alpha & Co.
However, they expressed their inability to undertake the investigation work.
Required:
State the matters your firm should consider and the procedures that should be followed prior to
the acceptance of this assignment.
 Solution:
Before accepting the assignment, your firm should consider the following factors:
AT A GLANCE
i. Whether the firm possesses technical competence to perform such services.
ii. Whether required resources would be available to carry out the engagement.
iii. Could there be any threats to compliance with the fundamental principles?
iv. Are there any professional reasons for not accepting the engagement?
Procedures to be followed by the Audit Firm
The non-acceptance by the existing auditor to carry out the assignment may represent a threat
to the fundamental principles. The necessary procedures to avoid this treat may be as follows:
i. After informing the client approach to the existing auditor to ascertain any
professional reason for not accepting their assignment.
ii. Acquire an appropriate understanding of the nature of the BCCL’s business, the
SPOTLIGHT
complexity of its operation and the relevant industries.
iii. Understand the specific requirements of the engagement and the purpose, nature
and scope of the work to be performed.
iv. Possess or obtain experience with relevant regulatory or reporting requirements.
2.4 Assignment of Engagement Teams (Ref: 14, A11-A13)

Be satisfied that engagement team and experts, collectively have appropriate competence & capabilities to:
1. Perform audit in accordance with professional standards and legal & regulatory requirements
2. Enable an auditor's report that is appropriate in the circumstances to be issued.
3. Engagement partner may consider matters such as the team's:
4. Understanding of, and practical experience with, audit of similar nature and complexity through proper
training and participation
5. Understanding of professional standards and applicable legal and regulatory requirements.
6. Technical expertise, including expertise with relevant technology and specialized areas of accounting or
auditing.
7. Knowledge of relevant industries in which the client operates.
8. Ability to apply professional judgment.
9. Understanding of firm's quality control policies and procedures.


The financial statements of Walter Limited (WL) a public unlisted company, for the year ended
30 June 2007 were significantly delayed and were finalized in April 2008. After finalization of
financial statements, a meeting of the board of directors (BOD) of WL was held in May 2008 and
Annual General Meeting (AGM) was held on June 18, 2008. Due to delay in holding the AGM, the
Securities and Exchange Commission of Pakistan (SECP) has imposed a penalty and has advised
WL that no such delay shall be entertained in future.
In the AGM, the shareholders of WL appointed your firm as the statutory auditors and the fact
has been communicated to you by the Company Secretary through his letter dated June 22, 2008
which was faxed to you on the same date.
The company’s financial year is closing on June 30, 2008 and the management wants to
commence the audit immediately in order to ensure timely financial reporting and holding of
AGM.
Required:
Explain the client acceptance procedures that you would like to perform in the above situation.
 Solution:
AT A GLANCE
CLIENT ACCEPTANCE PROCEDURES

The firm should perform procedures designed to provide it with reasonable assurance that the
firm:
i. has considered the integrity of the client and does not have information that would
lead it to conclude that the client lacks integrity;
ii. is competent to perform the engagement and has the capabilities, time and
resources to do so; and
iii. can comply with ethical requirements.
With regard to the integrity of a client, the firm should consider the following matters:
i. The identity and business reputation of the client’s principle owners, key
SPOTLIGHT
management, related parties and those charged with its governance.

ii. The nature of the client’s operations, including its business practices.
iii. Information concerning the attitude of the client’s principal owners, key
management and those charged with its governance towards such matters as
aggressive interpretation of accounting standards and the internal control
environment.
iv. Whether the client is aggressively concerned with maintaining the firm’s fees as low
as possible.
v. Indications that the client might be involved in money laundering or other criminal
activities.
vi. The reasons for the proposed appointment of the firm and non-reappointment of
the previous firm. In this situation, the firm should ascertain the reasons for delay
in finalization of the previous financial statements.
Information on the matters that the firm obtains may come from, for example:
i. Communications with existing or previous providers of professional accountancy
services to the client in accordance with the IFAC Code, and discussions with other
third parties.
ii. Inquiry of other firm personnel or third parties such as bankers, legal counsel and
industry peers.

In considering whether the firm has the capabilities, competence, time and resources to
undertake a new engagement, it should assess:
 the staff profiles at all relevant levels,
 special capabilities if any, required to audit the client
 Ability to perform work at all relevant locations
The firm also considers whether accepting an engagement from a new client may give rise to an
actual or perceived conflict of interest. Where a potential conflict is identified, the firm considers
whether it is appropriate to accept the engagement.
2.5 Engagement Performance (Ref: 15-18, A14-A23)
DIRECTION
Informing the members of the engagement team of matters such as:
1. Responsibilities, ethical requirements & professional skepticism.
2. Responsibilities of respective partners, if more than one partner is involved.
3. The objectives of the work to be performed.
AT A GLANCE
4. The nature of the entity's business.
5. Risk-related issues.
6. Problems that may arise.
7. The detailed approach to the performance of the engagement.
SUPERVISION
1. Tracking the progress of the audit engagement.
2. Considering competence and capabilities of team members, including availability of time
3. Whether they understand instructions
4. Whether work is being carried out in accordance with the planned approach.
SPOTLIGHT
5. Addressing significant matters arising during audit
6. Identifying matters for consultation or consideration by more experienced team members.
REVIEWS
1. Work performed in accordance with professional standards, legal & regulatory requirements
2. Significant matters have been raised for further consideration
3. Appropriate consultations taken place and conclusions have been documented & implemented
4. Need to revise nature, timing and extent of work performed;
5. Work performed supports conclusions reached and is appropriately documented;
6. Evidence obtained is sufficient and appropriate to support report;
7. Objectives of the engagement procedures have been achieved.
Where a member of engagement team with expertise in a specialized area of accounting or auditing is used,
direction, supervision and review of that member's work may include matters such as:
1. Agreeing nature, scope and objectives of that member's work including communication,
2. Evaluating adequacy of that member's work.

CONSULTATIONS
The engagement partner shall:
1. Take responsibility for team, undertaking appropriate consultation on difficult matters;
2. Be satisfied that team members have undertaken appropriate consultation during audit, both within
engagement team and between engagement team & others within or outside the firm;
3. Be satisfied that conclusions resulting from consultations are agreed with party consulted;
4. Determine that conclusions have been implemented.
2.5.1 Engagement Quality Control Review (Ref: 19-22, A24-A33)

For audits of listed entities and other **selected audit engagements, engagement partner shall:
1. Determine that an engagement quality control reviewer has been appointed;
2. Discuss significant matters arising during audit, including those identified during engagement quality
control review, with the engagement quality control reviewer;
3. Not date auditor's report until the completion of the engagement quality control review.
** Selected engagements means the engagements that meet the criteria established by the firm (e.g. all clients
over Rs 1 billion turnover etc.).
AT A GLANCE
Nature, Timing and Extent of Engagement Quality Control Review

1. Discussion of significant matters with the engagement partner;
2. Review of the financial statements and the proposed auditor's report;
3. Review of selected audit documentation relating to significant judgments of the engagement team;
4. Evaluation of conclusions reached in formulating auditor's report and consideration of whether the
proposed auditor's report is appropriate.
Engagement Quality Control Review of Listed Entities – Additional Requirements

For audits of listed entities, engagement quality control reviewer shall also consider following:
SPOTLIGHT
1. Engagement team's evaluation of the firm's independence;

2. Whether appropriate consultation has taken place on matters involving differences of opinion or other
difficult or debatable matters, and conclusions reached; and
3. Whether audit documentation selected for review reflects the work performed.
DIFFERENCES OF OPINION
If differences of opinion arise within engagement team, with those consulted or, where applicable, between
engagement partner and engagement quality control reviewer, engagement team shall follow the firm's policies
and procedures for dealing with and resolving differences of opinion.
The following matter is under the consideration of Mr. Jameel, who is the engagement partner:
Abdullah was the audit senior assigned to the audit of Insha (Private) Limited. During the course
of the audit, Abdullah had resigned from the firm. While reviewing the audit files Mr. Jameel has
noticed that the audit fieldwork was completed in almost half the time than is usually required.
Required:
Evaluate the above situation and briefly describe what course of action the engagement partner
would be expected to adopt.

Tutorial Notes:
Focusing only on proper and adequate documentation is not enough. It would not be good to
refer to the possibility that the job senior may have joined the same client, leading to conflict of
interest issues as there is no such indication in the question. Some other important matters are:
 need to discuss the matter with the Audit Manager;
 need to have the files reviewed by another Chartered Accountant; and
 the questions that may arise as regards the effectiveness of the firms’ quality control
policies and procedures, in case significant deficiencies are found, despite the fact that
the working papers had been reviewed by the Audit Manager.
 Solution:
Quality control issues:
 Mr. Jameel should have the audit files reviewed by another chartered accountant who
had not been involved in the said engagement.
 If the working papers reflect anything done improperly or not done in accordance with
the auditing standards Mr. Jameel should discuss the matter with the concerned
manager.
AT A GLANCE
 If the audit manager fails to provide a satisfactory reply, it would be indicative of a
quality control issue.
 In such a situation Mr. Jameel would need to take the following steps:
¯ Address the issues which have remained unattended during the audit.
¯ Assess the reasons for the manager’s failure to detect the situation and take
corrective measures which may include all or any of the following:
o Reviewing the firms’ systems, procedures and policies etc., and taking
corrective actions
o Emphasis on due training of staff at all levels.
2.6 Monitoring (Ref: 23, A34-A36)
SPOTLIGHT
Monitoring process is designed to provide firm with reasonable assurance that its policies and procedures
relating to system of quality control are relevant, adequate & operating effectively.
Engagement partner shall consider results of monitoring process as evidenced in latest information circulated
by the firm (and network firms) and whether deficiencies noted may affect audit.
1. Engagement partner may consider sufficient measures taken by firm to rectify the situation.
2. Such deficiency does not necessarily indicate that a particular audit engagement was not performed in
accordance with requirements or that audit report was not appropriate.
2.7 Documentation (Ref: 24-25, A34-A36)

1. Issues identified regarding compliance with relevant ethical requirements and how resolved.
2. Conclusions on compliance with independence requirements that apply to audit, and any relevant
discussions with firm that support these conclusions.
3. Conclusions reached regarding acceptance and continuance of client relationships.
4. Nature and scope of, and conclusions resulting from, consultations undertaken
Engagement quality control reviewer shall document that:
1. Procedures required by firm on engagement quality control review have been performed;
2. Engagement quality control review has been completed on or before date of auditor's report;
3. Reviewer is not aware of any unresolved matters causing reviewer to believe that significant judgments
and the conclusions were not appropriate.


As the Quality Control partner of a newly established medium sized firm of Chartered
Accountants, prepare the following:
a) Checklist for assessing quality of audit engagements with regard to planning of audit. (any
ten points)
b) Checklist for pre-engagement activities. (any eight points)
Tutor’s Note (for this question):
Student should develop the answers considering the requirements of ISA 220 and the pre
engagement activities identified by ISA 300.
 Solution:
a) The checklist would comprise of following things:
Planning of Audit
 In planning the audit engagement, did the auditor properly consider and/or
document:
AT A GLANCE
¯ matters affecting the industry in which the entity operates, such as accounting
practices, economic conditions, laws and government regulations, and
technological changes?
¯ matters affecting the entity's business, such as organization and types of
products and services?
¯ preliminary judgment about materiality levels for audit purposes?
¯ client's fraud risk factors?
 In planning the audit, did the auditor consider:
¯ client’s business and accounting system.
¯ key issues discussed in the preliminary meeting.
¯ assessment of the risk of material misstatements of the financial statements.
SPOTLIGHT
¯ the risk of management misrepresentation by reviewing information obtained

about risk factors and the internal control structure?
¯ use analytical procedures in planning the nature, timing and extent of other
audit procedures?
¯ obtain a sufficient understanding of the entity's internal control structure and
anticipated reliance on internal accounting controls.
¯ use of Work Performed by Others such as:
o Internal Audit
o Other Independent Auditors
o External Experts
¯ applicable assertions in developing audit objectives and in designing
substantive tests?
¯ sampling method(s) used and their relevance in the given situation.
b) Pre engagement activities
Professional clearance
In case of new engagement, whether the practice of communication with previous
auditor was followed.

Independence
 If this is a new engagement, whether the auditor carried out evaluation procedures
prior to accepting the engagement.
 If this is an ongoing engagement, whether the auditor considered need to reassess
the engagement acceptance criteria.
 Whether independence issues relating to performance of non-audit services were
given due consideration.
 Whether professional personnel of the firm have appropriately informed as to need
to observe independence requirements.
 Assurance of independence obtained from staff members engaged in the audit.
 If any evidence was noted during the review that may indicate a lack of
independence (including a lack of objectivity), whether the matter was identified
and appropriately resolved by the firm and its impact appropriately considered.
 Whether an engagement letter was issued/ Whether the auditor considered the
issuance of new engagement letter
Compliance with the law
AT A GLANCE
Whether auditor ensured that his appointment has been made after fulfilling all the
requirements of applicable laws and regulations.
Acceptability of the financial reporting framework
Whether auditor evaluated acceptability of the financial reporting framework in
accordance with ISA 210.
2.8 Tutorial note

The important paragraphs of the standard to be focused more by the students are:
Core Paragraphs: 11, 15 to 20 and 24
Explanatory Paragraphs: A2, A11, A13, A15, A17 and A28
SPOTLIGHT

3. QUALITY CONTROL FOR FIRMS (ISQC-1)

 Definition: Engagement quality control review
A process designed to provide an objective evaluation, on or before date of report, of the
significant judgments the engagement team made and the conclusions it reached in formulating
the report.
 Definition: Engagement quality control reviewer
A partner, other person in 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 evaluate the significant judgments engagement team
made and the conclusions it reached.
 Definition: Engagement team
All partners and staff performing the engagement, and any individuals engaged by firm or a
network firm who perform procedures on engagement. This excludes an auditor’s external
expert engaged by firm or a network firm. It also excludes individuals within client’s internal
audit function who provide direct assistance on an audit engagement (ISA 610).
 Definition: Partner
Any individual with authority to bind the firm with respect to the performance of a professional
AT A GLANCE
services engagement.
 Definition: Staff
Professionals, other than partners, including any experts the firm employs.
 Definition: Personnel
Partners and staff.
 Definition: Network firm
A firm or entity that belongs to a network.
 Definition: Network - A larger structure:
i. That is aimed at cooperation, and
ii. That is clearly aimed at profit or cost-sharing or shares common ownership, control or
SPOTLIGHT
management, common quality control policies and procedures, common business

strategy, the use of a common brand name, or a significant part of professional resources.
3.1 Applying, and Complying with, Relevant Requirements (Ref: 13-15)

Personnel within the firm responsible for establishing and maintaining firm’s system of quality control shall
have an understanding of the entire text of this ISQC
Firm shall comply with each requirement of this ISQC unless, in the circumstances of the firm, the
requirement is not relevant to the services provided
Firm shall consider whether there are particular matters or circumstances that require firm to establish policies
and procedures in addition to those required by this ISQC.
3.2 Elements of a System of Quality Control (Ref: 16-17)

1. Leadership responsibilities for quality within the firm.
2. Relevant ethical requirements.
3. Acceptance and continuance of client relationships and specific engagements.
4. Human resources.
5. Engagement performance.
6. Monitoring.
Firm shall document its policies and procedures and communicate them to firm’s personnel.

3.2.1. Leadership Responsibilities for Quality within the Firm (Ref: 18-19)
Firm shall establish policies and procedures:
1. Designed to promote an internal culture recognizing that quality is essential in performing engagements.
It shall require firm’s chief executive officer (or equivalent) or, if appropriate, managing board of
partners etc. to assume ultimate responsibility for system of quality control.
2. Such that any person(s) assigned operational responsibility for firm’s system of quality control by firm’s
chief executive officer or managing board of partners has sufficient and appropriate experience and
ability, and the necessary authority, to assume that responsibility.
3.2.2. Relevant Ethical Requirements (Ref: 20-25)

Firm and its personnel shall comply with relevant ethical requirements.
Independence
Firm, its personnel and others shall maintain independence where required by relevant ethical requirements. Policies
and procedures shall enable the firm to:
1. Communicate its independence requirements to its personnel and others; and
AT A GLANCE
2. Identify and evaluate circumstances and relationships creating threats to independence, and to take
appropriate action to eliminate those threats or reduce them to an acceptable level by applying
safeguards, or to withdraw from engagement, where possible.
Policies and procedures shall require:
1. Engagement partners to provide firm with relevant information about client engagements, including
scope of services, to enable firm to evaluate the overall impact on independence;
2. Personnel to promptly notify firm of circumstances and relationships creating a threat;
3. Accumulation & communication of relevant information to appropriate personnel so that:
 Firm and personnel can readily determine whether they satisfy independence;
 Firm can maintain and update its records relating to independence; and
SPOTLIGHT
 Firm can take appropriate action regarding identified threats to independence.
4. Personnel to promptly notify firm of independence breaches of which they become aware;
5. Firm to promptly communicate identified breaches of these policies and procedures to:
 Engagement partner who needs to address the breach;
 Other relevant personnel in the firm and network;
 Those who need to take appropriate action.
6. Prompt communication to firm, if necessary, by engagement partner and other of actions taken to
resolve matter, so that firm can determine whether it should take further action.
At least annually, firm shall obtain written confirmation of compliance with its policies and procedures on
independence from all firm personnel.
The firm shall establish policies and procedures:
1. Setting out criteria for determining need for safeguards to reduce familiarity threat when using same
senior personnel on an assurance engagement over a long period of time; and
2. For listed clients, requiring rotation of engagement partner and individuals responsible for engagement
quality control review.

3.2.3. Acceptance and Continuance of Client Relationships and Engagements (Ref: 26-28)
Firm shall only undertake or continue relationships and engagements where the firm:
1. Is competent to perform engagement and has capabilities, including time and resources, to do so;
2. Can comply with relevant ethical requirements; and
3. Has considered the integrity of the client, and does not have information that would lead it to conclude
that the client lacks integrity.
Policies and procedures shall require:
1. Firm to obtain such information as it considers necessary
 Before accepting an engagement with a new client;
 When deciding whether to continue an existing engagement; and
 When considering acceptance of a new engagement with an existing client.
2. If a potential conflict of interest is identified in accepting an engagement from a new or an existing client,
the firm to determine whether it is appropriate to accept the engagement.
3. If issues have been identified, and firm decides to accept or continue client relationship or a specific
AT A GLANCE
engagement, the firm to document how the issues were resolved.

If firm obtains information that would have caused it to decline the engagement had that information been
available earlier, policies and procedures shall include considering:
1. Professional and legal responsibilities applicable, including whether there is requirement to report to
person(s) who made the appointment or to regulatory authorities; and
2. Possibility of withdrawing from engagement or from both engagement & client.
3.2.4. Human Resources (Ref: 29-31)

Firm shall have sufficient personnel with competence, capabilities, and commitment to ethical principles
necessary to:
1. Perform engagements in accordance with professional standards and applicable legal and regulatory
SPOTLIGHT
requirements; and
2. Enable firm or engagement partners to issue appropriate reports.
Assignment of Engagement Teams

Firm shall assign responsibility for each engagement to an engagement partner and shall establish policies and
procedures requiring that:
1. The identity and role of the engagement partner are communicated to key members of client
management and those charged with governance;
2. Engagement partner has appropriate competence, capabilities and authority; and
3. Responsibilities of engagement partner are clearly defined and communicated to that partner.
3.2.5. Engagement Performance (Ref: 32-34)

Policies and procedures shall reasonably ensure that engagements are performed in accordance with
professional standards and applicable legal and regulatory requirements, and appropriate reports are issued.
Such policies and procedures shall include:
1. Matters relevant to promoting consistency in the quality of engagement performance;
2. Supervision responsibilities; and
3. Review responsibilities.

Firm’s review responsibility policies and procedures shall be determined on the basis that work of less experienced
team members is reviewed by more experienced engagement team members.
Consultation
Firm shall establish policies and procedures that:
1. Appropriate consultation takes place on difficult or contentious matters;
2. Sufficient resources are available to enable appropriate consultation to take place;
3. Nature and scope of, and conclusions resulting from, such consultations are documented and are agreed
by both the individual seeking consultation and individual consulted; and
4. Conclusions resulting from consultations are implemented.
3.2.5.1 Engagement Quality Control Review (Ref: 35-47)

Firm shall establish policies and procedures that shall:
1. Require an engagement quality control review for all audits of financial statements of listed entities and
other entities meeting the specific criteria; and
2. Set out that specific criteria against which all other audits and reviews of historical financial information
and other assurance and related services engagements shall be evaluated to determine whether
AT A GLANCE
engagement quality control review should be performed.
Firm shall establish policies and procedures setting out the nature, timing and extent of an engagement quality
control review. Such policies and procedures shall require that the engagement report not be dated until the
completion of the engagement quality control review.
Firm shall establish following policies and procedures in this regard:
1. Discussion of significant matters with the engagement partner;
2. Review of the financial statements or other subject matter information and the proposed report;
3. Review of selected engagement documentation relating to significant judgments the engagement team
made and the conclusions it reached; and
4. Evaluation of the conclusions reached in formulating the report and consideration of whether the
SPOTLIGHT
proposed report is appropriate.
For audits of financial statements of listed entities, firm shall establish policies and procedures to require the
engagement quality control review to also include consideration of the following:
1. Engagement team’s evaluation of firm’s independence in relation to specific engagement;
2. Whether appropriate consultation has taken place on matters involving differences of opinion or
difficult/contentious matters, and conclusions arising from consultations; and
3. Whether documentation selected for review reflects the work performed in relation to the significant
judgments and supports the conclusions reached.
Criteria for the Eligibility of Engagement Quality Control Reviewers

Firm shall establish policies and procedures to address the appointment of engagement quality control reviewers
and establish their eligibility through:
1. The technical qualifications required to perform the role, including necessary experience and authority;
and
2. The degree to which an engagement quality control reviewer can be consulted on the engagement
without compromising the reviewer’s objectivity.
Firm’s policies and procedures shall provide for the replacement of the engagement quality control reviewer
where the reviewer’s ability to perform an objective review may be impaired.

Documentation of the Engagement Quality Control Review

1. Procedures required by policies on quality control review have been performed;
2. Engagement quality control review has been completed on or before the date of report; and
3. Reviewer is not aware of any unresolved matters that would cause the reviewer to believe that
significant judgments made and the conclusions reached were not appropriate.
Differences of Opinion
Firm shall establish policies and procedures for dealing with and resolving differences of opinion within
engagement team, with those consulted and, where applicable, between the engagement partner and engagement
quality control reviewer. These shall require that:
1. Conclusions reached be documented and implemented; and
2. The report not be dated until the matter is resolved.
Engagement Documentation
1. For engagement teams to complete assembly of final engagement files on a timely basis after the
AT A GLANCE
engagement reports have been finalized.

2. Designed to maintain confidentiality, safe custody, integrity, accessibility and retrievability of
engagement documentation.
3. For the retention of engagement documentation for a period sufficient to meet the needs of the firm or
as required by law or regulation.
3.2.6. Monitoring (Ref: 48-56)

Firm shall establish a monitoring process that the policies and procedures relating to system of quality control
are relevant, adequate, and operating effectively. This process shall:
1. Include an ongoing consideration and evaluation of firm’s system of quality control including, on a
cyclical basis, inspection of at least one completed engagement for each engagement partner;
SPOTLIGHT
2. Require responsibility for monitoring process to be assigned to partner(s) or other persons with
sufficient and appropriate experience and authority in the firm; and
3. Require that those performing the engagement or engagement quality control review are not involved
in inspecting the engagement.
Evaluating, Communicating and Remedying Identified Deficiencies

Firm shall evaluate the effect of deficiencies noted as a result of the monitoring process and determine
whether they are either:
1. Instances that do not necessarily indicate that firm’s system of quality control is not working properly;
or
2. Systemic, repetitive or other significant deficiencies that require prompt corrective action.
Firm shall communicate to relevant engagement partners and other appropriate personnel deficiencies noted
as a result of the monitoring process and recommendations for appropriate remedial action.
Recommendations for appropriate remedial actions shall include one or more of following:
1. Taking appropriate remedial action in relation to an individual engagement or member;
2. Communication of findings to those responsible for training & professional development;
3. Changes to the quality control policies and procedures; and
4. Disciplinary action against those who fail to comply with the policies and procedures of the firm,
especially those who do so repeatedly.

Firm shall establish policies and procedures to address cases where results of monitoring procedures
indicate that a report may be inappropriate or that procedures were omitted during performance of
engagement. Such policies and procedures shall require the firm to determine what further action is
appropriate and to consider whether to obtain legal advice.
Firm shall communicate at least annually the results of its monitoring to engagement partners and other
appropriate individuals within firm, including firm’s chief executive officer or its managing board of partners.
Information communicated shall include following:
1. A description of the monitoring procedures performed.
2. The conclusions drawn from the monitoring procedures.
3. Where relevant, a description of systemic, repetitive or other significant deficiencies and of the actions
taken to resolve or amend those deficiencies.
Special consideration for Networks

Firm’s policies and procedures shall require that:
1. At least annually, the network communicates the overall scope, extent and results of the monitoring
process to appropriate individuals within the network firms; and
2. The network communicates promptly any identified deficiencies in system of quality control to
AT A GLANCE
appropriate individuals within relevant network firm(s) so that necessary action can be taken,
Complaints and Allegations

Firm shall establish policies and procedures to deal appropriately with:
1. Complaints and allegations that the work performed by the firm fails to comply with professional
standards and applicable legal and regulatory requirements; and
2. Allegations of non-compliance with the firm’s system of quality control.
Firm shall establish clearly defined channels for firm personnel to raise any concerns in a manner that enables
them to come forward without fear of reprisals.
SPOTLIGHT
3.3 Documentation of the System of Quality Control (Ref: 57-59)
1. Requiring appropriate documentation to provide evidence of operation of each element of its system of
quality control.
2. That require retention of documentation for a period of time sufficient to permit those performing
monitoring procedures to evaluate the firm’s compliance with its system of quality control, or for a
longer period if required by law or regulation.
3. Requiring documentation of complaints and allegations and the responses to them.
3.3 Tutorial note

Core Paragraphs: 16, 21, 26, 29, 30, 34, 35, 37, 39 and 42
Explanatory Paragraphs: 48, 49, 51, 53, 55, A18, A19, A24, A32, A34, A35, A41 and A45
Raza & Company, Chartered Accountants is an old and well reputed audit firm. It has been
growing at a rapid pace with the result that the partners of the firm had been unable to devote
much time to various important issues. In view of your experience, they have inducted you as a
partner, with the primary responsibility of improving the firm’s systems and procedures.

The major issues that have attracted your immediate attention relate to human resources, audit
documentation and client acceptance and retention procedures.
Required:
a) How would you evaluate the firm’s HR requirements and what steps would you take to
ensure that adequate human resources are available within the firm?
b) Identify the situations under which you would recommend declining an assurance
engagement or consider resigning from the current engagement.
c) Recommend how an engagement team member should evaluate as to what type of audit
documentation is required to be prepared in a particular situation.
 Solution:
a) To evaluate the firm’s HR requirements, we should keep in view the number, nature and
size of the assignments which the firm has to complete.
On the basis of the above, we should evaluate whether the firm has sufficient staff with
the required capabilities; competence; and commitment to ethical principles; to
complete these assignments in accordance with the required standards.
In order to ensure that adequate human resources are available within the firm, the firm
AT A GLANCE
shall have to make and implement appropriate policies to ensure that:

i. competent and capable staff is hired;
ii. adequate on the job training and education is provided to them;
iii. they are properly coached by senior members of the engagement team and staff;
iv. compensation and promotions are based on merit and the quality of performance.
b) The auditor should consider declining an assurance engagement or resigning there from,
in one or more of the following situations:
i. Where client’s integrity is in doubt.
ii. If the firm does not possess the skills or lacks resources to complete such
assignment.
SPOTLIGHT
iii. It is not possible for the firm to comply with ethical requirements.
iv. When there is a perceived conflict of interest and the issue cannot be resolved.
v. When for any other reason, the auditor is unable to obtain evidence which is
necessary to form an opinion.
c) For evaluating as to what type of audit documentation would be performed in a
particular situation, the engagement team member should consider the following:
i. the nature of the audit procedures to be performed;
ii. the identified risks of material misstatement;
iii. the extent of judgment required in performing the work and evaluating the results;
iv. the significance of the audit evidence obtained;
v. the nature and extent of exceptions identified;
vi. the need to document a conclusion or the basis for a conclusion not readily
determinable from the documentation of the work performed or audit evidence
obtained; and
vii. the audit methodology and tools used.

4. THE IAASB’S FRAMEWORK FOR AUDIT QUALITY

Introduction and objectives
Global financial stability is supported through high quality reporting. Audits can help foster trust in the quality
of reporting. This highlights the importance of audit quality, a topic of continuous debate and of relevance to all
stakeholders in the financial reporting supply chain.
With this in mind, the IAASB developed the Framework for Audit Quality which it launched in February 2014.
The Framework describes in a holistic manner the different elements that create the environment for audit
quality at the engagement, firm, and national levels, as well as relevant interactions and contextual factors.
The objectives of the Framework for Audit Quality include:
1. Raising awareness of the key elements of audit quality;
2. Encouraging key stakeholders to explore ways to improve audit quality; and
3. Facilitating greater dialogue between key stakeholders on the topic.
The IAASB expects that the Framework for Audit Quality will generate discussion in the financial reporting
supply chain and positive actions to achieve a continuous improvement in audit quality.
AT A GLANCE
Elements
The elements of the Framework for Audit Quality include:
1. Inputs
2. Processes
3. Outputs
4. Interactions
5. Contextual factors
While the primary responsibility for performing quality audits rests with auditors, audit quality is best achieved
in an environment where there is support from other participants in the financial reporting supply chain.
SPOTLIGHT

Inputs
Quality audits involve auditors:
1. exhibiting appropriate values, ethics and attitudes; and
2. being sufficiently knowledgeable, skilled, experienced, and having sufficient time allocated to them to
perform the audit work.
Within each of these categories quality attributes are further organised between those that apply at the
engagement, firm and national levels.
Processes
Quality audits involve auditors applying a rigorous audit process and quality control procedures that comply
with laws, regulations and applicable standards. In this regard various quality attributes are further organised
between those that apply at the engagement, firm, and national levels.
Outputs
Quality audits result in outputs that are useful and timely. Outputs are described in relation to the full reporting
supply chain and they include outputs from:
AT A GLANCE
1. the auditor
2. the audit firm
3. the entity
4. audit regulators
Outputs include reports and information that are formally prepared and presented by one party to another, as
well as outputs that arise from the auditing process that are generally not visible to those outside the audited
organization.
Interactions
Quality audits involve auditors interacting properly with the stakeholders in the financial reporting supply chain.
The interactions between the following key stakeholders are described within the Framework:
SPOTLIGHT
1. Auditors
2. Management
3. Those charged with governance
4. Users
5. Regulators
These interactions, including both formal and informal communications, will be influenced by the context in
which the audit is performed and allow a dynamic relationship to exist between inputs and outputs.
While each separate stakeholder in the financial reporting supply chain plays an important role in supporting
high-quality financial reporting, the way in which the stakeholders interact can have a particular impact on audit
quality.

AT A GLANCE
Contextual factors
SPOTLIGHT
Quality audits involve auditors who respond properly to contextual factors. Contextual factors are described as
having the potential to impact the nature and quality of financial reporting and, either directly or indirectly, audit
quality.
These include:
1. Business practices and commercial law
2. Laws and regulations relating to financial reporting
3. The applicable financial reporting framework
4. Information systems
5. Corporate governance
6. Financial reporting timetable
7. Broader cultural factors
8. Audit regulation
9. Litigation environment
10. Attracting talent
11. Financial reporting timetable.

AT A GLANCE
SPOTLIGHT

5. QUALITY CONTROL REVIEW (QCR) FRAMEWORK BY ICAP

5.1 Introduction
The Council of the Institute (ICAP) formed the Quality Control Review (QCR) Committee in 1987 with the primary
objective of establishing an independent quality control review framework in respect of audits of financial
statements conducted by the Firms.
With effect from October 2005, the QCR Committee was converted into a Quality Assurance Board and was
entrusted with this responsibility, as more fully described in this framework.
The framework of the QCR Program was issued first in 2003 which was revised in 2006, 2009, 2015 and 2019.
5.2 Scope
This framework describes the objectives and scope of the Institute’s Quality Control Review (QCR) and the
composition, responsibilities and functions of the Quality Assurance Board and Appellate Board and their
policies, procedures and process in relation to QCR program.
This framework applies to all Firms carrying out audit of financial statements prepared under any applicable
legal and financial reporting framework, which intend to get or renew a QCR rating or obtain registration with
AOB.
5.3 Audit Oversight Board (AOB)
AT A GLANCE
Pursuant to Part IXC of the Securities and Exchange Commission of Pakistan Act, 1997, Firms that carry out or
intend to carry out audit of public interest companies are required to register with Audit Oversight Board, which
requires a recommendation of QAB in accordance with the Quality Control Review Framework.
Under the Listed Companies (Code of Corporate Governance) Regulations, 2019, no company shall appoint as
external auditors, a firm of auditors, which has not been given a satisfactory rating under the Quality Control
Review program of the Institute of Chartered Accountants of Pakistan and registered with Audit Oversight Board
of Pakistan.
 Definition: Audit Oversight Board (AOB)
Audit Oversight Board means the independent audit oversight board established under Part IXC
of the Securities and Exchange Commission of Pakistan Act, 1997.
SPOTLIGHT
AOB is the independent audit oversight board established by the parliament to function in the public interest and
enhance the quality of audit of financial statements of public interest entities. This development is in line with
the efforts in other jurisdictions to enhance the audit quality and reliability of financial statements that are a key
source of information to investors and other stakeholders.
Functions of AOB
 Register audit firms, that conduct or intend to conduct the audit of public interest companies in the
manner laid down in sub-section (1) of section 36T;
 Deregister audit firms in the manner laid down in sub-section (2) of section 36T;
 Undertake comprehensive review and examination of the QAB work and independently assess the
appropriateness of the quality control review framework and take such actions as deemed necessary;
 Oversee and review policies, procedures, programs of QAB for ensuring an effective oversight of quality
of audit of public interest companies and to specify any improvement required in QAB’s policies,
procedures and systems;
 Direct the Institute of Chartered Accountants of Pakistan (ICAP) for making such changes in the quality
control review framework as it considers necessary or expedient for the purposes of this Part;
 Ensure that the auditing standards adopted by the Institute conform to the international standards as
issued by the International Auditing and Assurance Board;
 Conduct inspections and inquiries in respect of matters related to this Part and regulations made
hereunder; and

 Coordinate with relevant authorities including SECP, State Bank of Pakistan and ICAP in formulating and
implementing strategies for enhancing the reliability of quality and effectiveness of audits of public
interest companies.
5.4 QCR Program

Under S.R.O. 1044 (I)/2015 dated October 22, 2015 issued by the Securities and Exchange Commission of
Pakistan, following are required to appoint Satisfactory QCR rated Firms as their statutory external auditors:
 Public Interest Companies;
 Large Sized Companies; and
 Public Interest and Large Sized Companies which are either associations not for profit or limited by
guarantee.
The objectives of the QCR Program are to enhance the quality of audit report and credibility of accountancy
profession in public interest by evaluating that the:
 Audit engagements are conducted in accordance with the applicable ISAs, relevant ethical requirements
and legal and regulatory requirements as applicable in Pakistan;
 System of quality control has been appropriately designed and effectively implemented in accordance
with the requirements of ISQC 1; and
AT A GLANCE
 Firm’s quality control policies and procedures have been appropriately applied so that reports issued
are appropriate in the circumstances.
This framework applies to all office locations of the Firms located and operating in the territories of Islamic
Republic of Pakistan and Azad Jammu & Kashmir and registered with the Institute.
5.5 Quality Assurance Board (QAB) and its Functions
Composition
The Quality Assurance Board shall comprise of nine members nominated as follows:
 Three members shall be nominated by the Securities and Exchange Commission of Pakistan (SECP);
 Two members shall be nominated by the State Bank of Pakistan (SBP);
SPOTLIGHT
 One member shall be nominated by the Pakistan Stock Exchange;

 Three members shall be nominated by the Council; and
 The Chairman of QAB shall be a member of the Institute having at least ten years post qualification
experience and shall be elected by the members of QAB. Provided that a member in practice and/or a
member with an economic interest in an audit firm shall not be eligible to become the Chairman of QAB.
The above nominations shall be subject to following conditions:
 No more than two members shall be audit partners or employees in an audit firm and such members, if
any, shall only be nominated by the Institute;
 No member from the Council shall be a member of QAB; and
 No current employee, member, or official of the Audit Oversight Board or any other statutory regulatory
body or a securities exchange shall be a member of QAB.
Term of QAB and its Members

 QAB shall be a perpetual board without any tenure.
 No member of QAB shall serve more than two consecutive periods of three years each.
 A person who was appointed as a member of QAB, under a previous QCR Framework may remain a
member of QAB until the expiration of his term except an employee of SECP, SBP and PSX. The relevant
nominating body shall nominate a new member in accordance with this QCR Framework within sixty
(60) days of effective date of this Framework.

 In case of any casual vacancy the new member shall be nominated by the original appointing body within
sixty (60) days for remaining period of the member vacating his position.
Cessation of Membership
A member of QAB shall cease to be a member if he
 is replaced by his nominating body;
 has given his resignation in writing addressed to the Secretary of the Institute and the Council has
accepted the same;
 becomes of unsound mind;
 has applied to be adjudicated as an insolvent and his application is pending;
 is an undischarged insolvent;
 has been convicted by a court of law for an offence involving moral turpitude;
 has displayed lack of fiduciary behavior and a declaration to this effect has been made by a court; and/or
 is removed from the membership of the Institute.
Meetings of QAB
AT A GLANCE
 QAB shall hold at least six (6) meetings in a financial year.
 Procedure to call meetings of QAB shall be as follows:
¯ Notice of the meeting shall be issued at least fifteen (15) days, or any shorter period if decided by
the Chairman, before the date of the meeting.
¯ Agenda and working papers shall be sent by the Secretary to QAB, to all members of QAB at least
ten (10) days or any shorter period as may be decided by the Chairman, before the date of the
meeting.
¯ In the absence of the Chairman, the members present shall elect amongst themselves a Chairman,
who shall preside over the meeting of QAB.
 Except as otherwise specified in this framework, all the meetings of QAB, the vote of majority shall
prevail and in the event of equality of vote, the Chairman shall have a casting vote in addition to his own
SPOTLIGHT
vote.
 The Secretary to QAB shall prepare minutes of the QAB meeting not later than 14 days after the meeting
and shall circulate the minutes to all members of QAB.
 Minutes of meetings shall be signed by the Chairman of the meeting. Secretary to QAB shall maintain the
record of the signed minutes of the meetings of QAB.
 Subject to the approval by the competent authority under the provisions of Chartered Accountants
Ordinance, 1961, members of QAB shall be paid a meeting fee, as may be specified by the Council.
 Minimum five members of QAB shall form the ‘Quorum’ for a meeting of QAB.
Duties and Powers of the Chairman of QAB

The Chairman shall be responsible for the following:
 Chair the meetings of QAB;
 Ensure timely preparation and approval of agenda, working papers, minutes etc. of the meeting;
 Ensure that a meeting of QAB is planned effectively, conducted according to the framework and that
matters are dealt with in an orderly and efficient manner;
 Recommend removal of member(s) to the nominating body in case a member of QAB is absent for three
consecutive meetings of QAB;
 Refer the matter to the nominating body for filling up of any casual vacancy; and
 Any other function as required/prescribed in the framework.

Responsibilities and Functions of QAB

 To decide a QCR Rating on a timely basis in case of a new Firm or before the expiry of a Firm’s last QCR
rating;
 To set policies for the implementation of this framework and to decide on all matters relating thereto
and monitor its adequate and effective implementation;
 To prepare annual report within four (4) months after June 30 of the year summarizing the performance
of QAB and the results of the QCR Program;
 To evaluate the performance of Head of QAD and Secretary to QAB for the HR Committee of the Institute;
 To determine required capacity of QAD in view of the work hours required to perform reviews and
recommend the same to ICAP;
 To ensure that remedial actions or recommendations made by AOB are properly implemented within
specified time period;
 To recommend a Firm to AOB for registration under section 36T of Part IXC of Securities and Exchange
Commission of Pakistan Act 1997, within such time and manner as may be specified by AOB;
 To recommend a Firm to AOB for de-registration under section 36T of Part IXC of Securities and
Exchange Commission of Pakistan Act 1997, within such time and manner as may be specified by AOB.
A recommendation for de-registration shall be made upon the removal of a Firm from the List of Firms
AT A GLANCE
having Satisfactory QCR Rating, request by Firm for voluntary de- registration or any other grounds as
may be deemed appropriate by QAB or AOB;
 To appoint Secretary to QAB from amongst the candidates recommended by the Institute and approve
the terms and conditions of his appointment; and
 To appoint Head of QAD from amongst the candidates recommended by the Institute and approve the
terms and conditions of his appointment.
 Definition: Quality Assurance Department (QAD)
A department established, resourced and funded by the Institute in consultation with the Quality
Assurance Board to carry out such functions and responsibilities as assigned to it by the Quality
Assurance Board in line with this framework.
SPOTLIGHT
Secretary to the QAB and the Head of QAD shall be two different offices held by two different persons and a Head
of QAD already appointed by the Institute shall be deemed to have been appointed by QAB.
In carrying out the above functions, QAB shall be assisted by its Secretary and the QAD.

6. PLANNING AN AUDIT OF FINANCIAL STATEMENTS (ISA 300)

6.1 The Role and Timing of Planning (Ref: 2, A1-A3)
Benefits of Adequate planning
1. Helps to devote appropriate attention to important areas of audit.
2. Helps identify and resolve potential problems on a timely basis.
3. Helps auditor properly organize and manage the audit.
4. Helps in assignment of engagement team members and audit work.
5. Facilitating direction, supervision and review of audit work.
6. Assisting in coordination of work done by component auditors (ISA-600) and experts (ISA-620).
Planning activities vary according to:
1. Size of the entity.
2. Complexity of the entity.
3. Team member's previous experience with entity.
4. Changes in circumstances occurring during audit.
AT A GLANCE
Planning includes need to consider, prior to risk assessment, such matters as:
1. Analytical procedure to be applied as risk assessment procedure
2. Obtaining general understanding of the legal and regulatory framework of the entity.
3. Determination of materiality.
4. Involvement of experts.
5. Performance of other risk assessment procedures.
Auditor may discuss planning with management to facilitate management of the audit, but should not
compromise the effectiveness of the audit by making audit procedures too predictable.
6.2 Involvement of Key Engagement Team Members (Ref: 5, A4)
SPOTLIGHT
Engagement partner and other key members shall be involved in the planning
6.3 Preliminary Engagement Activities (Ref: 6, A5-A7)

Auditor shall undertake the following activities at the beginning of current audit engagement:
1. Procedures regarding continuance of client (ISA-220)
2. Evaluating compliance with ethical requirements (ISA 220)
3. Establishing an understanding of terms of engagement (ISA 210)
It enables auditor to plan an audit engagement for which:
1. Auditor maintains necessary independence and ability to perform the engagement.
2. No issues with management integrity affecting auditor's willingness to continue engagement
3. There is no misunderstanding with the client as to the terms of the engagement.
6.4 Additional Considerations in Initial Audit Engagements (Ref: 13, A22)

1. Performing procedures regarding acceptance of client relationship and specific audit engagement (ISA
220)
2. Prior to starting an initial audit, auditor shall communicate with predecessor auditor, in compliance with
ethical requirements.
3. Additional matters he may consider in establishing overall audit strategy & audit plan includes:

4. Arrangements to be made with predecessor auditor e.g. reviewing auditor’s working papers.
5. Any major issues discussed with management in connection with initial selection as auditor,
communicating matters to those charged with governance and how these matters affect the overall
planning.
6. Procedures necessary to obtain sufficient appropriate audit evidence for opening balances.
7. Other procedures required by firm's system of quality control for initial audits
viii. (e.g. involvement of another partner or senior individual to review planning
activities)
6.5 Planning Activities (Ref: 7-11, A8-A17)

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”.
OVERALL AUDIT STRATEGY

Establishing overall audit strategy assists auditor to determine:
1. Resources to deploy for specific audit areas (e.g. experienced team members for risky areas)
2. Amount of resources to allocate to specific audit areas (e.g. number of team members)
AT A GLANCE
3. Timing of deployment of these resources (e.g. whether interim audit stage or at cutoff dates)
4. How these resources are managed, directed and supervised?
SPOTLIGHT
AUDIT PLAN
Once overall audit strategy has been established, an audit plan can be developed to address various matters
identified in overall audit strategy.
The auditor shall develop an audit plan that shall include a description of the nature, timing and extent of planned
risk assessment procedures and further audit procedures.

Changes to Planning Decisions during the Course of the Audit

Auditor shall update & change overall audit strategy and audit plan, as and when necessary, during course of
audit as a result of unexpected events, changes in conditions, or audit evidence obtained
Direction, Supervision and Review (factors)

1. Size and complexity of the entity.
2. Area of the audit.
3. Assessed risks of material misstatement.
4. Capabilities and competence of the individual team members performing the audit work.
6.6 Documentation (Ref: 12, A18-21)

1. The overall audit strategy;
2. The audit plan
3. Any significant changes made during audit to above two and reasons for such change
6.7 Tutorial note
AT A GLANCE
Core Paragraphs: 6, 8, 9 and 12
Explanatory Paragraphs: A9, A8, A12, A14 and A20
SPOTLIGHT

7. CHANGES IN A PROFESSIONAL APPOINTMENT

7.1 Why a change might arise
An ICAP member may be asked to accept a new audit appointment in a situation where the existing auditor will
not be reappointed. This may be for any of the following reasons:
1. The current firm is too small to cope with the demands of an expanding client (who now operates from
multiple locations, in different towns or countries).
2. There may be a change in the composition of the company’s board of directors, and the new directors
wish to appoint an auditor of their own choice.
3. There may be a perceived lack of independence, possibly one that has just arisen.
4. There may have been a disagreement between the directors and the ‘old’ audit firm (for example, over
the accounting treatment of an item in the financial statements).
In theory, the auditor is appointed by the shareholders. However, in practice recommendations are made by the
directors to the shareholders when they consider that there should be a change of auditors.
If the outgoing auditor feels that the change is for a reason that should be brought to the attention of the
shareholders (for example, in the case of a dispute) then national legislation (s253 of the Companies Act, 2017
AT A GLANCE
in Pakistan) allows them to make representations to the shareholders.
7.2 Procedures before accepting a new audit appointment

Before accepting an appointment, the audit firm should take the following steps:
1. It should assess whether there are any professional problems attached to accepting the engagement.
These might include, for example, problems of lack of independence, or a lack of technical expertise, or
a conflict of interest.
2. It should ensure that resources are available to complete the audit assignment; in particular, it must
ensure that there will be sufficient staff (of the right level of expertise) available at the right time.
3. It should take up references on the proposed client company and its directors, if they are not already
known to the auditors. This is usually referred to as client screening.
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4. It should communicate with the incumbent (existing) auditors, if there are any, to discuss the
appointment, the client and the audit work and to find out whether there is any reason why the proposed
audit appointment should not be accepted. The method of communication is referred to as professional
enquiry (see below).
Client identification
In order to comply with anti-money laundering regulations, the audit firm should carry out client identification
procedures. The purpose of these procedures is to confirm that the client is ‘as they say they are’, and that there
are no grounds for suspicion that the client may be involved in money laundering activities.
1. If the client is a company or other business entity, documentary evidence of the identity of the entity
should be obtained – for example a certificate of incorporation in the case of a company.
2. Evidence should also be obtained to confirm the address of the entity, such as letter head.
3. If the client is an individual, evidence of identity can be obtained from a passport or driving license, and
evidence of address (possibly) from a recent utility bill.
4. The audit firm should consider whether the business of the potential new client ‘makes commercial
sense’. For example, it would not make sense for a very large company to be engaged in operating a
number of dry cleaning shops, because the size of the company would be too large for the nature of its
business operations. When this happens, the client’s declared business may simply be a front or cover
for hidden illegal activities.
The audit firm should explain the regulatory purpose of client identification, to remove any doubts or concerns
that the new client may have.

Professional enquiry
The firm should communicate with the current auditors (if there are any) to establish if there are any matters
that it should be aware of when deciding whether or not to accept the appointment. Although this is partly a
matter of courtesy between professionals, this will involve discussion of the appointment, the client and the audit
work. Such discussion will allow the firm to decide if the client is someone for whom it would wish to act.
The following points should be noted in connection with communicating with the current auditors:
1. When a member is first approached by a prospective client to act or be nominated, they should explain
that they have a professional duty to communicate with the existing auditor or advisor.
2. Client permission is required for any such communication. If the client refuses to give its permission, the
appointment as auditor should not be accepted.
3. If the client does not give the current auditor permission to reply to any relevant questions, the current
auditor should communicate this fact to the prospective auditor who should subsequently not accept
appointment.
4. If the current auditor does not provide any information relevant to the appointment, the new auditor
should accept or reject the engagement based on other available knowledge.
5. The existing auditor or adviser should answer without delay the communication from the prospective
auditor. If there are no matters of which the latter should be aware, the existing auditor or adviser should
AT A GLANCE
write to say that this is the case.
6. If, however, there are such matters they should inform the prospective auditor of those facts within their
knowledge of which, in their opinion, the prospective auditor should be aware. It is not sufficient to state
that unspecified facts exist.
7. The existing auditor or adviser might prefer to explain these facts orally and the prospective auditor or
adviser should be prepared to confer with the existing auditor or adviser if the latter so desires, and each
should make their own record of such a discussion.
8. If an issue of conflicting viewpoints between the client and themselves has been raised by the existing
auditor in their reply, the prospective successor should discuss the conflict with the client and satisfy
themselves either that the client’s view is one which they can accept as reasonable or that the client will
accept that the incoming auditor or adviser might have to express a contrary opinion.
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9. Where the existing auditor or adviser does not respond within a reasonable time, the prospective
successor should endeavor to contact the existing auditor by some other means, for instance, by
telephone or e-mail.
10. Should this fail, and where the prospective successor has no reason to believe that there are untoward
circumstances surrounding the change, they should send a final letter by recorded delivery service
stating that unless they receive a reply within a specified time they will assume that there are no matters
of which the existing auditor is aware that should be brought to their attention. A member who accepts
nomination in such circumstances is not precluded from complaining to the Institute that the existing
auditor did not respond to their enquiry letter.
11. If the prospective auditor is satisfied that they can properly act, and are prepared to accept
nomination/appointment, they should so inform the client in writing.
Unpaid Fees
A member in public practice should not accept an audit assignment previously carried out by another member,
without first ensuring that the other member has been properly removed from office as auditor and that all
outstanding fees due to the other member have been fully paid.
ICAP’s technical release no.16 (ATR-16) states that ICAP members shall be deemed guilty of professional
misconduct if they accept the appointment as auditor (for statutory audits to be performed under the Companies
Act, 2017 or other statute) where the undisputed audit fee of the prospective client due to a fellow Chartered
Accountant has not been paid.

Confidentiality
The prospective auditor should ordinarily treat in confidence any information provided by the existing auditor.
However, it may be essential to the fulfilment of a prospective auditor’s obligations that they should disclose
such information. It may, for example, be unavoidable for the prospective auditor to disclose to officers or
employees of the client matters brought to their attention by the predecessor firm, which needs to be properly
investigated. Such disclosure should be no wider than is necessary.
Defamation
An existing auditor might need to communicate matters to a prospective auditor that are potentially damaging
to a client (or to an individual concerned with the client’s business) during ‘professional enquiry’ e.g. statements
regarding management’s integrity.
Auditors will normally be protected against any defamation claim against them relating to professional enquiry
so long as they have followed professional and ethical guidelines when making such communications.
This type of protection is called ‘qualified privilege’ and means that the auditor would not be liable to pay
damages for defamatory statements even if they turn out to be untrue, provided that they are made without
malice.
AT A GLANCE
Joint auditor
A member whose firm is nominated as a joint auditor should communicate with all existing auditors and be
guided by similar principles to those set out in relation to nomination as an auditor. Where it is proposed that a
joint audit appointment becomes a sole appointment, the surviving auditor should communicate formally with
the outgoing joint auditor.
Vacancy
A member whose firm is invited to accept nomination on the death of a sole practitioner auditor should endeavor
to obtain such information as they may need from the late practitioner’s alternative (where appropriate), the
administrators of the estate or other relevant sources.
Additional work
SPOTLIGHT
A member invited to undertake recurring or non-recurring work, which is additional to and related to continuing
work carried out by another Chartered Accountant or adviser should normally notify that other Chartered
Accountant of the work they have been asked to undertake.
1. It is generally in the interest of the client that the existing auditor be aware of the nature of the additional
work being undertaken. The existing Chartered Accountant will be provided with the opportunity to
communicate with the member to provide information, lack of which might otherwise prevent the
additional work from being carried out effectively. Additionally, such notification could affect the way
an existing Chartered Accountant discharges their continuing responsibilities to their client.
2. Notification should always be given to the existing Chartered Accountant.
3. Provision of all opinions on the application of accounting standards or principles clearly requires
particular sensitivity to avoid adversarial positions between an auditor and other Chartered
Accountants wherever possible.
7.3 Deciding whether to accept a new audit appointment

An accountancy firm may occasionally decide that to accept a new audit appointment would threaten the firm’s
reputation and might also raise serious ethical issues.
 Example: accepting a new audit appointment
Gudrat Company is an owner-managed company. It has asked your firm to become its auditors.
The following information has been obtained about the company, mainly from the company’s
current auditors.

1. The current auditors have just resigned from the audit because they no longer have
sufficient resources to carry out the audit work for Gudrat. They had taken on the
audit two years earlier, after the previous auditors had resigned due to a dispute
about fees. The current auditors commented that the company’s management liked
to keep a close control over costs, and they had agreed to do the audit for a lower
fee.
2. The current auditors had discovered a number of internal control weaknesses in
Gudrat and had reported them to management, but nothing appeared to have been
done by management to improve the control system.
3. There were ongoing disputes with the tax authorities about the amount of tax
payable by Gudrat on profits for the previous three years.
4. Gudrat Company has a poor public relations image. It is currently under
investigation by both the police authorities and the regulatory authorities for
alleged breaches of regulations, and some of these had been widely reported.
5. The company is ambitious and plans to expand its business in the next year or so. It
expected to obtain bank loans to finance most of the expansion.
What issues should the audit firm consider when deciding whether or not to accept the new audit
appointment?
AT A GLANCE
 Answer
The following matters may be considered.
1. Reputation. The audit firm may decide that it does not wish to be associated with a client
company whose public relations image is poor. The bad reputation of the company may
transfer to its auditors.
2. Advocacy threat. The criminal or regulatory investigation may lead to legal action, and
the audit firm may be faced with an advocacy threat, and be expected to defend the
company against the allegations that have been made against it.
3. Aggressive management. Gudrat Company has aggressive managers who are willing to
argue with auditors and who want to keep costs as low as possible. There is a high risk
SPOTLIGHT
of continuing disputes over audit fees.
4. Audit risk. If the company applies for new bank loans, it will probably be required to
submit audited financial statements to the bank as part of the loan application. The
management of Gudrat have a strong interest in presenting financial statements that
show strong profits and a healthy statement of financial position. The risk that the
financial statements may be misstated could therefore be high. (The audit firm would
probably wish to consider including a disclaimer in their audit report, to reduce the risk
of liability to a bank for ‘negligent’ auditing in the event that the financial statements
turn out to be misstated and the errors are not identified by the auditors.)
5. High audit risk is also suggested by the weak internal controls and failure by
management to improve controls.
6. The high audit risk means that a new auditor would want to conduct a very careful audit
of the opening balances: this would add to the cost and time required for the audit, which
Gudrat management may refuse to accept.
However, there is no evidence of fraud (or suggestion of fraud) by anyone in the company, and
the audit firm may decide to accept the audit appointment, subject to agreement about fees.
Acceptance of a new audit client is a matter of judgement.

7.4 Books, documents and records
Client books and records: right of lien

Once a new auditor has been appointed, the outgoing auditor should arrange for the transfer of any books and
records belonging to the client that are in their possession.
However, where fees remain unpaid, the outgoing auditor may wish to exercise a legal right of lien over those
client books and records.
1. A lien is a right to retain possession of property belonging to another until amounts due are paid.
2. Auditors have a ‘particular’ (as opposed to a ‘general’) lien. This means that the right of lien is only in
respect of those books and records on which the auditor has performed audit work.
3. In order for the lien to be applied:
4. the documents must have come into the auditor’s possession lawfully, and
5. an invoice must have been sent to the client company for the fees owing, and there must be no dispute
over fees.
Unfortunately, in some countries, legal decisions have been taken that mean a lien cannot be exercised over
books and records which the client is required to keep by law. In many cases, this legal requirement applies to
AT A GLANCE
most of the client’s books and records. Consequently, these legal decisions may significantly reduce the
effectiveness of the right of lien.
Auditor working papers

Audit working papers are documents prepared by the auditors for the purpose of carrying out their audit work.
In general, these belong to the auditors, unless there is a provision to the contrary in the engagement letter or in
national law.
However, the outgoing auditor will be expected to provide the proposed new auditor with information that is
sufficient for a reasonable handover of audit responsibilities. The precise nature of this information will depend
on the stage that the audit has reached when the responsibility for the audit passes from the outgoing audit firm
to the new one.
SPOTLIGHT
7.5 Accepting engagements other than audit

The procedures for accepting non-audit engagements are very similar to those for accepting audit engagements
and include:
1. Ethical considerations – e.g. does the firm have staff who are technically competent to perform the
engagement? Might there be a conflict of interest with an existing client? There can be instances where
a proposed appointment for a non-audit engagement, for example advice on business restructuring or
accounting assistance, could potentially conflict the auditor’s need to apply professional scepticism as
part of the audit due to the increased self-interest. Such non-audit engagements need to be thoroughly
reviewed prior to acceptance.
2. Commercial considerations – e.g. does the engagement fit with the strategy of the firm at an appropriate
and fair fee level?
3. Client identification – e.g. the firm should apply client due diligence (know your client) procedures to all
new clients, not just audit clients.
4. Communication – it may or may not be appropriate and/or feasible to communicate with another
practitioner in the same way an incoming auditor is required to communicate with the existing auditor.
Protocol will depend on the particular circumstances of the non-audit engagement.


The financial statements of Walter Limited (WL) a public unlisted company, for the year ended
30 June 2007 were significantly delayed and were finalized in April 2008. After finalization of
financial statements, a meeting of the board of directors (BOD) of WL was held in May 2008 and
Annual General Meeting (AGM) was held on June 18, 2008. Due to delay in holding the AGM, the
Securities and Exchange Commission of Pakistan (SECP) has imposed a penalty and has advised
WL that no such delay shall be entertained in future.
In the AGM, the shareholders of WL appointed your firm as the statutory auditors and the fact
has been communicated to you by the Company Secretary through his letter dated June 22, 2008
which was faxed to you on the same date.
The company’s financial year is closing on June 30, 2008 and the management wants to
commence the audit immediately in order to ensure timely financial reporting and holding of
AGM.
Required:
What other steps would you like to take before commencement of the audit?
 Solution:
AT A GLANCE
OTHER STEPS
Professional Clearance Letter we need to refer to the Code of Ethics for Chartered Accountants
which requires that the proposed chartered accountant in practice should:
i. Ascertain if the prospective client has advised the existing auditors of the proposed
change and has given them the permission, preferably in writing, to discuss the client’s
affairs fully and freely with the new auditors i.e. our firm.
ii. After getting satisfactory reply from prospective client, request permission to
communicate with the existing chartered accountant. If such permission is refused or
the permission referred to in (a) above is not given, the proposed chartered accountant
in practice should, barring some judgmental exception, decline the appointment.
iii. On receipt of permission, we shall ask the existing auditors, preferably in writing:
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a) To provide information on any professional reasons if any, on account of which our
firm may decide not to accept the appointment and,
b) If there are any such matters, to provide all the necessary details to enable us to
come to a decision.
Particularly in view of the fact that it is the first audit, we should send an engagement letter,
preferably before the commencement of the engagement, to help in avoiding misunderstanding
with respect to the engagement.

8. OBTAINING AND CHARGING FOR PROFESSIONAL WORK

8.1 Obtaining professional work
Audit practices will want to increase the size of their client base as a means of increasing the profits of the
practice. This can be achieved by:
1. promoting their (good) reputation in the business community
2. recommendations from existing clients
3. advertising
4. publicity and promotion (such as sponsorship activities)
8.2 Advertising and publicity
When a professional accountant in public practice solicits new work through advertising or other forms of
marketing, there may be a threat to compliance with the fundamental ethical principles. For example, a self-
interest threat to compliance with the principle of professional behaviour is created if services, achievements, or
products are marketed in a way that is inconsistent with that principle.
Advertising and publicity activities by accountancy firms are therefore regulated by IFAC and ICAP through their
codes of ethics and conduct respectively.
AT A GLANCE
Advertising and publicity - ICAP Code of Ethics

Undue publicity to be avoided
In any communications, announcements and public notices, chartered accountants should not:
1. use means which bring the profession into disrepute;
2. make exaggerated claims for the services they are able to offer, the qualifications they possess, or
experience they have gained; and
3. denigrate the work of other accountants.
A Chartered Accountant preparing or authorizing the issue of matter falling within this Section should do so with
a due sense of responsibility to the profession and to the public as a whole. In particular, such material should be
in good taste both as to content and presentation and should not belittle services offered by others, whether
SPOTLIGHT
members or not, either by claiming superiority for the services of a particular Chartered Accountant or
otherwise. The same attitude should be adopted towards activities mentioned in subsequent paragraphs.
Advertising for solicitation must be avoided
All communications, announcements and public notices should be issued in such a manner and within the limits
prescribed in the following paragraphs:
1. All announcements, communications and public notices should:
 be aimed at informing the recipients or the public in an objective manner;
 conform to the basic principles of legality, decency, clarity, honesty and truthfulness; and
 not project an image, which is inconsistent with that of a professional person bound to high ethical
and technical standards.
2. Activities which may expressly be considered not to meet the above criteria and are therefore prohibited
include those that:
 create false, deceptive or unjustified expectations of favourable results;
 imply the ability to influence any court, tribunal, regulatory agency or similar body or official;
 consist of self-laudatory statements that are not based on verifiable facts;
 make comparisons with other professional accountants in practice;
 contain testimonials or endorsements;
 contain any other representations that would be likely to cause a reasonable person to
misunderstand or be deceived; and
 make unjustified claims to be an expert or specialist in a particular field of accountancy.

8.3 Fees
General principles
The question of setting a ‘price’ for the provision of a service is always a sensitive matter, because of disputes
that may arise if the fees are unreasonable.
In establishing the fee for professional work, the accountant should follow professional guidance. In any case
they must ensure they do not breach any of the fundamental ethical principles.
For example, a self-interest threat to professional competence and due care may be created if the fee quoted is
so low that it may be difficult to perform the engagement in accordance with applicable technical and
professional standards for that price.
Safeguards against threats may include:
1. making the client aware of the terms of the engagement and, in particular, the basis on which fees are
charged and which services are covered by the quoted fee (through the engagement letter); and
2. assigning appropriate time and qualified staff to the task.
Promotional material
Where reference is made in promotional material to fees:
AT A GLANCE
1. this must not be misleading with regard to the precise range of services and the time commitment
covered.
2. comparison may be made to the fees of others, provided that this is not misleading and that it follows
local regulations or legislation.
3. discounts on existing fees may be offered, or a free consultation at which the level of fees will be
discussed. However, the discount should not be so low that it constitutes lowballing, as described above.
Introductions
Fees and commissions may be paid to third parties for the introduction of potential new clients, but safeguards
must be in place to reduce the threats to the fundamental principles. Such safeguards would include disclosure
to the client.
SPOTLIGHT
8.4 Tendering
Introduction
Tendering is a commercial process widely-used by companies (especially larger companies) when they wish to
change auditors. Tendering involves two or more audit firms being invited by a company to submit a proposal
for its audit work. The invitation may or may not include the existing auditor.
A company may also invite firms to tender for the audit work when the term of the appointment for the current
audit firm has come to an end. In this case, if the current auditor wishes to be re-appointed, it will have to go
through a tendering process.
Initial considerations
Tendering should commence only when a firm has been approached by a prospective client. In any case, a firm
should not submit a tender for the work unless it can give satisfactory answers to the following questions:
1. Does the firm have the expertise to carry out this audit?
2. Does the firm have (or could it have) sufficient staff available at the appropriate time?
3. Are there any ethical reasons why the firm could not act (for example, a problem with independence, or
a conflict of interest)?
4. Are there any problems, of which the firm is aware, with the current audit or auditors?

Specifically, in relation to a tender, the firm should also ask itself:

1. Why has it been asked to tender?
2. Could it (and should it?) offer to do the audit for a lower fee than other firms are likely to quote?
3. Are there any reasons why this audit is particularly attractive to the firm? For example, will the work be
carried out at a quiet time of year, or is the company in an industry area where the firm wishes to develop
its audit experience and expertise?
4. What audit risks might arise with this particular client?
The tendering process
The principal benefit to the client of a tendering process should be lower audit fees, because several firms are
competing for the work.
In response to the pressure to reduce their fees, audit firms have become more efficient and lowered their costs.
Even so, the tendering process can still be ‘high risk’ for a firm.
For example:
1. The firm needs to be confident that the client is one that it can deal with professionally and economically
if the tender is accepted.
AT A GLANCE
2. If the tender is not accepted, the time and cost involved in the tendering process (which may be
considerable) has been wasted. The firm needs to be sure that a sufficiently high proportion of its
tenders will be successful, to justify the costs.
The tendering process should be broken down into the following stages (assuming that a firm is submitting a
tender for the audit of a new client):
1. Collect background information about the possible new client. (This is necessary when evaluating any
new client, whether the fee is to be set by tender or by any other method.)
2. Establish the precise scope of the work to be performed and the specific requirements of the prospective
client.
3. Carry out a preliminary audit risk assessment and prepare a preliminary plan for the audit. The plan
must cover the staffing requirements and the time requirements for the work.
SPOTLIGHT
4. Estimate a fee.
5. Prepare a submission document for the potential client. The contents of this document will typically
include:
 an outline of the key characteristics of the firm
 clarification of the nature of the audit work or other non-audit work to be performed
 a statement of the requirements of the client and how the firm will comply with them
 an outline of how the work will be performed
 the proposed fee and the basis of its calculation
 the range of other services which the firm could offer to the client.
6. If required, prepare and give a presentation to the potential client.
Evaluating the tender
In evaluating the tender, the client (company) is likely to consider the following issues:
1. Fees
2. The services that the firm is able to provide
3. Geographical locations and coverage of the firm’s offices
4. Expertise of the firm and its staff
5. Reputation of the firm
6. Whether the senior management of the company think that they will be able to work well (on a personal
level) with the potential engagement partner and key audit staff

7. The formal presentation itself by the audit firm

8. The extent to which the company wants to change its audit firm and its dissatisfaction with the current
audit firm.
Lowballing
Lowballing is the practice of tendering for the audit work at a very low fee, with the objective of winning the
audit. If it is successful in obtaining the audit, the firm will hope that:
1. it will be able to raise the audit fee in future years, or
2. it will be able to recover losses on the audit fee by providing other, more lucrative non-audit services.
Although there is no evidence that lowballing leads to a poor-quality audit, the fact that it exists does nothing to
improve the reputation of the auditing profession. The existence of low fees may suggest to the business
community and to the general public that audit work is of a low quality. All fees should be sufficiently adequate
to compensate a firm for the work that it carries out. With this in mind, the ICAP Code of Ethics requires Chartered
accountants in practice to comply with provision ATR-14 denoting minimum hourly charge-out rates and fees
for audit engagements.
8.5 Credit control within an audit firm
AT A GLANCE
An audit firm does not just charge fees. It has to collect the fees that it charges. A failure to invoice clients
promptly or a failure to collect payment within a reasonable time after the invoice date would be an indication
of poor credit management. Any such management weaknesses should be corrected if they occur.
Occasionally, non-payment of fees may be due to the fact that the audit client is in financial difficulties and cannot
pay.
1. Overdue fees are a threat to the independence and objectivity of the auditor, because it might be argued
that audit work has been provided free of charge. If the unpaid amount has been overdue for a long time,
it could be regarded as a form of loan by the audit firm to the client.
2. The risk to auditor independence could be significant if the unpaid amount is material.
3. When a client is in temporary financial difficulties it is permissible for an auditor to make commercial
arrangements for staged payments of the fees due. The client should be made aware, however, of the
SPOTLIGHT
ethical problems that non-payment or late payment create for the audit firm.
4. For future audits, if the audit engagement is retained, the auditor should pay particular attention to the
going concern assumption. If the client still has continuing cash flow problems, the going concern
assumption may be challenged.
When unpaid fees are owed by a client and the period of late payment is in excess of what might be regarded as
commercially acceptable, the audit firm should consider whether it would be ethically appropriate to resign as
auditors.
1. The ethics partner of the firm should be asked to assess the ethical threat to the firm’s independence
and integrity.
2. If the decision is to continue as auditor of the client, the reason should be documented.
3. The most recent audit papers should be checked to ensure that sufficient appropriate evidence was
obtained to support the going concern assumption in the financial statements.

AT A GLANCE
SPOTLIGHT

CHAPTER 5
PROFESSIONAL RESPONSIBILITY
AND LIABILITY
AT A GLANCE
IN THIS CHAPTER: This chapter deals with a number of aspects of law and
regulation under which auditors may have:
AT A GLANCE
 penalties imposed on them for a criminal offence, or
SPOTLIGHT  legal claims made against them for negligence.
AT A GLANCE
1. Auditors’ liability and the ISA-240 deals with the auditor’s responsibilities relating to
expectations gap fraud in an audit of financial statements. Misstatements in the
financial statements can arise from either fraud or error. The
2. The auditor’s responsibilities distinguishing factor between fraud and error is whether the
relating to fraud in an audit underlying action that results in the misstatement of the
of financial statements (ISA financial statements is intentional or unintentional.
240) Legal claims made against auditors fall within one of two legal
strands:
3. The auditor’s liability
 Auditor may be prosecuted by the authorities for a criminal
4. Managing the auditor’s act, and be criminally liable if found guilty. (The penalty may
liability be a fine, or possibly imprisonment)
SPOTLIGHT
 The auditor may be liable under civil law. A ‘civil’ legal
5. Communication with those action may be brought against an auditor by another person
charged with governance who has suffered loss or damage because of the auditor’s
(ISA 260 - Revised) actions.
Different ways of meeting auditor’s liability are also dealt in
with in this chapter.
ISA-260 deals with the auditor’s responsibility to communicate
with those charged with governance in an audit of financial
statements. Although this ISA applies irrespective of an entity’s
governance structure or size, particular considerations apply
where all of those charged with governance are involved in
managing an entity, and for listed entities.

CHAPTER 5: PROFESSIONAL RESPONSIBILITY AND LIABILITY CFAP 6: AARS
1. AUDITORS’ LIABILITY AND THE EXPECTATIONS GAP

1.1 Introduction
This chapter deals with a number of aspects of law and regulation under which auditors:
 may have penalties imposed on them for a criminal offence, or
 may have legal claims made against them (for ‘damages’) for negligence.
The potential liability of auditors has become an important topic in recent years, due to the growing complexity
of the business and legal environment and an increase in legal actions against auditors.
One explanation put forward to explain the high number of legal actions against auditors is the ‘expectations
gap’.
1.2 The expectations gap

The expectations gap is the difference (or ‘gap’) between:
 what the users of financial statements and other members of the public think that the auditors should
do, and
AT A GLANCE
 what the auditors are actually required by the law and the profession to do.
There are three main elements in the expectations gap:
 A standards gap. This occurs because of a perception that auditing standards are more prescriptive than
they actually are, and that auditors have wide-ranging rules that they must follow:
 A performance gap. This occurs because of a perception that audit work has fallen below the required
standards.
 A liability gap. This arises from a lack of understanding about the auditor’s liability and who the auditor
may be liable to.
In addition, there is a perception that auditors have a responsibility for detecting all frauds, whenever they occur.
High levels of expectation about what auditors should do may lead to legal action against auditors if this level of
SPOTLIGHT
expectation is not met. To reduce the frequency and cost of legal action, and to maintain the image of the audit
profession in the mind of the public, it is in the interests of the profession to take steps to close the expectations
gap.
1.3 Closing the expectations gap

A number of strategies exist that could assist in closing the expectation gap and are discussed below.
 The profession should attempt to improve the general level of knowledge and understanding about the
audit process. One such attempt has been made with the issuance of revised ISA 700, the auditing
standard on auditor’s reports. This requires the audit report to include an explanation of the nature of
an audit.
 The revised ISA 700 (see later chapter on current affairs) extends the description of the nature of an
audit and provides more useful and relevant information about the audit to users.
 Controls over the auditing profession are important in enhancing public confidence. For example:
¯ The European Union requires the audit of companies whose shares are quoted on a stock market in
the EU to be conducted in accordance with international auditing standards (ISAs);
¯ National oversight bodies such as PCAOB (Public Company Accounting Oversight Board) in USA and
FRC (Financial Reporting Councils) in the UK monitor the compliance of audit firms in their conduct
of audits by performing audit inspections;

CFAP 6: AARS CHAPTER 5: PROFESSIONAL RESPONSIBILITY AND LIABILITY
 Significant guidance for auditors and management aimed at increasing quality and addressing issues
such as going concern has been issued by standard setters, professional bodies and regulators. There
has been an increased focus on corporate governance and the role that audit committees play in
companies, reducing inconsistencies and enhancing the quality of audits.
 Open and candid communication between internal and external auditors, financial management and the
audit committee is increasingly being seen as critical in helping reduce the expectation gap. Such
communication helps the audit committee to perform their governance role with the necessary
transparency and realistic expectations that will help achieve effective risk management.
 Enhanced communication between the parties and confirmation of their respective roles and
responsibilities should be presented in the audit committee and directors’ reports to the shareholders.
This will ensure that users become much more aware of the various parties’ roles and responsibilities
beyond the understanding they gain just from the audit report.
 The expectation gap will hopefully narrow further as financial reporting participants work together even
more effectively to improve the deterrence and detection of financial reporting fraud.
The level of success in narrowing the expectation gap is likely to vary considerably between territories
depending on factors such as culture, ethics, the level of incidence of governance mechanisms beyond the
minimum required by law and regulation and the quality, availability and transparency of corporate reporting.
AT A GLANCE
One thing that is certain is that audit committees are well positioned to play a vital role in reducing the
expectation gap given their open and direct relationship with all the key parties including shareholders, board
of directors, internal audit and external audit. This is also because audit committees include an appropriate mix
of independent and/or non-executive directors to add the necessary transparency and impartiality which is
required for stakeholders’ confidence in the overall financial reporting process and the audit itself.
1.4 IAASB Q&A: Professional scepticism in an audit of financial statements

The IAASB issued a Q&A-style briefing paper on professional scepticism in 2012 which articulates the meaning
and application of professional scepticism in the audit of financial statements.
The Q&A focuses on considerations in the ISAs and the IAASB’s quality control standard that are of particular
relevance to the proper understanding and application of professional scepticism during an audit of financial
statements.
SPOTLIGHT
Q&A
Question Answer
1. What is professional scepticism? The ISAs define professional scepticism as “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 audit evidence.” They explicitly require the auditor to plan and
perform an audit with professional scepticism recognizing that
circumstances may exist that cause the financial statements to be
materially misstated.
i.e. An inquisitive mind.
2. Why is professional scepticism Professional scepticism plays a fundamentally important role in the
important in audits of financial audit and forms an integral part of the auditor’s skill set. Professional
statements? scepticism is closely interrelated with professional judgment. Both
are essential to the proper conduct of the audit and are key inputs to
audit quality. Professional scepticism facilitates the appropriate
exercise of professional judgment by the auditor, particularly
regarding decisions about, for example:
 The nature, timing and extent of audit procedures to be
performed.

Question Answer
 Whether or not sufficient appropriate audit evidence has been
obtained and whether or not more needs to be done to achieve
the objectives of the ISAs.
 The evaluation of management’s judgments in applying the
entity’s applicable financial reporting framework.
 The drawing of conclusions based on the audit evidence obtained,
for example, assessing the reasonableness of the estimates made
by management in preparing the financial statements.
3. What can be done by audit firms Professional scepticism within the engagement team is also
and auditors to enhance the influenced both by the actions of the firm’s leadership and the
awareness of the importance of engagement partner, and by the culture and business environment of
professional scepticism and its the firm. The ISAs and ISQC 1 include requirements and guidance
application? designed to help create an environment at both the firm and
engagement levels in which the auditor can cultivate appropriate
professional scepticism. For example:
 Auditors must consider the integrity of the principal owners and
AT A GLANCE
management during engagement acceptance (ISQC 1).

 The auditor must consider the reasonableness of significant
assumptions used by management for accounting estimates
giving rise to significant risks (ISA 540).
 ISA 240 (relating to fraud) notes that the auditor must maintain
an ongoing questioning mind and be alert to the possibility of
fraud.
 When considering going concern (ISA 570) the auditor must
consider the reasonableness of assumptions and whether
management’s plans are feasible in the circumstances.
 Another area where professional scepticism is particularly
important is in relation to auditing significant unusual or highly
SPOTLIGHT
complex transactions (ISA 330).

 The auditor is required to document how they have applied
professional scepticism (ISA 230).
4. At what stage in the audit Professional scepticism is relevant and necessary throughout the
process is professional scepticism audit, even though reference to it is not repeated within each ISA,
necessary? including:
 Engagement acceptance – integrity of owners and management.
 Identifying and assessing risks of material misstatements.
 Designing nature, timing and extent of further audit procedures
that are responsive to assessed risks of material misstatement,
and evaluating audit evidence.
 Forming the audit opinion.
5. How does professional Due to the characteristics of fraud, including the fact that fraud may
scepticism relate to the auditor’s include sophisticated and carefully organised schemes designed to
responsibilities with respect to conceal it or may involve collusion, the auditor’s professional
fraud? scepticism is particularly important when considering the risks of
material misstatement due to fraud.
ISA 240 places special emphasis on professional scepticism.

Question Answer
6. In addition to fraud, are there Professional scepticism is important and necessary throughout the
other aspects of an audit where entire audit process. The auditor’s professional scepticism becomes
professional scepticism may be particularly important when addressing areas of the audit that are
particularly important? more complex, significant or highly judgmental such as:
 Accounting estimates e.g. fair value;
 Going concern – e.g. management’s plans for future actions;
 Related party relationships and transactions – e.g. business
rationale;
 Consideration of laws and regulations;
 When auditing significant unusual or highly complex
transactions.
7. How can the application of Professional scepticism is often demonstrated in the various
professional scepticism be discussions held by the auditor during the course of an audit. For
evidenced? example, the auditor’s communication with those charged with
governance includes, where applicable, why the auditor considers a
AT A GLANCE
significant accounting practice that is acceptable under the applicable
financial reporting framework not to be most appropriate to the
particular circumstances of the entity.
Documentation remains critical. The ISAs require auditors to
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. Such documentation helps the auditor
demonstrate how significant judgments and key audit issues were
addressed and how the auditor has evaluated whether sufficient and
appropriate audit evidence has been obtained.
Examples of circumstances where it is particularly important to
prepare documentation:
SPOTLIGHT
 Significant decisions from engagement team discussions
regarding fraud;
 Identified or suspected non-compliance with laws and
regulations;
 Basis of auditor’s conclusions about estimates;
 Identifying information that is inconsistent with the auditor’s
final conclusions on a significant matter;
 Reasonableness of areas of subjective judgments.
8. Do regulators and oversight The ISAs do not set forth requirements for regulators and oversight
bodies of audit firms and those bodies of the audit firms, or for those charged with governance.
charged with governance have a However because of the critical role that those stakeholders serve in
role to play in supporting sceptical achieving audit quality, they are in a position to further challenge
behaviour among auditors? auditors.

2. THE AUDITOR’S RESPONSIBILITIES RELATING TO FRAUD IN AN AUDIT OF

FINANCIAL STATEMENTS (ISA 240)
Definition: 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.
2.1 Characteristics of Fraud (Ref: 2-3, A1-A5)

Misstatements in financial statements can arise from either fraud or error. Distinguishing factor between fraud
and error is whether the action that results in the misstatement is intentional or unintentional.
 Fraud Risk Factors
Incentive or pressure
May exist when management is under pressure, from sources outside or inside entity, to achieve
an expected (and perhaps unrealistic) earnings target or financial outcome.
Perceived opportunity
AT A GLANCE
May exist when an individual believes internal control can be overridden due to his position or
he has knowledge of deficiencies in internal control.
Attitudes / Rationalization
Some individuals possess an attitude, character or set of ethical values that allow them knowingly
and intentionally to commit a dishonest act.
Auditor may suspect or identify occurrence of fraud, but he does not make legal determinations of whether fraud
has actually occurred.
Fraud is a broad legal concept but auditor is concerned with fraud that causes a material misstatement in
financial statements. There are two types of Frauds relevant to financial statements:
1) Fraudulent financial reporting

SPOTLIGHT
 Manipulation, falsification (including forgery), or alteration of accounting records or supporting

documentation.
 Misrepresentation or intentional omission from financial statements of events, transactions or other
significant information.
 Intentional misapplication of accounting principles relating to amounts, classification, manner of
presentation or disclosure.
Also involves management override of controls using techniques as:
 Recording fictitious entries, particularly close to period end, to manipulate operating results or achieve
other objectives.
 Inappropriately adjusting assumptions and changing judgments.
 Omitting, advancing or delaying recognition of events and transactions in financial statements.
 Concealing or not disclosing facts that could affect financial statements.
 Engaging in complex transactions structured to misrepresent the financial position or financial
performance of entity.
 Altering records & terms of significant and unusual transactions.

2) Misappropriation of assets
Involves theft of entity's assets and is often perpetrated by employees & management. It can be accomplished
in a variety of ways including:
 Embezzling receipts.
 Stealing physical assets or intellectual property.
 Causing an entity to pay for goods and services not received.
 Using an entity's assets for personal use.
Misappropriation is often accompanied by false or misleading records or documents in order to conceal
fraud.
2.2 Responsibility for the Prevention and Detection of Fraud (Ref: 4-9, A6-A7)
Primary responsibility for prevention and detection of fraud rests with both those charged with governance
and management.
Responsibilities of the Auditor

An auditor is responsible for obtaining reasonable assurance that financial statements as a whole are free from
AT A GLANCE
material misstatement, whether caused by fraud or error.
Due to inherent limitations, there is an unavoidable risk that some material misstatements may not be detected;
even the audit is properly planned & performed in accordance with ISAs.
Risk of not detecting a material misstatement resulting from fraud is higher than risk of not detecting one
resulting from error.
Risk of not detecting a material misstatement resulting from management fraud is greater than for employee
fraud.
2.3 Discussion among the Engagement Team (Ref: 16, A11-A12)

 Exchange of ideas among team members about how and where the entity's financial statements may be
susceptible to material misstatement due to fraud, how management could commit and conceal fraud
SPOTLIGHT
 Circumstances that might be indicative of earnings management and practices to manage earnings
leading to fraud.
 Consideration of known external and internal fraud risk factors.
 Management's involvement in overseeing employees with access to cash or other assets susceptible to
misappropriation.
 Consideration of any unusual or unexplained changes in behavior or lifestyle of management or
employees.
 An emphasis on maintaining a proper state of mind throughout audit regarding potential for material
misstatement due to fraud.
 How an element of unpredictability will be incorporated into nature, timing and extent of audit
procedures?
 Consideration of audit procedures that might be selected to respond to the susceptibility of fraud.
 Consideration of any allegations of fraud that have come to the auditor's attention.
 A consideration of the risk of management override of controls.
2.4 Identification and Assessment of Risks of Material Misstatement Due to Fraud (Ref: 26-28, A29-A33)
Risks of Fraud in Revenue Recognition

Auditor shall evaluate which types of revenue, transactions or assertions give rise to such risks. (Assuming such
risk exists).

Material misstatement for revenue recognition often results from:

 Overstatement of revenues
 Understatement of revenues
Understanding Entity's Related Controls

Auditor shall treat those assessed risks of material misstatement due to fraud as significant risks and accordingly
shall obtain an understanding of entity's related controls, including control activities relevant to such risks.
2.5 Risk Assessment Procedures and Related Activities (Ref: 17-25, A13-A28)
Inquiries:
To determine whether they have knowledge of any actual, suspected or alleged fraud affecting the entity, Auditor
shall make inquiries of:
 Management
 Those charged with governance
 Internal Audit Function
AT A GLANCE
 Others
¯ Operating personnel not directly involved in financial statements process.
¯ Employees with different levels of authority.
¯ Employees involved in initiating, processing or recording complex or unusual transactions and their
supervisors.
¯ In-house legal counsel.
¯ Chief ethics officer or equivalent person.
¯ Person or persons charged with dealing allegations of fraud.
Specific Inquiries of management:

 Management's assessment of risk that financial statements may be materially misstated due to fraud;
SPOTLIGHT
 Management's process for identifying and responding to risks of fraud including fraud identified by
management or brought to its attention or areas for which such risk is likely to exist;
 Management's communication to those charged with governance regarding its processes;
 Management's communication to employees regarding its views on business practices and ethical
behavior.
Specific Inquiries of those charged with governance
Unless all of those charged with governance are involved in managing entity, auditor shall obtain an
understanding of:
 How those charged with governance exercise oversight of management's processes for identifying and
responding to the risks of fraud.
 Internal control management has established to mitigate risks.
Unusual or Unexpected Relationships Identified
Auditor shall evaluate whether such relationships identified in performing analytical procedures, including those
related to revenue accounts, may indicate risks of material misstatement due to fraud.
Other Information
Auditor shall consider whether other information obtained by auditor indicates risks of material misstatement
due to fraud.

Evaluation of Fraud Risk Factors

Auditor shall evaluate whether information obtained from other risk assessment procedures and related
activities indicates that one or more fraud risk factors are present.
The fact that fraud is usually concealed can make it very difficult to detect. However, auditor may identify events
or conditions that indicate an incentive or pressure to commit fraud or provide an opportunity to commit fraud.
2.6 Responses to Assessed Risks of Material Misstatement (Ref: 29-31, A34-A41)
At Financial Statement Level

 Assign and supervise personnel taking account of knowledge, skill and ability of individuals and
auditor's assessment of the risks.
 Evaluate whether selection and application of accounting policies by entity may be indicative of
fraudulent financial reporting.
 Incorporate an element of unpredictability in selection of the nature, timing and extent of audit
procedures.
¯ Performing substantive procedures on selected account balances and assertions (neither material
nor risky).
AT A GLANCE
¯ Adjusting timing of audit procedures from that otherwise expected.
¯ Using different sampling methods.
¯ Performing audit procedures at unexpected or different locations.
At the Assertion Level

Procedures may include changing the nature, timing and extent of audit procedures in the following ways:
 Nature: To obtain more relevant and reliable audit evidence or to obtain additional corroborative
information.
 Timing: Auditor may conclude that performing testing at or near period end better addresses risk of
material misstatement.
SPOTLIGHT
 Extent of procedures applied reflects the assessment of risks of material misstatement due to fraud.
2.7 Audit Procedures for Risks Related to Override of Controls (Ref: 32-34, A42-A49)
Auditor shall design and perform audit procedures to:
a) Test appropriateness of journal entries recorded in general ledger and other adjustments made in
preparation of financial statements:
 Make inquiries of individuals involved in financial reporting process about inappropriate or unusual
activity relating to the processing of journal entries and other adjustments;
 Select journal entries and other adjustments made at period end;
 Consider need to test journal entries and other adjustments.
In designing and performing audit procedures for such tests, we would:
 make inquiries of individuals involved in the financial reporting process about inappropriate or unusual
activity relating to the processing of journal entries and other adjustments;
 select journal entries and other adjustments made at the end of reporting period; and
 Consider the need to test journal entries and other adjustments throughout the period.
For above factors, the following matters are of relevance:
 Assessment of the risks of material misstatement due to fraud

 Controls implemented over journal entries and other adjustments

 Financial reporting process and nature of evidence that can be obtained
 Characteristics of fraudulent journal entries or other adjustments
¯ Made to unrelated, unusual, or seldom-used accounts
¯ Made by individuals who typically do not make journal entries,
¯ Recorded at period end or as post-closing entries that have little or no explanation or description,
¯ That do not have account numbers, or
¯ Containing round numbers or consistent ending numbers.
 Nature and complexity of the accounts
¯ Contain transactions that are complex or unusual in nature,
¯ Contain significant estimates and period end adjustments,
¯ Have been prone to misstatements in the past,
¯ Not been reconciled timely or contain unreconciled differences,
¯ Contain inter-company transactions,
¯ Are associated with an identified risk of material misstatement.
AT A GLANCE
 Journal entries or other adjustments processed outside the normal course of business
Our firm is the auditor of Daud Limited (DL), a listed company, since last four years. DL is a
low risk client with a very cooperative management. At year-end you have noticed significant
increase in the number of journal entries. The management has given various reasons for the
same which appear to be reasonable.
Required:
i. Identify the characteristics of entries which involve fraudulent adjustments.
ii. Discuss how would you deal with the above situation.
Tutorial Notes:
SPOTLIGHT
i. While answering this part, students are suggested to pay attention to the requirement
of specifying the characteristics of journal entries that may be indicative of fraudulent
adjustments. This part is not asking for verification of journal entries.
ii. Student should explain the fact that irrespective of the auditor's assessment regarding
management’s over-ride of controls, the auditor should test the appropriateness of
journal entries recorded in the general ledger.
 Solution:
i. Characteristics of fraudulent journal entries:
i. entries involving unrelated, unusual or seldom used accounts;
ii. entries made by individual who typically does not prepare journal entries;
iii. entries recorded at the end of the period;
iv. closing entries that have little or no explanation or description;
v. entries made either before or during the financial statements that do not have
account numbers;
vi. entries containing round numbers or consistent by ending numbers;
vii. entries involving complex transactions;
viii. entries containing significant estimates and period-end adjustments;

ix. entries affecting accounts which:

a. have been prone to misstatement in the past;
b. have not been reconciled on a timely basis or contain reconciled
differences;
x. entries involving inter-company transactions;
xi. entries made during unusual timing or on weekends;
xii. entries involving large number of small account balances.
Although DL is a low risk client, however as per the requirement of ISA, irrespective of the
auditor’s assessment of the risks of management override of controls, the auditor shall
design and perform audit procedures to test appropriateness of journal entries recorded in
the general ledger and other adjustments made in the preparation of the financial
statements.
ii. Review accounting estimates for biases:
 Evaluate whether judgments and decisions made by management in making
accounting estimates indicate a possible bias.
 Perform retrospective review of management judgments and assumptions related
AT A GLANCE
to significant accounting estimates reflected in financial statements of prior year.
iii. For significant transactions outside normal course of business or that are unusual
 Auditor shall evaluate whether the business rationale of transactions suggests
possibility of fraud.
 Following are indicators of such fraud:
¯ Form of such transactions appears overly complete.
¯ Management has not discussed nature of and accounting for such transactions
with those charged with governance.
¯ There is inadequate documentation.
¯ Management is placing more emphasis on a particular accounting treatment.
SPOTLIGHT
¯ Transactions involving related parties, including special purpose entities, not
been properly approved by those charged with governance.
¯ Transactions involve previously unidentified related parties.
Beta Construction Company Limited (BCCL) is involved in the construction of large buildings and
shopping plazas. The company commenced its business in 2004 by establishing an office in
Karachi and has grown rapidly. It currently has offices in five major cities of the country and as
many as 25 projects are in various stages of execution.
A substantial portion of the work is done through sub-contractors. Payment to subcontractors is
based on certificate of work completion which is issued by the supervisor in charge of each
project. The certificate is sent through email to the finance department. The payment is credited
directly into the bank accounts of the sub-contractors.
Recently, the management has discovered that the project supervisor of a large project had
issued a fraudulent work completion certificate. The preliminary investigation indicated that
some other sub-contractors have also been paid fraudulently in the past and the practice was
ongoing for the past two years.
The management of BCCL has asked your audit firm to conduct an investigation into the matter.
Your initial discussion with the client has revealed the following:

i. For the past four years the external auditors of the company are Alpha & Co., Chartered
Accountants. They had issued unqualified audit reports for all those years and had not
reported any internal control weakness in their management letters.
ii. Prior to approaching your firm, BCCL wanted to give this assignment to Alpha & Co.
However, they expressed their inability to undertake the investigation work.
Required:
a) State the basic objectives of the above investigation.
b) Recommend the controls which the management should put in place, to avoid such
frauds in future.
 Solution:
a) Basic Objectives of the above investigation
i. To ascertain a deliberate fraud has actually taken place.
ii. To discover the perpetrator(s) of the fraud, and ultimately to assist in their
prosecution.
iii. To quantify the financial loss suffered by the company as a result of fraud.
b) Control measure for dealing with sub-contractors
AT A GLANCE
i. An authentic list of approved sub-contractors should be maintained.

ii. All sub-contracting work should be awarded only to the approved sub-contractor.
iii. There should be a proper procedure for inclusion / deletion from the list of
approved sub- contractors.
iv. A company senior official visit to the sites and monitoring the performance of the
sub-contractors on a regular interval.
v. Compliance of above procedures should be monitored regularly.
Control procedure for payments to sub-contractors
i. Work completion certificates should be issued on specific pre-printed forms (SPP) which
should be controlled sequentially.
SPOTLIGHT
ii. Books of SPPs should be supplied only to authorized supervisors with instructions for their
safekeeping.
iii. The stock of unused SPPs should be kept in the custody of an authorized senior
management official.
iv. Original SPPs should be sent directly to Finance Department. Copies may however be sent
earlier (by fax or e-mail) to save processing time. The actual SPPs must be sent by courier
immediately after sending fax/scanned copy.
v. All alterations on SPPs should be authenticated by the concerned supervisor.
vi. Strict budgetary control should be exercised in respect of each project. Variances between
the actual and budgeted expenditure should be analyzed and explained. Monthly cash
outflow forecast of each project should be prepared and monitored.
2.8 Auditor Unable to Continue the Engagement due to fraud (Ref: 39, A55-A58)
In such exceptional circumstances, auditor shall:
 Determine professional and legal responsibilities applicable.
 Consider whether it is appropriate to withdraw from engagement. If the auditor withdraws, discuss with
appropriate level of management and those charged with governance.

 Examples of such exceptional circumstances:

 Entity does not take appropriate action regarding fraud that auditor considers
necessary, even where the fraud is not material;
 Auditor's consideration of risks of material misstatement and results of audit tests
indicate a significant risk of pervasive fraud;
 Significant concern about competence or integrity of management or those charged with
governance.
2.9 Written Representations (Ref: 40, A59-A60)

It is important for auditor to obtain a written representation from management and those charged with
governance confirming that they have disclosed:
 Results of management's assessment of the risk that financial statements may be materially misstated
as a result of fraud.
 Knowledge of actual, suspected or alleged fraud affecting entity.
2.10 Communications to Management and with those charged with governance (Ref: 41-43, A61-A66)
AT A GLANCE
 Identification of information indicating fraud shall be communicated to appropriate level of
management.
 If auditor has identified or suspects fraud involving management, employees having significant roles in
internal control or others:
¯ Auditor shall communicate to those charged with governance on a timely basis.
¯ Discuss with those charged with governance the nature, timing and extent of audit procedures
necessary to complete audit.
Other Matters Related to Fraud to be discussed with those charged with governance
 Concerns about nature, extent and frequency of management's assessments of controls in place to
prevent and detect fraud.
SPOTLIGHT
 Management failure to address identified significant deficiencies in internal control or to appropriately
respond to identified fraud.
 Auditor's evaluation of control environment, including questions regarding the competence and
integrity of management.
 Management Actions indicative of fraudulent financial reporting.
 Concerns about adequacy and completeness of authorization of transactions appear to be outside
normal course of business.
2.11 Communications to Regulatory and Enforcement Authorities (Ref: 44, A67-A69)

If auditor has identified or suspects a fraud, auditor shall determine whether there is a responsibility to report
the occurrence or suspicion to a party outside the entity.
 Law may require reporting the occurrence of fraud to supervisory authorities
 Auditor may consider it appropriate to obtain legal advice
2.12 Documentation (Ref: 45)

 Significant decisions reached during discussion among engagement team
 Identified and assessed risks of material misstatement due to fraud at the financial statements level and
at the assertion level.

 Appendix 1 - Examples of Fraud Risk Factors (Selected)

Fraudulent Financial Reporting
Incentives/Pressures:
 Financial stability or profitability is threatened
 Pressure for management to meet the exception of third parties
 Personal financial situation of management threatened by entities’ financial
performance
 Excessive pressure on management or operating personnel to meet financial targets
Opportunities:
 Significant related party transaction
 Assets/liabilities, Revenue, Expenditures based on significant estimates
 Domination of management by single person or group
 Complex or unstable organizational structure
 Internal control components are deficient
Attitudes:
AT A GLANCE
 Ineffective communication or enforcement of entities values or ethical standards by

management
 Known history of violation of security laws or other laws
 A practice by management of committing to aggressive or unrealistic forces
 Low morale among senior management
Misappropriation of Assets:
Incentives/Pressures:
 Personal financial obligations
 Adverse relationship between the entity and employees with access to cash or other
SPOTLIGHT
assets susceptible to theft

Opportunities:
 Large amount of cash on hand
 Inventory items that are small in size, of high in value or in high demand
 Easily convertible assets e.g. diamonds, bearer bonds and gold
 Inadequate internal controls over assets
Attitudes/Rationalizations:
 Overriding existing controls
 Failing to correct known internal control deficiencies
 Behavior indicating displeasure or dissatisfaction with the entity
 Changes in behavior or lifestyle
 Appendix 3 - Examples of Circumstances that Indicate the Possibility of Fraud
The following are examples of circumstances that may indicate the possibility that the financial
statements may contain a material misstatement resulting from fraud.
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.
Conflicting or missing evidence, including:
 Missing documents.
 Documents that appear to have been altered.
 Unavailability of other than photocopied or electronically transmitted documents when
documents in original form are expected to exist.
 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 adjustments made to accounts receivable records.
AT A GLANCE
 Unexplained or inadequately explained differences between the accounts 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.
 Fewer responses to confirmations than anticipated or a greater number of responses
than anticipated.
SPOTLIGHT
 Inability to produce evidence of key systems development and program change testing
and implementation activities for current year system changes and deployments.
 Problematic or unusual relationships between the auditor and management, including:
o Denial of access to records, facilities, certain employees, customers, vendors, or
others from whom audit evidence might be sought.
o Undue time pressures imposed by management to resolve complex or
contentious issues.
o Complaints by management about the conduct of the audit or management
intimidation of engagement team members, particularly in connection with the
auditor’s critical assessment of audit evidence or in the resolution of potential
disagreements with management.
o Unusual delays by the entity in providing requested information.
o Unwillingness to facilitate auditor access to key electronic files for testing
through the use of computer assisted audit techniques
o Denial of access to key IT operations staff and facilities, including security,
operations, and systems development personnel.
o An unwillingness to add or revise disclosures in the financial statements to
make them more complete and understandable.
o An unwillingness to address identified deficiencies in internal control on a
timely basis.

Other
 Unwillingness by management to permit the auditor to meet privately with those
 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.
AT A GLANCE
SPOTLIGHT

3. THE AUDITOR’S LIABILITY

3.1 Introduction
Legal claims made against auditors fall within one of two legal strands:
 The auditor may be prosecuted by the authorities for a criminal act, and be criminally liable if found
guilty. (The penalty may be a fine, or possibly imprisonment for a guilty individual.)
 The auditor may be liable under civil law. A ‘civil’ legal action may be brought against an auditor by
another person who has suffered loss or damage because of the auditor’s actions. The person bringing
the legal action usually seeks a money payment (‘damages’) from the auditor, to recover their losses they
have suffered.
The precise details about an auditor’s criminal and civil liabilities vary from one country to another, depending
on national legislation. This section addresses the areas of Pakistani law most directly relevant to Pakistani
auditors, in particular liability arising through auditor negligence.
Note that the legal system relating to Pakistani auditors is based on the English legal system with its two main
strands:
 Criminal law (e.g. fraudulent trading or insider dealing); and
AT A GLANCE
 Civil law (e.g. contract law and the law of tort)
and laws being established by:
 Statute (e.g. Companies Act, 2017)
 Common law (i.e. precedents set by rulings in previous legal cases).
Whilst the common law cases described below are not necessarily Pakistani cases, they still remain the reference
point in today’s Pakistani legal system relevant to auditors.
3.2 Criminal liability

Examples of when the auditor may be criminally liable include:
SPOTLIGHT
 Where they accept appointment as auditor under a statutory provision without being qualified to act.
 Where they are involved in fraud, such as falsifying accounting documents or records.
 Where they are guilty of ‘insider dealing’. The criminal law of many countries makes it an offence for a
person with inside knowledge of price-sensitive information to use or pass on that information. Insider
dealing is also prohibited under the IFAC and ICAP rules of professional conduct.
Auditing practices should take suitable steps to reduce the risk of insider dealing. For example, it is normal
practice for audit firms to impose restrictions on the amount of shares that their staff may hold in client
companies and to require staff to declare all their shareholdings.
Criminal liability may also arise for certain offences relating to:
 the winding up of a company
 tax law
 financial services legislation, in areas such as dealing in investments or giving investment advice
 money laundering (as discussed in Chapter 2).
3.3 Civil liability

A major threat faced by the auditing profession is the possibility of legal claims against auditors as a result of
negligent (or ‘careless’) auditing.

Contract law and the law of tort

An auditor may face legal claims for losses suffered as a result of negligent auditing under two separate branches
of law: contract law and the law of tort. A summary of the position is as follows:
AT A GLANCE
SPOTLIGHT
Contract law
A company has a contract with its external auditor for the provision of audit services. It can therefore sue the
auditor for breach of contract if the auditor is negligent in carrying out the terms of the contract.
Note that only the company can sue the auditor for a breach of contract. Other persons (third parties) who
might want to sue an auditor, such as banks, creditors and shareholders, do not have a contract with the auditor;
therefore, they cannot bring a legal action under the law of contract.
When a legal action is brought against an auditor by a company for breach of contract (negligence), the action is
usually initiated by the board of directors of the company.
Standards of skill and care

When carrying out their duties for a client, the auditors must exercise reasonable care and skill. IFAC and ICAP’s
codes of ethics require that members should carry out their professional work with professional competence
and due care and with proper regard for the technical and professional standards expected of them as members.
The degree of skill and care expected of an auditor in a particular situation depends on the circumstances. There
is no general standard of skill and care; the auditor is expected to react to the situation and the particular
circumstances that they are facing.
In general, if the auditor has followed auditing standards and can demonstrate this in their working papers, they
will not usually be found guilty of negligence. This is why it is so important for the auditor to ensure that they
maintain adequate working papers and obtain sufficient, relevant and reliable evidence to support their audit
opinion.

Liability in tort
Only the client company can sue the auditor in the law of contract, because only the company has a contract
with the auditor. Third parties who feel they may have suffered as a result of negligent auditing have to rely on a
different branch of law – the law of tort. An important question is: ‘To what extent can others rely on the civil
law, and bring an action for negligence against the auditors of a company?’
A tort can be defined as a ‘civil wrong’ other than that arising under contract law, giving rise to a claim for
damages. (A civil wrong is wrongdoing that is not a criminal offence, but which allows the injured person to bring
an action in civil law against the wrongdoer.) Negligence is just one of many branches of tort.
Examples of other persons who may suffer loss because of an auditor’s negligence and relying on financial
statements that do not give a true and fair view are:
 A bank that lends money to a company, and the company subsequently defaults and fails to make
payments of interest or repayments of the loan principal
 A supplier who has given credit to the company, whose debts have to be written off as ‘bad’
 Another company who relies on the financial statements when deciding to make a takeover bid for the
audited company
 An investor who relies on the financial statements to buy shares in the company, and the share price
AT A GLANCE
falls when the true state of the company later becomes apparent
Making a successful claim for auditor negligence (law of tort)

If a person is to make a successful claim against the auditor in the tort of negligence, three conditions must be
satisfied.
Negligence
requires
SPOTLIGHT
(1) (2) (3)
A duty of care That duty is Loss or damage
exists breached results
 Condition (1) – The auditor must owe a duty of care to the person who has suffered a loss due to the
auditor’s negligence. The existence of a duty of care has proved the most troublesome of the three
conditions to establish, in cases brought before the courts. This is considered in more detail below.
 Condition (2) – The duty of care must have been breached. The party bringing the claim against the
auditor has to show that the auditor did not exercise a reasonable degree of care in the circumstances,
so that the duty of care was breached. A typical method used in court cases to prove that a duty has been
breached is to call another firm of auditors as expert witnesses. The expert witnesses are asked to give
their view on whether the audit was performed correctly.
 Condition (3) – A loss or damage must result from breach of the duty of care. Proving that this condition
has been met is usually a question of demonstrating that the person making the claim suffered a financial
loss as a result of the negligent auditing. For example, if a bank lent money to a company on the basis of
audited accounts that were subsequently found to contain material errors or omissions, and the
company subsequently defaulted on its loan, the bank can demonstrate a measurable financial loss.

Establishing the existence of a duty of care (law of tort)

Most of the major court cases on auditor negligence have been concerned with the question of whether the
auditor owes a duty of care to the ‘plaintiff’. (The plaintiff is the person making the claim for damages.) The cases
summarised below, taken from UK law, show how the view of the courts on this question has developed over
time, since the 1950s. As mentioned earlier, these cases also form the common law precedent in Pakistan today.
You should concentrate on the principles involved, rather than the details of the cases. Whilst some of the cases
do not deal specifically with auditors, the principle established by the court is however applied by the courts to
auditors in similar situations.
 Illustration: Candler v Crane Christmas (1951)
In this case, Candler sued the accountants Crane Christmas when they lost money they had
invested in a company. Crane Christmas had prepared the accounts, and it was alleged that they
had been negligent in doing so. But were the accountants liable to Candler?
The court ruling was that although the accounts were negligently prepared, Candler could not
recover their losses from the accountants because they did not have a contract with them.
Therefore, in the 1950s, the legal view was that an auditor did not owe a duty of care to third
parties who were not in a contractual relationship with the auditor.
AT A GLANCE
 Illustration: Hedley Byrne v Heller & Partners (1964)

This is a case dealing with banks, but it was seen as relevant to all professionals, including
auditors and accountants. The plaintiff, Hedley Byrne, lost money when a bank reference from
the defendant (Heller & Partners, a bank) turned out to have been negligently produced. The
bank indicated in its reference that a mutual client was a good credit risk when this was not the
case.
The court ruled that although Hedley Byrne did not have a contract with the bank, Heller &
Partners, they could recover their losses due to the negligence and loss involved, because the
bank knew the plaintiff by name. However, the bank did not have to pay any damages due to a
general disclaimer in its letter (that gave the reference) absolving it from any liability.
This legal decision affected auditors, because the court has decided that if a third party (with
SPOTLIGHT
whom the auditor did not have a contract) could show that it relied on the work of an auditor
which later turned out to be wrong, the auditor might be liable for damages for negligence.
However, this principle was only extended to plaintiffs that the auditor actually knew by name.
Unidentified third parties were not able to claim against the auditor for negligence.
 Illustration: JEB Fasteners v Marks Bloom (1980)
In this case, the plaintiff acquired the share capital of a company. The audited accounts, due to
the negligence of the auditors, did not show a true and fair view of the state of affairs of the
company. It was accepted that, at the time of the audit, the defendant auditors did know of the
plaintiffs, but did not know that they were contemplating a take-over bid.
Whilst recognising that the auditors owed a duty of care in this situation, the court decided that
the auditors were not liable because the plaintiff had not actually suffered any loss. It was proved
that the plaintiffs would have bought the share capital of the company at the agreed price, no
matter what the accounts of the company had shown.
 Illustration: Caparo Industries v Dickman and Touche Ross & Co (1989)
This is seen as a leading case in English law in the area of ‘to whom does the auditor owe a duty
of care’.
Fidelity plc was taken over by Caparo Industries. Fidelity’s accounts had been audited by Touche
Ross. Caparo alleged that the accounts overstated the profits of Fidelity plc and that they had
relied on the audited accounts of Fidelity when deciding to purchase shares in the company and
make a takeover bid.

The court held that a duty of care was not owed to potential investors in a company, or persons
making a takeover bid, because of:
 a lack of proximity (a lack of ‘closeness of relationship’) between the auditor and a
potential investor, and
 the fact that it would not be just and reasonable to impose a duty on the auditor to such
investors.
In the above case, the court identified the auditor’s functions as being:
 to protect the company itself from errors and wrongdoing - not to protect the shareholders of the
company from error; and
 to provide shareholders with information such that they can scrutinise the conduct of a company’s
affairs and remove or reward those responsible (the directors).
The auditor does not exist to aid investment decisions.
Out-of-court settlements
Large claims against auditors in high-profile cases (such as Enron) receive a high level of publicity. Many other
cases are not widely publicised, often because they are settled ‘out of court’. This involves the parties who are in
AT A GLANCE
dispute reaching a negotiated settlement, rather than taking their case to court.
The advantages of out-of-court settlements are that:
 it avoids the cost and time involved in a court case
 it may avoid adverse publicity for the auditor
 the final settlement may be lower (because both sides save legal costs, and the plaintiff might agree to a
lower settlement to avoid the cost and the risk of losing the case)
The disadvantages of out-of-court settlements are that:
 the final responsibility may be left undecided, so the legal position remains unclear
 it may encourage others to take action against auditors
SPOTLIGHT
 insurance premiums may rise.
 Example:
An audit firm has been the auditor of Entity AZ for a number of years.
Its audit team has recently discovered that during that time, the managing director of AZ has
been consistently overvaluing inventories.
Entity B has recently purchased a major stake in Entity AZ, relying on the audited financial
statements to do so.
Required
What possible defence might the audit firm use if it is sued by Entity B after a successful takeover?
 Answer
The audit firm can claim that it did not owe a duty of care to Entity B.
If the audit work has been performed to expected standards, the firm should be able to claim that
the audit work was performed with diligence and care, and in accordance with ISAs. The audit
work could not reasonably have detected the fraud given its nature and the seniority of the
individual committing the fraud.
The firm might also be able to claim that Entity B has not suffered any financial loss as a result of
its reliance on the audited financial statements.

Use of disclaimers in audit reports

A disclaimer is not a requirement of an audit report, but some audit reports include one. A disclaimer states that:
 the auditor’s report is intended for use of the company and the company’s shareholders as a body, and
 no responsibility is accepted by the auditor to anyone except the company or the shareholders as a body
for the content of the report.
The purpose of a disclaimer is to reduce the risk of legal claims by ‘third parties’ against the auditor for
negligence.
The main problem with a disclaimer however is that a disclaimer cannot guarantee protection for an auditor
against third party claims, because the circumstances of each individual claim may be different.
AT A GLANCE
SPOTLIGHT

4. MANAGING THE AUDITOR’S LIABILITY

4.1 Avoiding liability
Clearly, it is preferable to avoid claims arising for negligent auditing. Firms can minimise the risks of being sued
by ensuring that their staff perform high-quality audit work. Auditors should therefore:
 follow appropriate auditing standards
 use effective quality control procedures
 train staff to an appropriate level of knowledge and skill
 adopt robust client acceptance procedures
 issue appropriate disclaimers
 ensure that the firm is up-to-date with modern auditing methods.
4.2 Meeting claims: professional indemnity insurance

If successful legal claims are made (or if out-of-court settlements are reached, where the audit firm agrees to
make a payment to settle the dispute) the auditor will have to pay damages. If the damages are so large that they
are more than the firm can afford, the law in some countries may also allow claims to be made against the
AT A GLANCE
personal assets of partners of the audit firm.
The threat of very high claims for damages, beyond the financial means of the audit firm, applies to the major
audit firms as well as smaller firms.
The professional accountancy bodies take the view that the image of the profession would be seriously damaged
if claims awarded against auditors and accountants are not met because of a lack of financial resources. As a
result, professional bodies often require members in practice to carry professional indemnity insurance (PII).
PII is an insurance policy that provides cover against all civil liabilities that are incurred as a result of the conduct
of the firm’s business. Money is paid out by the insurance firm on these policies if the firm itself is unable to pay.
However, the requirement for compulsory PII has the following disadvantages:
 It may increase the frequency and size of claims made against firms, which are seen to have large
SPOTLIGHT
amounts of funds at their disposal to meet claims.
 It may encourage more careless auditing.
 It imposes a high cost on audit firms. These costs of insurance are likely to increase as the general level
of legal claims rises.
4.3 Fidelity Guarantee Insurance

Fidelity Guarantee Insurance is another tool that can be used to limit an auditor’s professional liability. Fidelity
Guarantee Insurance provides protection for an employer (in this case the audit firm) against direct financial
losses suffered due to an employee’s dishonesty, theft and/or fraud in the course of their employment.
4.4 Limiting liability

Because of the high costs of legal claims and professional indemnity insurance, a number of suggestions have
been made for finding other ways of limiting claims against auditors.
 One suggestion is that there should be a statutory limit on claims, either a maximum percentage of the
audit fee or a maximum fixed amount.
 Another suggestion is that auditors should be permitted to agree a ‘cap’ (limit) on their liability with
their clients, so that a company cannot make a claim against its auditors for more than the agreed
amount (cap).

For example, a company and its auditors in the UK can now agree to a specified monetary sum as a cap on the
auditors’ liability.
 The use of ‘limited liability partnerships’ whereby an audit firm that is structured as a limited liability
partnership cannot lose more than its total fixed capital. This is similar to limited liability for companies.
 The use of the equivalent of PII for directors of client companies. This may expose the directors of
companies to legal actions by other parties, rather than the audit firm, because the plaintiffs will know
that the directors can afford to pay any successful claims for negligence.
 Including disclaimers of liability to parties other than the company and its shareholders in the auditors’
report.
AT A GLANCE
SPOTLIGHT

5. COMMUNICATION WITH THOSE CHARGED WITH GOVERNANCE (ISA 260 -

REVISED)
 Definition: Those Charged with Governance
The person(s) or organization(s) (e.g., a corporate trustee) with responsibility for
overseeing the strategic direction of the entity and obligations related to the accountability
of 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.
 Definition: 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.
5.1 Those Charged with Governance – those charged with governance (Ref: 11-13, A1-A8)
The auditor shall determine the appropriate person(s) within entity’s governance structure with whom to
AT A GLANCE
communicate.
 Governance structures may vary by jurisdiction and by entity, and the size and ownership characteristics.
Some examples of such governance structures are:
 A supervisory board exists that is separate from an executive board. (two-tier)
 Both supervisory and executive functions are the legal responsibility of a single board.
 Those charged with governance hold positions that are integral part of entity’s legal
structure (e.g. directors).
 In some government entities, a body that is not part of entity is charged with governance.
 Some or all of those charged with governance are involved in managing the entity.
 Those charged with governance and management comprise different persons.
SPOTLIGHT
 Those charged with governance are responsible for approving the entity’s financial
statements (in other cases management do so).
 Governance is collective responsibility of governing body; Subgroup e.g. audit
committee or even an individual may be charged with specific task to assist governing
body.
Such diversity means that it is not possible for this ISA to specify the person(s) with whom the auditor should
communicate particular matters. In such cases, auditor may need to discuss and agree with engaging party
the relevant person(s) with whom to communicate. In deciding so, understanding of entity’s governance
structure is relevant. The appropriate person(s) with whom to communicate may vary depending on matter to
be communicated.
Communication with a Subgroup of those charged with governance
If auditor communicates with a subgroup of those charged with governance (e.g. audit committee), the auditor
shall determine whether the auditor also needs to communicate with the governing body.
When considering communicating with subgroup of those charged with governance, auditor may take into
account such matters as:
 The respective responsibilities of the subgroup and the governing body.
 The nature of the matter to be communicated.
 Relevant legal or regulatory requirements.
 Whether the subgroup has authority to take action in relation to the information communicated, and can
provide further required information and explanations.

Good governance principles suggest that:

 The auditor will be invited to regularly attend meetings of the audit committee.
 The chair of audit committee and, when relevant, other members of the audit committee, will liaise with
the auditor periodically.
 The audit committee will meet the auditor without management present at least annually.
When All of those charged with governance Are Involved in Managing the Entity
If matters are communicated with persons with management responsibilities, and those persons also have
governance responsibilities, matters need not be communicated again.
Auditor shall however be satisfied that communication with persons with management responsibilities
adequately informs all of those with whom auditor would otherwise communicate in their governance capacity.
(E.g. in a company where all directors are involved in managing entity, one responsible for marketing may be
unaware of discussion with one responsible for preparation of financial statements).
5.2 Matters to Be Communicated (Ref: 14-17, A9-A32)
Auditor’s Responsibilities in Relation to Financial Statement Audit (Ref: 14, A9-A10)

AT A GLANCE
Auditor shall communicate responsibilities of auditor for financial statements audit, including that:
 Auditor is responsible for forming and expressing an opinion on the financial statements that have been
prepared by management with the oversight of those charged with governance; and
 Audit of the financial statements does not relieve management or those charged with governance of their
responsibilities.
Auditor’s responsibilities are often included in the engagement letter etc. Law, regulation or governance
structure of entity may require those charged with governance to agree those terms with auditor. When this
is not the case, providing those charged with governance with a copy of that engagement letter etc. may be an
appropriate way to communicate with them regarding such matters as:
 Auditor’s responsibility for performing audit in accordance with ISAs
SPOTLIGHT
 The fact that ISAs do not require auditor to design procedures for purpose of identifying supplementary
matters to communicate with those charged with governance.
 Auditor’s responsibilities to determine and communicate key audit matters in report.
 Auditor’s responsibility for communicating particular matters required by law or regulation, by
agreement with entity or by additional requirements applicable.
Planned Scope and Timing of the Audit (Ref: 15, A11-A16)

Auditor shall communicate overview of planned scope and timing of audit, which includes communicating
about significant risks identified by the auditor. Such communication may:
 Assist those charged with governance to understand better the consequences of auditor’s work, to
discuss issues of risk and the concept of materiality with auditor, and to identify any areas in which they
may request the auditor to undertake additional procedures; and
 Assist the auditor to understand better the entity and its environment.
Matters communicated may include:
 How auditor plans to address the significant risks of material misstatement.
 How auditor plans to address areas of higher assessed risks of material misstatement.
 The auditor’s approach to internal control relevant to the audit.
 The application of concept of materiality in the context of an audit.

 The nature and extent of specialized skill or knowledge needed to perform planned audit procedures or
evaluate audit results, including use of an auditor’s expert.
 For ISA 701, auditor’s preliminary views about matters that may be key audit matters.
 Planned approach to addressing implications on individual statements and the disclosures of any
significant changes within applicable financial reporting framework or in entity’s environment or
financial condition.
 Other planning matters that it may be appropriate to discuss with those charged with governance
include:
 How external auditor and internal auditors can work together in a constructive and complementary
manner (where applicable)
 The views of those charged with governance about:
o Appropriate person(s) in entity’s governance structure with whom to communicate.
o The allocation of responsibilities between those charged with governance and management.
o Entity’s objectives and strategies, and related business risks that may result in material
misstatements.
o Matters those charged with governance consider warrant particular attention during audit
o Significant communications between the entity and regulators.
AT A GLANCE
o Other matters those charged with governance consider may influence the audit of the financial
statements.
 The attitudes, awareness, and actions of those charged with governance concerning
o Entity’s internal control and its importance in the entity, including how those charged with
governance oversee the effectiveness of internal control, and
o Detection or possibility of fraud.
 The actions of those charged with governance in response to developments in accounting standards,
corporate governance practices, exchange listing rules, and related matters, and effect of such
developments on the overall presentation, structure and content of the financial statements, including:
o Relevance, reliability, comparability and understandability of information in financial
statements; and
SPOTLIGHT
o Considering whether financial statements are undermined by inclusion of information that is
not relevant or that obscures a proper understanding of the matters disclosed.
 The responses of those charged with governance to previous communications with the auditor.
 The documents comprising other information (ISA 720) and the planned manner and timing of the
issuance of such documents.
Significant Findings from the Audit (Ref: 16, A17-A28)

Auditor shall communicate with those charged with governance including requesting further information from
them:
a) Auditor’s views about significant qualitative aspects of entity’s accounting practices, including accounting
policies, accounting estimates and financial statement disclosures.
 Auditor’s views on subjective aspects of financial statements may be particularly relevant to those
charged with governance in discharging their responsibilities for oversight of the financial reporting
process.
 Open and constructive communication about significant qualitative aspects of entity’s accounting
practices also may include comment on acceptability of significant accounting practices and quality of
disclosures.

b) Significant difficulties, if any, encountered during the audit;

 Significant delays by management, unavailability of personnel, or unwillingness by management to
provide necessary information.
 An unreasonably brief time to complete the audit.
 Extensive unexpected effort required to obtain audit evidence.
 Unavailability of expected information.
 Restrictions imposed on the auditor by management.
 Management’s unwillingness to make or extend its assessment of going concern.
c) Unless all of those charged with governance are involved in managing the entity:
 Significant matters arising during audit that were discussed, or subject to the correspondence, with
management;
 Significant events or transactions that occurred during the year.
 Business conditions affecting entity, business plans and strategies affecting risk.
 Correspondence in connection with initial or recurring appointment of auditor regarding accounting
practices, application of auditing standards, or fees etc.
AT A GLANCE
 Significant matters on which there are disagreement with management.

 Written representations the auditor is requesting;
d) Circumstances that affect the form and content of the auditor’s report, if any;
 To inform those charged with governance about circumstances in which auditor’s report may differ from
its expected form and content or may include additional information about audit.
 Circumstances where auditor is required to or may include additional information:
o Auditor expects to modify opinion (ISA 705)
o Material uncertainty related to going concern is reported (ISA 570)
o Key audit matters are communicated (ISA 701)
o Auditor considers it necessary to include an Emphasis of Matter paragraph or Other Matters
SPOTLIGHT
paragraph (ISA 706)

o There is an uncorrected material misstatement of other information; Auditor may consider it
useful to provide those charged with governance with a draft of auditor’s report to facilitate a
discussion of how such matters will be addressed in auditor’s report. (ISA 720)
o Auditor intends, in rare circumstances, not to include the name of engagement partner in report
due to severity of personal security threat (ISA 700)
o Auditor elects not to include description of auditor’s responsibilities in body of the auditor’s
report (ISA 700)
e) Any other significant matters arising during audit that, in auditor’s professional judgment, are relevant to the
oversight of the financial reporting process.
 Unexpected events, changes in conditions, or audit evidence obtained, requiring the auditor to modify
the overall audit strategy and audit plan.
 Material misstatements of the other information that have been corrected.
 Other matters discussed and considered by, engagement quality control reviewer, if any.
Auditor Independence (Ref: 17, A29-A32)

In the case of listed entities, auditor shall communicate with those charged with governance:
 A statement that engagement team and others in firm, the firm and, when applicable, network firms have
complied with relevant ethical requirements regarding independence;

 All relationships and other matters between firm, network firms, and entity that, in the auditor’s
professional judgment, may reasonably be thought to bear on independence;
 Related safeguards that have been applied to eliminate identified threats to independence or reduce
them to an acceptable level.
Relevant ethical requirements or law/regulation may also specify communications to those charged with
governance in circumstances where breaches of independence requirements have been identified.
5.3 The Communication Process (Ref: 18-22, A37-A53)
Establishing the Communication Process

Auditor shall communicate form, timing and expected general content of communications. Clear
communication helps establish the basis for effective two-way communication.
Matters that may also contribute to effective communication include discussion of the:
 Purpose of communications.
 Form in which communications will be made.
 Persons in engagement team and in those charged with governance who will communicate regarding
AT A GLANCE
matters.
 Auditor’s expectation that those charged with governance will also communicate with auditor for
matters relevant to audit (e.g. suspicion of fraud or concerns with integrity or competence of
management).
 The process for taking action and reporting back on matters communicated by the auditor.
 The process for taking action and reporting back on matters communicated by those charged with
governance.
Before communicating matters with those charged with governance, auditor may discuss them with
management, unless that is inappropriate (e.g. questions of management’s competence or integrity).
When entity has an internal audit function, the auditor may discuss matters with the internal auditor before
communicating with those charged with governance.
SPOTLIGHT
Communication with Third Parties
Those charged with governance may be required by law or regulation, or may wish, to provide third parties (e.g.
banks, regulators etc.), with copies of a written communication from auditor.
In some cases, disclosure to third parties may be illegal or otherwise inappropriate.
When such written communication prepared for those charged with governance is provided to third parties, it
may be important to inform them that the communication was not exactly prepared for them.
Auditor may need prior consent of those charged with governance before providing a third party with a copy of
the written communications with those charged with governance, unless that was required by law or regulation.
Forms of Communication
 Auditor shall communicate in writing with those charged with governance.
 Oral communication would not be adequate.
 Written communications need not include all matters that arose during course of audit.
 Effective communication may involve structured presentations and written reports as well as less
structured communications, including discussions.
 Auditor may communicate matters other than identified above either orally or in writing.

In addition to significance of particular matter, form of communication (orally/writing, extent of detail,

structured/unstructured manner etc.) may be affected by such factors as:
 Whether a discussion of the matter will be included in auditor’s report.
 Whether the matter has been satisfactorily resolved.
 Whether management has previously communicated the matter.
 The size, operating structure, control environment, and legal structure of the entity.
 In audit of special purpose financial statements, whether auditor also audits entity’s general purpose
 Legal requirements.
 Expectations of those charged with governance.
 The amount of ongoing contact and dialogue the auditor has with those charged with governance.
 Whether there have been significant changes in the membership of a governing body.
Timing of Communications
Auditor shall communicate with those charged with governance on a timely basis:
AT A GLANCE
 Communications regarding planning matters may often be made at early time in audit and, for an initial
engagement, may be made as part of agreeing the terms of the engagement.
 Significant difficulty arising during audit shall be communicated as soon as practicable.
 Auditor may communicate orally to those charged with governance as soon as practicable significant
deficiencies in internal control that the auditor has identified, prior to communicating these in writing.
 Auditor may communicate preliminary views about key audit matters when discussing the planned
scope and timing of the audit.
 Communications regarding independence may be appropriate whenever significant judgments are
made about threats to independence and related safeguards.
 Communications regarding findings from audit, including views about qualitative aspects of the entity’s
accounting practices, may also be made as part of the concluding discussion.
SPOTLIGHT
 Other factors that may be relevant to the timing of communications include:

 Size, operating structure, control environment, and legal structure of the entity
 Any legal obligation to communicate certain matters within a specified timeframe.
 Expectations of those charged with governance, including arrangements made for periodic meetings etc.
 The time at which auditor identifies certain matters
Adequacy of the Communication Process

Auditor shall evaluate whether two-way communication between auditor and those charged with governance
has been adequate for audit purposes. Such evaluation may be based on observations such as:
 Appropriateness and timeliness of actions taken by those charged with governance in response to
matters raised:
o In case of no action, auditor may inquire the reasons
o Consider raising the point again to highlight its importance.
 Apparent openness of those charged with governance in their communications with the auditor.
 Willingness and capacity of those charged with governance to meet with auditor without management
present.
 Apparent ability of those charged with governance to fully comprehend matters raised by auditor
 Difficulty in establishing with those charged with governance a mutual understanding of form, timing
and expected general content of communications.

 Whether two-way communication between the auditor and those charged with governance meets
applicable legal and regulatory requirements.
If two-way communication between auditor and those charged with governance is not adequate and situation
cannot be resolved, the auditor may take such actions as:
 Modifying the auditor’s opinion on the basis of a scope limitation.
 Obtaining legal advice about the consequences of different courses of action.
 Communicating with third parties (e.g., a regulator), or a higher authority in governance structure that
is outside the entity, such as the owners of a business (e.g., shareholders)
 Withdrawing from engagement, where it is possible under applicable law or regulation.
5.4 Documentation (Ref: 23, A54)

Where matters have been communicated in writing, auditor shall retain a copy of the communication as
part of the audit documentation.
Where matters required are communicated orally, auditor shall include them in audit documentation, and when
and to whom they were communicated.
(May also include a copy of minutes prepared by entity retained as part of audit documentation where those
AT A GLANCE
minutes are an appropriate record of the communication).
SPOTLIGHT

AT A GLANCE
SPOTLIGHT

CHAPTER 6
THE AUDIT APPROACH
AT A GLANCE
IN THIS CHAPTER:
Several possible methodologies are available for developing the
AT A GLANCE audit strategy, including:
 an audit-risk approach
SPOTLIGHT
 a business risk (top-down) approach
1. Audit methodology  a systems-based approach
 a transaction-cycle approach
AT A GLANCE
2. Risk-based strategies  a balance sheet approach (substantive testing).
3. Systems-based strategies The business risk approach involves the auditor looking at the
business as a whole and carrying out an evaluation of the risks
4. Communicating deficiencies in to which it may be exposed.
internal control to those charged A systems-based approach to an audit focuses on the internal
with governance and control system of the client company and the adequacy of its
management (ISA 265) internal controls over the major transaction cycles (sales,
purchases, payroll and other expenses).
5. Balance sheet (substantive)
strategies A transaction-cycle approach focuses on substantively testing
the transactions that occur throughout those same transaction
6. The auditor’s responses to cycles.
SPOTLIGHT
assessed risks (ISA 330) ISA-265 deals with the auditor’s responsibility to communicate
appropriately to those charged with governance and
7. IAS / IFRS Checklist for Auditors management deficiencies in internal control that the auditor has
identified in an audit of financial statements. This ISA does not
impose additional responsibilities on the auditor regarding
obtaining an understanding of internal control and designing
and performing tests of controls over and above the
requirements of ISA 315 (Revised) and ISA 330.
Substantive tests are audit procedures performed to detect
material misstatements in the figures reported in the financial
statements. They are designed to obtain evidence about the
financial statement assertions.
ISA-330 deals with the auditor’s responsibility to design and
implement responses to the risks of material misstatement
identified and assessed by the auditor.

CHAPTER 6: THE AUDIT APPROACH CFAP 6: AARS
1 AUDIT METHODOLOGY
1.1 A choice of audit methodologies
The audit strategy describes the overall approach that the auditor will take to gather sufficient, appropriate
evidence in an audit. A detailed audit plan can then be developed in the context of the audit strategy. The strategy
may adopt a range of methodologies depending on the particular circumstances of the audit.
Several possible methodologies are available for developing the audit strategy, including:
 an audit-risk approach
 a business risk (top-down) approach
 a systems-based approach
 a transaction-cycle approach
 a balance sheet approach (substantive testing).
These methodologies are not necessarily mutually exclusive and they are likely to be used in combination to form
the overall audit strategy. For example, although most of the work on a particular audit might be ‘systems-based’
and focused in the highest business risk areas, the auditor will also carry out some substantive testing on all
material balances and transactions.
AT A GLANCE
The different approaches describe the emphasis of the audit strategy and where the auditor expects to find most
of the evidence that they need to reach an audit opinion about the ‘fair presentation’ or ‘true and fair view’ in the
1.2 Summary of available audit methodologies

The main audit methodologies/strategies are summarised in the following table. They will be described in more
detail in the rest of the chapter.
Methodology / strategy Outline of approach
Risk-based strategies  An assessment is made of the likelihood of material misstatements in each

SPOTLIGHT
(audit-risk and business area of the financial statements. This is based on the auditors’
risk) understanding of the business risks faced by the client.
 Areas that are assessed as high-risk are audited extensively (using the
various methodologies described below).
 Areas assessed as low-risk are given a low level of attention in the audit,
thus saving time.
 ‘Business risk’ and ‘audit risk’ are linked in that the areas’ most susceptible
to material misstatement (and hence audit risk) are likely to arise from
areas of greatest business risk.
Systems-based approach  The audit focus is on the application of tests of control to the systems that
produce the figures in the financial statements, rather than on the figures
themselves.
 The systems-based approach is driven by the transaction cycles including
sales, purchases, payroll and other expenses.
 A systems-based approach is supported by some degree of substantive
testing due to the unavoidable limitations or weaknesses in internal
control systems. (The amount of substantive testing required will depend
on the auditor’s judgement about the effectiveness of the internal
controls).

CFAP 6: AARS CHAPTER 6: THE AUDIT APPROACH
Methodology / strategy Outline of approach

 The systems-based approach is also supported by the use of analytical
procedures.
 It is more cost-effective than a fully substantive testing (balance sheet)
approach, but there is still a danger of doing too much unnecessary
auditing of areas where controls operate well.
Transaction cycle  The transaction cycle approach is similar in many ways to the systems-
approach based approach because it is based on the same transaction cycles (sales,
purchases, payroll and other expenses).
 However, the ‘transaction cycle’ approach adopts substantive procedures
to test the transactions that occur throughout the cycle, rather than testing
the controls over the cycles.
 Systems-based and transaction cycle approaches are often combined
within the overall audit strategy.
Balance sheet  The balance sheet approach is fundamentally based on the accounting
AT A GLANCE
(substantive) approach equation. The basic premise is that if current year-end and prior year-end
net assets are fairly presented then it is easier to gain audit comfort on the
intervening profit and loss and other changes in equity, thus resulting in
reduced procedures on the income statement.
 This approach focuses on applying substantive tests to a large number of
transactions and account balances recorded in the accounting system of
the client in order to prove year-end balances.
 If the auditor focuses purely on recorded transactions and balances, then

under-statement may not be detected (i.e. the auditor may ignore
transactions that have not been recorded). Therefore, directional testing
must be employed as part of the substantive procedures based on whether
SPOTLIGHT
the test addresses over- or under-statement.
 This approach can be time-consuming and costly for the audit of large
companies.
 This approach is appropriate where systems and controls are weak or not
operating effectively, thus rendering substantive tests on transactions and
balances necessary to reach an opinion about the financial statements.
 It is widely used for the audit of smaller entities where controls are less
likely to be developed or effective.
 There is a danger of spending too much time auditing transactions or
balances that are not material and/or have a low risk of material
misstatement.
 There is also a risk that misstatements in the financial transactions will
not be detected unless all transactions and balances are tested, not just a
sample.

1.3 Factors in the choice of audit strategy

The development of an audit strategy will depend on a number of factors, including:
 the nature and size of the client’s business: a business risk approach is best-suited for large companies,
and a balance sheet approach is usually the most suitable for small companies.
 the control procedures and control environment in place: a systems-based approach is most suitable
when there is a strong control environment and internal control system.
 the audit methods and techniques favoured by the audit firm: for example, larger audit firms may favour
a business risk approach.
You may be asked to select and justify an audit strategy for a particular client in the examination, in which case,
students would be considering factors such as these.
AT A GLANCE
SPOTLIGHT

2 RISK-BASED STRATEGIES
2.1 The development of audit strategy and practices
Auditing practice has developed significantly over recent years. The main reasons have been:
 the increasing size and complexity of business units, and the challenges created for the audit process by
size and complexity
 an attempt to improve the efficiency of the audit process.
The first major development in the ‘normal’ audit approach was a switch from an emphasis on substantive testing
to a systems-based approach, that concentrates much more on internal control systems and the testing of
systems and controls, and normally relies much less on substantive testing.
Then the concept of the ‘risk-based’ audit developed. In a risk-based audit, the auditor concentrates most of the
audit work on areas of high overall audit risk. (As you know, audit risk is a combination of inherent risk, control
risk and detection risk.)
More recently, larger audit practices in particular have developed a ‘business risk’ approach to audit work.
Business risk is the threat that an event or development may adversely affect the ability of the entity to achieve
its objectives. It is the risk of an adverse development that could have a major impact on the company’s business,
AT A GLANCE
such as the loss of a major customer, or an increase in the cost of a key commodity. An adverse business event is
likely to affect the company’s business significantly, and so should be expected to affect its financial statements.
Business risks are risks faced by management of the client entity, which could have an impact on the financial
statements (including the going concern assumption).
2.2 The meaning of the business risk approach

The business risk approach involves the auditor looking at the business as a whole and carrying out an
evaluation of the risks to which it may be exposed.
The auditor identifies the business risks which may have an impact on the financial statements of the client
company. The general approach is to:
 identify the key business risks
SPOTLIGHT
 evaluate their possible impact on the financial statements
 plan the approach to the audit around the key business risks that have been identified as having a
material impact on the financial statements.
This approach cannot work effectively unless the auditor has a good understanding of the client’s business and
the environment in which it operates. (Understanding the client’s business and business environment is a
requirement for all auditors, in ISA 315 Identifying and assessing the risks of material misstatement through
understanding the entity and its environment.)
2.3 The nature of the business risk approach

The business risk approach starts at an earlier stage than the ‘conventional’ audit risk model, which is based on
inherent risks and control risks (and detection risks). [The audit risk model is addressed in more detail in the
next chapter].
By looking at the nature of the client’s business, the auditor should develop an understanding of the events and
circumstances that may affect the entity’s ability to meet its objectives. By understanding business risks, the
auditor should also develop a better understanding of the inherent risks and the control risks facing the client.
The business risk approach is sometimes referred to as a ‘top down’ approach to an audit.
 The approach starts ‘at the top’ with the business, which generates the financial transactions.
 The approach ends ‘at the bottom’ with the financial statements which record the outcome of the
business transactions.

The business ‘drives’ the financial statements.

This is a ‘high level’ approach to the audit, and has similarities with business management and strategy. Using
this approach to an audit successfully depends on having adequate and up-to-date information about the client’s
business and business environment.
For this reason, the larger auditing practices that use the business risk approach will often organise their audit
teams into specialised industry groups, or may have industry experts available or may construct specialised
databases for particular industries.
When the auditor takes a business risk approach they need to be aware not only of the current position of the
client’s business, but also of possible future developments that may affect its goals and objectives.
The auditor is interested in business risk not for its own sake, but in the light of its possible impact on the financial
statements.
2.4 Internal business risks and external business risks

With the business risk approach, the auditor must identify key business risks for the client company. Business
risks may arise from the external environment in which a company operates, or from within the company itself.
External business risks

AT A GLANCE
Examples of external business risks might include the following:

 The possible loss of a major contract as a result of a dispute with the customer.
 Long-term decline in demand for the company’s products, and failure to invest in research and
development of new products.
 The impact of a new competitor moving into the market.
 The impact of proposed changes in laws and regulations: for example, where a company needs a license
to operate (as in financial services) there may be a risk that the license will be withdrawn or will not be
renewed.
 The effect of recently discovered new technology.
 The effect of changes in the macro-economy, such as changes in interest rates or exchange rates, or a
SPOTLIGHT
downturn in the economy (lower economic growth, or possibly an economic recession).

 The impact of natural hazards (such as storms and flooding that may affect the company’s ability to
maintain operational capacity).
 Threats from competitors to a company’s patents or copyrights.
Internal business risks

Examples of internal business risks might include the following:
 Risks arising from ineffective employees or weak management.
 The risks from a lack of customer care and attention to customer needs: poor customer awareness will
eventually have an effect on sales demand.
 Poor financial management (such as excessive levels of gearing, poor cash management and poor
working capital control).
 Lack of finance for capital expenditure on equipment replacement or modernisation.
 Risks due to systems weaknesses or system failures: internal control weaknesses.
 Risks from over-reliance on one or a few key individuals.
 The risk of fraud or the misappropriation of assets.
The internal and external risks listed above are examples of risk, not a comprehensive list of business risks. In
an examination question, you may be expected to identify key business risks (both external and internal) from
the nature of the business and the facts given to you in the question. See the comprehensive example at the end
of this section.

2.5 Risk evaluation

Not all risks are of equal significance. The significance of a risk to the auditors depends on two factors:
 The ‘impact’ that it will have on the financial statements if an adverse event occurs. It is the ‘size’ of the
risk. In an auditing context, this could be broadly interpreted as the ‘materiality’ of the risk.
 The likelihood or probability that an adverse event will occur so that the risk becomes ‘reality’.
Auditors may use a standard model to assist them to rank risks in order of importance. The model below is widely
used in management and strategy areas – it is not specifically an auditing model.
Category 2 Risk
Category 1 Risk
I (Most Significant)
M
P
A
C Category 3 Risk
Category 4 Risk
T
AT A GLANCE
LIKELIHOOD
Most of the emphasis in an audit will be placed on risks in Category 1, where the impact of an adverse event and
the probability that it will happen are both high. The least emphasis will be placed on risks in Category 4, because
the impact of an adverse event will be small and the probability of it happening is low. Ranking risks in categories
2 and 3 in order of seriousness/priority will depend on the judgement of the auditor.
2.6 Advantages and disadvantages of the business risk approach

The business risk approach has some advantages and also some disadvantages.
Advantages
SPOTLIGHT
 The approach requires the auditors to acquire an in-depth knowledge of the client’s business. This
should make the auditors more knowledgeable, and able to make a better judgement about the client’s
 When the business environment is changing rapidly, a business risk approach keeps the auditor up-to-
date.
 Evidence suggests that major audit problems are more likely to result from business-related problems
than from internal control weaknesses.
 A business risk approach may allow the auditor to ‘add value’ by making effective recommendations to
improve the performance of the client’s business.
 Audit costs may be reduced, because there is less audit testing, which saves time, especially the time of
junior audit staff.
 The approach may benefit the auditor’s own business, because its use of a ‘modern’ business risk
approach may differentiate the firm’s audit services from those of its competitors.
Disadvantages
 The business risk approach requires audit staff with suitable experience, including partners and
managers. The time of these individuals is expensive. This may offset some of the cost savings
(mentioned above) from a reduced need for junior audit staff.

 The business risk approach requires a closer involvement by the auditor in the client’s business. This
may raise questions about auditor independence.
 Some auditors feel uneasy about the ‘broad’ view taken by the business risk approach, and consider a
systems-based view to be more appropriate for reaching an opinion on the financial statements.
 The approach may be effective only for the audits of larger companies.
2.7 Comparison of business risk and financial statement risk

Business risk is a risk that the business entity will fail to meet its objectives. Financial statement risk is the risk
that the financial statements will not give a true and fair view, due to misstatements and omissions.
There is normally a close connection between these two categories of risk.
 When there is a significant business risk, failure by management to deal with the risk could affect items
in the financial statements. For example, a risk from declining sales demand for a product should raise
questions about the obsolescence of product inventories and the realistic useful economic life and net
realisable value of the non-current assets that make the product. The going concern assumption may be
challenged, if the product has been a major source of income and profit in the past.
 Weaknesses in internal control are a business risk which could result in misstatements in the financial
statements.
AT A GLANCE
 Example: Business risk and financial statement risk

An audit team has just completed the audit of an important client. One of the risks they identified
was as follows:
The client’s new research laboratory was threatened with closure due to failure by the company
to obtain official planning permission for its construction. The laboratory was therefore
constructed illegally, and there was the risk that it would have to be demolished.
 The business risk was the risk that the laboratory would be forced to close, for
regulatory reasons.
 The financial statement risk was that if this were to happen, the value of the laboratory
(and possibly all the equipment within it) would be over-stated in the accounts and
SPOTLIGHT
should be written down substantially in value, possibly to Rs. nil.

Both business risk and financial statement risk should be assessed by the auditor, in order to
assess the elements of the financial statements where misstatement is most likely to happen.
2.8 Business risk approach - comprehensive example

For your examination you need the ability to read a case study or scenario and:
 identify and explain business risks that are apparent in the information you are given; plus
 explain how these business risks impact financial statement risk and hence impact the audit.
Attempt your own answer for the following example, before reading the answer provided.
 Example: Business risks
Sting, a limited liability company, was incorporated in Ruritania on 1 June Year 1. In July, the
company exercised an exclusive right that it had been granted by the government of Sordobia to
provide daily flights direct between Zob (the capital city of Sordobia) and Polletta (the main
commercial city of Ruritania).
The service has been widely advertised in the national newspapers of both countries as ‘prompt,
efficient and reliable’. As a result of these flights, it is expected that the travelling time between
Zob and Polletta will be reduced by about eight to ten hours. This shortened travelling time
should increase the volume of commerce and trade between the two countries.

Sting operates a refurbished 30-year-old aircraft. This is leased from an international airline and
registered with the Sordobian Airways Authority (SAA). The SAA has a strict requirement that
the engines of all aircraft on its register should be overhauled every two years. The overhaul of
an aircraft engine usually puts the aircraft out of operational activity for up to five weeks.
The aircraft can carry 20 First Class, 50 Business Class and 80 Economy Class passengers. It also
has a large hold for transporting cargo, in addition to passenger luggage.
On-board meals for the three-hour journey are prepared in Zob under a contract with an airport
catering company. Market research by Sting has shown that passengers are in general
dissatisfied with the quality of in-flight food, especially on the Polletta to Zob flight.
Sting employs 12 full-time cabin crew attendants whose training in air-stewardship includes first
aid training and medical procedures in the event that passengers are taken ill or injured during
a flight. The captain and co-pilots for the aircraft are provided under contract by the international
airline that leases the aircraft to Sting.
Flight tickets are sold by Sting (by telephone and at its offices and airport reception desks) and
by travel agents in Ruritania and Sordobia. On several occasions there has been over-booking of
Economy Class seats. When this happens, customers are upgraded to Business Class. At the
moment there is spare capacity in First Class and Business Class on all flights. Ticket prices for
AT A GLANCE
each class depend on several factors, such as whether the tickets are refundable (so that
customers get their money back if they cancel their trip), exchangeable (so that customers can
exchange tickets on one flight for tickets on an earlier or later flight). Ticket prices also vary with
the day of the week and time of year.
Sting has extensive insurance cover, including employer’s liability insurance (against the risk of
accidents to employees) and passenger liability insurance (against the risk of liability to
passengers for death, injury, extensive flight delays and other risks)
Required
Identify and explain the business risks and associated financial statement risks facing Sting.
 Answer
SPOTLIGHT
The business objective of Sting is to make profits from the provision of a daily air service between
the two cities.
An analysis of business risks should identify what risks exist within the business of Sting that
might threaten the successful achievement of this objective, and in doing so have an impact on
the financial statements of Sting.
Key word or phrase in the Associated financial
Business risk indicated
text of the scenario statement risk
Exclusive right Sting has a right to If Sting has breached the terms
operate the flights, but of the exclusive rights deal:
there are presumably  liabilities may be
terms and conditions understated relating to
attached to this right that undisclosed penalties
Sting must comply with.
The risk is a risk of non-  there may be significant
compliance with the uncertainty as to whether
terms and conditions, Sting remains a going
which might put into concern should it lose its
doubt the company’s license
continued right to
operate the flights.


Exclusive right Sting is currently  The value of landing slots
operating a monopoly, may be overstated and
but this may not always financial projections
be the case and potential misstated if future
future competition could exclusivity is no longer
significantly affect the guaranteed.
company’s business.
Widely advertised as ‘prompt, Sting might not live up to If Sting has failed to meet
efficient and reliable’ its own advertising and contractual operational
might disappoint targets:
customers, affecting its  Liabilities may be
business. understated relating to
unrecorded provisions for
fines and customer
refunds.
AT A GLANCE
 Sting might lose its

operating license which
would raise uncertainty
about whether the going
concern basis remains
appropriate.
30 year-old aircraft The age of the aircraft  Profit might be overstated

could cause operating if repairs and maintenance
problems if it needs expenses have been
frequent repair. The capitalised rather than
relatively old age might expensed.
also mean that fuel
SPOTLIGHT
consumption (and
therefore costs) is higher.
Leased Sting will have no means If Sting has breached the terms
of operating its service if of its operating leases:
it does not keep up the  Liabilities may be
lease payments. understated relating to
unrecorded provisions for
penalties and unpaid
interest.
 There may be uncertainty
about Sting’s ability to
continue as a going
concern if the lessor
breaks the leases early.
Lease expenses may be
incorrectly classified in the


Overhaul of an engine usually Sting must have the If Sting has failed to regularly
puts the aircraft out of engine overhauled overhaul its aircraft:
operational activity for up to regularly under the  Liabilities may be
five weeks. regulations of the SAA, understated relating to
but this will mean a break unrecorded regulatory
in its services as there is penalties and/or
only one plane. compensation payable in
the event of litigation faced
due to negligence.
 Sting may be unable to
continue as a going
concern if it does not have
the financial and
operational resources to
rectify the situation.
AT A GLANCE
Note that a case study might include information about problems that are not sufficient to justify the attention of
the auditors. There are arguably three examples here: the quality of in-flight food, over-selling Economy Class
tickets and having to upgrade some passengers to Business Class, and the need to obtain insurance.
You are the engagement partner on the audit of Faraz Industries Limited. The company has
recently started using internet to carry out its business activities and the share of business
conducted through e-commerce is growing rapidly.
Required:
a) Identify the matters that you believe would be relevant while updating your knowledge
of the company’s business.
SPOTLIGHT
b) Identify the business risks related to the company’s e-commerce activities.
c) Identify the matters that need to be addressed in order to ensure the integrity of the
transactions carried out through the company’s website.
Tutorial Notes:
In part c the focus should be on identifying the matters that need to be addressed for ensuring
the integrity of the transaction, rather than on the controls relating to transaction integrity.
 Solution:
a) Matters that are relevant while updating knowledge of business:
The following matters should be considered by the auditors while updating the
knowledge of company’s business:
i. The company’s business activities and industry
ii. The company’s e-commerce strategy
iii. The extent of the company’s e-commerce activities
iv. The company’s outsourcing arrangements
b) Business risks that the company may face on account of its e-commerce activities
i. Loss of transaction integrity
ii. E-commerce security risks, like virus attacks and un-authorized access etc.
iii. Improper accounting policies related to capitalization of website expenditures.

iv. Misunderstanding of complex contractual arrangements

v. Translation of foreign currencies etc.
vi. Title transfer risks
vii. Allowances for warranties/ returns
viii. Revenue recognition issues and cut off issues
ix. The treatment of volume discounts and introductory offers
x. Non-compliance with taxation and other legal and regulatory requirements,
particularly in case of transactions with parties in other countries;
xi. Failure to ensure that contracts evidenced only by electronic means are binding;
xii. Over reliance on e-commerce when placing significant business systems or other
business transactions on the Internet; and
xiii. Systems and infrastructure failures or “crashes.”
c) Risks to be addressed to ensure integrity of the transactions carried out through the
Company’s website. In an e-commerce environment, the main risk that could affect the
integrity of the transactions carried out are as follows:
i. Incorrect input of data
AT A GLANCE
ii. Duplication or omission of transactions

iii. Party to a transaction may later deny having agreed to specified terms (non-
repudiation)
iv. Transactions made without approval of the parties
v. Incomplete processing and recording of data
vi. Improper maintenance of files, systems and networks
vii. Improper distribution of transaction details across multiple systems in a network
(Loss of data and systems)
Jhelum Machinery (Private) Limited (JMPL) is engaged in the manufacture of customized
machinery. Recently a fraud has been discovered which was perpetrated by Salahuddin, the
SPOTLIGHT
purchase manager. Salahuddin was responsible for approving the suppliers after obtaining and
evaluating the competitive quotes and placement of orders. Final approval was made by the
managing director.
Salahuddin had set up a private limited company Neelum (Private) Limited (NPL) in which his
brother and wife are directors. NPL supplies spare parts to JMPL. The fraud was committed with
the help of Karamat, a production supervisor and Farhan, the store keeper. The supplies
delivered by NPL contained a large proportion of damaged spare parts. However, full payments
were made to NPL as Farhan never raised any objections on the quality of goods received.
On the other hand, Karamat issued inflated consumption reports to cover significant part of the
damaged spare parts. The fraud was discovered when Farhan went on leave due to illness.
A review of inventory sheets indicates that large quantities of spare parts are still lying in
inventory.
Required: Identify the control weaknesses in the above situation which may have enabled the
perpetration of fraud.
Tutorial Notes:
While answering the other things, keep in mind the two very important points regarding controls
over stock consumption and stock balances.

 Solution:
Control weaknesses in the System:
 There is a lack of segregation of duties as the functions of obtaining and evaluation of
bids, approval of supplier and placement of orders are performed by Salahuddin.
 Controls over authorization and approval of supplier, as purchase manager was able to
get the approval of NPL, without any detailed background checking.
 There appears no system of stock inspection by an independent person when it is
received in the store.
 There appears to be no system of physical verification of stock to identify any damage
stock, so that it can be identified on timely basis.
 It appears that there are no benchmarks/standards or other controls over stock
consumption i.e. identification of over consumption/under consumption as no concern
is raised when production supervisor charges extra costs as to the consumption reports.
 It appears that there are no benchmarks/standards regarding the quantities of
inventory that are to be maintained.
AT A GLANCE
Zubair & Shahid Limited is a distributor of personal care products. Its sales manager had
committed a fraud by making sales to fictitious customers. Cheques received from various
genuine customers were credited to these fictitious accounts to keep their balances within
reasonable limits. The sales manager had the outstanding amounts, appearing against fictitious
and genuine customers, written off by convincing the sales director that those customers were
unable to pay their remaining balances. A total of 38 invoices amounting to Rs. 7.2 million were
issued over a period of seven months. The fraud was detected when the sales manager had left
the company’s employment.
Required:
Identify the usual controls which may have been lacking in the aforementioned situation.
Tutorial Notes:
This question may not be addressed properly unless student concentrate on the requirement of
SPOTLIGHT
the question. A common mistake could be that Instead of identifying the missing controls, student
may divert their efforts towards giving recommendations and suggestions to improve the
situation in future which is quite irrelevant.
 Solution:
Controls which may have been lacking in the given situation:
 Control over authorization and approval of customer, as the sales manager was able to
make the sale to fictitious customers which means that no proper investigation or
processes were followed during approval of said customers.
 Lack of segregation of duties as the write off of receivable balance should have been
approved by credit control department/section, instead of or in addition to sales
director.
 Controls over write off of debts seem to be lacking. Debts should only be written off when
the legal department confirms that they are not recoverable.
 Moreover, the legal department should also notify as to what action was taken before
deciding that the debts are not recoverable and why a suit was not being filed against
the customer. This process does not seem to have been followed.
 Control over accounting of customer’s cheques is lacking as the sales manager manages
to credit the fictitious customers’ accounts with other customers’ cheques.
 Controls over preparation, checking and dispatching of debtor’s statements to
customers is lacking as sales manager manages to manipulate the debtor’s accounts for
seven months, without any check and balances.

2.9 Components of Audit Risk (ISA 200)

Audit Risk = Risk of Material Misstatement x Detection Risk
(Inherent Risk x Control Risk)
 Definition: Audit Risk:

Risk that auditor expresses an inappropriate audit opinion when financial statements are
materially misstated
 Definition: Inherent Risk:
Susceptibility of an assertion to a misstatement that could be material before consideration of
any related controls
 Definition: Control Risk:
Risk that misstatement that could occur in an assertion and that could be material will not be
prevented, or detected and corrected, on a timely basis by entity's internal control
 Definition: Detection Risk:
Risk that procedures performed by auditor to reduce audit risk to an acceptably low level will
AT A GLANCE
not detect a misstatement that exists and that could be material

SPOTLIGHT

3 SYSTEMS-BASED STRATEGIES
3.1 The nature of a systems-based approach to an audit
A systems-based approach to an audit focuses on the internal control system of the client company and the
adequacy of its internal controls over the major transaction cycles (sales, purchases, payroll and other expenses).
A transaction-cycle approach focuses on substantively testing the transactions that occur throughout those
same transaction cycles.
As part of their risk assessment exercise, the auditor is required by ISA 315 to ‘obtain an understanding of the
entity and its environment, including its internal controls.’
It is the responsibility of management to put in place a suitable system of internal control, to address identified
financial statement risks, operational risks and compliance risks. Effective internal controls, provided that they
are implemented properly, should ensure:
 reliable financial reporting
 the effectiveness and efficiency of operations
 compliance with appropriate laws and regulations.
AT A GLANCE
The effectiveness of internal controls: testing the controls for effectiveness
With a systems-based approach, the auditor aims to rely on the accounting systems and the related internal
controls to ensure that transactions are properly recorded.
 His assumption is that if the systems and the internal controls are adequate, the transactions should be
processed correctly, and the financial statements should therefore give a true and fair view.
 The audit emphasis is therefore, as much as possible, on the systems that process the transactions rather
than on the transactions themselves.
Before the auditor can rely on the systems and controls that are in place, they must establish what those systems
and controls are, and carry out an evaluation of the effectiveness of the controls.
SPOTLIGHT
3.2 What makes an effective system of internal controls?
ISA 315 identifies five elements which together make up an internal control system. These are:
 the control environment
 the entity’s risk assessment process
 the information system
 control activities (internal controls)
 the review and monitoring of controls.
3.3 The control environment

The ‘control environment’ is often referred to as the general ‘attitude’ of management and employees in the
organisation towards internal controls.
The control environment has been defined by the Institute of Internal Auditors as follows: ‘the attitude and
actions of the board [of directors] and management regarding the significance of control within the organisation.
The control environment provides the discipline and structure for the achievement of the primary objectives of
the system of internal control. The control environment includes the following elements:
 integrity and ethical values
 management’s philosophy and operating style
 organisational structure

 assignment of authority and responsibility

 human resource policies and practice
 competence of personnel.
A strong control environment is typically one where management shows a high level of commitment to
establishing and operating sound controls.
The existence of a strong control environment cannot guarantee that controls are operating effectively, but it is
seen as a positive factor in the auditor’s risk assessment process. Without a strong control environment, the
control system as a whole is likely to be weak.
Evaluating the control environment

ISA 315 requires auditors to gain an understanding of the control environment. Part of this understanding
involves the auditor evaluating the control environment, and assessing its effectiveness.
In evaluating the control environment, the auditor should consider such factors as:
 management participation in the control process, including participation by the board of directors
 management’s commitment to a control culture

AT A GLANCE
the existence of an appropriate organisation structure with clear divisions of authority and
responsibility
 an organisation culture that expects ethically-acceptable behaviour from its managers and employees
 appropriate human resource policies, covering recruitment, training, development and motivation,
which reflect a commitment to quality and competence in the organisation.
You are carrying out the audit of Akhtar Autos Limited (AAL) for the year ended 31 March 2015,
a listed company, engaged in the business of manufacture of spare parts for trucks, buses and
tractors. Extracts from the draft financial statements are as follows:
2015 2014
SPOTLIGHT
-----(Rs. In '000')------
Sales 1,250,000 1,440,000
Loss before taxation -70,000 -15,000
Current assets 325,000 350,000
Other assets 145,000 135,000
Total assets 470,000 485,000
Current liabilities 345,000 305,000
Other liabilities 175,000 160,000
Total liabilities 520,000 465,000
Equity -50,000 20,000
Previous year’s audit report was qualified on account of inability to obtain sufficient and
appropriate audit evidence with respect to stores and spares, as ledger of stores and spares
contained many negative balances.
The following further information has been obtained during the audit:
i. Agreements with two local distributors contain clauses that offer a significantly higher
percentage of discounts which are above normal market rates. Due to the tough
competition in the local market, the management of the company is currently
negotiating with certain foreign customers for export of company’s products.

ii. In May 2015, court notices from two major customers were published in the
newspapers, alleging the company of supplying inferior quality spare parts in the
month of April 2015 and claiming damages of Rs. 150 million. The management is of
the view that the allegations are baseless.
iii. A supplier of the company has become bankrupt. The company owes an amount of Rs.
138 million to the supplier. However, the liquidator has lodged a claim of Rs. 140
million.
iv. AAL is a family owned company. Out of its seven directors, four are executive directors.
The non-executive directors have been elected on the board for the 4th time.
v. The Board has formed a three-member Audit Committee, which is chaired by a non-
executive director, who is also the maternal uncle of the chief executive.
vi. The half yearly accounts were not finalised because of a legal dispute. The company had
informed SECP in respect of such non-compliance.
vii. Internal audit department includes only one person who is a chartered accountant and
is engaged on a part time basis.
viii. The warehouse from where goods are dispatched is under the management of sales
department.
AT A GLANCE
Required:
Give suggestions for improvement in the control environment.
Tutorial Notes:
Please remember that the general components of internal control and control environment are not
required in the question.
 Solution:
Apart from suggestions given in part (d), the other suggestions for improvement in control
environment are as follows:
 The warehouse should not be under supervision of sales department;
 The management of the company should be independent of those charged with
SPOTLIGHT
governance and there should be minimum interference of those charged with
governance in the management of the company.
 The internal audit department or some other department independent of sales should
be assign the responsibility for ascertaining discount of distributors before any payment
/ credit is processed;
 Historical trend analysis of sales made to distributor should be done in order to assess
if any unethical practice is being going on in the company.
 Appointment of qualified personnel in internal audit department.
Education for All Foundation (EFAF) is a large charity based organization, engaged in providing
education to needy children, at a token fee of Rs. 100 per child. It receives donations for its
activities both in cash and through its bank accounts. The major expenditure relates to payment
to teachers and petty cash.
Required:
Briefly describe the key controls which you as an auditor expect to find in respect of receipts and
payments.

Tutorial Notes:
This is pertinent to mention that more emphasis of the students should be on the specific areas like
donations, fee income and petty cash etc. rather than stating general control measures.
 Solution:
Overall controls –
statement showing donations, fee and income and payments are reviewed by senior
management personnel on a monthly basis (i.e. business performance review covering all
assertions) Control over donations
Cash
 For cash received at counters, the cashier counts the cash and prepares a receipt voucher
(Completeness, Accuracy, Rights/Obligation, Cut off)
 For donation boxes – donation boxes are unlocked / opened in the presence of two /
three persons and then a cash count is performed following which a receipt voucher is
prepared showing details about the date, time, place of box and the total cash collected.
(Completeness, Accuracy)
 Cash count is performed on regular basis by a person independent of the custodian of
AT A GLANCE
cash and results are matched with the daily receipt record maintained in the system
(Existence)
 Cash is kept in safe custody and at day end the cash is deposited with bank. (Existence)
 Surprise cash counts are also conducted by the persons independent of the custodian of
cash (Existence)
 Appropriate segregation of duties exists, i.e. person receiving the cash, maintaining its
custody and recording the transactions is not the same
Bank accounts
 Bank reconciliation statements are prepared and reviewed on a regular basis and
unadjusted / reconciling items are investigated and recorded on timely basis.
SPOTLIGHT
(Completeness, Accuracy, Rights / Obligations, Cut off)

Controls over fee income
 The cashier counts the cash and prepares a receipt voucher showing details about the
date, time, name of student and the cash collected. (Completeness, Accuracy, Rights /
Obligations, Cut off)
 A student wise fee outstanding report is prepared and reviewed on a monthly basis and
the schedule of overdue fee is presented to the management for appropriate action as
per policy.
Controls over Payments
i. Teachers
 Payroll process is initiated by the payroll department based on the master data
maintained by HR department.
 The attendance record reviewed by the Head of the Department before the processing
of payroll.
 A month-to-month payroll reconciliation is prepared before the distribution of payroll.
 Changes to master data is made by the HR department only after due authorization.

ii. Petty cash

 Pre-numbered / sequentially controlled petty cash vouchers are maintained.
 Cash on the basis of IOUs is not disbursed.
 Surprise cash counts are conducted by the persons independent of the custodian of cash
(Existence)
 Payments are recorded in general ledgers after the details are reviewed by the Finance
Manager.
3.4 The entity’s risk assessment process

Within a strong system of internal control, management should identify, assess and manage business risks, on a
continual basis. Significant business risks are any events or omissions that may prevent the entity from achieving
its objectives.
Identifying risks means recognising the existence of risks or potential risks. Assessing the risks means deciding
whether the risks are significant, and possibly ranking risks in order of significance. Managing risks means
developing and implementing controls and other measures to deal with those risks.
ISA 315 requires the auditor to gain an understanding of these risk assessment processes used by the client
AT A GLANCE
company’s management, to the extent that those risk assessment processes may affect the financial reporting
process.
The quality of the risk assessment and management process within the client company can be used by the auditor
to assess the overall level of audit risk. If management has no such process in place, the auditor will need to do
more work on this aspect of the audit planning.
3.5 The information system

ISA 315 requires the auditor to gain an understanding of the business information systems (including the
accounting systems) used by management to the extent that they may affect the financial reporting process.
This aspect of the auditor’s work will involve identifying and understanding the following:
 the entity’s principal business transactions
SPOTLIGHT
 how these transactions and other events relevant to the financial reporting process are ‘captured’
(identified and recorded) by the entity
 the processing methods, both manual and electronic, applied to those transactions
 the accounting records used, both manual and electronic, to support the figures appearing in the
financial statements
 the processes used in the preparation of the financial statements.
The information system therefore consists of:
 infrastructure (physical and hardware components) – manual accounting systems may have little
infrastructure.
 software (in IT-based accounting systems)
 people
 procedures
 data
3.6 Control activities

Control activities are the practices and procedures, other than the control environment, used to ensure that the
entity’s objectives are achieved. They are the application of internal controls.

Control activities are the specific procedures designed:

 to prevent errors that may arise in processing information, or
 to detect and correct errors that may arise in processing information.
Categories of control activities (internal controls)

Internal controls include the following types: (In the examination, if you are asked to suggest suitable internal
controls within a given system the items in this list should provide a useful checklist.)
 Authorisation controls. These require that all significant transactions must be authorised by a manager
at an appropriate level in the organisation.
 Physical controls over assets. These are controls for safeguarding assets from unauthorised use, or from
theft or damage. An example is limiting access to inventory areas to a restricted number of authorised
personnel.
 Arithmetic controls. These are checks on the arithmetical accuracy of processing. An example is checking
invoices from suppliers, to make sure that the amount payable has been calculated correctly.
 Accounting controls. These are controls that are provided within accounting procedures to ensure the
accuracy or completeness of records. An example is the use of control account reconciliations to check
the accuracy of total trade receivables or total trade payables.
AT A GLANCE
 Management controls. These are controls applied by management. They include supervision by
management of the work of subordinates, management review of performance and control reporting
(including management accounting techniques such as standards setting, variance analysis, budgeting
and budgetary control).
 Segregation of duties. This type of control is explained below.
Segregation of duties
Segregation of duties means dividing the work to be done between two or more individuals, so that the work
done by one individual acts as a check on the work of the others. This reduces the risk of error or fraud.
 If several individuals are involved in the completion of an overall task, this increases the likelihood that
errors will be detected when they are made. Individuals can often spot mistakes of other people more
SPOTLIGHT
easily than they can identify their own mistakes.

 It is more difficult for a person to commit fraud, because a colleague may identify suspicious transactions
by a colleague who is trying to commit a fraud.
3.7 Monitoring of controls

It is important within an internal control system that management should review and monitor the operation of
the controls, on a systematic basis, to satisfy themselves that the controls remain adequate and that they are
being applied properly. ISA 315 requires the auditor to obtain an understanding of this monitoring process.
3.8 Internal controls - illustration

 Illustration: internal controls
The scenario
Waqar Wheels is a listed car dealership with over thirty showrooms across Pakistan and
headquarters in Karachi. The directors introduced a code of ethics and conduct four years ago
which it updates regularly and implements enthusiastically with routine training session and a
robust disciplinary procedure. Monthly ‘all-staff’ newsletters remind employees about core
ethical values and the need to maintain strong internal controls across all business processes.
The directors take both employee and customer safety very seriously. A number of staff were
dismissed following serious breaches of the code of conduct.

Waqar Wheels employs an experienced internal audit department. It also has a number of non-
executive directors on its board of directors. Waqar Wheels complies fully with the code of
corporate governance applicable to listed companies in Pakistan.
A risk committee comprising three experienced members of the board of directors was
established four years ago. The committee is responsible for assessing the business risks faced
by Waqar Wheels and working with senior management to ensure appropriate internal controls
are employed across the business.
For example, sales representatives are allowed to offer discounts of up to 6% without manager
approval. However, discounts above 6% must be authorised by a showroom manager. The sales
system automatically checks whether an approval is required and prevents any sale being
recorded without an approval code. Regional sales managers receive a weekly report detailing
all discounted sales above 6% to check that they were authorised.
Analysis of the system of internal controls
 Control environment - Waqar Wheels has a strong control environment with directors
who take internal controls seriously. They employ an internal audit department and
vigorously implement codes of ethics and conduct, reinforcing their control-focused
attitude with regular all-staff communications. The directors also ensure full compliance
AT A GLANCE
with the code of corporate governance.
 The entity’s risk assessment process – Waqar Wheels has a risk committee comprising
three experienced directors who are responsible for assessing business risks faced by
the company. The committee works with senior management to ensure a robust system
of internal controls is implemented.
 The information system – The scenario made reference to a ‘sales system’ for recording
sales and discounts. The ‘sales system’ is part of the overall information system used to
record transactions at Waqar Wheels.
 Control activities – Sales discounts above 6% must be authorised by a showroom
manager prior to recording the sale. This is an example of an authorisation control.
 Monitoring of controls – Regional sales managers monitor the operation of the
authorisation control by reviewing a weekly report to ensure discounts above 6% have
SPOTLIGHT
been authorised.
3.9 How the auditor uses internal controls

When a client operates an effective system of internal control the most efficient method of generating audit
evidence normally involves the testing of controls where possible (rather than substantive procedures).
‘Systems-based’ techniques therefore complement the business risk approach described above in an effort to
maximise audit efficiency and focus testing on the higher risk areas.
The auditor relies on the accounting systems and the related controls to ensure that transactions are properly
recorded. The audit emphasis is therefore, as much as possible, on the systems processing the transactions rather
than on the transactions themselves.
Understanding the controls

ISA 315 requires the auditor to 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.
ISA 315 requires the auditor to:
 gain an understanding of each of the five elements of the client’s internal control system, and
 document the relevant features of the control systems.

Once this understanding has been gained, the auditor should confirm that their understanding is correct by
performing ‘walk-through’ procedures on each major type of transaction (for example, sales transactions,
purchase transactions, payroll).
Walk-through testing involves the auditor selecting a small sample of transactions and following them through
the various stages in their processing from initiation to reporting in order to establish whether their
understanding of the process is correct.
 Example: Walk-through procedures
In a walkthrough test over the sales transaction, the auditor would select a sales transaction and
start from the receipt of a Sales Order from a customer. The auditor would then review each
document (e.g. order, invoice, goods dispatch note, customer acknowledgement of receipt) and
process (e.g. review of order, preparation and approval of sales invoice etc.) until the final
customer’s acknowledgment of receipt of goods, thereby ensuring that the system of sales as
understood is in fact also implemented in the same way.
If they understand the controls that are in place, the auditor can go on to assess their effectiveness, and the extent
to which they can rely on those controls for the purpose of the audit.
Assessing the effectiveness of controls
AT A GLANCE
The degree of effectiveness of an internal control system will depend on the following two factors:
 The design of the internal control system and the individual internal controls. Is the control system able
to prevent material misstatements, or is it able to detect and correct material misstatements if they
occur? Do the internal controls appear to be adequate and effective ‘on paper’?
 The proper implementation of the controls. Controls are not effective unless they are implemented
properly. So are the controls operated properly by the client’s management and other employees?
The outcome of this evaluation helps the auditor to assess the control risk. This is the risk that the internal
controls will fail to prevent or detect and correct errors in the financial statements. This evaluation will allow the
auditor to decide on the extent to which they can take a systems-based approach to the audit.
3.10 The auditor’s evaluation of internal controls
The auditor may judge that the control risk is high, or that the control risk is low because the internal controls
SPOTLIGHT
are effective.
 If the auditor assesses the control risk as very high, they will probably take the view that a systems-
based audit approach will not be appropriate. They will therefore move on to detailed testing of
transactions and balances (and take a substantive testing approach to the audit).
 Before they can assess the control risk as low, the auditor must be satisfied that the controls are well-
designed and should be effective (in other words, they seem effective ‘on paper’). Even if the controls
appear to be acceptable on paper, the auditor cannot rely on them and perform a systems-based audit
unless they are confident that the controls are actually working in practice. In this situation, the next
stage in the audit process is to carry out tests of controls.
If the outcome of the tests of control indicates that controls are actually operating effectively, the audit can use a
systems-based approach, with a reduced amount of substantive testing. Even if the internal control system seems
to be effective, the auditor will never rely 100% on their assessment of the controls. They will always do some
substantive testing before reaching their conclusion about the financial statements.
This is because of the limitations that are inherent in all control systems. It is impossible to avoid the risk of
control failure that is caused by:
 human error (and a failure to apply a control properly)
 obsolescence of controls
 over-riding of controls by management (which is a deliberate decision to ignore a control), and
 the possibility of collusion and fraud.

Auditors will always supplement their work on systems with some substantive testing. The amount of this testing
will depend on the auditor’s evaluation of the effectiveness of the controls.
The performance of tests of controls does not guarantee that few substantive procedures would be carried out;
in fact, if the performance of tests of controls reveals that the internal controls within a particular type or class
of transaction are not operating effectively, the auditor will increase the nature, timing and extent of their
substantive audit procedures.
3.11 Summary of the approach to reliance on internal controls

The auditor’s use of a systems-based approach to an audit is summarised in the following flowchart:
Planning and
risk assessment
Assessment of Assessment of
internal controls internal controls
as weak as strong
AT A GLANCE
Tests of controls
Good controls
Extensive Reduced
substantive substantive
testing testing
SPOTLIGHT
Overall review
of financial
statements
Issue audit
report

4. COMMUNICATING DEFICIENCIES IN INTERNAL CONTROL TO THOSE

CHARGED WITH GOVERNANCE AND MANAGEMENT (ISA 265)
 Definition: Deficiency in internal control
* 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 financial statements on a
timely basis is missing.
 Definition: Significant deficiency in internal control
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.
Auditor shall determine whether, on the basis of the audit work performed, the auditor has identified one or
more deficiencies in internal control.
 Auditor may discuss the relevant facts and circumstances of auditor’s findings with the appropriate level
of management.
AT A GLANCE
 Auditor may obtain other relevant information for further consideration, such as:
¯ Management understanding of the actual or suspected causes of the deficiencies.
¯ Exceptions arising from deficiencies that management may have noted (e.g. misstatements that
were not prevented by relevant IT controls).
¯ A preliminary indication from management of its response to the findings.
4.1 Significant Deficiencies in Internal Control (Ref: 8, A5-A11)

If auditor has identified one or more deficiencies in internal control, auditor shall determine, on the basis of the
audit work performed, whether, individually or in combination, they constitute significant deficiencies.
Examples of matters that the auditor may consider in determining the significance:
SPOTLIGHT
 Likelihood of the deficiencies leading to material misstatements in the financial statements in the future.
 The susceptibility to loss or fraud of the related asset or liability.
 Subjectivity and complexity of determining estimated amounts, e.g. fair value estimates.
 The financial statement amounts exposed to the deficiencies.
 The volume of activity that has occurred or could occur in the account balance or class of transactions
exposed to the deficiency or deficiencies.
 The importance of the controls to the financial reporting process; for example:
¯ General monitoring controls (such as oversight of management).
¯ Controls over the prevention and detection of fraud.
¯ Controls over selection and application of significant accounting policies.
¯ Controls over significant transactions with related parties.
¯ Controls over significant transactions outside the entity’s normal course of business.
¯ Controls over the period-end financial reporting process
 Cause and frequency of the exceptions detected as a result of deficiencies in the controls.
 The interaction of the deficiency with other deficiencies in internal control.

Indicators of significant deficiencies in internal control:

 Evidence of ineffective aspects of control environment, such as:
¯ Indications that significant transactions in which management is financially interested are not being
appropriately scrutinized by those charged with governance.
¯ Identification of management fraud, that was not prevented by internal control.
¯ Management’s failure to implement appropriate remedial action on significant deficiencies
previously communicated.
 Absence of a risk assessment process within entity (where it is expected to be present)
 Evidence of an ineffective risk assessment process (fails to identify risks)
 Evidence of an ineffective response to identified significant risks
 Misstatements detected by auditor that were not prevented, or detected and corrected, by entity’s
internal control.
 Restatement of previously issued financial statements to reflect correction of a material misstatement.
 Evidence of management’s inability to oversee the preparation of the financial statements.
AT A GLANCE
Kiran is the audit senior responsible for the audit of Xengen Limited. She has noticed that a large
number of journal entries were processed near the year end.
Required:
What course of action should the audit team take if serious deficiencies are identified during the
control testing process?
 Solution:
Reassess the risk of material misstatement and modify the nature timing and extent of further
audit procedures, such as:
 Identify the ledger accounts in which most of the journal entries were processed, for e.g.
(revenue or fixed assets).
SPOTLIGHT
 Inquire accounting and data entry personnel whether they were requested to make any
unusual entries during the period.
 Introduce an element of unpredictability regarding the amount and types of journal
entries and other adjustments tested.
 Computer assisted audit techniques may be used to identify the journal entries and other
adjustments to be tested or to detect unusual entries or entries made at unusual time or
by unusual users.
 Increase the extent of substantive procedures.
 Focus on journal entries posted at quarter-end and year-end.
 Assess whether the control weakness identified represents management override of
control and represents a fraud risk.
If the management integrity or competence is not in doubt the auditor shall communicate to
management at an appropriate level of responsibility significant deficiencies in internal control
it intends to communicate to those charged with governance along with the description of the
deficiencies and an explanation of their potential effects.
If the findings appear to call management’s integrity or competence in doubt the auditor shall
communicate the significant deficiencies to those charged with governance and consider
resigning from the assignment and obtain legal opinion in this regard and shall determine
whether there is a responsibility to report to the regulatory authorities.

4.2 Communication of Deficiencies in Internal Control (Ref: 9, A12-A18)

Auditor shall communicate in writing significant deficiencies in internal control identified during the audit to
those charged with governance on a timely basis.
 In determining when to issue written communication, auditor may consider whether receipt of such
communication would be an important factor in enabling those charged with governance to discharge
their oversight responsibilities.
 Auditor may also communicate these orally in the first instance to management and those charged with
governance.
 The level of detail at which to communicate significant deficiencies is a matter of auditor’s professional
judgment. Factors that auditor may consider in determining so include:
¯ The nature of the entity.
¯ (e.g. communication required for public interest entity may be different from others)
¯ The size and complexity of the entity.
¯ The nature of significant deficiencies that the auditor has identified.
¯ The entity’s governance composition.
¯ (e.g. more detail may be needed if those charged with governance include inexperienced members)
AT A GLANCE
¯ Legal or regulatory requirements regarding such communication

 The fact that auditor communicated a significant deficiency to those charged with governance and
management in a previous audit does not eliminate the need for the auditor to repeat the communication
if remedial action has not yet been taken.
¯ If a previously communicated significant deficiency remains, this year communication may repeat
the description from previous communication, or simply refer it
¯ Auditor may ask management or those charged with governance, why the deficiency has not yet
been remedied.
¯ A failure to take remedial action may in itself represent a significant deficiency.
4.3 Communication of Deficiencies to Management (Ref: Para. 10, A19-A27)

SPOTLIGHT
Auditor shall also communicate to appropriate level of management on a timely basis:

 In writing, significant deficiencies in internal control that auditor has communicated or intends to
communicate to those charged with governance, unless it is inappropriate to communicate to them. (E.g.
where deficiency call into question the integrity or competence of management)
 Other deficiencies in internal control identified during audit that have not been communicated to
management by other parties and that, in auditor’s professional judgment, are of sufficient importance
to merit management’s attention.
Other considerations relating to Communication of Other Deficiencies
 Communication of other deficiencies need not be in writing but may be oral.
 If auditor has communicated other deficiencies in internal control to management in prior period and
management has chosen not to remedy them for cost or other reasons, auditor need not repeat the
communication in the current period.
 Auditor may re- communicate these other deficiencies if there has been a change of management, or if
new information has come to auditor’s attention
 If deemed appropriate, auditor may also inform those charged with governance of such communication
4.4 Content of Written Communication of Significant Deficiencies (Ref: 11, A28-A30)

Auditor shall include in written communication of significant deficiencies in internal control:
 A description of the deficiencies and an explanation of their potential effects; and

 Sufficient information to enable those charged with governance and management to understand the
context of the communication. In particular, the auditor shall explain that:
¯ The purpose of the audit was for the auditor to express an opinion on the financial statements;
¯ The audit included consideration of internal control relevant to preparation of financial statements
in order to design audit procedures that are appropriate in the circumstances, but not for the purpose
of expressing an opinion on effectiveness of internal control; and
¯ The matters being reported are limited to those deficiencies that auditor has identified during audit
and that auditor has concluded are of sufficient importance to be reported
Other Considerations
 In explaining potential effects, auditor need not quantify those effects.
 Significant deficiencies may be grouped together for reporting purposes, if appropriate.
 Auditor may also include suggestions for remedial action on deficiencies, management’s actual or
proposed responses, and a statement as to whether auditor has undertaken any steps to verify whether
management’s responses have been implemented.
 Auditor may consider it appropriate to include the indications that:
¯ By performed more extensive procedures, more deficiencies could also be identified.
AT A GLANCE
¯ Such communication has been provided for those charged with governance, and that is not suitable
for others.
 Law or regulation may require auditor or management to furnish copy of communication to appropriate
regulatory authorities.
(In this case, auditor’s written communication may identify such regulatory authorities)
The Board of Directors of an insurance company is very concerned about the increasing incidents
of fraud in verification of claims by the surveyors.
Required:
Suggest controls that should be implemented by the company for claim verification.
SPOTLIGHT
Tutorial Notes:
Common errors while answering could be:
1. Specifying irrelevant controls which could not play any role in the identification of frauds
such as, controls over recording of claims and verification of payments, etc.
2. Not apprehending that the answer should be given in context of an Insurance company.
 Solution:
Suggested controls for claim verification:
i. Employ a panel of qualified surveyors with good reputation.
ii. Segregation of duties relating to the claim process.
iii. Monitoring the time lag between policy issuance and claim reported and between the
claim lodge and settlement date, and investigate unusual cases.
iv. A second survey may be conducted on a test basis especially in unusual cases.
v. Surveyors should be required to submit pictures of the damaged assets whenever
possible.
vi. Monitor which agent and insuree has the highest claim ratio.
vii. Review the total claims verified by each surveyor and compare it with value of assets
insured to identify unusual ratio.

4.5 Tutorial note

Core Paragraphs: 10, 11
Explanatory Paragraphs: A2, A6, A7, A15 and A29
AT A GLANCE
SPOTLIGHT

5. BALANCE SHEET (SUBSTANTIVE) STRATEGIES

5.1 Substantive tests
When an auditor assesses the control risk as high, they will not be able to adopt a systems-based approach to the
audit. Instead they will carry out extensive substantive testing.
Substantive tests are audit procedures performed to detect material misstatements in the figures reported in
the financial statements. They are designed to obtain evidence about the financial statement assertions. They
include:
 tests of detail on transactions, account balances and disclosures, and
 analytical procedures.
Examples of tests of details include inspection of third party evidences such as suppliers’ statements or invoices,
obtaining confirmations and/or recalculating items such as depreciation or rent expense for the year.
Similarly, examples of analytical procedures include ratio analysis, comparison with past trends, industry
information or company budgets and corroboration with the information obtained from other substantive
procedures.
AT A GLANCE
5.2 The balance sheet approach
The balance sheet approach is also an approach to the audit based wholly on substantive testing. However,
unlike the transaction cycle approach, with the balance sheet approach the auditor concentrates primarily on:
 testing balances, as opposed to;
 testing balances and transactions.
It is an approach that is often well-suited to small companies and to companies where assets and liabilities are
substantial in relation to transactions (e.g. investment companies).
This approach is based on the following accounting equation:
Opening net assets + Profit for the year = Closing net assets
SPOTLIGHT
The theory is that if the opening and closing statements of financial position are ‘correct’ then the profit for the
year must also be correct.
5.3 Directional testing

Directional testing is the concept applied to substantive testing to differentiate between testing for
misstatements (over- or under-statement) or omissions (under-statement).
 When testing for misstatements the audit sample will be selected from the accounting records (i.e.
recorded transactions).
 When testing for omissions the audit sample will be selected from outside the accounting records e.g.
bank statements or supplier statements.
 The testing is therefore said to be performed in opposite directions when testing for omissions rather
than misstatements.
5.4 Smaller entities

ISAs apply to the audits of all entities – whatever their size. However, additional considerations specific to audits
of smaller entities are included within the application and other explanatory material of a ISAs, where
appropriate. These additional considerations assist in the application of the requirements of the ISA in the audit
of such entities. They do not, however, limit or reduce the responsibility of the auditor to apply and comply with
the requirements of the ISAs.

 Definition: Small entity

The IAASB’s Glossary of terms defines a smaller entity as one which typically possesses the
following characteristics:
 Concentration of ownership and management in a small number of individuals (often a
single owner-manager)
 One or more of the following:
¯ Uncomplicated transactions
¯ Simple record-keeping
¯ Few lines of business/products
¯ Few internal controls
¯ Few levels of management with responsibility for a broad range of controls
¯ Few personnel, many having a wide range of duties
Many of the control activities that would typically be found in a large company may be inappropriate, too costly
or impractical for a small entity. Segregation of duties is an obvious example of this. Smaller entities do not have
enough employees for an ‘ideal’ segregation of duties.
AT A GLANCE
Often, control systems in smaller entities are based on a high level of involvement in day-to-day operations by
the directors or owners of the company. Authorisation controls and review controls, with the owner-manager
personally authorising many transactions, might therefore be a key feature of the control systems in smaller
entities.
Although the active involvement of an owner-manager might mitigate risks arising from a lack of segregation of
duties, the auditor will often see the involvement of an owner-manager in day-to-day operations as only a partial
substitute for ‘normal’ control systems. The following problems may arise in such types of businesses:
 There may be a lack of evidence as to how systems are supposed to operate. The auditor will need to
rely more on inquiry than on review of documentation.
 There may be a lack of evidence of the application of controls in practice (for example, authorisations
may not be documented).

SPOTLIGHT
Management may override whatever internal controls are in place.

 Management may lack the expertise necessary to control the entity effectively and efficiently.
 There is unlikely to be any independent person within the management team as there would be within
“those charged with governance” in a larger entity.
The attitudes and actions of the owner-manager will be key to the auditor’s risk assessment. There is unlikely to
be a written code of conduct so a culture of integrity and ethical behaviour, as demonstrated by management
example, will be important.
The auditor needs to understand and evaluate whatever controls are in place and plan their audit work
accordingly. However, it is likely that a lower level of reliance will be placed on controls in a smaller entity, which
means that a considerable amount of substantive testing will be needed.

6. THE AUDITOR’S RESPONSES TO ASSESSED RISKS (ISA 330)

 Definition: Substantive procedure
An audit procedure designed to detect material misstatements at the assertion level.
Substantive procedures comprise:
i. Tests of details; and
ii. Substantive analytical procedures.
 Definition: Test 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.
6.1 Overall Responses (Ref: 5, A1-A3)

Auditor shall design and implement overall responses to address the assessed risks of material misstatement at
the financial statements level.
Such overall responses may include:
AT A GLANCE
 Emphasizing to the engagement team the need to maintain professional skepticism.
 Assigning more experienced staff or those with special skills or using experts.
 Providing more supervision.
 Incorporating unpredictability in selection of further audit procedures to be performed.
 Making general changes to nature, timing or extent of audit procedures
(e.g. performing substantive procedures at period end instead of at an interim date etc.)
6.2 Responses to the Assessed Risks at the Assertion Level (Ref: 6, 7, A4-A19)
Auditor shall design and perform further audit procedures whose nature, timing and extent are based on the
assessed risks of material misstatement at assertion level.
SPOTLIGHT
Assessment of identified risks at assertion level provides a basis for considering the appropriate audit approach for
designing and performing further audit procedures. For example:
 Only by performing tests of controls
 Performing only substantive procedures is appropriate; or
(auditor excludes the effect of controls from the relevant risk assessment)
 A combined approach using both tests of controls and substantive procedures
In designing further audit procedures to be performed, auditor shall:
 Consider the reasons for risk assessment at the assertion level, including:
¯ Likelihood of material misstatement due to particular characteristics of relevant class of
transactions, account balance, or disclosure (i.e. inherent risk); and
¯ Whether the risk assessment takes account of relevant controls (i.e. control risk)
 Obtain more persuasive audit evidence in case of higher assessment of risk.
(May increase quantity of evidence, or obtain more relevant and reliable evidence)
Nature of an Audit Procedure

Nature of an audit procedure refers to:
 Its purpose (e.g. test of controls or substantive procedure); and
 Its type (e.g. inspection, observation, inquiry, recalculation, or analytical procedure etc.).

Auditor’s assessed risks may affect both the types of audit procedures to be performed and their combination.
For example, when an assessed risk is high, auditor may confirm completeness of the terms of a contract with
counterparty, in addition to inspecting the document.
Timing of an Audit Procedure

Timing of an audit procedure refers to when it is performed, or the period or date to which the audit evidence
applies.
The higher the risk of material misstatement, the more likely it is that auditor may decide it is more effective to
perform substantive procedures nearer to, or at the period end
On other hand, performing audit procedures before period end may assist the auditor in identifying significant
matters at an early stage of audit, and resolving them with management
Certain audit procedures can be performed only at or after the period end, for example:
 Agreeing the financial statements to the accounting records;
 Examining adjustments made during the course of preparing the financial statements; and
 Procedures to respond to a risk that entity may have entered into improper sales contracts at period end
Other Relevant factors influencing auditor’s consideration of timing of auditors’ procedures:
AT A GLANCE
 The control environment.

 Timing of availability of relevant information
 Nature of the risk
 The period or date to which the audit evidence relates
Extent of an Audit Procedure

Extent of an audit procedure refers to quantity to be performed
Extent of an audit procedure is determined after considering materiality, assessed risk, and the degree of
assurance required.
SPOTLIGHT
Use of the computer-assisted audit techniques (CAATs) may enable more extensive testing of electronic
transactions and account files, which may be useful when auditor decides to modify extent of testing. Such techniques
can be used to select sample transactions from key electronic files, to sort transactions with specific characteristics,
or to test an entire population instead of a sample.
6.3 Tests of Controls (Ref: 8-17, A20-A41)

Auditor shall design and perform tests of controls to obtain sufficient appropriate audit evidence as to the
operating effectiveness of relevant controls if:
 Auditor’s assessment of risks at assertion level includes an expectation that controls are operating
effectively i.e. auditor intends to rely on operating effectiveness of controls; or Auditor shall obtain more
persuasive audit evidence in test of controls.
 Substantive procedures alone cannot provide sufficient appropriate audit evidence e.g. when business
is conducted using IT and paper documentation is not maintained.
Testing the operating effectiveness of controls is different from obtaining an understanding of and evaluating
design and implementation of controls (as per ISA 315). Auditor may decide that it is efficient to test operating
effectiveness of controls at same time when evaluating those.
Nature and Extent of Tests of Controls

In designing and performing tests of controls, auditor shall:
 Perform procedures to obtain evidence about operating effectiveness of controls:

 How the controls were applied at relevant times during the accounting period;
 The consistency with which they were applied; and
 By whom or by what means they were applied.
 Determine whether controls are interdependent and whether to check other controls.
Nature
Nature of particular control influences the type of procedure required to obtain audit evidence about whether the
control was operating effectively.
Timing
 Evidence pertaining only to a point in time may be sufficient for auditor’s purpose; or e.g. when testing
controls over entity’s physical inventory counting at the period end.
 Auditor may intend to rely on a control over a period.
Extent
Auditor may consider following matters in determining the extent of tests of controls:
 Frequency of the performance of the control by the entity.
AT A GLANCE
 Length of time during period that auditor is relying on operating effectiveness of control
 Expected rate of deviation from a control.
 Relevance and reliability of audit evidence to be obtained
 Extent to which audit evidence is obtained from tests of other controls.
Because of inherent consistency of IT processing, it may not be necessary to increase the extent of testing of an
automated control. It can be expected to function consistently unless the program (including the tables, files, or
other permanent data used by the program) is changed.
Using audit evidence obtained about controls during an interim period

Auditor shall:
SPOTLIGHT
 Obtain evidence about significant changes to those controls subsequent to that period; and
 Determine the additional audit evidence to be obtained for the remaining period
Relevant factors in determining additional audit evidence include:
 Significance of assessed risks of material misstatement at the assertion level.
 Degree to which audit evidence about those controls was obtained.
 The length of the remaining period.
 Extent to which the auditor intends to rely on controls.
 The control environment.
Using audit evidence obtained in previous audits

Auditor shall consider the following:
 Effectiveness of other elements of internal control
 Risks arising from characteristics of control, including whether it is manual or automated;
 The effectiveness of general IT controls;
 The effectiveness of the control and its application by the entity;
 Whether lack of a change poses a risk due to changing circumstances; and
 The risks of material misstatement and the extent of reliance on the control.

Auditor shall establish the continuing relevance of that evidence by obtaining audit evidence about whether
significant changes in those controls have occurred subsequent to previous audit.
 If there have been changes, auditor shall test the controls in the current audit.
 If there have been no changes, auditor shall test controls at least once in every 3rd audit
If auditor plans to rely on controls over a significant risk, auditor shall test those controls in the current period.
Evaluating the operating effectiveness of relevant controls

Auditor shall evaluate whether the misstatements detected by the substantive procedures indicate that controls
are not operating effectively.
If deviations from controls are detected, auditor shall make specific inquiries to understand these matters and
their potential consequences, and shall determine whether:
 Performed tests of controls provide an appropriate basis for reliance on the controls;
 Additional tests of controls are necessary; or
 The potential risks of misstatement need to be addressed using substantive procedures.
6.4 Substantive Procedures (Ref: 18-23, A42-A58)

AT A GLANCE
Irrespective of risks of material misstatement, auditor shall design and perform substantive procedures for each
material class of transactions, account balance, and disclosure
Depending on the circumstances, auditor may determine that:
 Performing only substantive analytical procedures will be sufficient to reduce audit risk;
 Only tests of details are appropriate; or
 A combination of substantive analytical procedures and tests of details are required.
Extent of substantive procedures may need to be increased when the results from tests of controls are
unsatisfactory. This is normally done through increasing the sample size.
Substantive Procedures Related to the Financial Statement Closing Process

SPOTLIGHT
Substantive procedures shall include following audit procedures related to financial statements closing process:
 Agreeing or reconciling the financial statements with the underlying accounting records; and
 Examining material journal entries and other adjustments made during the course of preparing the
financial statements. (Ref: Para. A52)
Kiran is the audit senior responsible for the audit of Xengen Limited. She has noticed that a large
number of journal entries were processed near the year end.
Required:
What controls should she expect to be in place for recording and processing of journal entries?
Tutorial Notes:
Along with other controls students are expected to discuss documented policies and procedures,
standardized forms for standard journal entries, automated exception reports for un-usual
entries in order to gain maximum marks. Similarly, auditors’ actions like use of computer
assisted audit techniques, increasing the extent of substantive testing and assessing risk of
management override of controls would also add a flavor to the answer.

 Solution:
i. Policies and procedures involving journal entries and other adjustments should be
documented and available to personnel involved in initiating the entries to the general
ledger/transaction processing systems.
ii. Entries should be identified with adequate descriptions and/or supporting
documentation including calculations.
iii. Each entry should be signed by the preparer and approved by the authorized
personnel.
iv. Authority limits for approval of journal entries should be well defined.
v. Each entry should be sequentially numbered and dated.
vi. Standardized forms should be used for standard journal entries e.g. forms containing
the account numbers of ledgers in which the entry is to be posted.
vii. Automated exception reports of entries such as amounts in excess of certain limits,
credit entries in accounts where only debit entries are posted, entries in rarely used
accounts, etc. should be regularly generated and reviewed.
Substantive Procedures Responsive to Significant Risks
AT A GLANCE
Auditor shall perform substantive procedures that are specifically responsive to that risk. When the approach to a
significant risk consists only of substantive procedures, those procedures shall include tests of details. External
confirmations received directly by auditor from appropriate confirming parties may assist auditor in obtaining audit
evidence with high reliability.
Timing of Substantive Procedures

If substantive procedures are performed at an interim date, auditor shall cover the remaining period by
performing:
 Substantive procedures, combined with tests of controls for the intervening period; or
 Further substantive procedures only.
Factors that may influence whether to perform substantive procedures at an interim date:
SPOTLIGHT
 The control environment and other relevant controls.
 The availability at a later date of information necessary for the auditor’s procedures.
 The purpose of the substantive procedure.
 The assessed risk of material misstatement.
 The nature of the class of transactions or account balance and related assertions.
 The ability of the auditor to perform appropriate substantive procedures or substantive procedures
combined with tests of controls to cover the remaining period in order to reduce the risk that
misstatements that may exist at the period end will not be detected.
Following factors may influence whether to perform substantive analytical procedures with respect to the period
between the interim date and the period end:
 Whether period-end balances are reasonably predictable.
 Whether the entity’s procedures for analyzing and adjusting such items and for establishing proper
accounting cutoffs are appropriate.
 Whether information system relevant to financial reporting will provide information that is sufficient to
permit investigation of:
¯ Significant unusual transactions or entries (including those at or near the period end);
¯ Other causes of significant fluctuations, or expected fluctuations that did not occur; and
¯ Changes in the composition of the classes of transactions or account balances.


Develop audit work programs in respect of dividend to shareholders stating therein the related
assertions, audit objectives and substantive audit procedures.
 Solution:
A. AUDIT OBJECTIVES
To determine whether:
(a) All liabilities on account of unclaimed/unpaid dividends are properly recorded and
represent valid liabilities of the entity at the balance sheet date.
(b) These are properly described and classified and adequate disclosures with respect
to these amounts have been made.
(c) Zakat has been adequately deducted and deposited in the Central Zakat Fund
according to the requirements of Zakat and Ushr Ordinance, 1980 and Rules made
there under.
(d) Dividends have been paid within stipulated time.
B. ASSERTIONS AND SUBSTANTIVE PROCEDURES
1. Recording of liability / dividend declared
AT A GLANCE
Assertions addressed
(i) Rights and obligations
(ii) Completeness
(iii) Existence
(iv) Valuation and allocation
Procedures
(i) See authority of Board and / or general meeting for all dividends declared.
(ii) Agree capital on which dividend is paid with issued capital.
SPOTLIGHT
(iii) Ensure that any unpaid / unclaimed amount of dividends is adequately

disclosed.
(iv) Ensure that dividends are paid out of profits only.
(v) Ensure that no dividend is paid out of profits from sale or disposal of any
immovable property / asset of capital nature.
(vi) In case of stock dividend the following steps would be performed:
 Ensure that Companies Issue of Capital Rules, 1996 have been complied
properly.
 Ensure that free reserve and surplus retained after the issue of bonus
shares will not be less than 25% of the increased capital.
 Obtain confirmation from CDC to check issue of bonus shares.

2. Payments
(i) Occurrence
(ii) Completeness
(iii) Accuracy
(iv) Cut-off
Procedures
(i) Ensure that dividend warrants are issued in the name of registered
shareholders or to their order.
(ii) Ensure that dividend is paid within 45 days of declaration thereof (or 30 days
in case of a private company by such)/by such time as specified by
commissioner.
(iii) Ensure that withholding tax has been properly deducted from cash dividend.
(iv) Ensure compliance with Foreign Exchange Act, 1947 including nomination of
authorized dealer and permission from SBP in respect of for remittance of
AT A GLANCE
dividend to foreign shareholders.
(v) Obtain reconciliations in respect of dividends related to prior years and check
the movement on test basis
Zakat
(i) Check the cases where Zakat has not been deducted to ensure that those are
not in violation of Zakat and Ushr Ordinance, 1980 and relevant Rules.
(ii) Check Zakat exemption declarations on test basis, where applicable.
(iii) Check deposit challan for payment of Zakat in the Central Zakat Fund.
3. Disclosure
SPOTLIGHT
(i) Occurrence & rights and obligation
(ii) Classification and understandability
(iii) Completeness
Procedures
(i) Ensure appropriate disclosure have been made in accordance with the
reporting framework.
(ii) Fill relevant portion of Financial Statement Disclosure Checklist (FSDCL).
Develop audit programmes in respect of contingent liabilities and taxation (including deferred
taxation) stating therein the audit objectives and substantive audit procedures.
 Solution:
AUDIT PROGRAM FOR CONTINGENT LIABILITIES
Audit objectives
(a) The contingent liabilities disclosed by the management include all contingencies.

(b) Contingent liabilities do not include:

(i) any obligation which should be provided for in the books of account of the Company
as the probabilities of its outcome against the Company are on the higher side and the
quantum and timing of payment may be estimated;
(ii) any obligation for which the possibility of outflow of resources embodying economic
benefits is remote.
Substantive procedures
(a)
(i) Discuss with management the client’s policies and procedures for determining the
estimated financial effect of contingencies, including those resulting from litigation,
claims, and unasserted claims.
(ii) Examine the policies and procedures that the client has in place to monitor compliance
with laws and regulations, including those procedures designed to prevent the
occurrence of illegal acts.
(iii) Obtain confirmation from the legal advisors including tax consultants and
banks/financial institutions.
AT A GLANCE
(iv) Review the schedule of contingencies provided by the client and carry out the following
steps:
 Compare current year’s position with the previous years and check the items which
have not been reported this year.
 Examine documents, files and correspondence related to each material
contingency reported in the schedule.
 Discuss the latest status in each case with the appropriate management personnel.
 Check the basis of measurement of the contingencies.
 Check that the contingencies do not include items the probability of which is
remote.
SPOTLIGHT
 Ensure that provision has been made against all items that meet the relevant
criteria as mentioned in IAS 37.
 Refer the confirmation received from the legal advisors, tax consultants, banks and
financial institutions, with the schedule of contingencies.
 Where some or all of the expenditure required settling a contingent liability is
expected to be reimbursed by another party, ensure that the reimbursement
should be disclosed when, and only when, it is virtually certain that the
reimbursement will be received if the enterprise settles the potential obligation.
(v) Perform the following steps to ensure that all contingencies have been disclosed.
 Review the minutes of board of directors and of other important meetings.
 Review important agreements and contracts and ensure that the company is in
compliance thereof.
 Review schedule of legal charges to ascertain the names of all legal advisors to
ensure that all the cases being defended have been identified.
 Review the results of audit procedures performed in other heads of accounts to
identify any contingency which may not be recorded.
(vi) Obtain representation from client that all known contingencies have been disclosed.
(vii) Ensure that all contingencies have been appropriately disclosed in the financial
statements.

AUDIT PROGRAM FOR TAXATION

Audit objectives
(a) Tax exposure, tax liability/receivable and deferred tax have been correctly calculated.
(b) All disclosures in respect of the above have been properly made in accordance with the
relevant standards.
Substantive procedures
(a) Current Taxation
(i) Overall Analytical Procedures
 Compare amounts and ratios (e.g., effective tax rates) for the current period with
the prior year. Investigate significant fluctuations.
 Perform detailed comparative analysis of trading and operating results with causes
and reason for variation duly supported with justification.
(ii) Tax Expense
For the current year
AT A GLANCE
 Review the computation of taxable income and ensure that all
additions/deductions are computed in accordance with the provisions of the
Income Tax Ordinance, 2001
 Compare balances as per computation schedule given by client with the general
ledger. Investigate any differences.
 Obtain and test the client's support for significant add backs/ deductions
appearing in the schedule.
 Compare the amounts of significant permanent and temporary differences for the
current period with comparable amounts for the preceding period.
 Ensure that tax in respect of income covered under FTR (if any) has been correctly
computed and accounted for.
SPOTLIGHT
Prior period tax provision
 Check tax charge / reversal in current year with respect to previous year with
appropriate documents, i.e. assessment order issued during the year, amended
returns filed by the company (if any), notices received from tax department and
related correspondence, etc.
 Where the client has decided to file an appeal against an order of the taxation
authorities and have not made full provision there against, discuss the issue with
the client and review the tax consultants advise thereon.
(iii) Tax Payable / Refundable
Obtain a schedule showing movement in tax payable / refundable and check as follows:
 Check opening balances with the last year’s working papers
 Test check advance payment of tax and tax deducted at source from payment
challan, bill of entries, certificate of deduction of tax issued by the customers, etc.
 Check any adjustments (reduction in tax liability) with the refund orders / revised
assessment orders issued by the tax authorities.
(iv) Correspondence and confirmation from Tax Advisor(s)
 Obtain and study correspondence with tax advisor (s).
 Circularize confirmation to tax advisors and examine the response.

(v) Tax Contingencies Evaluate tax contingencies and ensure that these have been
appropriately accounted for and disclosed in the financial statements.
(vi) Obtain representation from the management that all information has been disclosed.
(b) Deferred Taxation
 Obtain a deferred tax working schedule from the client along with related disclosures
for current and prior periods.
 Check the calculation of major timing differences specially in respect of:
¯ Depreciation and amortization
¯ Provisions
¯ Revaluation of fixed assets, etc.
 Ensure that correct rate of tax has been applied to arrive at the deferred tax liability /
asset.
 Ensure that the difference between the tax effect of opening and closing balance of
timing difference has been debited / credited, as appropriate, in deferred tax expense
/ reversal account.
AT A GLANCE
 In case of carry forward of tax losses/ minimum tax, ensure that deferred tax has only
been provided where the losses/ minimum tax are expected to be reversed in the
foreseeable future.
 Ensure that loss carry forwards utilized to offset current year taxable income have not
expired.
(c) Disclosure Ensure appropriate disclosure have been made in accordance with the relevant
standards which include the reconciliation of tax charge for the year.
During the audit of Shahid Limited, your IS audit team has reported the following issues:
i. The client did not have an approved business continuity plan.
ii. There were several program changes made during the year which were not approved
SPOTLIGHT
by the higher management. However, a complete log of program changes was

maintained.
iii. IDs of the employees who have left the company are not deleted on a timely basis.
Required:
Discuss the possible course of action that you may take in respect of the above identified issues.
(Reporting implications are not required)
Tutorial Notes:
 While suggesting getting the program changes approved student should also discuss the
change process, the possible financial impact and the related audit procedures to obtain
sufficient appropriate evidence on the affected account balance/transactions.
 A good discussion should also be done on the employees’ ID issues.
 Solution:
i. The client does not have Disaster recovery (DR) and Business Continuity Plan (BCP):
The above deficiency might impact business operations but do not have any direct
impact on the financial statements. The auditor is not expected to alter audit strategy
or audit plan due to this deficiency.

Even though this control deficiency has no direct impact on the financial statements,
still the auditor shall consider whether the IT deficiency needs to be reported to those
charged with governance as required under ISA 260.
ii. Program changes without approval but change log is maintained:
There is a risk that unauthorized changes may have been made. This deficiency shall
impact audit strategy and plan.
The auditor may perform the following procedures to mitigate the risk of unauthorized
program changes that may result in material misstatements in the financial statements:
 Understand the process of program changes such as initiation of change
management request, authorization of request, validation of changes made etc. to
see if there are any mitigating controls which can be relied upon;
 Understand the application which is impacted by above deficiency and the financial
statements areas that are impacted by that application;
 For identified financial statements areas, following audit procedures may be
performed:
¯ Review key reconciliations, such as reconciliation of subsidiary and control
AT A GLANCE
accounts;
¯ Perform analytical procedures over information extracted from the
application to identify unusual pattern/trend.
¯ Perform substantive procedures such as test of details to ensure the accuracy
of information.
Based on the aforementioned procedures, the auditor shall evaluate whether the risk
of material misstatements due to unauthorized changes has been reduced to an
acceptable level. The auditor shall consider whether the IT deficiency as noted above
constitute a significant control deficiency which needs to be reported to those charged
with governance as required under ISA 260.
SPOTLIGHT
iii. IDs of employees who have left the organization are not deleted/deactivated on a
timely basis:
This deficiency possesses a risk that unauthorized changes may be made through IDs
of ex-employees which may result in material misstatements in the financial
statements. To address the risk, the auditor needs to alter the audit strategy/plan and
may perform the following procedures:
 Check the current status of active IDs of ex-employees and request management to
deactivate these;
 Review system logs to identify any changes that have been made through these IDs
during the time of severance of employees and deactivation of their IDs;
 If any changes are identified, follow the complete trail and understand the rationale
and impact of the change.
Based on the aforementioned procedures auditor shall evaluate whether the risk of
material misstatements due to unauthorized changes has been reduced to an
acceptable level. The auditor shall consider whether the IT deficiency as noted above
constitute a significant control deficiency which needs to be reported to those charged
with governance as required under ISA 260.


You are the audit manager in a firm of chartered accountants responsible for the statutory audit
of Fazal Limited (FL) for the year ended 31 March 2021.
During the audit, your audit team was informed that on 1 January 2021, FL entered into a sale
and leaseback agreement with Arabian Leasing Company (ALC) for its head office property
situated at premier commercial hub. FL sold the property to ALC at fair value with useful life of
thirty years as assessed on the date of sale. Subsequently, ALC leased back the property to FL for
a period of ten years.
Required:
State the audit procedures which may be performed in respect of the above transaction.
 Solution:
Audit Procedures
 Review the key details of agreement, in particular the rights of the lessee and the lessor
to control the asset, sale proceeds, lease rental, the lease term and the interest rate
implicit in the lease.
AT A GLANCE
 Read minutes of BOD meetings for management discussion and approval of the sale and
leaseback transaction.
 Review third party surveyor reports to verify the fair value and expected remaining life
of the property.
 Review client workings for the computation of the present value of the lease payments
and whether the client has recognized the right-of-use asset at the correct amount.
 Verify the sale proceeds received from ALC from bank statement.
 Determine whether the correct carrying amount of the property has been derecognized
in the financial statements.
 Review the working to verify whether the gain or loss on disposal has been recorded
correctly as per IFRS.
SPOTLIGHT
 Determine the disclosure made in the financial statements is in compliance with IFRS.
Misstatements detected at an interim date

Auditor shall evaluate whether the related assessment of risk and planned nature, timing or extent of substantive
procedures covering the remaining period need to be modified. Such modification may include extending or
repeating the procedures at the period end.
6.5 Adequacy of Presentation and Disclosure (Ref: 24, A59)

Auditor shall perform audit procedures to evaluate whether the overall presentation of financial statements,
including the related disclosures, is in accordance with applicable financial reporting framework
6.6 Evaluating Sufficiency and Appropriateness of Audit Evidence (Ref: 25-27, A60-A62)
Auditor shall evaluate before conclusion of audit whether the assessments of risks of material misstatement at
the assertion level remain appropriate. Auditor may need to reevaluate planned audit procedures, based on
revised consideration of assessed risks
Auditor shall conclude whether sufficient appropriate audit evidence has been obtained to enable auditor in
forming an opinion (whether it corroborates or contradicts the assertions)
If auditor has not obtained sufficient appropriate audit evidence, auditor shall attempt to obtain further audit
evidence. If auditor is unable to obtain sufficient appropriate audit evidence, auditor shall express a qualified
opinion or disclaim an opinion on the financial statements.

6.7 Documentation (Ref: 28-30, A63)

Documentation shall demonstrate that financial statements reconcile with underlying accounting records.
Auditor shall include in the audit documentation:
 Overall responses to address the assessed risks of material misstatement at financial statements level,
and the nature, timing and extent of the further audit procedures performed;
 The linkage of those procedures with the assessed risks at the assertion level;
 Results of audit procedures, including conclusions where these are not otherwise clear; and
 Conclusions reached about relying on controls tested in a previous audit (if relevant).
6.8 Tutorial note

Core Paragraphs: 7, 8, 10, 13, 14, 17, 20, 22 and 28
Explanatory Paragraphs: A1, A22, A28, A33, A38, A48, A51, A56, A57, A60 and A62
AT A GLANCE
SPOTLIGHT

7. IAS / IFRS CHECKLIST FOR AUDITORS

IAS 1: Presentation of financial statements
 Has the going concern basis been adopted? Is the going concern basis appropriate?
 If the directors of the client company have decided that the going concern basis is not appropriate, have
the relevant disclosures been made?
 If there is uncertainty about the going concern status of the company, have the relevant disclosures been
made?
 Has the accruals concept been complied with?
 Is there consistency in the presentation and classification of items in the financial statements, between
the current and previous financial periods?
 Has each material class of items been separately presented in the financial statements?
 Has offsetting (of assets and liabilities, or income and expense) been applied only as permitted by an
accounting standard?
 Has an appropriate format been adopted for the statement of financial position, income
statement/statement of comprehensive income and statement of changes in equity?
AT A GLANCE
 Are appropriate disclosure notes included?
IAS 2: Inventories
 Has inventory been consistently valued at the lower of cost and net realisable value, on an item-by-item
basis?
 Has an acceptable costing method been used for inventory? (Remember that LIFO is not permitted by
IAS 2.)
 Has inventory been counted accurately? (What is the evidence for this?)
 Has an appropriate method been used for the treatment of overheads?
IAS 7: Statement of cash flows

SPOTLIGHT
 Is the presentation of the statement of cash flows in accordance with the requirements of IAS7?
IAS 8: Accounting policies, changes in accounting estimates and errors

 Have appropriate accounting policies been selected and consistently applied?
 Have any changes in accounting policy permitted under IAS 8 been correctly accounted for as prior
period adjustments?
 Have fundamental errors in prior period financial statements been accounted for as prior period
adjustments?
 Have changes in accounting estimates been reflected on a prospective basis?
IAS 10: Events after the reporting period

 Has the definition of events after the reporting period (as defined by IAS 10) been properly applied?
 Have all subsequent events having an impact on amounts and/or disclosures in the financial statements
been identified?
 Is there a correct distinction between adjusting and non-adjusting events after the reporting period?
 Have adjustments been made correctly for adjusting events, in accordance with the appropriate IAS
/IFRS?
 Have non-adjusting events been adequately disclosed?

IAS 12: Income taxes

 Has the income tax liability been correctly calculated and disclosed?
 Has deferred tax been recognised in respect of all material temporary differences in accordance with
IAS 12 guidance??
 Has an appropriate rate of tax been used in measuring the amount of the deferred tax liability (asset)?
 Are deferred tax assets recoverable?
IAS 16: Property, plant and equipment

 Has cost of property, plant and equipment been determined in accordance with IAS 16?
 Has cost been correctly allocated to components of an asset in accordance with IAS 16?
 Has post-acquisition expenditure on property, plant and equipment been properly analysed between
capital expenditure and revenue expenditure?
 Has depreciation been properly calculated and accounted for?
 Have asset revaluations been performed in accordance with IAS 16 and accounted for correctly?
 Have disposals and the resulting gain or loss on disposal been properly calculated and recorded?
AT A GLANCE
IFRS 16: Leases
 Have leases been properly classified between finance leases and operating leases, and has the
appropriate accounting treatment been applied to each type of lease?
 Have leasing obligations (finance leases) been properly analysed into current and noncurrent liabilities?
 For finance leases, have the depreciation and finance charges been allocated to accounting periods in
accordance with standard.
 Have the appropriate disclosures been made?
IFRS 15: Revenue from contracts with customers

 Have the appropriate principles of revenue recognition been applied to the recognition of revenue from
SPOTLIGHT
the sale of goods, the provision of services and other items?
IAS 19: Employee benefits

 Have appropriate liabilities been recognised correctly when employees have provided service in
exchange for employee benefits to be paid in the future?
 Has the expense of the entity consuming the economic benefit arising from service provided by
employees in exchange for employee benefits been recognised correctly?
IAS 20: Accounting for government grants and disclosure of government assistance
 Have revenue-based grants been credited to the income statement/statement of comprehensive income
at the same time as the related expense?
 Have capital-based grants been accounted for in accordance with IAS 20? The grant should either (1) be
credited to the asset account, with depreciation then on the net cost of the asset, or (2) carried as a
deferred credit which is then amortised to the income statement/statement of comprehensive income
over the life of the asset.
IAS 21: The effects of changes in foreign exchange rates

 Have appropriate exchange rates been used in generating exchange differences and translating from
functional to presentation currencies?
 Have exchange differences on settlement of monetary items been correctly calculated and classified
within the income statement?

 Have exchange differences on foreign currency monetary items in the statement of financial position at
year-end been correctly calculated and allocated within the income statement (or other comprehensive
income if the asset/liability is a designated hedge)?
 Have exchange differences on non-monetary foreign currency assets/liabilities carried at fair value at
year-end been correctly calculated and allocated within other comprehensive income?
 Have appropriate exchange rates been used?
IAS 23: Borrowing costs

 Have borrowing costs been recognised as an expense in the period in which they are incurred?
 If borrowing costs have been capitalised, are they directly attributable to the acquisition, construction
or production of a qualifying asset?
 Have appropriate disclosures been made of the accounting policy, the amount of capitalised borrowing
costs in the period and the capitalisation rate used to determine the amount of borrowing costs eligible
for capitalisation?
IAS 24: Related party disclosures

 Have necessary disclosures been made to draw attention to possibility that the company’s financial
AT A GLANCE
position or profit/loss has been affected by related parties and transactions?
IAS 29: Financial reporting in hyperinflationary economies

 Does the entities’ functional currency satisfy IAS 29’s definition of hyperinflationary?
 Have the financial statements been correctly restated into ‘measuring units’ at the reporting date
including non-monetary assets/liabilities and income/expense items?
 Has the gain or loss on monetary items been calculated accurately and classified appropriately within
the income statement?
 For group audits does parent company retain a sufficient level of control (for a subsidiary) or significant
influence (for an associate) to satisfy the accounting treatment applied?
 Does the hyperinflationary entity remain a going concern?
SPOTLIGHT
IAS 32: Financial instruments: Presentation and IFRS 7: Disclosures

 Have financial instruments (liabilities) been properly classified as debt or equity based on their
substance?
 Have compound instruments been properly analysed into their debt and equity elements?
 Have payments to the providers of capital been correctly classified as borrowing cost or dividend in
accordance with the classification of the instrument to which they relate?
 Have appropriate disclosures been made of risk exposures, risk management and hedging policies?
IAS 33: Earnings per share

 Have the basic earnings per share been correctly calculated and disclosed for the current and prior
reporting period?
 Has diluted earnings per share been properly calculated and disclosed where relevant?
IAS 34: Interim financial reporting

 Have the interim financial reports been prepared in accordance with local requirements as well as IAS
34?
 Do the contents comply with the minimum requirements of IAS 34?
 Are appropriate disclosures included in notes to the interim statements?

IAS 36: Impairment of assets

 Have directors identified events that may indicate that impairment review is necessary?
 Have recoverable amounts been calculated in accordance with IAS 36?
 Where appropriate, have cash-generating units been identified?
 If an impairment loss has been recognised, has the loss been allocated to assets and recorded correctly?
IAS 37: Provisions, contingent liabilities and contingent assets

 Have all necessary provisions been recorded?
 Have contingent liabilities/ contingent assets been disclosed as required by IAS 37?
IAS 38: Intangible assets

 Have purchased intangible assets been recognised and measured in accordance with IAS 38?
 Have the useful lives of intangible assets been estimated in a reasonable way?
 Is there evidence to support the non-depreciation of intangibles with an indefinite useful life?
 Have intangible assets been subject to annual impairment reviews?
AT A GLANCE
IAS 39: Financial instruments: recognition and measurement
 Have financial instruments been recognised and measured in accordance with IAS 39?
IAS 40: Investment property

 Has the company adopted the cost model or the fair value model?
 If the cost model has been adopted, have the principles of IAS 16 been complied with?
 If the fair value model has been adopted, have annual valuations been performed and the gain or loss
correctly accounted for?
IAS 41: Agriculture
SPOTLIGHT
 Have changes in fair value less point-of-sale costs in respect of biological assets been - included in the
income statement in the period in which they arose?
 Have government grants relating to biological assets been recognised only when they become receivable
and measured as fair value less estimated point-of-sale costs?
IFRS 1: First-time adoption of International Financial Reporting Standards

 Has the company followed the specific guidance in Pakistan issued in respect of the IFRS 1 guidance on
exemptions and exceptions from full retrospective restatement on first time adoption?
 Has the company adopted a set of accounting policies that are appropriate and in compliance with IFRSs?
 Have all assets and liabilities recognised under IFRS been properly recognised and classified?
 Have all assets and liabilities not recognised under IFRS been removed from the financial statements?
IFRS 2: Share-based payments

 Is the calculation of share-based payments correct? (Check the number of employees granted share
options and the number of options per employee; the official date for the grant of the options; the length
of the vesting period; the required performance conditions attached to the options.)
 Has the cost of the share-based payments been spread fairly over the vesting period?
 Are the assumptions used to predict the level of staff turnover reasonable, based on available evidence?
(If not, what assumptions would be reasonable?) The assumption about staff turnover affects the
estimated cost of the share-based payments.

 Is the estimate of the fair value of the equity instrument reasonable, and is it consistent with any
valuation provided by an external expert (such as a chartered financial analyst)?
IFRS 3: Business combinations

 Does the “event” meet the definition of a “business combination” such that IFRS 3 applies, or is the
“event” an acquisition of an asset/group of assets that does not constitute a business?
 The date from which the acquisition took place – when did the acquirer effectively obtain control?
 Fair value of any pre-held equity interest in the event of a “step acquisition”, when the acquiree is not an
entity that is traded in a public market.
 Whether all contingent consideration has been identified and fair-valued at acquisition date?
 Whether contingent arrangements that “crystallize” during a reporting period are “measurement period
adjustments” and therefore back-dated against goodwill?
IFRS 4: Insurance contracts

 Do the financial statements present fairly the substance of the insurance contract?
 Is the insurer exposed to both financial and insurance risk and hence satisfy the definition of an
insurance contract?
AT A GLANCE
 Has the liability adequacy test been appropriately performed?

 Has the required impairment test been applied for any reinsurance?
 Do the financial statements show insurance liabilities and reinsurance assets separately (gross) or have
they been netted-off (and hence require restatement)?
 Have bundled contracts been unbundled correctly into the insurance and deposit components?
IFRS 5: Non-current assets held for sale and discontinued operations

 Has the definition of discontinued operations in IFRS 5 been properly applied?
 Have the results of discontinued operations been properly quantified and disclosed?
 Has the definition of assets held for sale contained in IFRS 5 been properly applied?
SPOTLIGHT
 Have assets held for sale been properly valued and disclosed?
IFRS 6: Exploration for evaluation of mineral resources

 Where a company has recognised assets as a result of exploration and evaluation expenditures, and facts
and circumstances suggest that the carrying value may exceed the recoverable amount, has an
impairment test of those assets been carried out?
 Has any impairment loss been measured, presented and disclosed in accordance with IAS 36?
 Has the entity disclosed information that identifies and explains the amounts recognised in its financial
statements arising from the exploration for and evaluation of mineral resources?
IFRS 7: Financial instruments: disclosures

 Has the entity appropriately identified “classes” of financial instrument by reference to the type of
instruments and type of information that is relevant, and then reconciled the totals to the category line
items required by IAS 39?
 Whether any “risk disclosures” if made in a separate document, have been included in the scope of the
audit, and suitably cross-referred to the financial statements?
 Whether the sensitivity disclosures of changes in the variables that are part of market-price risk have
been correctly calculated and disclosed?

IFRS 8: Operating segments

 Have the criteria for reportable segments been properly applied?
 Has all the required information been disclosed?
IFRS 9: Financial instruments

 Have financial instruments been recognised and measured in accordance with IFRS 9?
IFRS 10: Consolidated financial statements

 Whether or not control exists?
 Whether there is adequate disclosure of the judgements entered into in determining the type of
relationship with another entity.
 Whether the criteria for treating the parent as an investment entity have been met?
 Whether transactions involving an increase or decrease in a controlling shareholding that do not change
the relationship have been correctly recorded in equity, and not through goodwill or as a profit on
disposal?
AT A GLANCE
IFRS 11: Joint arrangements
 Whether or not joint control as defined in IFRS 11 exists?
 The type of the joint arrangement (joint operations or joint venture) has been correctly identified,
especially when structured through a separate vehicle?
IFRS 12: Disclosure of interests in other entities

 Whether the additional requirements concerning “structured entities” have been correctly interpreted,
especially in the context of financial institutions?
IFRS 13: Fair value measurement

 The correct identification of a principal market, or in its absence, the most advantageous market.
SPOTLIGHT
 Identifying whether or not an observed transaction is “orderly”, and therefore provides relevant
evidence.
 Identifying the “highest and best use” for non-financial assets.
IFRS 14: Regulatory deferral accounts

 Whether or not an entity has activities that put it in scope of IFRS 14, and therefore which enable it to
carry “regulatory deferral balances” that otherwise do not meet the definitions of assets and liabilities
under the IASB Conceptual Framework?
IFRS 15: Revenue from contracts with customers

 Whether or not a contract with a customer exists?
 Whether modifications to an existing contract require to be treated as an entirely new contract, or as an
amendment to an existing contract and possible “catch-up” adjustments?
 What are the performance obligations in the contract, and are there “distinct” goods or services?
 Whether a contract includes a significant financing effect, requiring the use of discounting?
 Whether or not a contract is performed “at an instant” or “over a period of time”?


You are the audit manager responsible for the audit of Kamran Limited (KL) for the year ended
31 May 2021. On 1 October 2020, KL raised Rs. 400 million by issuing convertible bonds (having
par value of Rs. 100 each). The bonds are convertible to KL’s ordinary shares in 5 years' time at
the option of bond holders. The convertible bonds carry coupon rate of 5% payable on 30
September each year.
KL’s total shareholders’ equity as at 31 May 2021 was Rs. 3,250 million.
Required:
Specify the matters to be considered by the auditor while planning the audit of convertible bonds.
Also suggest the related audit procedures.
 Solution:
Planning:
The auditor will consider the following matter while planning the convertible bonds:
 Understand the accounting, disclosure and regulatory requirements for convertible debt
instruments.
 Determine whether the audit team has relevant knowledge and resources for the audit
of convertible debt instrument and should appoint audit team members having the
AT A GLANCE
required skills and knowledge.

 Understand and evaluate the management system of internal control and its process for
recording and disclosing the convertible bonds.
Audit procedures:
i. Obtain the convertible bond instrument from management to confirm the terms of the
bond issue.
ii. Obtain the working of the future cash flows of the bonds (interest and principle)
prepared by management and review working to authenticate it with terms of bonds.
iii. Compare the discount rate used by the management with the similar debt instrument
in the market without the conversion option.
iv. Verify the total proceeds of the bond from the bank statement.
SPOTLIGHT
v. Verify that interest is charged to the income statement based on the effective interest
rate.
vi. Check management has correctly recognised the equity and liability component of the
convertible bond in the financial statements using residual approach method.
vii. Check that the company has complied with all the regulatory compliances for the
issuance of the bond.
viii. Ensure that all disclosures as required by IFRS-9 has been made in the financial
statements.
You are the audit manager responsible for the audit of Kekra Pakistan Limited (KPL). KPL has
various production facilities across the country. Your audit team has brought the following
matters to your notice which require your guidance:
(i) KPL is required to decommission its production facilities and restore the site at the end of
their economic life. Notes to the financial statements for the year ended 30 September 2020
contain the following disclosures related to decommissioning provision:
Rs. in million
Balance at the beginning of the year 7,126
Provision made during the year 371
Reversal due to changes in estimates (1,471)
Unwinding of discount 720
Balance at the end of the year 6,746

(ii) As a result of decrease in demand, the management adjusted its medium-term and long-term
price assumptions and discount rates, which had a significant impact on asset valuation. At
30 September 2020, KPL recognized an impairment of Rs. 2,184 million against the carrying
value of cash generating unit.
Required:
Brief the audit team regarding the significance of the above matters and the audit procedures to
be performed in this respect.
Tutorial Notes:
 Commenting on the significance of the matters is a must requirement of this question.
 Cash generating unit aspect of the question and the related audit procedures should also
be given due consideration.
 Solution:
Decommissioning provision:
Measurement of the decommissioning provision of the production facilities is inherently
subjective and complex, as it involves estimations of the expected decommissioning cost, the
AT A GLANCE
estimated life of the production facilities, and the application of an appropriate discount factor
to calculate the present value of the expected costs.
From the movement of the provision it is apparent that KPL has started some new production
facilities in the current year. It also needs to be investigated that what led the management to
reverse the provision in the current year because normally the value of the provision increases
over time, as the provision is unwound each year to increase its present value.
Audit Procedures:
 Review agreements issued by authorities pertaining to KPL operation of its production
facilities requiring it to decommission and restoration of the affected site.
 Obtain and review the management’s assumptions and calculations used to measure the
provision.
SPOTLIGHT
 Confirm that the calculation is based on assumptions in line with our understanding of
the entity, and which are consistent with other audit evidence obtained.
 Review documentation used to support management’s assumptions such as the
estimated cost of decommissioned and live of the assets to be decommissioned.
 Conduct meeting with the management, including technical and operational personnel
to obtain detailed understanding of the key assumptions used.
 Discuss with the management as to why there has been, a change from the prior year in
the methods for making the estimates or assumptions used in the measurement of the
provision.
 Ensure that the reduction in the decommissioning provision is deducted from the cost
of the related asset in the current period.
 Obtain the source data used by the management for its working and consider its
adequacy.
 Assess the controls in place over the estimate of the provision to ensure that the
circumstances giving rise to the provision, and the assumptions used in calculations are
periodically reviewed.
 Evaluate the competency and objectivity of experts who estimated the decommissioning
liability and the restoration cost by considering their professional qualifications and
experience;

 Involve auditor’s expert to assess the reasonableness of estimates by KL in its closure

and rehabilitation provisions.
 Obtain a written representation from management indicating that management
consider that significant assumptions used in making the accounting estimate are
reasonable.
 Review the notes to the draft financial statements to confirm sufficiency of narrative and
numerical disclosures provided in compliance with IAS 37 and IAS 1.
Impairment of CGU:
Identification of cash generating unit and their carrying amount requires significant judgement.
It needs to be considered that how management monitors the entity’s operations, product lines,
and how management makes decisions about continuing or disposing of the entity’s assets or
operations.
Apart from the identification of CGU’s it also needs to be considered that how future cash flows,
or the fair value less cost to sell for the Cash Generating Unit (‘CGU’), which is used to assess the
recoverable value of property, plant and equipment and intangible assets is determined.
 Assess the appropriateness of the KPL’s identification of CGUs for alignment with our
knowledge of the business and its internal reporting structure;
AT A GLANCE
 Evaluate the forecast prices incorporated into the Group’s impairment testing by
comparing inputs to available market data and externally available benchmarks;
 Obtain the source data used by the management for its working and consider its
adequacy.
 Agree the management working to the latest approved plans and budgets and assessed
the historical accuracy of the plans and budgets;
 Evaluate the competency and objectivity of experts who produced the reserve
statements utilized within the models by considering their professional qualifications
and experience;
 Work with our valuation specialists to compare key assumptions such as commodity
prices, discount rates, inflation rates, country risk rates and foreign exchange rates to
SPOTLIGHT
external market data, and performed sensitivity analysis using a range of these
assumptions.
Rehmat Pakistan Limited (RPL) has share based payment plan for its employees. RPL’s
employees receive share options subject to certain vesting conditions. Discuss the key controls
that RPL is expected to employ while carrying out the valuation of share options.
Tutorial Notes:
It is important to note that the question requires the key controls for valuation of the share options
rather than controls for share-based payment or substantive procedures for share based payments.
 Solution:
(i) Source data is reviewed to ensure its completeness, relevance and accuracy for the fair
value of share option.
(ii) Before appointment of an expert his competence, capabilities and objectivity is evaluated.
(iii) Performance of expert that are relied on for the determination of fair value is regularly
monitored.
(iv) There is due diligence in the selection or development of a particular model for the fair
valuation.

(v) The model used for the valuation of the share option is periodically tested for its integrity.
(vi) The valuation including the assumptions or inputs used in their development are reviewed
and approved at an appropriate level or when required by those charged with governance.
(vii) Comparisons are made between the estimate and the actual results and necessary changes
are made.
(viii) Accurate and timely information is available to those who need it in making determinations
regarding fair value issues (e.g., information regarding changes in market conditions, new
laws, regulations, and accounting standards with fair value accounting implications etc.).
(ix) Proper supporting documentation is available for all accounting entries, especially all
journal entries involving adjustments to fair value accounts.
Accounting system provides for the proper collection and reporting of information needed to
comply with fair value accounting standards, including all information necessary for disclosure
in the notes to the financial statements.
HT Ragib and Company, Chartered Accountants (HTRC) is a member firm of an international firm
of chartered accountants, HT Network. HTRC has offices in Karachi, Lahore and Islamabad.
AT A GLANCE
You are the audit manager at Karachi office of HTRC. You are responsible for the audit of Health
Pharma Limited and its group financial statements for the year ended 30 November
2019. The extracts of the draft planning memorandum for the group audit prepared by the audit
senior are as follows:
Name of Revenue Profit/(loss) Total Materiality Remarks

company before tax Assets
------------------ Rs. in million ------------------
Health Group 70,127 4,764 58,304 286
(Consolidated)
Health Pharma 38,487 5,850 36,563 322 Refer note 1
SPOTLIGHT
Limited (HPL)
Fair Cosmetics 24,773 (2,371) 24,484 129 Refer note 2
Limited (FCL)
Services (Private) 273 (47) 155 2 Refer note 3
Limited (SPL)
Quality Chemicals - - - - Refer note 4
Limited (QCL)
Note 1: HPL is the holding company and owns 100% shareholdings in FCL and SPL.
Note 2: FCL is audited by HTRC’s Lahore office. Since FCL is being audited by HTRC’s Lahore
office, no further procedures have been planned for obtaining the understanding of the
component auditor.
Note 3: SPL was incorporated in 2014 in United Arab Emirates (UAE) and is being audited by a
member firm of HT Network in UAE. Since SPL operates in foreign jurisdiction, detailed
audit procedures have been planned and confirmation will be sent to assess the
component auditor’s ethics, competence and the regulatory environment.
Note 4: HPL has disposed-off its entire shareholdings in QCL, a wholly owned subsidiary on 30
June 2019 at a gain of Rs. 450 million. QCL is being audited by HTRC’s Islamabad office.
Since QCL is no more part of the group as at 30 November 2019, no procedures have
been planned at the group level.

Required:
Suggest five key audit procedures to verify the disposal of the subsidiary.
Tutorial Notes:
Following point may be missed inadvertently while answering:
 Obtaining the financial position of the subsidiary to confirm value of assets and
liabilities, which had been derecognized from the group.
 Reasonableness of the amount of profit consolidated from the beginning of the year to
the date of disposal.
 Ensuring whether all legal compliance have been made for the disposal.
 Solution:
i. Obtain the statement of financial position of the subsidiary to confirm the value of
assets and liabilities which have been derecognized from the group.
ii. Obtain legal documentation/sale agreement in relation to the disposal to confirm the
date of the disposal and confirm that the subsidiary’s profit has been consolidated up
to this date only.
AT A GLANCE
iii. Perform substantive analytical procedures to gain assurance that the amount of profit
consolidated from the beginning of the year to the date of disposal appears reasonable
and in line with expectations based on prior year profit.
iv. Review the group financial statements to ensure that disposal of the subsidiary has
been correctly recorded and the required disclosures as per the IFRS are made.
v. Review relevant board minutes for approval of disposal.
vi. Ensure that all legal compliances have been made for the disposal of the subsidiary.
Chester Limited (CL) has introduced an equity settled share based payment plan for its
executives on 1 April 2017. Under the plan, 50 of its executives have received 100 share options
each, which will vest on 31 May 2022 if the executives remain in employment at that date and
SPOTLIGHT
CL’s share price increases to Rs. 180 at 31 May 2022.

Required:
Mention the key audit procedures for share based payment options described above, assuming
that evaluation of the competency and integrity of the management expert has already been
tested.
Tutorial Notes:
Knowledge of IFRS-2 is a must before attempting to solve this question.
 Solution:
i. Verify the following information to be used in the calculation of the amount of expense
from Board Minutes and other records of the company:
 The grant date and vesting date
 The number of executives to whom options are awarded
 The number of share options awarded to each individual
 The required conditions attached to the options
 The number of executives who have accepted share based payment options
ii. Agree the fair value of share options with valuer’s report and evaluate whether it is a
reliable source of evidence.

iii. Test the operating effectiveness of the controls over how management made the
accounting estimate.
iv. The relevance and reasonableness of management expert findings or conclusion and
their consistency with other audit evidence and whether they have been appropriately
reflected in the financial statement.
v. If management expert work involves significant use of source data, the relevance,
completeness and accuracy of source data.
vi. Obtain and review the forecast of staffing levels or employee turnover rates relevant to
executives over the vesting period and consider whether assumptions used for the
forecast appear reasonable.
vii. Ensure that share based payment options have been accounted for and disclosed as per
IFRS - 2.
viii. Consider the use of auditor’s expert.
You are the audit manager in GMP Chartered Accountants. The following matters are under your
consideration for the year ended 30 September 2017:
i. Kamran Limited (KL) is in the business of manufacturing generators. On 1 October
AT A GLANCE
2016, KL acquired 750,000 ordinary shares of HL (which supplies generator
components to KL), constituting 75% of the issued, subscribed and paid-up capital
against a gross consideration of Rs. 700 million. KL paid Rs. 500 million on the date of
acquisition whereas Rs. 200 million was paid on 1 October 2017.
At the acquisition date, the identifiable net assets were recognized at their carrying
amount which was approximately equal to the fair value of Rs. 670 million, except the
building and leasehold land whose fair value was assessed at Rs. 130 million above
their carrying amount. The fair value of NCI at the date of acquisition was assessed at
Rs. 155 million.
KL recognised goodwill amounting to Rs. 45 million on acquisition of HL, under the full
goodwill method.
SPOTLIGHT
ii. Waris Limited has changed its accounting policy for property, plant and equipment
from historical cost to revaluation model.
Required:
Guide your audit team on key audit procedures with regard to the above information.
(Audit procedures related to verification of property, plant and equipment are not required)
Tutorial Notes:
This question can be proved to be hardest in this area if the relevant understanding is not up to
the mark.
i. Three issues should be properly addressed i.e. measurement of goodwill, impairment
of goodwill and inter-company transactions.
Some probable common mistakes can be as follows:
 Verification of discount rate used to discount the purchase consideration received
after one year of the acquisition and ignoring the methods / assumptions used to
determine the fair value of the assets and liabilities.
 Only mentioned that impairment of goodwill should be tested without telling
further steps.
 For inter-company transactions, reversal of profit on intercompany stocks may be
missed.

ii. Correct treatment as per IAS-8 is a pre-requisite of this part.

 Solution:
(i) Kamran Limited:
Measurement of goodwill on acquisition
 Agree the purchase consideration to the legal documentation pertaining to the
acquisition and review the documents to ensure that the figures included in the
goodwill calculation are complete.
 Review due diligence report relevant to the acquisition, for confirmation of acquired
assets and liabilities and their fair values.
 Verify and assess the reasonableness of the discount rate used for discounting the
purchase consideration received on 1 October 2017.
 Evaluate the methods / assumptions used to determine the fair value of acquired
assets, including the property and liabilities, to confirm compliance with IFRS 3 and
IFRS 13.
 Review of board minutes for discussions relating to the acquisition and for the
AT A GLANCE
relevant minutes of board approval.

 Verify and assess the reasonableness of the fair value of NCI.
Impairment of goodwill:
 Discussion with management regarding potential impairment of Group assets and
confirmation as to whether an impairment review has been performed.
 A copy of any impairment review performed by management, with scrutiny of the
assumptions used, and re performance of calculations.
 Assess the reliability of cash flow forecasts through a review of actual past
performance and comparison to previous forecast
SPOTLIGHT
 Involve our valuation specialist for evaluating the appropriateness of the fair value of
the building, leasehold land and also for the impairment testing of goodwill.
Intercompany transactions:
 Ensure the elimination of intercompany balances.
 Ensure that profit included in inventory purchased from HL has been reversed.
 Ensure that appropriate adjustments have been made for consistent application of
accounting policies across the group as required by IFRS 3.
(ii) Waris Limited:
 We need to assess, why the accounting policy was changed and the impact of the
change on the financial statements. We should also consider whether the change in
accounting policy is free from bias.
 Evaluate whether the change in accounting policy has been properly accounted for
and adequately presented and disclosed.
 The change of policy will be required to be reported to those charged with governance
and change in policy would also require board approval.
 The opinion paragraph of our report will be altered to mention the fact about change
in accounting policy and whether we concur with it or not.


You are the audit manager responsible for the audit of Mechanic Engineering Limited, (MEL)
which provides mechanical parts to different industries. The draft financial statements for the
year ended 30 September 2016 show profit before taxation of Rs. 150 million (2015: Rs. 200
million) and total assets of Rs. 1.2 billion (2015: Rs. 1.1 billion).
Presently following matters are under your consideration:
MEL has recognized a late payment surcharge of Rs. 2.5 billion on amount due from Government
agencies. Last year, the audit report was qualified with respect to the recognition of late payment
surcharge. The management has informed you that the Government authorities have conveyed
their willingness to pay Rs. 2 billion instead of Rs. 2.5 billion and has provided you a written
representation with respect to the said amount. MEL however wants to preclude you from
sending a confirmation to the relevant agency.
Required:
Evaluate the above situations and determine the course of action in respect of each of the above
independent situations. (Reporting implications are not required)
Tutorial Notes:
AT A GLANCE
A discussion for written representation as a reliable audit evidence should be done. Significance
of the amount and communication with those charged with governance are some other
important considerations while answering this question.
 Solution:
 Amount of Rs. 2.5 billion is approximately 16.67 times of profit before tax and is
therefore material.
 Status of Rs. 500 million outstanding since last year, whether the company is still
negotiating with the government or has decided to write off the same.
 Evidence available in respect of Rs. 2 billion (agreement or any correspondence)
SPOTLIGHT
 The written representation provided by management is not an alternative to other audit
evidence in the absence of any written agreement or correspondence and cannot in itself
taken as a reliable audit evidence, when in this case the audit report was also qualified
with respect to this matter.
 Evaluate the implications of management’s refusal on the auditor’s assessment of the
relevant risks of material misstatement, including the risk of fraud, and on the nature,
timing and extent of other audit procedures; and
Course of action:
 Inquire management of reasons of refusal and seek audit evidence as to their validity
and reasonableness.
 Perform alternative audit procedures to obtain relevant and reliable audit evidence.
 Check subsequent clearance from post year end bank statements to verify if Rs. 2 billion
has been received.
 Communicate with those charged with governance. If:
¯ the auditor concludes that management’s refusal to allow the auditor to send a
confirmation request is unreasonable; or
¯ the auditor is unable to obtain relevant and reliable audit evidence from alternative
audit procedures,
¯


You are the audit manager of Bolan Pharmaceuticals Limited (BPL) a listed company. For the
year ended 30 September 2016, BPL has prepared its financial statements which indicate a net
operating loss, current ratio of 0.79 and significant amount appearing as capital work in progress
comprising of expenses incurred on acquisition and installation of plant and machinery. The
following information is also available:
i. The operations of BPL are currently suspended due to Balancing, Modernization and
Replacement (BMR) work.
ii. The decision to carry out BMR was approved by the Board of Directors in 2015 with a
completion deadline of 31 March 2016.
iii. Due to certain technical issues, BPL has not been able to complete the project to date.
iv. Because of the above situation, loan from a bank became overdue on 1 September 2016.
Further, BPL had also not complied with certain key covenants.
v. In this difficult situation BPL has requested its major shareholders to inject additional
equity.
Required:
Besides the issue of going concern, state the other key matters that the auditor should consider
AT A GLANCE
with respect to the above situation.

Tutorial Notes:
Key aspects should not be confused with Key Audit Matters.
 Solution:
Besides the going concern issue, the auditor should also consider the following matters with
respect to the given situation:
 As the loan covenants have been breached by the Company, the fact should be disclosed
 Proper understanding of the loan agreements need to be obtained.
 The correspondence with the banks should also be obtained / examined and the
SPOTLIGHT
potential contingency arising as a result of any case filed by the bank, if any be disclosed
 The classification of liabilities either “current” or “long term” should also be assessed in
the light of the loan agreements.
 The proper accrual of markup, penalties and any related charges due to nonpayment on
a timely basis should be properly accounted for in the financial statements.
 Appropriate accrual of redundancy payments and salaries with respect to leavers should
be reflected in financial statements.
 Proper adjustments in the financial statements to be ensured in respect of Impairment
of existing plant and machinery as well as Capital work in progress.
 Treatment and bifurcation of revenue and capital nature expenditures incurred on BMR.
 Impact of subsequent events on the financial statements of BPL.
You are the engagement manager of National Pharmaceuticals Limited (NPL). The company’s
intangible assets include patents amounting to Rs. 100 million belonging to the company’s Health
Care Division.
It is the company’s policy to value the intangible assets at cost less accumulated impairment. NPL
has recorded an impairment loss on the basis of impairment review which contains certain
projections regarding future profits.

Required:
List the procedures which you would perform to verify the working prepared by the
management.
Tutorial Notes:
Focus should be on substantive procedures rather than control review and testing. While talking
about assessing the reasonableness of the assumptions it is good to mention how and from what
perspective this aspect has to be reviewed.
 Solution:
Procedure for verification of working of impairment review:
 Interview management to evaluate whether or not the assumptions on which the value
measurements are based, are reasonable and consistent with:
¯ the general economic environment, the economic environment of the specific
industry, existing market information and the entity’s economic circumstances;
¯ assumptions made in prior periods; and
¯ the risk associated with cash flows, including the potential variability in the amount
AT A GLANCE
and timing of the cash flows and the related effect on the discount rate.
 Check whether the forecast have been approved at the appropriate level of management.
 Compare prior year forecasts with current year actual result and identify and assess the
variances.
 Check the cash flow projections with the most recent financial budgets/forecasts
approved by management.
 Check the projections covered the maximum period of five years as prescribed by IAS
36. If the period is greater than five years, understand how the entity has justified it.
 Ensure that projections do not include any cash flows arising from future restructuring.
 Evaluating the competence, capabilities and objectivity of personnel preparing the
SPOTLIGHT
projections.
 Check the appropriateness of discount rate used by the management
 Test the underlying data to confirm that it is accurate, complete, relevant and provides
objective support for the assumptions used in the valuation analysis.
 Consider involving internal expert to review the working.
 Check subsequent period performance as far as possible.
The following situations have arisen at different audit clients of your firm. The year-end in each
case is 30 September 2015.
40% of client’s operations are in a foreign country which has been impacted severely by political
and law and order situation since March 2015.
Required:
Evaluate the above situations and briefly explain the steps that the auditor would be required to
carry out in each of the above situations. (Impact on audit report is not required)
Tutorial Notes:
Considering the limited information that is available, there are two key issues that should be
addressed i.e. possibility of impairment of foreign operations or possibility of going concern
issue.

 Solution:
The steps that the auditor would need to carryout in the given situation are as follows:
 Check the impairment assessment of the foreign operations (cash generating unit)
carried out by the management and assesses the reasonableness thereof.
 Ensure that impairment (if any) has been appropriately recorded or disclosed in the
 Involve the subject matter expert in assessing the workings and assumptions of the
impairment, in case the auditor does not have the relevant expertise.
 In case the use of going concern assumption is no more appropriate, discuss the matter
with management for relevant disclosure and change in accounting treatment.
You are the audit incharge of Domestic Appliances Limited, a listed company, for the year ended
31 March 2015. The draft financial statements disclose profit before tax of Rs. 1.2 billion (2014:
Rs. 0.98 billion) and total assets of Rs. 15.5 billion (2014: Rs. 13.8 billion)
Company’s products are covered under warranty arrangements for twelve months. The company
has changed its policy for recording warranty expense from cash basis to accrual basis. The
AT A GLANCE
company has made provision for warranty claims equal to twelve times the actual warranty
claims of March 2015.
Required:
Analyse the above situation and discuss how you would deal with it in your audit.
Tutorial Notes:
Following points should not be missed:
 The policy during the previous year to recognize the warranty expense on cash basis
was not appropriate and hence a re-statement of last year’s figures was required.
 If the management’s basis of making the estimate was considered inappropriate, the
auditor should make a revised estimate, either on his own or by using an expert.
SPOTLIGHT
 Solution:
Warranty claims:
i. As the company has been historically recording its warranty claims on cash basis, a
restatement under IAS 8 is required, if material.
ii. The auditor should obtain an understanding of the entity’s assumptions on which the
estimate is based.
iii. If the basis is considered inappropriate, the auditor should make a revised estimate
either on his own or by using expert opinion. The revised estimate should be based on:
 Industry practice and trend of warranty claims
 company’s terms of warranties
iv. Own estimate prepared on the above assumptions will be compared with
management’s estimate. If the difference is material, the management will be asked to
explain.
v. Subsequent sales return upto the date of authorization will also provide an evidence
about the reasonableness or otherwise of the management’s estimate.


Your audit firm has been appointed as auditor of Lucrative Industries Limited (LIL) a listed
company for the year ended 31 March 2015. LIL’s financial statements for five years depict the
following:
2015
2014 2013 2012 2011
(draft)
--------------------------- Rupees in millions ---------------------------
Sales 1,570 1,276 1,064 980 859
Profit before tax 1,159 212 190 165 155
Profit after tax 815 130 135 106 110
Total assets 1,521 1,344 1,270 1,188 1,100
Following further information is available:
2015 2014
Rupees in millions
AT A GLANCE
Sales revenue-exports 1,057 944
Sales revenue- local supplies 513 332
Cost of sales and administrative expenses -1,299 -1,049
Gain on sale of office building 901 -
Other provisions / write offs -11 -13
Other charges -2 -2
Profit before taxation 1,159 212
Profit after taxation 815 130
SPOTLIGHT
Intangible assets 350 362
The results for the current year include the impact of following items:
i. During the year, an increase in export and local sales was noticed due to new agreement
with foreign customers and supplies made to Government for flood affected people.
Sales to new customers and Government amount to Rs. 105 million and Rs. 225 million
respectively. Mark-up on such sales was 15%.
ii. Administrative expenses include loss of raw material amounting to Rs. 210 million,
which was destroyed due to fire. Raw material was not insured.
iii. During the year, the head office of the company was shifted to new premises and the
old building was sold for Rs. 1.2 billion.
Required:
Enumerate audit procedures to be performed on opening balance of intangible assets.
Tutorial Notes:
Time should not be spent on writing general procedures relating to verification of opening
balances instead of identifying the specific procedures for verification of opening balance of
intangible assets.

 Solution:
Intangible Assets Procedures to consider when auditing intangible assets at the beginning of the
period include:
 obtain schedule of intangible assets summarizing the amounts of (and the nature of
changes in) the assets and related amortization for a reasonable period.
 determine the basis on which the additions to and reductions in intangible assets have
been recorded by tracing them to the underlying documents.
 identify major items and check them with related supports and verify the dates on which
these were recorded.
 Review the predecessor auditor’s working papers.
 check accumulated amortization to ensure that amortization has been provided over the
years as per company’s policy.
 check whether any impairment testing was performed last year, and if the answer is in
the affirmative, then check the basis/ assumptions and the calculations and evaluate the
competency and capacity of the valuer.
 review the write offs and impairment recorded in the current year to ensure that these
AT A GLANCE
do not reflect situation created in previous year.

The following situations have arisen at different audit clients of your firm. The year end in each
a) Galaxy Limited has a policy to carry its building at revalued amounts. In the financial
statements for the year ended 30 September 2014, the revalued amounts were stated
on the basis of valuation report issued by Buildings Valuation Experts (BVE).
However, during the audit it was accidentally discovered that prior to valuation by BVE,
another valuation exercise was carried out, which was done by Accurate Valuers
Enterprise.
b) The financial statements of Modern Technologies Limited, a company involved in
SPOTLIGHT
manufacturing of customized machinery and parts, reveal that the company has paid an
advisory fee of Rs. 100 million to a non-executive director according to an agreement
approved by the board of directors. The advisory services were rendered in connection
with an agreement with Burewala Tractors Limited, for supply of customized parts.
Total operating expenses amount to Rs. 282 million (2013: Rs. 161 million). The profit
before taxation is Rs. 350 million (2013: Loss before taxation of Rs. 120 million).
Required:
Discuss the matters which the auditor should consider and the steps that he may need to take, in
each of the above situations.
Tutorial Notes:
a) The requirement of this part should appropriately be construed by students. Further, in
such situations the auditor may be inclined to appoint his own expert.
b) A key point that might be skipped while answering is that if the advisory services lacked
substance then the auditor should issue a qualified opinion and if integrity of
management was doubtful then the auditor should withdraw or disclaim the report.

 Solution:
a) Galaxy Limited:
 The carrying out of two valuation exercise for buildings raises doubts as to the
valuation assertion of the buildings in the financial statements.
 The auditor should make an inquiry and evaluate the reasons provided by
management for engaging BVE as valuers, when the valuation was already carried
out by AVE.
 If the reasons provided by management are not satisfactory, then the auditor is
required to revise his risk assessment and accordingly amend the nature, timing and
extent of audit procedures.
 The auditor should consider the extent of difference between the two valuation
reports and assess the reason thereof.
 If the valuations of both the valuers are different then it also raises doubts as to the
competence, capability and objectivity of the valuers.
 The auditor may also consider the need of appointing an auditor expert.
 If auditor is not satisfied with differences in both reports, he shall ask the
management to justify the situation in consultation with BVE.
 If after considering the clients and BVE’s clarification’s and auditor expert, the
AT A GLANCE
auditor is of the view that financial statements are materially misstated then he will
ask the management to make appropriate adjustment in the financial statements.
 In case of management refusal, the auditor will issue a qualified or adverse opinion
 depending upon the materiality and pervasiveness of matter.
 In case the auditor concludes that management integrity is doubtful, then the
auditor will consider withdrawing from engagement or issuing a disclaimer of
opinion.
b) Modern Technologies Limited:
 Advisory fees are material to financial statements as it comprises of 35% of
operating expenses and 28% of profit before taxation.
 The auditor will consider the nature of advisory provided and necessity of such
SPOTLIGHT
advisory in execution of agreement with Burewala Tractors Limited (BTL).
 The auditor will assess the role that the agreement with BTL has played in the highly
improved performance of the company.
 The auditor will also review the agreement with the non-executive director and
assess its reasonableness.
 The auditor will need to assess whether the amount paid is appropriate considering
the nature and extent of business provided by the director and compare with market
value of such services provided by other professional experts.
 The auditor will also consider any relationship between the non-executive director,
MTL and BTL.
 The auditor will also consider the verification of approval and authorization and
mode of payment of such advisory fees.
 If the auditor is satisfied with the payment, he should ensure that it is appropriately
disclosed in accordance with IAS 24 and Companies Ordinance, 1984
 If after considering the above, the auditor is of the view that transaction of advisory
fee lacks substance and proper business consideration, and the auditor concludes
that the matter is material to financial statements, the auditor will issue a qualified
opinion.
 In case the auditor concludes that management integrity is doubtful, then the
auditor
 will consider withdrawing from engagement or issuing a disclaimer of opinion.


You are the audit manager responsible for audit of consolidated as well as separate accounts of
Five Star Limited (FSL) and its subsidiaries. In the initial meeting, the financial controller has
informed you that during the year:
a) the group has changed its policy for valuation of plant and machinery from cost to
revalued amount. The revaluation has been carried out by a global firm of professional
valuers, who have been advising FSL for the last several years.
b) One of FSL’s subsidiary has incurred substantial losses. Deferred tax has been
recognized on these losses. The financial projections prepared by the CFO show that as
a result of planned re-structuring, the subsidiary would be able to recoup the losses
during the next three years.
Required:
Describe the steps that you would take in each of the above situations.
Tutorial Notes:
a) Don’t restrict yourself to audit steps relating to the use of an expert only while ignoring
other important issues like accounting and disclosures.
AT A GLANCE
b) Don’t restrict yourself to accounting aspects of deferred tax while ignoring steps needed
to gather evidence that the recognition criteria for booking of deferred tax had been met.
 Solution:
i. Change in Accounting Policy
Steps needs to be taken by the auditor:
 Review change in accounting policy for biases and evaluate whether the
circumstances producing the bias, if any, represent a risk of material
misstatement due to fraud. Whether the change in accounting policy will result
in reliable and more relevant information about entity’s financial position, its
performance and cash flows.
SPOTLIGHT
 Whether requirements of IAS 16 in relation to change in accounting policy, has

been complied with.
 Evaluate the competence, capabilities and objectivity of the professional
valuers;
 Obtain an understanding of the work of that valuer; and
 Evaluate the appropriateness of that valuer’s work as audit evidence for the
relevant assertion
 Consider the need for appointment of an auditor’s expert.
 Ensure that all the assets in the entire class of plant and machinery has been
revalued.

Checking appropriateness of disclosures related to the requirements of
Companies Ordinance, 1984 and IAS 16.
ii. Deferred tax asset:
Steps needs to be taken by the auditor:
 Whether the recognition criteria for deferred tax asset as specified in IFRS has
been met.
 Whether the methods estimating the amount of deferred tax are appropriate
and have been applied consistently, and whether changes, if any, in accounting
estimates are appropriate in the circumstances.

 Determining whether events occurring up to the date of the auditor’s report

provide evidence regarding the deferred tax asset.
 Review the company’s restructuring plan (assumptions) to assess its
reasonableness and viability.
 Review the future projections provided by the client and their viability vis a vis
restructuring plan.
 Checking appropriateness of disclosures related to the requirements of IAS 12.
 Written representations from the management.
You are the audit manager of Ravi Pharmaceuticals Limited (RPL) for the year ended 30
September 2013. The draft financial statements disclose a profit before tax of Rs. 200 million
(2012: Rs. 150 million) and total assets of Rs. 5 billion (2012: Rs. 4.8 billion). The following
matters arose during the course of audit and are under your consideration:
a) RPL has been awarded a 20 year patent right for a new drug with a brand name of Dengcol.
The drug has been developed at a cost of Rs. 400 million.
b) As part of the Dengue Control Program, the Government had provided a conditional grant of
Rs. 150 million to RPL for development of Dengcol. Under the terms of the grant, RPL was
AT A GLANCE
required to sell 40% of the total production to the Government Hospitals subject to a
minimum of 1,000,000 vaccines per annum, for the next five years.
Required: Identify the matters that you should consider in the above situations, and state the
audit evidence you would expect to find in your review of the audit working papers for the year
ended 30 September 2013.
Tutorial Notes:
Following points can be overlooked inadvertently while answering:
 Possibility of impairment and how would the auditor satisfy himself in this regard.
 Company’s ability to meet the conditions associated with the grant.
 Verification of development costs.
SPOTLIGHT
 Management representations.
 Solution:
a) Matters to consider:
 Development cost is approximately 8% of total assets and 200% of profit before tax
and is therefore material.
 Whether the development costs incurred on Dengcol meet the capitalization criteria
as specified in IAS 38.
 Carrying value of the patent and possibility of impairment thereof.
Audit Evidence:
 Details of development costs to ensure that all the costs meet the criteria specified
in IAS 38 for capitalization as intangible asset.
 Assessment and conclusion whether all the costs are related to the development of
Dengcol.
 Supports/ vouching related to major payments
 Details of market research performed to ensure that the project is commercially
viable.
 Projections prepared by management, assessment of reasonableness of
assumptions, recalculation of projections, conclusion whether or not economic
benefits to be generated from the use of asset exceed the cost.

 Documents related to registration of patent.

 Written representations from management as to the commercial viability, technical
feasibility and adequacy of findings.
b) Matters to consider:
 The Government grant represents 75% of profit before tax and is therefore material
to the financial statements.
 Accounting treatment of the Government Grant.
 Company’s ability to meet the conditions associated with the grant.
Audit Evidence
 Receipt of the government grant of Rs. 150 million, to confirm that the amount has
been granted.
 Agreement with the government, to confirm that it is a grant.
 Assessment of whether the company is complying with or in a position to comply
with the terms and conditions contained in the agreement.
 Management representation confirming that it is in compliance and would be able
to comply with all the conditions attached to the Government Grant.
AT A GLANCE

You are the manager responsible for the audit of Dilawar Paints Limited (DPL). draft financial
statements for the year ended 31 March 2013 show revenue of Rs. 1,250 million (2012: Rs. 1,175
million), profit before taxation of Rs. 100 million and total assets of Rs. 1.2 billion.
The audit incharge has noted the following points for your consideration:
In May 2012 a chemical leakage from one of the tanks in the factory caused a fire which damaged
the plant and machinery and the premises. DPL has incurred Rs. 3 million in cleanup costs, Rs.
10 million for modernisation of tanks to prevent future leakages and a fine of Rs. 500,000 to a
regulatory agency. The fine has been expensed whereas the remaining costs have been
capitalized.
SPOTLIGHT
Required:
Discuss the matters that you would consider and how would you obtain the necessary audit
evidence.
Tutorial Notes:
Very few students might realize that the situation is warranting impairment testing. No need to
go too far and highlighting Going Concern issue whereas there are no such indications in the
question, particularly when the company had earned an after tax profit of Rs. 100 million.
 Solution:
Chemical leakage- Evaluation of the situation:
Matters to be considered
 Fine of Rs. 500,000 has been correctly expensed out but is immaterial.
 The cost of clean-up represents 0.25% of the total assets and 3% of the profit before tax
and is therefore not material. However, this expense does not improve the future
operating capacity of the property and hence it should not be capitalized. If management
does not agree to reverse the capitalized amount it will not affect the audit opinion,
however, this amount could be included in the aggregate of uncorrected misstatements.
 Rs. 10 million spent on modernizing the storage tanks represents a major overhaul of
the asset. It constitutes 10% of profit before tax and is therefore material to the financial
statements. The Company has rightly capitalized the said cost.

 The substantial cost of modernization of tanks when included in the present carrying
value, may result in carrying value being in excess of the recoverable amount. In this case
auditor would need to carryout impairment testing of the storage tanks and if said
testing concludes any impairment loss, the auditor would need to check whether such
losses have been recognized appropriately.
How audit evidence would be obtained
 The management would be asked as to whether any other fine has been levied by any
regulatory agency, due to this leakage; and the matter would be documented.
 Review legal confirmations obtained by you and see whether they contain any
information in this regard.
 Physical verification of storage tanks should be carried out.
 Major payments should be vouched.
 Obtain management representation that the matter is now closed and no further
proceeding are in progress against the company
Your firm has been appointed as the auditor of Jugnu Limited (JL), which is a manufacturer of
consumer products. The auditor’s report on the preceding year’s financial statements was
AT A GLANCE
unmodified. The draft financial statements for the year ended April 30, 2011 disclose a profit
before taxation of Rs.75 million (2010: Rs. 155 million) and total assets of Rs. 2,100 million
(2010: Rs. 1,910 million).
You are audit manager at JL following issues arose during audit and now require attention:
i. JL incurred an expenditure of Rs. 25 million on the development of five new products.
It is expected that these new products would generate future economic benefits.
ii. On July 1, 2008 JL had acquired four high-tech machines for Rs. 200 million which are
being depreciated over a period of 10 years on the straight line method. JL did not have
the expertise to operate the machines and had entered into an agreement with Umer
Limited to operate the machines. The contract is expiring on June 30, 2011 and Umer
Limited has shown its inability to continue after the expiry of the contract.
SPOTLIGHT
Required:
(b) For each of the above issues, comment on the matters that you should consider and state the
audit evidence that you expect to be available.
Tutorial Notes:
Don’t miss the following points while answering:
• Materiality of the amount of development expenditure
• Obtaining representation from the management on the intended use of the machines
 Solution:
i. Matters to be considered:
 Although IAS-38 allows the recognition of internally generated intangible assets,
the auditor should ensure that all the requirements of IAS-38 would be complied
with, while capitalizing the development expenditures.
 Assess the basis of management’s expectation to ensure that future economic
benefits will flow to the enterprise.
 Rs. 25 million, the proposed intangible asset is not material to the financial
statement, but if it were written off as an expense for the year it would have been
material to the income statement as it would have reduced profit by 33.33%.

Audit Evidence:
 A breakdown of amount of Rs. 25 million.
 An assessment of various elements of the cost to assess whether any part thereof
can be classified as expense (e.g. research).
 Supporting invoices and other documents related to the cost of asset.

Workings showing determination of the value in use, based on projections of
revenue from new products, to evaluate impairment, if any.
ii. Matters to be considered:
 The auditors need to discover what management’s future intentions for the assets
are. Whether they want to dispose of or want to continue to use.
 If management intends to dispose of the machine, then an impairment review
under IAS 36 must be carried out.
 If management intends to continue to use these machines, find out whether JL:
¯ would be able to find another service provider to operate these machines; or
¯ has developed internal expertise to operate the machines
If the answer to each of the above questions is in the negative, an impairment review
AT A GLANCE
may need to be carried out.

 The carrying amount of the machines as of April 30, 2011 is approximately Rs. 143
million. This represents 6.8% of total assets and is therefore material to the balance
sheet.
Audit Evidence:
 Documentation of the discussion with the management and written representation
as regards future use of the machines.
 Evidence supporting the test of impairment e.g. draft sales agreements, cash flow
projections relating to value in use, any contract relating to new uses of machines
in the company.
 Working showing computations related to impairment review (if required) as
SPOTLIGHT
discussed in preceding paragraphs.

You are planning the statutory audit of the financial statements of Mahiwal Limited (ML) for the
year ending June 30, 2011. ML sells and distributes networking equipment and accessories to
corporate and retail customers. Since January 1, 2009 ML has exclusive country-wide
distribution rights of ‘Bisco’ and ‘Portel’, which are the leading international brands of
networking equipment.
Your review of the prior year’s working papers has disclosed that ML has expanded its operations
significantly after securing the distribution rights of ‘Bisco’ and ‘Portel’. By June 30, 2010 there
had been a 60% increase in its customer base whereas the number of its branches had increased
from 3 to 10and the number of employees had risen from 30 to 115. The latest available draft
financial statements show that the sales of ‘Bisco’ and ‘Portel’ represent 90% of its total sales.
During a recent meeting with the finance director, you have been informed as follows:
i. ML has shifted its warehouse and customer service center to larger premises in order
to handle increased inventory level and the rising level of after sales warranty claims.
ii. ML has witnessed a slight fall in sales of ‘Bisco’ and ‘Portel’ because of tough
competition from other low priced brands.
A review of the draft financial statements has also disclosed that ML had revalued a property in
accordance with the requirements of the International Financial Reporting Standards. The
property was acquired many years ago to earn rental income.

Required:
Enumerate the key audit procedures to be conducted to assess the appropriateness of the
revaluation of property and the accounting treatment thereof.
 Solution:
Principal audit procedures – valuation of Investment property
i. To ensure the reliability of Valuation report by the Valuer:
 Assess the nature and complexity of the matter of valuation of the investment
property.
 Ensure the reliability of the information provided by the Expert from alternative
sources of information.
 Assess the nature, scope and objectives of the valuer’s work.
 Enquire whether the Management can exercise control or influence over the work
of the valuer.
 Enquire whether the valuer valuation work is subject to technical performance
standards or other professional or industry requirement.
AT A GLANCE
ii. To ensure the Competence, Capability and Objectivity of the valuer:
 Enquire the professional certification of the valuer
 Enquire whether he is a member of any professional body.
 Enquire whether any professional or legal standard are applicable to them
 What assumptions and methods are used by the expert and are they generally
accepted with that expert’s field and appropriate for financial reporting purposes.
 The nature of internal and external information that the expert uses.
 Enquire whether he has any experience in the valuation of investment property
and their recognition at fair value.
iii. To determine the objectivity of the valuer so that the independence of the valuation can
SPOTLIGHT
be judged:
 Enquire whether valuer is related to the entity. (e.g., close family member of the
director)
 Enquire whether the valuer has any financial interest in the ML (e.g., shareholder)
 Enquire whether the fee received by the valuer is reasonable and at market price?
iv. To ensure that revaluation has been properly accounted for in the books and the
 Ensure that revaluation has been done in accordance with the ML’s accounting
policy for recording the investment property.
 Ensure that the entire class of investment property should be revalued.
 Ensure that gain or loss arises due to revaluation should be recognized in profit or
loss for the year.
 Ensure appropriate disclosures have been in accordance with IAS-40
You are the manager in charge on the audit of Hexa Garments Limited (HGL). The company is
listed on the Karachi Stock Exchange and has nine directors. It is engaged in the manufacture and
sale of fancy garments through its own retail outlets. You are considering the following matters
in respect of the audit for the year ended December 31, 2009:

a) The diluted earnings per share of Rs. 36.60 has been calculated without taking into account
the share options held by three directors. To justify the above calculations, these directors
have confirmed in writing that they do not intend to exercise the share option. Had the share
options been considered, the diluted earnings per share would have been Rs. 35.60. The
review of subsequent events revealed that four of the remaining directors had exercised
their share options following the balance sheet date. The share options are available upto
December 31, 2010.
b) According to the draft financial statements the total assets of the company are valued at Rs.
375 million. These include value of ten retail outlets amounting to Rs. 175 million. The
valuation is based on historical cost less accumulated depreciation. During the year ended
December 31, 2009, the management had decided to revalue all the retail outlets. The valuer
appointed by the management has not been able to complete the assignment to date.
However, he has submitted two interim reports as described below:
Interim Report
First Second
Date of report 31/12/2009 20/02/2010
Number of shops revalued 3 4
AT A GLANCE
Book value as on 31/12/2009 (Rs. in million) 40 60

Revalued amount (Rs. in million) 70 100
c) During the year HGL has developed two new brands “Deebal” and “Kalachi” and has launched
an aggressive marketing campaign for their promotion. The company has recognised the
cost incurred on the campaign amounting to Rs. 10 million as an intangible asset. It is being
written off over the estimated useful life of the brands i.e. four years.
Required:
Discuss the matters that may be of significance to you as an auditor, in respect of the above issues.
Also explain their implications on the audit report.
SPOTLIGHT
 Solution:
a) Matters significant to the Auditor
i. According to IAS-33, for the purpose of calculating diluted earnings per share, an
entity shall assume the exercise of dilutive options of the entity. The IAS does not
allow any exception to this rule.
ii. Whether the share options given to the directors have been properly disclosed in
the financial statements.
iii. The exercise of share options after the close of year needs disclosure as a non-
adjusting event.
Implications on the audit report
i. If the directors do not agree to amend the diluted earnings per share, the audit
report should be modified in this respect on the ground of disagreement.
ii. If proper disclosure relating to exercise of share option has not been made, the audit
report should be modified due to non-disclosure of material information.
b) Matters significant to the Auditor
i. According to IAS-16 Property, Plant and equipment, if an item of property, plant and
equipment is revalued, the entire class of property, plant and equipment to which
that asset belongs shall be revalued.

ii. The increase due to revaluation of 7 of the 10 retail shops amounts to Rs. 70 million,
which represents 18.67% of total assets and is therefore material to the statement
of financial position. A disclosure will be required.
iii. The auditor should ask the management either to defer the revaluation to a period
when all information related to all the shops is available from the valuer or revalue
all the shops by requesting the valuer to submit his final report prior to audit
completion.
Implication on the Audit Report:
If the management refuses to disclose the information about the outcome of valuation
exercise, the audit report should be modified on the ground of disagreement with
qualified” opinion.
c) Matters significance to the Auditor
i. According to IAS-38, internally generated brands shall not be recognized as
intangible assets. Hence, capitalization of internally generated brands is a
contravention to the requirement of
ii. IAS-38. The intangible asset is material as it represents 2.7% of total assets.
AT A GLANCE
Red Sea Company Limited (RSCL) builds ships and constructs oil rigs for the offshore oil industry.
Under one of the contracts with Black Oil Company Limited, RSCL was required to construct a rig
for drilling oil, off the coast of Makran. The oil rig should have been completed by April 30, 2009
but on account of delays and technical problems, it is not expected to be completed until February
28, 2010. Consequently, Black Oil Company Limited has cancelled the contract and lodged a claim
for damages amounting to Rs. 150 million. This claim for damages was lodged by Black Oil
Company Limited on August 29, 2009 and it has been disclosed as a contingency, in RSCL’s
financial statements for year ended September 30, 2009.
Required:
Describe the work that the auditor should carry out in the above situation, to determine whether
SPOTLIGHT
the accounting treatment and related disclosures, if any, in the financial statements of Red Sea
Company Limited for the year ended September 30, 2009 are appropriate.
 Solution:
Suggested audit work:
 Examine the contract paying specific attention to the following:
¯ Clauses relating to delays or breaches of contract and consequential provision for
damages relating to the above.
¯ Under what circumstances a contract can be cancelled. Can it be cancelled only on
account of delay?
 Examine all correspondence relating to the alleged breach of contract. This would
include correspondence between Red Sea Company Limited and Black Oil Company
Limited and between their legal advisors.
 Obtain confirmation from Black Oil Company.
 Review subsequent events.
 With the permission of the client, approach the company’ solicitors and ask their opinion
on the likelihood of the success of the action and an estimate of the likely damages.
 Assuming that the amount involved is material enough, the auditor would also have to
consider obtaining legal advice from an independent source.

 Consider the impact of the situation on revenue recognition, based on the terms of the
contract.
 Evaluate the appropriateness of the assumptions used by the management in
determining the financial consequences of the claim and whether it includes all the
information that was relevant and existed at the time the estimate was made.
 Consider whether the management has appropriately disclosed the contingency with
respect to the nature and potential financial consequences in the respective notes to the
 If the contract with Black Oil Company Limited was material for the profitability and
sustainability of the Red Sea Company Limited consider whether there is a doubt as to
the Company’s ability to continue as a going concern, in such a case the auditor would
consider performing related audit procedures.
 Obtain specific representation from management regarding the existence, completeness
and disclosure of contingencies in the financial statements.
 If the matter is properly accounted for and disclosed, consider giving an emphasis of the
matter paragraph otherwise consider a qualified or an adverse opinion. The materiality
of the amount will have to be taken into account.
AT A GLANCE

Narrow Street Limited is an auto parts manufacturing company. The Company offers product
warranty to its customers. You are senior incharge on the audit of the Company for the financial
year ended December 31, 2008. While reviewing the draft balance sheet, you have noted that the
provision for product warranties has increased to Rs. 150 million as compared to Rs. 85 million
in the previous year. The Company’s profit after taxation as appearing in the draft profit and loss
account is Rs. 50 million. Considering the significance of this change, you have decided to carry
out a detailed test to verify the amount.
Required:
a) Describe the matters that should be discussed with the senior management while
carrying out the above verification.
b) State the audit procedures to be performed in order to conclude that product warranty
SPOTLIGHT
liabilities are fairly stated in the financial statements of the Company.

 Solution:
a) The following matters should be discussed with the management:
 Change in operating policies and procedures that would affect warranties;
 The types of warranty coverage offered by the Company; (General, special, extended
etc.);
 The factors that affect warranty coverage, such as volume purchased, type of
installation, change in warranty period, alterations to basic product, etc.;
 Any production problems or possible changes in operations that are resulting in
increased warranty costs. Also, consider if the problems are isolated or generic; and
 Any implicit/ implied warranty obligations that exist based on common industry
practice.
 Involvement of any expert.
 Procedures used to calculate estimated costs of warranty repairs;
 Whether there is change in sales volume from last year that affected the warranty
 Other reasons for major variations.
b) Audit Procedures
 Review contracts, sale agreements and/or sales catalogs to verify the terms and
provisions of warranty coverage;

 Review contract files, correspondence files, and/or production reports that may
indicate potential warranty problems;
 Test estimated costs to complete warranty repairs by:
¯ Reviewing current estimates of warranty repair cost and compare it with the
actual costs incurred after the balance sheet date;
¯ Comparison of estimate made for prior periods with actual results for those
periods.
¯ Compare current estimates of warranty repair cost for selected items with their
prior warranty actual cost
¯ Reviewing supports of estimated warranty repair cost by component (material,
labor and overhead).
¯ Consider the appropriateness of the Company’s model (cost estimation
method) and test the accuracy of its application to the relevant date;
¯ Develop an alternative model to test the reasonableness of the provision;
¯ Obtain direct confirmations from the customers;
¯ Review confirmations from legal advisors to identify major disputes with any of
the customers;
¯ Review a summary of items included in the provision for completeness and
AT A GLANCE
unusual items;
¯ Consider penalties and/or other costs associated with warranty or other
performance guarantees in determining the provision.
¯ For new products, determine whether the Company has developed a reasonable
basis for providing warranty costs;
¯ Review activity in the provision and the related expense accounts;
Trade Limited has been engaged in sales of product X for a long time. In January 2007, it started
trading of product Y which was sold with money-back guarantee being exercisable within 120
days of sale. Consequently, the sale of Y far exceeded the company’s expectation and eventually
constituted 40% of the total sales of the company in the year 2007. An extract from the Trading
SPOTLIGHT
Account of product Y for the year ended December 31, 2007 is as under:
Particulars Rs. (in Million)

Gross sales 650
Sales return and allowances 13
provision for sales return- Gross 18
cost of sales 400
On account of money-back guarantee a provision has been made, for sales return subsequent to
year end. The provision is three times the actual sales returns during the first 15 days of January
2008.
As the time available for presenting financial statements is limited, the management has decided
to adopt it as a consistent accounting policy to be followed each year.
The audit is to be finalized by February 15, 2008. The team member who was assigned to verify
the provisions believes that in such situation the auditor is compelled to rely on management’s
estimate. Therefore, a simple procedure of recalculation will be appropriate.
Required:
Explain the appropriate audit procedures to verify the provision for sales returns in the light of
relevant International Standard on Auditing.

 Solution:
Audit procedure to verify Provision for sales return:
 Apparently, the provision made by the company has no plausible basis.
 The actual returns during the year are Rs. 130 million as against the total sales of Rs. 650
million. If the sales and sales returns are made evenly throughout the year, a plain
application of return percentage suggests that the provision should be nearly Rs. 32.5
million.
 In the above circumstances the auditor should obtain an understanding of the entity’s
assumptions on which estimate is based.
 If the basis is considered inappropriate, the auditor should make a revised estimate
either on his own or by using expert opinion. The estimate should be based on:
¯ industry practice and trend of sales return;
¯ comparison of industry and company’s terms of sale;
¯ Trend of sales return in the company i.e. sales return with-in first 15 days; between
16 to 30 days; between 31 – 45 and so on.
 Own estimate prepared on the above assumptions will be compared with management’s
estimates. If the difference is material, the management will be asked to explain.
AT A GLANCE
 Subsequent sales return up to the date of authorization will also provide an evidence
about the reasonableness or otherwise of the management’s estimate.
SPOTLIGHT

CHAPTER 7
UNDERSTANDING THE ENTITY

AND THE RISK ASSESSMENT
AT A GLANCE
IN THIS CHAPTER:
ISA-315 deals with the auditor’s responsibility to identify and
AT A GLANCE assess the risks of material misstatement in the financial
statements, through understanding the entity and its
environment, including the entity’s internal control.
SPOTLIGHT
AT A GLANCE
The objective of the auditor is to identify and assess the risks of
1. Identifying and assessing the material misstatement, whether due to fraud or error, at the
risks of material financial statement and assertion levels, through understanding
misstatement through the entity and its environment, including the entity’s internal
understanding the entity and control, thereby providing a basis for designing and
its environment (ISA 315) implementing responses to the assessed risks of material
misstatement.
2. Understanding the entity
and its environment ISA-320 deals with the auditor’s responsibility to apply the
concept of materiality in planning and performing an audit of
3. Components of internal
control
The auditor’s determination of materiality is a matter of
4. Manual and automated
professional judgment and is affected by the auditor’s
SPOTLIGHT
elements of internal control
perception of the financial information needs of users of the
5. IT Risks & Controls financial statements.
6. Materiality in planning and ISA-450 deals with the auditor’s responsibility to evaluate the
performing an audit (ISA effect of identified misstatements on the audit and of
320) uncorrected misstatements, if any, on the financial statements.
It also explains how materiality is applied in evaluating the effect
7. Evaluation of misstatements
of identified misstatements on the audit and of uncorrected
identified during the audit
misstatements, if any, on the financial statements.
(ISA 450)
ISA-550 deals with the auditor’s responsibilities relating to
8. Related parties (ISA 550)
related party relationships and transactions in an audit of
9. Risk Assessment Questions financial statements. Specifically, it expands on how ISA 315
(Revised), ISA 330, and ISA 240 are to be applied in relation to
risks of material misstatement associated with related party
relationships and transactions.

CHAPTER 7: UNDERSTANDING THE ENTITY AND THE RISK ASSESSMENT CFAP 6: AARS
1. IDENTIFYING AND ASSESSING THE RISKS OF MATERIAL MISSTATEMENT

THROUGH UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT (ISA
315)
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.
Risk assessment procedures

 Inquiries from management, and others within entity.
 Analytical procedures.
(May help identify the existence of unusual transactions or events, and amounts, ratios, and trends)
 Observation.
 Inspection.
AT A GLANCE
Related activities
 Client Acceptance or Continuance Process
 Other engagements of same entity
 Information from previous audits
¯ Past misstatements and whether they were corrected timely
¯ Nature of entity and its environment and internal control
¯ Significant changes in entity’s operations
 Discussion among Engagement Team
¯ Provides opportunity for senior engagement team members to share their insights based on their
knowledge
SPOTLIGHT
¯ Allows team members to exchange information about business risks

¯ Assists team members to gain a better understanding of potential for material misstatement of F/s
in specific areas
¯ Helps to understand how the results of audit procedures that they perform may affect other aspects
of the audit
¯ Provides a basis upon which engagement team members communicate and share new information
obtained
1.2 Identifying and Assessing the Risks of Material Misstatement (Ref: 25-31, A122-A152)
1) Financial statement level

 Refer to risks that relate pervasively to the financial statements as a whole and potentially affect many
assertions
 Risks may also derive from a deficient control environment
 Understanding of internal control may raise doubts about auditability of entity's financial statements.
E.g.:
¯ Integrity of entity's management.
¯ Condition and reliability of an entity's records

CFAP 6: AARS CHAPTER 7: UNDERSTANDING THE ENTITY AND THE RISK ASSESSMENT
2) Assertion Level
Assertions Class of Account

(Description) Transaction Balance
Occurrence: Transactions and events that have been recorded or disclosed, 
have occurred and such transactions and events pertains to entity
Existence: Assets, liabilities, and equity interests exist 
Accuracy: Amounts and other data relating to recorded transactions and 
events have been recorded appropriately and related disclosures have been
appropriately measured & described.
Accuracy, Valuation & Allocation: Assets, liabilities, and equity interests 
are included in the financial statements at appropriate amounts
Completeness: Assets, liabilities, equity interests, transactions and events  
that should have been recorded have been recorded, and all related
disclosures have been included in the financial statements
Rights and Obligation: The entity holds or controls the rights to assets, and 
AT A GLANCE
liabilities are the obligations of the entity
Cut-Off: Transactions and events have been recorded in the correct 
accounting period
Classification: Assets, liabilities and equity interests have been recorded in 
the proper accounts
Presentation – Transactions, events, assets, liabilities and equity interest  
are appropriately aggregated or disaggregated and clearly described, and
related disclosures are relevant & understandable in context of
requirements of applicable financial reporting framework
Auditor shall:
SPOTLIGHT
 Identify risks throughout during obtaining understanding and by considering assertions
 Assess identified risks, and evaluate whether they relate more pervasively to financial statements as a
whole and affect many assertions
 Relate identified risks to what can go wrong at assertion level, taking account of relevant controls
 Consider likelihood of misstatement
Judgment about significance of a risk

 Whether the risk is a risk of fraud
 Whether risk is related to recent significant economic, accounting or other developments and,
therefore, requires specific attention
 Complexity of transactions
 Whether risk involves significant transactions with related parties
 Degree of subjectivity in measurement of financial information related to risk
 Whether risk involves significant transactions that are unusual or are outside the normal course of
business.

1.3 Identifying Significant Risks relating to non-routine transactions or judgmental matters (Ref: 28,
A140-A143)
Risks for non-routine transactions may arise from following:
 Greater management intervention to specify accounting treatment.
 Greater manual intervention for data collection and processing.
 Complex calculations or accounting principles.
 Nature of non-routine transactions, making it difficult for entity to implement effective controls over
the risks.
Risks may be greater for significant judgmental matters requiring development of accounting estimates, arising
from following matters:
 Principles for estimates or revenue recognition may be subject to differing interpretation.
 Required judgment may be subjective or complex, or require assumptions about the effects of future
events.
1.4 Understanding Controls Related to Significant Risks (Ref: 29, A145-A147)

AT A GLANCE
If auditor has determined that a significant risk exists, he shall obtain an understanding of the entity's controls.
Understanding also includes how management responds to risks.
Responses might include control activities, documented processes and approvals by those charged with
governance.
1.5 Revision of Risk Assessment (Ref: 31, A151)

Risk assessment at assertion level may change during the audit as additional audit evidence is obtained.
If audit evidence obtained from further audit procedures or new information is inconsistent with previous audit
evidence, auditor shall revise assessment and modify further audit procedures.
1.6 Limitations of Internal Control (Ref: A54-A56)

SPOTLIGHT
 Human judgment in decision-making can be faulty.

 Breakdowns can occur because of human error.
 Collusion of two or more people.
 Inappropriate management override of internal control.
 Management’s judgments on selection and application of controls.
1.7 Documentation (Ref: 32, A153-156)

 Discussion among engagement team and significant decisions;
 Key elements of understanding obtained;
¯ Sources of information
¯ Risk assessment procedures performed;
 Risks of material misstatement at financial statements level and assertion level;
 Risks identified, and related controls.

2. UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT (REF: 11, A25-A49)

2.1 Relevant industry, regulatory & other external factors including applicable financial reporting
framework.
 Industry Factors
¯ The market and competition, including demand, capacity and price competition
¯ Cyclical or seasonal activity
¯ Product technology relating to the entity's products
¯ Energy supply and cost
 Regulatory Factors
¯ Accounting principles and industry-specific practices
¯ Regulatory framework for a regulated industry
¯ Legislation and regulation affecting entity's operations
¯ Taxation
¯ Government policies affecting conduct of entity's business
¯ Environmental requirements.
AT A GLANCE
 Other Factors
¯ General economic conditions
¯ Interest rates
¯ Availability of financing, and inflation/currency revaluation.
2.2 The nature of the entity, including:

 Business operations.
 Its ownership and governance structures.
 Types of investments by the entity including investments in special-purpose entities.
 The way that the entity is structured and how it is financed.
 Financial reporting.
SPOTLIGHT
2.3 Entity's selection and application of accounting policies, including the reasons for changes thereto.
 Methods to account for significant and unusual transactions.
 Effect of significant accounting policies in controversial or emerging areas for which there is a lack of
guidance or consensus.
 Changes in the entity's accounting policies.
 Financial reporting standards and laws and regulations that are new to entity and how entity will
adopt such requirements.
2.4 Objectives and strategies and related business risks that may result in risks of material misstatement
Example of Strategy Potential related Business Risk might be that:

Industry developments Entity does not have personnel or expertise to deal with changes in the industry
New products and services There is increased product liability
Expansion of business Demand has not been accurately estimated
New accounting Incomplete or improper implementation, or increased costs
requirements
Regulatory requirements There is increased legal exposure

Example of Strategy Potential related Business Risk might be that:

Current and prospective Loss of financing due to the entity's inability to meet requirements
financing requirements
Use of IT Systems and processes are incompatible
2.5 The measurement and review of financial performance.

 Key performance indicators (financial and non-financial) and key ratios, trends and operating
statistics.
 Period-on-period financial performance analysis.
 Budgets, forecasts, variance analyses, segment information and divisional, departmental or other level
performance reports.
 Employee performance measures and incentive compensation policies.
 Comparisons of an entity's performance with that of competitors.
 Examples of conditions and events that may indicate risks of material misstatement (Appendix 2)
 Operations exposed to volatile markets e.g. futures trading.

AT A GLANCE
Operations that are subject to high degree of complex regulation.

 Going concern and liquidity issues
 Loss of significant customers.
 Constraints on the availability of capital and credit.
 Changes in the industry in which the entity operates.
 Changes in the supply chain.
 Developing or offering new products or services.
 Expanding into new locations.
 Changes in entity such as large acquisitions or reorganizations.
 Entities or business segments likely to be sold.
 The existence of complex alliances and joint ventures.
SPOTLIGHT
 Use of off balance sheet finance, special-purpose entities etc.

 Significant transactions with related parties.
 Lack of personnel with appropriate financial reporting skills.
 Changes in key personnel including departure of key executives.
 Deficiencies in internal control, especially not addressed by entity.
 Inconsistencies between entity's IT strategy & business strategies.
 Changes in the IT environment.
 Installation of significant new financial reporting IT systems.
 Inquiries by regulatory or government bodies.
 Past misstatements or significant adjustments at period end.
 Significant amount of non-routine or non-systematic transactions
 Operations in regions that are economically unstable
 Transactions that are recorded based on management's intent
 Application of new accounting pronouncements.
 Accounting measurements that involve complex processes.
 Events or transactions involving uncertainty
 Pending litigation and contingent liabilities

3. COMPONENTS OF INTERNAL CONTROL

(REF 12-24, A50-A121, APPENDIX 1)
3.1 Control environment
 Communication and enforcement of integrity and ethical values
 Commitment to competence
 Participation by those charged with governance
 Management philosophy and operating style
 Organizational structure
 Assignment of authority and responsibility
 Human resource policies and practices
3.2 The Entity's Risk Assessment Process

Obtain understanding of whether entity has a process for:
 Identifying risks relevant to financial reporting objectives;
AT A GLANCE
 Estimating the significance of the risks;
 Assessing the likelihood of their occurrence; and
 Deciding about actions to address those risks.
If the entity has established “risk assessment process”
 Auditor shall obtain an understanding of it, and results thereof.
 If auditor identifies risks that management failed to identify, auditor shall obtain an understanding of
why that process failed.
 Determine if there is a significant deficiency in internal control with regard to the entity's risk
assessment process.
If entity has not established such a process or has ad hoc process
SPOTLIGHT
 Auditor shall discuss with management whether business risks have been identified and addressed.
 Auditor shall evaluate whether absence of a documented risk assessment process is appropriate or
whether it represents deficiency in internal control.
3.3 Information System, including Related Business Processes, Relevant to Financial Reporting, and
Communication
 Classes of transactions that are significant to financial statements
 Procedures, within both manual and IT systems
 Related accounting records and supporting information
 How information system captures significant events & conditions
 Financial reporting process used to prepare financial statements
 Controls surrounding journal entries, including non-standard journal entries used to record non-
recurring, unusual transactions
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).

Journal entries
 An information system typically includes use of standard journal entries required on a recurring basis
to record transactions
 Financial reporting process also includes use of non-standard journal entries to record non-recurring,
unusual transactions.
¯ In manual systems, such entries may be identified through inspection of ledgers, journals &
supporting documentation.
¯ In IT environment, such entries may exist only in electronic form and therefore be more easily
identified through CAAT.
You are the audit manager at Moosa and Company, Chartered Accountants responsible for the
audit of Beta Bank Limited (BBL). While planning the audit for the year ending 31 December
2020, you come across a news published in a national newspaper that BBL has suffered a cyber-
attack which has resulted in theft of depositors’ confidential data.
Required:
AT A GLANCE
Discuss the course of action you should plan in response to cyber-attack.

Tutorial Notes:
Following important points should not be missed:
 Obtaining the details of claims filed by customers and the management’s intention to
honor them or pursue legal proceedings.
 Inspecting subsequent payments to ascertain the amount of penalties and fines.
 Inquiring about management’s risk assessment for the possible loss of business and its
impact on the financial statements.
 Determining whether continued reliance can be placed on the IT automated controls.
 Considering the course of action if the non-disclosure of the incident by the management
SPOTLIGHT
appears intentional.
 Solution:
Due to the theft of confidential data, BBL is exposed to severe legal action and claims from the
depositors.
Course of action:
 Discuss with the management and those charged with governance regarding the
following issues:
- How the incident occurred along with the extent and nature of data lost.
- BBL’s expected plans to mitigate and rectify the situation.
- Whether any going concern assessment has been performed by the entity to assess
the impact of this incident.
 Consult the legal advisor about the laws and regulations and the possible impact of the
non-compliance on the client.
 Consider about consulting with auditor’s expert, relating to possible legal consequences.
 Obtain the details about the claims filled by the customers against BBL.
 Inquire from management whether:
- BBL intends to honor those claims. In such a scenario ensure that appropriate
provision has been made in the financial statements.
- In case BBL intends to challenge these claims in the court of law, then depending on
the advice of legal advisor, disclose it as a contingent liability.

 Inspect the correspondence with the Central Bank to assess BBL’s exposure towards the
penalties and fines.
 Inspect subsequent payments and post year end accounts to ascertain the amount of
penalties and fines.
 Involve the firm’s IT expert to ascertain the reason of the data breach and its impact on
the other control of the entity.
 Determine whether continued reliance can be placed on the IT automated controls.
 Inquire whether the management has carried out any risk assessment for the possible
loss of business and its impact on the financial statements.
 Include a key audit matter in the auditor report regarding how the matter was addressed
by the auditor.
 Consider whether management disclosed incidence of cyber-attack to audit team. If the
non-disclosure by management appears intentional (and therefore creates doubt on
integrity of management), evaluate the implications for the audit.
 Revise the initial risk assessment, and the impact to nature, timing and extent of other
planned audit procedures.
3.4 Monitoring of Controls
AT A GLANCE
Auditor shall obtain an understanding of
 Major activities that entity uses to monitor internal controls
 How entity initiates remedial actions to deficiencies in controls.
 Sources of information used in the entity's monitoring activities
If the entity has an internal audit function, auditor shall obtain an understanding of the following:
 Nature of internal audit function's responsibilities
 How it fits in the organizational structure
 Activities of internal audit function.
SPOTLIGHT
3.5 Control Activities
 Performance reviews.
¯ Reviews and analyses of actual performance versus budgets, forecasts, and prior period
performance
 Information processing.
¯ Application controls
¯ (apply to the processing of individual applications)
¯ General IT controls
 Physical controls.
¯ Physical security of assets, including adequate safeguards such as secured facilities over access to
assets and records.
¯ Authorization for access to computer programs and files.
¯ Periodic counting and comparison with amounts on records
 Authorization & Segregation of duties
¯ To reduce opportunities to allow any person to be in a position to both perpetrate and conceal
errors or fraud.

¯ Assigning different people for

o Authorizing transactions
o Recording transactions
o Custody of assets.
 Examples of Control Activities
 Approval and control of documents
 Checking the arithmetical accuracy of records
 Maintaining and reviewing control accounts and trial balances
 Reconciliations
 Comparing the results of cash, security and inventory counts with accounting records
 Comparing internal data with external sources
 Limiting physical access to assets and records
4.6 Tutorial note: How to deal with Risk Assessment (mix) Question in Exam
AT A GLANCE
Identify Risk: Analytical working may or may not be required

A64 of ISA 315
A141 of ISA 315
A129 of ISA 315
Appendix 1 of Para 4
Appendix 2 of ISA 315
A3 of ISA 570
SPOTLIGHT

Think like Accountant
Give responses on each of the issue identified by you.
Appendix 2 of ISA 240 Specific responses for addressing risks due to
fraud
A1 of ISA 330 Overall responses to Financial Statement level
risks
Assertions Give assertion by assertion responses
Assertion by assertion responses (Account Balances)
Existence  Physical verification
 Third party confirmations
Accuracy, valuation and allocation  Matching amounts to invoices
 Recalculations
 Review of post year-end payments and invoices
 Expert valuation

Assertion by assertion responses (Account Balances)

Completeness  Cut-off testing
 Analytical review
 Confirmations
 Reconciliations to control accounts
Rights and obligation  Reviewing invoices for proof that items belongs
to company
 Confirmation with 3rd parties
Classification and presentation  Confirming compliance with laws and AFRF
 Check the recording in proper account
 Reviewing notes for understand ability
 Confirming accounting policy is consistent and
reasonable
Assertion by assertion responses (Class of transactions)
AT A GLANCE
Occurrence  Inspection of supporting documentation
 External confirmations
Accuracy  Recalculations of amounts
 Third party confirmation
Completeness  Cut-off testing
 Confirmations
 Reconciliation to control accounts
SPOTLIGHT
Cut-off  Cut off testing
Classification and Presentation  Confirming compliance with laws and AFRF
 Check the recording in proper account
 Reviewing notes for understand ability
 Confirming accounting policy is consistent and
reasonable

4. MANUAL AND AUTOMATED ELEMENTS OF INTERNAL CONTROL (A61-

A67)
Controls in a manual system: May include approvals and reviews of transactions, and reconciliations and
follow-up of reconciling items.
Controls in IT systems: Consist of combination of automated controls and manual controls.
Benefits of IT in entity's internal control:

 Consistently apply predefined business rules
 Perform complex calculations in processing large volumes
 Enhance timeliness, availability, and accuracy of information
 Facilitate additional analysis of information;
 Enhance ability to monitor performance of entity
 Reduce the risk that controls will be circumvented
 Enhance ability to achieve effective segregation of duties.
AT A GLANCE
Risks of using IT in internal control:

 Reliance on systems or programs that is faulty.
 Unauthorized access to data
 IT personnel gaining access privileges beyond authority.
 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.
 Potential loss of data or inability to access data as required.
SPOTLIGHT
Manual elements in internal control may be more suitable where judgment and discretion are required:
 Large, unusual or non-recurring transactions.
 Circumstances where errors are difficult to define or predict.
 In changing circumstances requiring a control response outside the scope of an existing control.
 In monitoring effectiveness of automated controls.
Manual elements in internal control may be less reliable than automated elements
 High volume or recurring transactions, or situations where anticipated errors can be prevented, or
detected and corrected.
 Control activities where the specific ways to perform the control can be adequately designed and
automated.
 General IT controls are policies and procedures that relate to many applications and support the effective
functioning of application controls. General IT controls that maintain the integrity of information and security
of data commonly include controls over following:
 Data center and network operations.
 System software acquisition, change and maintenance.
 Program change.
 Access security.
 Application system acquisition, development, and maintenance.

 Application controls are manual or automated procedures that typically operate at a business process level
and apply to the processing of transactions by individual applications. Examples include
 Edit checks of input data
 Correction at the point of data entry.
Nature and Extent of the Understanding of Relevant Controls (Ref 13, A74-A76)
Risk assessment procedures to obtain audit evidence about design and implementation of controls may
include:
 Inquiring of entity personnel.
 Observing the application of specific controls.
 Inspecting documents and reports.
 Tracing transactions through the information system relevant to financial reporting.
 Evaluating design involves considering whether control is capable of effectively preventing, or detecting and
correcting, material misstatements.
 Implementation means that control exists and entity is using it. An improperly designed control may
AT A GLANCE
represent significant deficiency in control.
SPOTLIGHT

5. IT RISKS AND CONTROLS

5.1 What is ICT and the related security issue
Information and communications technology (ICT) is an extension of information technology (IT) that emphasize
the role of unified communications and the integration of telecommunications and computers, as well as
necessary enterprise software, storage and audiovisual, that enable users to access, store, transmit, understand
and information.
ICT is the use of technology for gathering, storing, retrieving, processing, analysing and transmitting information.
It includes software and hardware such as smartphones, handheld devices, laptop computers, desktop
computers, drones, video cameras, wearable technology, artificial intelligence and others.
IT Security
Business and organisations are increasingly dependent on ICT for communication outside a “protected” internal,
organisation-only environment. Trends such as mobile technology, cloud and social networking increase an
organisation's interaction with customers, staff, suppliers, partners and other parties. At the same time, this
makes them more vulnerable to deliberate or accidental security breaches and cyber-attacks.
The demand for security technologies and skills in IT security is evolving into a need for complex, context-aware
AT A GLANCE
protection. As a result, IT security technology and skills are in big demand.

There are three main areas of ICT security:
 Identity and access management (IAM) - solutions used to identify users in a system and control their
access to resources within that system by associating user rights and restrictions with established
identity.
 Secure content and threat management (SCTM) - products to defend against viruses, spyware, spam,
hackers, intrusions, and the unauthorised use or disclosure of confidential information.
 Security and vulnerability management - solutions that focus on allowing business and organisations
to determine, interpret, and improve their risk position.
5.2 Improvements in ICT Processes

SPOTLIGHT
Risk control Internal Audit function

Companies should assign the responsibility for managing and overseeing ICT and security risks to a Risk control
function. Companies should ensure the independence and objectivity of this control function by appropriately
segregating it from ICT operations processes.
This control function should be directly accountable to the management body and responsible for monitoring
and controlling adherence to the ICT and security risk management framework. It should ensure that ICT and
security risks are identified, measured, assessed, managed, monitored and reported.
Companies should ensure that this control function is not responsible for any internal audit. The internal audit
function should, following a risk-based approach, have the capacity to independently review and provide
objective assurance of the compliance of all ICT and security related activities and units of a financial institution
with the financial institution’s policies and procedures and with external requirements, adhering to the
requirements of Companies, should define and assign key roles and responsibilities, and relevant reporting lines,
for the ICT and security risk management framework to be effective.
Classification and Risk Assessment

Companies should classify the identified business functions, supporting processes and information assets.
To define the criticality of these identified business functions, supporting processes and information assets,
companies should, at a minimum, consider the confidentiality, integrity and availability requirements. There
should be clearly assigned accountability and responsibility for the information assets.

Companies should review the adequacy of the classification of the information assets and relevant
documentation, when risk assessment is performed.
Companies should identify the ICT and security risks that impact the identified and classified business functions,
supporting processes and information assets, according to their criticality. This risk assessment should be
carried out and documented annually or at shorter intervals, if required. Such risk assessments should also be
performed on any major changes in infrastructure, processes or procedures affecting the business functions,
supporting processes or information assets, and consequently the current risk assessment of companies should
be updated.
Companies should ensure that they continuously monitor threats and vulnerabilities relevant to their business
processes, supporting functions and information assets and should regularly review the risk scenarios impacting
them.
5.3 Data Analytics

Big Data is one of the fastest growing areas of computing and Ireland has become the European data centre
location of choice for world leaders including Microsoft, Google, Yahoo, MSN, Adobe and IBM, and is now poised
to become a global cloud centre of excellence.
Historically, the type of data generated has been 'structured data' from financial institutions, bank accounts and
big institutions. Today we have unstructured data, the type of data being generated by social media, mobile
AT A GLANCE
phones for example. The management of data is essential to business, and its importance will continue to grow
as long as more and more devices, technologies and services harvest more and more information from society.
Data analytics involves the collection, organisation, and interpretation of statistical information to make it
useful to a range of businesses and organisations. A Data Analyst is someone who scrutinises information using
data analysis tools. The meaningful results they pull from the raw data helps their employers or clients make
important decisions by identifying various facts and trends.
The work of Data Analysis involves:
 Use of advanced computerised models to extract the data needed
 Removal of corrupted data
 Performing initial analysis to assess the quality of the data
 Performing further analysis to determine the meaning of the data
SPOTLIGHT
 Performing final analysis to provide additional data screening
 Preparing reports based on analysis and present to management
Data analytics has been around in various forms for a long time, but businesses are finding increasingly
sophisticated and timely methods to utilise data analytics to enhance their operations. Data analytics enable
businesses to identify new opportunities, costs savings and to enable faster and effective decision making.
Big data and ICT go together where data is generated by ICT tools and handled by big data optimization tools to
discover hidden knowledge and information. The most remarkable use of predictive analytics is in business
processes to determine the outcomes for current models. The technology advances such as predictive analytics
with ICT are proving to benefit with less cost and higher efficiency. For example, online web portals Amazon,
Google, Twitter, and others are availing consumer information. This information proves to be vital to discover
the usage patterns with socio- behavioral analysis to predict models for relevant customer to upgrade them to
substantial offers. In addition, online web portal data, if analyzed properly, can facilitate to discover risk factors
and fraud customers which prove to be set back for companies’ growth. This information can widely be
anticipated at a global platform to enhance overall net profit for development purposes.
5.4 Identification of Cyber Security Risks

Cybersecurity is one of the essential tasks for any business. It’s not just a matter of protecting your company’s
data and information from external threats, but also ensuring that it remains robust to internal ones. All three,
i.e. people, processes and technology, are your greatest asset. If they are not embedded and managed throughout
the organisation, you can expect that they will inadvertently put your sensitive data at risk.

Identifying and assessing cyber risk

Cyberattacks are on the rise, and organisations of all sizes are struggling to cope with them.
Problem is that most companies don’t know how to tell if they’re being targeted by a cyberattack in advance. And
even when an attack does happen, it’s too late to do anything about it except try to clean up after the fact.
Cyber risk is a type of business and operational risk that’s unique in its pervasiveness. It can happen anywhere,
anytime, to anyone with an internet connection.
In some cases, cyber risks are new or not as well understood as other types of risks such as physical damages
from natural disasters – but the impacts can be long lasting. This can only be reduced by proper risk mitigation
in advance.
Identification of entity’s vulnerabilities

First step of cyber risk assessment is identifying things (in business) that attracts cybercriminals the most.
Ask yourself these questions while assessing risks faced by your organisation,
 How is information collected and stored?
 What information is collected?
AT A GLANCE
 Who has access to the stored data?

 How our entity secures its systems, networks, email, etc.?
 How much of my information is stored in the cloud?
 What are our backup strategies, and how effective they are?
 Is there a disaster recovery plan for data centre failures?
External and internal risks

Cybercrime is something that needs to be taken seriously and should not only be thought about in terms of
external threats. Internal events are just as important; for example, human error or misconduct can lead to severe
consequences like fraud schemes. Before risk mitigation, Identification of external and internal risks is
mandatory.
SPOTLIGHT
To start with, look into the different types of cybercrime:

 Phishing scams are carried out when hackers send emails or texts that ask for personal information.
 Ransomware typically arrives as an email attachment that opens malware onto your computer or
software.
 Supply chain attacks cause disruptions to the targeted company.
 Keystroke logging programs record passwords by monitoring inputted data from keyboards without
authorization and these represent only the tip of the iceberg! Not sure what you’re up against?
Risk Assessment
Cyber security risk assessments help you identify the threats to your business from cybercrime, data breaches
or malware. The process identifies risks that an attacker could exploit with malicious intent. It also highlights
vulnerabilities in your systems that may have been overlooked because of time pressure or lack of awareness.
Risk acceptance strategy at the beginning is crucial for effective risk mitigation.
Risk Evaluation
Risk evaluation determines the significance of risks through a comparative process to have an accurate
assessment. Cyber threats are growing in number and sophistication, with no end in sight.
Your risk evaluation should account for the following;
 The importance to your business;

 How much control do you have over it;

 Potential losses if something goes wrong with this activity or project, as well as any benefits that might
arise; from taking a particular course of action when faced with possible problems such as these.
Risk Analysis
Your business’s risk analysis process will help you judge how much money; effort or resources are required for
risk mitigation of the losses incurred from risk or how much the company can afford to lose. The following are
some of the criteria that can be considered by an organisation when performing a cyber-security analysis:
 The probability for a specific incident to happen about other incidents
 The consequences if it does happen, including potential damage and how much time would need to be
spent repairing cracks or restoring lost services
5.5 Common cyber-security risks and use of general or application controls to mitigate those
Cyber-security Risk Description Prevention

Malware Malware is when an unwanted piece of Organizations should have the latest anti-
programming or software installs malware programs installed, for starters.
itself on a target system, causing It’s also important to recognize suspicious
AT A GLANCE
unusual behavior. This ranges from links, files, or websites, which are
denying access to programs, deleting effective ways of implementing malware.
files, stealing information, and
spreading itself to other systems.
Password Theft An unwanted third party manage to Two-factor authentication is a robust
steal or guess your password and has protection method, as it requires an
access to all your information. It’s far additional device to complete the
worse for an enterprise, which may login. Additionally, using complicated
lose sensitive data. logins with alpha numeric can help.
Traffic Interception When a third-party “listens” to info Avoiding compromised websites (such as
sent between a user and host. The kind those not using HTML5). Encrypting
of information stolen varies based on network traffic – such as through a VPN.
SPOTLIGHT
traffic.
Phishing Attacks Typically, an end user receives a Generally, a common-sense approach to
message or email which requests security is the best prevention. Official
sensitive data, such as a password. emails from organizations do not request
Sometimes, the phishing message personal data, so this is a giveaway there
appears official, using legitimate is malicious intent.
appearing addresses and media.
Distributed Denial of DDoS is an attack method in which Stopping a DDoS requires identifying
Service (DDoS) malicious parties target servers an malicious traffic. This can take time
overload them with user traffic. When depending on how many malicious IPs are
a server cannot handle incoming used to distribute attack. In cases, servers
requests, the website it hosts shuts need to be taken offline for maintenance.
down or slows to unusable
performance.
Cross Site Attack A third-party will target a vulnerable Encryption is usually required on the
website, typically one lacking host’s side. Additionally, providing the
encryption. Once targeted the option to turn off page scripts is vital to
dangerous code loads onto the site. thwart a malicious payload from
When a regular user accesses that activating. Users can also install script-
website, that payload is delivered blocker add-ons to their browser.

Cyber-security Risk Description Prevention

either to their system or browser,
causing unwanted behavior.
SQL Injection Malicious 3rd parties manipulate SQL Implementation of smart firewalls.
“queries” (the typical string of code Generally, most effective way is to
request sent to a service or server) to develop code which identifies illegal user
retrieve sensitive info. inputs.
Ransomware A nasty variant of malware, Keeping anti-virus updated and avoiding
ransomware installs itself on a user malicious links are the best current
system or network. Once installed, it prevention methods. Also, current
prevents access to functionalities (in backups and replications are effective
part or whole) until a “ransom” is paid
to third parties.
Crypto jacking An attempt to install malware which Keep all security apps/software updated
forces the infected system to perform and make sure firmware on smart devices
“crypto-mining,” a popular form of is also using the latest version.
gaining crypto-currency. Like all
AT A GLANCE
viruses, it can infect unprotected

systems
Trojan Virus Attempts to deliver its payload by Avoid downloading programs or
disguising itself as legitimate software. executable from unrecognized vendors or
One technique used is an “alert about a those that attempt to alarm the user to a
system compromised by malware”, serious problem.
recommending a scan, whereby the
scan actually delivered the malware.
5.6 Improving cyber security

The foremost task should be to develop an overall risk mitigation strategy for managing cyber risks. Businesses
SPOTLIGHT
should have an enterprise-wide view of the cybersecurity risks as well as its sub-units. This is the only way to
ensure that all areas are covered and that a proper risk assessment occurs.
Common Cyber Risk Mitigation Control Strategies

1. Keep your software updated
The software your company run on the machine is vulnerable to a cyber-attack and zero-day exploits. Updates
must be applied as soon as possible, or hackers will create new N-days that can do severe damage.
2. Restricted Access
Security measures should be taken to protect privileged access. To manage privilege, these risk mitigation
strategies may help your company:
 Tiered administrative access or one-time passwords/tokens with procedural guidelines designed
around secure resetting credentials such as by Password authentication services.
 Procedures should also be in place for securely resetting passwords or other types of credentials if
they are compromised, so high-value assets aren’t inadvertently exposed.
3. Disaster Recovery Plan
Cybersecurity professionals must have an important risk mitigation strategy to create, review, and exercise a
system recovery plan that will ensure restoration of data as part of a comprehensive disaster recovery strategy.

4. Get rid of unwanted hardware

You should remove unwanted or unneeded hardware from the equation as much as possible by starting with a
known baseline. This will allow you to establish control over operations going forward while reducing the attack
surface even more so than before. Systems must be actively managed –they can adapt dynamically in response
to changing threat environments while scaling up and streamlining administrative tasks.
5. Ensure Signed Software Policies
In order to make sure that your computer is secure, you should use a modern operating system that enforces
signed software execution policies for scripts, executables and device drivers.
6. Hunt for Intrusions
Dedicated teams should be formed, continuously seeking out any evil presences or threat actors that may have
access within the organisation. Passive detection mechanisms (like Logs) is an efficient risk mitigation strategy.
7. Stay away from single-factor authentication
Include multi-factor authentication in your risk mitigation plans. It is essential for organisations to transition
away from single-factor authentication, such as passwords and PINs.
5.7 Cybersecurity Framework
AT A GLANCE
The Framework comprises of three main components:
1) The Framework Core
A set of cybersecurity activities and applicable references that having five simultaneous and constant functions
− Identify, Protect, Detect, Respond, and Recover. The framework core has methods to ensure the following:
 Develop and implement procedures to protect the most critical intellectual property and assets.
 Have resources in place to identify any cybersecurity breach.
 Recover from a breach, if and when one occurs.
2) The Implementation Tiers
Defines the level of sophistication and consistency an organization employs in applying its cybersecurity
SPOTLIGHT
practices. It has the following 4 levels.
 Tier 1 (Partial) − In this level, the organization’s cyber-risk management profiles are not defined.
There is a partial consciousness of the organization’s cybersecurity risk at the organization level.
 Tier 2 (Risk Informed) − In this level, organizations establish a cyber-risk management policy that is
directly approved by the senior management.
 Tier 3 (Repeatable) − In this level, the organization runs with formal cybersecurity measures, which
are regularly updated based on requirement.
 Tier 4 (Adaptive) − In this level, the organization adapts its cybersecurity practices "in real-time"
derived from previous and current cybersecurity activities.
3) The Framework Profile
It is a tool that provides organizations a platform for storing information concerning their cybersecurity
program. A profile allows organizations to clearly express the goals of their cybersecurity program.
Where do You Start with Implementing the Framework?
Senior management including the directors should first get acquainted with the Framework. After which, the
directors should have a detailed discussion with the management about organization’s Implementation Tiers.
Educating the managers and staff on the Framework will ensure that everyone understands its importance.
5.8 Using ICT Processes by auditor to identify risks and mitigating controls
As information and communication technology (ICT) becomes more sophisticated, it is important to be able to
use ICT to optimize audit effectiveness and efficiency, and to support and maintain integrity of audit process.

Examples of the use of ICT during audits may include but are not limited to:
 Meetings; by means of teleconference facilities, including audio, video and data sharing
 Audit of documents and records by means of remote access
 Recording of information and evidence by means of still video, video or audio recordings
 Providing visual/audio access to remote or potentially hazardous locations
The objectives for the effective application of ICT for audit purposes are:
 To provide a methodology for the use of ICT that is sufficiently flexible and non-prescriptive in nature
to optimize the conventional audit process
 To ensure that adequate controls are in place to avoid abuses that could compromise the integrity of
the audit process
 To support the principles of safety and sustainability
Benefits of Using ICT in auditing
 Continued management system viability for emergency situations, like COVID-19.
 Audit effectiveness has resulted due to the evolution and sophistication of technology with tools
 Requires to assess and understand the potential risks of remote audits including client’s ICT capability,
tool familiarity, audit cycle considerations and certification scope.
AT A GLANCE
 Requires additional auditor planning, preparation and coordination with the customer that leads to an
improved and effective audit.
 Reduces 3rd-party certification expenses to client due to reduced auditor travel costs resulting in
savings.
 Increases auditor resiliency as it reduces auditor travel fatigue and associated stress.
 ICT can be used in auditing of management systems, persons, and product and is applicable to
conformity assessment bodies and accreditation bodies.
Limitations on the use of ICT

 Scope of using ICT is much difficult to determine and requires a substantial professional judgement.
 Effectiveness is dependent upon the organization and the auditor familiarity and expertise with ICT
SPOTLIGHT
tools.
 Auditors find it difficult to remotely audit “hands-on” processes such as Receiving, Production, and
Verification processes.
 ICT auditing is more complicated for mostly paper-based organizations.
 ICT auditing can create auditor and client frustrations due to poor internet connectivity, internet dead
zones, or not being able to hear or communicate effectively.
 ICT auditing may not appeal to all auditors as some are not comfortable with the ICT technology and
find auditing remotely frustrating.
5.9 Use of Data Analytics by the auditor

IAASB defines data analytics for audit as the science and art of discovering and analysing patterns, deviations
and inconsistencies and extracting other useful information in the data underlying or related to the subject
matter of audit through analysis, modelling and visualisation for the purpose of planning and performing audit.
The larger audit firms and increasingly smaller firms utilise data analytics as part of their audit offering to reduce
risk and to add value to the client. Bigger firms often have the resources to create their own data analytics
platforms whereas smaller firms may opt to acquire an off the shelf package.
For auditors, the main driver of using data analytics is to improve audit quality. It allows auditors to more
effectively audit the large amounts of data held and processed in IT systems in larger clients. Auditors can extract
and manipulate client data and analyse it. By doing so they can better understand the client’s information and
better identify the risks.

Data analytics tools have power to turn all data into pre-structured forms/presentations understandable to both
auditors and clients and even to generate audit programmes tailored to client-specific risks or to provide data
directly into computerised audit procedures thus allowing the auditor to more efficiently arrive at result.
 Examples of the use of data analytics to perform audit procedures include:
 NRV testing – comparing the last time an inventory item was purchased with the last time it was sold
 Analysis of revenue trends by product and region
 Matching purchase orders to invoices and payments
 Segregation of duties testing by identifying combinations of users involved in processing transactions
from the metadata attached to transactions
Benefits of data analytics

The increased access and manipulation of data and the consistency of application of data analytics tools should
increase audit quality and efficiency through:
 Increased business understanding through a more thorough analysis of a client’s data and the use of
visual output such as dashboard displays rather than text or numerical information allows.
 This increase in understanding, aids the identification of risks associated with a client, enabling testing
AT A GLANCE
to be better directed at those areas.
 Freeing up auditor time from analysing routine data so that more time can be spent on areas of risk.
 Increased consistency across group audits where all auditors are using the same technology and
process.
 increased efficiency through the use of computer programmes to perform very fast processing of large
volumes of data and provide analysis to auditors on which to base their conclusion, saving time within
the audit and allowing better focus on judgemental and risk areas (often 100% testing is also possible).
 Data can be more easily manipulated by auditor as part of audit testing, for example performing
sensitivity analysis on management assumptions.
 Increased fraud detection through the ability to interrogate all data and to test segregation of duties.
 Information obtained through data analytics can be shared with the client, adding value to the audit
SPOTLIGHT
and providing a real benefit to management in that they are provided with that useful information.
Challenges of data analytics

At present there is a lack of consistency or a widely accepted standard across firms and even within a firm. Other
issues which can arise with the introduction of data analytics as an audit tool include:
 Data privacy and confidentiality.
 Client may be reluctant to allow the audit firm sufficient access to their systems to perform data
analytics.
 Completeness and integrity of the extracted client data may not be guaranteed.
 Compatibility issues with client systems may render standard tests ineffective.
 Audit staff may not be competent to understand the exact nature of the data and output to draw
appropriate conclusions.
 Practice management issues arise relating to data storage and accessibility for the duration of the
required retention period for audit evidence.
 An expectation gap among stakeholders who think that because the auditor is testing 100% of
transactions in a specific area, the client’s data must be 100% correct.
5.10 Cyber-Security Audit

A cyber security audit is a systematic and independent examination of an organization’s cyber security. which
ensures that the proper security controls, policies and procedures are in place and working effectively.

The purpose of a cyber-security audit is to provide a ‘checklist’ in order to validate your controls are working
properly. In short, it allows you to inspect what you expect from your security policies.
Audits play a critical role in helping organizations avoid cyber threats. They identify and test your security in
order to highlight any weaknesses or vulnerabilities.
Elements of a cyber-security audit: -

A cyber security audit focuses on cyber security standards, guidelines, and policies. Furthermore, it focuses on
ensuring that all security controls are optimized, and all compliance requirements are met.
 Operational Security (review of policies, procedures, and security controls)
 Data Security (review of encryption use, network access control, data security in transmission &
storage)
 System Security (review of patching processes, role-based access, management of privileged accounts,
etc.)
 Network Security (review of network and security controls, anti-virus configurations, SOC, security
monitoring capabilities)
 Physical Security (review of role-based access controls, disk encryption, multifactor authentication,
biometric data, etc.)
AT A GLANCE
Benefits of a cyber-security audit

A cyber security audit is the highest level of assurance service that an independent cyber security audit offers. It
provides an organization, as well as their business partners and customers, with confidence in the effectiveness
of their cyber security controls.
 Identifying gaps in security
 Highlight weaknesses
 Compliance
 Reputational value
 Testing control
SPOTLIGHT
 Improving security posture

 Assurance to vendors, employees, and clients
 Confidence in your security controls
 Increased performance of your technology and security
Cyber security audit checklist

Audit checklist will depend on industry, size, and compliance framework. However, there are some basic
categories that every audit should include. Specifically, the following are essential categories to review:
 Inventory and control of hardware assets
 Inventory and control of software assets
 Continuous vulnerability management
 Controlled use of administrative privileges
 Secure configuration for hardware and software on mobile devices, laptops, workstations, and servers
 Maintenance, monitoring, and analysis of audit logs
 Email and web browser protection
 Malware defenses
 Limitation and control of network ports, protocols, and servers.

IT security controls auditors can look to implement:

 Formal IT security policy
 Formal incident response plan
 Security awareness training
 Password lengths of eight or more characters
 Two-factor authentication
 Network firewall
 Intrusion prevention system
 Website filtering solution
 Hard disk encryption for laptops
 Anti-virus software for all PCs and servers
 Quarterly OS patching for servers
 Automatic OS patching for PCs
 Daily data back-up
 Cyber insurance
AT A GLANCE
SPOTLIGHT

6. MATERIALITY IN PLANNING AND PERFORMING AN AUDIT (ISA 320)

6.1 Materiality in the Context of an Audit (Ref: 2-6, A1)
Misstatements, including omissions, are considered to be material if they, individually or in aggregate, could
reasonably be expected to influence the economic decisions of users taken on the basis of financial statements
Determining materiality is a matter of professional judgment, auditor assume that users:
 Have a reasonable knowledge of business & economic activities
 Understand that financial statements are prepared, presented and audited to levels of materiality;
 Recognize the uncertainties inherent; and
 Make reasonable economic decision
Materiality is applied both in planning and performing audit.
In planning, auditor makes judgments about size of misstatements that will be considered material.
These judgments provide a basis for:
 Determining nature, timing & extent of risk assessment procedures
AT A GLANCE
 Determining nature, timing & extent of further audit procedures.

 Identifying and assessing risks of material misstatement
Auditor considers not only the size but also the nature of uncorrected misstatements.
6.2 Determining Materiality and Performance Materiality When Planning the Audit (Ref: 10-11, A3-A13)
For the financial statements as a Whole

Determining materiality involves the exercise of professional judgment. A percentage is often applied to a
chosen benchmark as a starting point in determining materiality.
Factors relevant for identifying benchmark are:
SPOTLIGHT
 Elements of financial statements (e.g. assets, liabilities, equity, revenue, expenses),

 Items on which attention of users of particular entity's financial statements tends to be focused,
 Nature of entity, current phase of life cycle, and industry & economic environment,
 Entity's ownership structure and the way it is financed,
 The relative volatility of the benchmark.
For Particular Classes of Transactions, Account Balances or Disclosures

If there are one or more particular classes of transactions, account balances or disclosures for which
misstatements of lesser amounts than materiality for financial statements as a whole could reasonably be
expected to influence the economic decisions of users.
Factors indicating existence such materiality include:
 Whether law, regulation or applicable financial reporting framework affect users' expectations
regarding measurement or disclosure of certain items (e.g. related party transactions).
 Key disclosures in relation to industry.
 Whether attention is focused on a particular aspect of entity's business that is separately disclosed in
financial statements (for example, a newly acquired business).

Performance Materiality
Amount or amounts set by 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 amount
or amounts set by the auditor at less than the materiality level or levels for particular classes of transactions,
account balances or disclosures.
Auditor shall determine performance materiality for purposes of assessing risks of material misstatement and
determining the nature, timing and extent of further audit procedures.
6.3 Revision as the Audit Progresses (Ref: 12-13, A14)

Auditor shall revise materiality on becoming aware of information during the audit
(E.g. 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.)

 Materiality for the financial statements as a whole
AT A GLANCE
 Materiality level(s) for particular classes of transactions, account balances or disclosures
 Performance materiality
 Any revision in above as the audit progressed
Your audit firm has been appointed as auditor of Lucrative Industries Limited (LIL) a listed
company for the year ended 31 March 2015. LIL’s financial statements for five years depict the
following:
2015 2014 2013 2012 2011

(draft)
--------------------------- Rupees in millions ---------------------------
SPOTLIGHT
Sales 1,570 1,276 1,064 980 859
Profit before tax 1,159 212 190 165 155
Profit after tax 815 130 135 106 110
Total assets 1,521 1,344 1,270 1,188 1,100
2015 2014
Rupees in millions
Sales revenue-exports 1,057 944
Sales revenue- local supplies 513 332
Cost of sales and administrative expenses -1,299 -1,049
Gain on sale of office building 901 -
Other provisions / write offs -11 -13
Other charges -2 -2
Profit before taxation 1,159 212
Profit after taxation 815 130

The results for the current year include the impact of following items:
During the year, an increase in export and local sales was noticed due to new agreement
with foreign customers and supplies made to Government for flood affected people.
Sales to new customers and Government amount to Rs. 105 million and Rs. 225 million
respectively. Mark-up on such sales was 15%.
Administrative expenses include loss of raw material amounting to Rs. 210 million,
which was destroyed due to fire. Raw material was not insured.
During the year, the head office of the company was shifted to new premises and the old
building was sold for Rs. 1.2 billion.
Required:
Determine the materiality for the financial statements as a whole and also discuss the
basis/benchmarks adopted by you in this regard.
 Solution:
Discussion on the benchmark adopted in above calculation:
N-1: Profit before tax often forms the basis for calculating planning materiality unless it is
significantly volatile.
AT A GLANCE
N-2: Circumstances that give rise to an exceptional decrease or increase in such profits may lead
the auditor to conclude that materiality for the financial statement as a whole is more
appropriately determined using a normalized profit before tax from continuing operations figure
based on past results, therefore following items are excluded to arrive at normalized profit:
 sales to Govt. department is excluded;
 Loss due to raw material destroyed; and
 Gain on sale building
Further, increase in sale due to new agreement is part of normal operations therefore it is not
excluded.
N-3: Determining a percentage to be applied to a chosen benchmark involves the exercise of
SPOTLIGHT
professional judgment, as ISA 320, suggests the rate of 5% of profit before tax therefore it is used.

7. EVALUATION OF MISSTATEMENTS IDENTIFIED DURING THE AUDIT (ISA

450)
 Misstatement
A difference between the amount, classification, presentation, or disclosure of a reported
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.
When the auditor expresses an opinion on whether the financial statements are presented fairly, in
all material respects, or give a true and fair view, misstatements also include those adjustments of
amounts, classifications, presentation, or disclosures that, in the auditor’s judgment, are necessary for
the financial statements to be presented fairly, in all material respects, or to give a true and fair view.
 Uncorrected misstatements
Misstatements that the auditor has accumulated during audit and that have not been corrected.
7.1 Accumulation of Identified Misstatements (Ref: 5, A2-A3)
AT A GLANCE
Auditor shall accumulate misstatements identified during the audit, other than those that are clearly trivial.
Auditor may designate an amount below which misstatements would be clearly trivial and would not need to be
accumulated.
Type of Misstatements
 Factual misstatements: Misstatements about which there is no doubt.
 Judgmental misstatements: Differences arising from the judgments of management concerning.
accounting estimates, or selection or application of accounting policies that the auditor considers
inappropriate.
 Projected misstatements: Auditor’s best estimate of misstatements in populations. (See ISA 530).
7.2 Consideration of Identified Misstatements as the Audit Progresses (Ref: 6, 7, A4-A6)
SPOTLIGHT
Auditor shall determine whether the overall audit strategy and audit plan need to be revised if:
 The nature of identified misstatements and circumstances of their occurrence indicate the existence of
other similar misstatements. (e.g. misstatement arose from a breakdown in internal control or from
inappropriate assumptions or valuation methods that have been widely applied by the entity)
 Aggregate of misstatements accumulated during audit approaches materiality.
If management has examined and corrected misstatements that were detected by auditor, the auditor shall
perform additional procedures to determine whether misstatements remain.
7.3 Communication and Correction of Misstatements (Ref: 8-9, A7-A10)

Auditor shall communicate on a timely basis all misstatements accumulated during the audit with the
appropriate level of management, unless prohibited by law or regulation.
Auditor shall request management to correct those misstatements. (Such correction enables management to
maintain accurate accounting books and records).
If management refuses to correct some or all of the misstatements communicated by the auditor, the auditor
shall:
 Obtain an understanding of management’s reasons for not making the corrections; and
 Take that understanding into account when evaluating whether the financial statements are free from

7.4 Evaluating the Effect of Uncorrected Misstatements (Ref: 10-13, A11-A23)

Prior to evaluating effect of uncorrected misstatements, auditor shall reassess materiality to confirm whether it
remains appropriate in the context of the entity’s actual financial results.
If reassessment gives rise to a lower amount, then performance materiality and appropriateness of the nature,
timing and extent of the further audit procedures shall also be reconsidered.
Auditor shall determine whether uncorrected misstatements are material, individually or in aggregate. In
making this determination, the auditor shall consider:
 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
 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.
 Examples of Particular Circumstances (nature of misstatement)
Circumstances that may affect the evaluation of any misstatement as material, include the extent
to which the misstatement:
AT A GLANCE
 Affects compliance with regulatory requirements;

 Affects compliance with debt covenants or other contractual requirements;
 Relates to the incorrect selection or application of an accounting policy that has an
immaterial effect on the current period’s financial statements but is likely to have a
material effect on future periods’ financial statements;
 Masks a change in earnings or other trends, especially in the context of general economic
and industry conditions;
 Affects ratios used to evaluate entity’s financial position, results of operations or cash
flows;
 Affects segment information presented in financial statements;
 Has the effect of increasing management compensation, for example, by ensuring that
SPOTLIGHT
the requirements for the award of bonuses or other incentives are satisfied;
 Is significant having regard to auditor’s understanding of the known previous
communications to users, for example, in relation to forecast earnings;
 Relates to items involving particular parties (for example, whether external parties to
the transaction are related to members of the entity’s management);
 Is an omission of information not specifically required by applicable financial reporting
framework but which, in the judgment of auditor, is important to users’ understanding
of financial position & performance etc.; or
 Affects other information that will be communicated in documents containing the
audited financial statements (for example, information to be included in a “Management
Discussion and Analysis” or an “Operating and Financial Review”) that may reasonably
be expected to influence the economic decisions of the users of the financial statements.
7.5 Communication with those charged with governance (Ref: 12, A21-A23)
 Auditor shall communicate with those charged with governance uncorrected misstatements and the
effect that they may have on the auditor’s opinion (unless prohibited by law or regulation).
 Where there is a large number of individual immaterial uncorrected misstatements, auditor may communicate
the number and overall monetary effect of uncorrected misstatements.
 Auditor shall identify material uncorrected misstatements individually.

 Auditor shall request that uncorrected misstatements be corrected.

 Auditor shall also communicate with those charged with governance the effect of uncorrected
misstatements related to prior periods on current financial statements. (See ISA 710).
7.6 Written Representations (Ref: 14, A24)

Auditor shall request a written representation from management and, where appropriate, those charged with
governance whether they believe the effects of uncorrected misstatements are immaterial, individually and in
aggregate, to the financial statements as a whole.
A summary of such items shall be included in or attached to the written representation.
They may add to their written representation words such as: “We do not agree that items … and … constitute
misstatements because [description of reasons].”
Obtaining representation does not, however, relieve the auditor from his responsibilities.

 Amount below which misstatements would be regarded as clearly trivial;
AT A GLANCE
 All misstatements accumulated during audit and whether they have been corrected; and
 Auditor’s conclusion as to whether uncorrected misstatements are material, individually or in
aggregate and the basis for that conclusion.
SPOTLIGHT

8. RELATED PARTIES (ISA 550)

 Important Definitions:
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.
 Related party:
1. A related party as defined in the applicable financial reporting framework; or
2. Where the applicable financial reporting framework establishes minimal or no related party
requirements:
a) A person or other entity that has control or significant influence, directly or indirectly
through one or more intermediaries, over the reporting entity;
b) Another entity over which the reporting entity has control or significant influence,
directly or indirectly through one or more intermediaries; or
c) Another entity that is under common control with the reporting entity through having:
i. Common controlling ownership;
ii. Owners who are close family members; or
AT A GLANCE
iii. Common key management.
8.1 Responsibilities of the Auditor (3-7)

Because related parties are not independent of each other, many financial reporting frameworks establish
specific accounting and disclosure requirements for related party relationships, transactions and balances to
enable users of the financial statements to understand their nature and actual or potential effects on financial
statements.
Where the applicable financial reporting framework establishes such requirements
Auditor has a responsibility to perform audit procedures to identify, assess and respond to the risks of material
misstatement arising from entity's failure to appropriately account for or disclose these.
SPOTLIGHT
Even if applicable financial reporting framework establishes minimal or no related party requirements
Auditor still needs to obtain an understanding of related party relationships and transactions sufficient to be able
to conclude whether financial statements, in so far as they are affected by those relationships and transactions:
 Achieve fair presentation (for fair presentation frameworks); or
 Are not misleading (for compliance frameworks).
In addition, an understanding of related party is relevant to the auditor's evaluation of whether one or more
fraud risk factors are present, because fraud may be more easily committed through related parties.
Planning and performing the audit with professional skepticism is therefore particularly important in this
context, given the potential for undisclosed related party relationships and transactions.
8.2 Risk Assessment Procedures and Related Activities (11-14, A9, A17-A18)
Auditor shall perform audit procedures and related activities to obtain information relevant to identifying risks
of material misstatement attached with related parties.
Discussion among the Engagement Team
It shall include specific consideration of susceptibility of financial statements to material misstatement due to
fraud or error that could result from entity's related party relationships and transactions.
Matters that may be addressed in the discussion among the engagement team include:
 Nature and extent of the entity's relationships and transactions with related parties.

 An emphasis on the importance of maintaining professional skepticism throughout the audit regarding
the potential for material misstatement associated with related party relationships and transactions.
 Circumstances or conditions of the entity that may indicate the existence of related party relationships
or transactions that management has not identified or disclosed to the auditor (e.g. a complex
organizational structure, use of special-purpose entities for off-balance sheet transactions, or an
inadequate information system).
 The records or documents that may indicate the existence of related party relationships or transactions.
 Importance that management and those charged with governance attach to identification, appropriate
accounting for and disclosure of related party relationships and transactions and related risk of
management override of controls.
Understanding the entity
The auditor shall inquire management regarding:
 The identity of the entity's related parties, including changes from the prior period;
 The nature of the relationships between the entity and these related parties; and
 Whether the entity entered into any transactions with these related parties during the period and, if so,
the type and purpose of the transactions.
AT A GLANCE
Understanding of the controls over related party relationships and transactions
Auditor shall inquire management and others within entity and perform other risk assessment procedures
considered appropriate, to obtain an understanding of the controls, if any, that management has established to:
 Identify, account for, and disclose related party relationships and transactions in accordance with the
applicable financial reporting framework;
 Authorize & approve significant transactions and arrangements with related parties; and
 Authorize and approve significant transactions and arrangements outside the normal course of
business.
Auditor may consider features of the control environment relevant to mitigating risks of material
misstatement associated with related party relationships and transactions, such as:
SPOTLIGHT
 Internal ethical codes, appropriately communicated to entity's personnel and enforced, governing the
circumstances in which the entity may enter into specific types of related party transactions.
 Policies and procedures for open and timely disclosure of the interests that management and those
charged with governance have.
 Assignment of responsibilities within entity for identifying, recording, summarizing, and disclosing
these.
 Timely disclosure and discussion between management and those charged with governance of
significant related party transactions outside the entity's normal course of business, including whether
those charged with governance have appropriately challenged the business rationale of such
transactions (e.g. by seeking advice from external professional advisors).
 Clear guidelines for approval of related party transactions involving actual or perceived conflicts of
interest, such as approval by a subcommittee of those charged with governance comprising individuals
independent of management.
 Periodic reviews by internal auditors, where applicable.
 Proactive action taken by management to resolve related party disclosure issues.
 The existence of whistle-blowing policies and procedures, where applicable.


ABC and Company, Chartered Accountants, have been appointed as the auditor of Neptune
Limited (NL). During the audit it has been revealed that:
NL’s operation involves significant and frequent transactions with related parties.
Required: Discuss the overall audit approach and related audit procedures to address the above
issues. Also state the possible implications on the audit report.
Tutorial Notes:
Don’t restrict your answers to procedures aimed at verifying the list of related party transactions
provided by the client; do also focus on addressing the main issue i.e. risk of unidentified related
parties or related party transactions.
 Solution:
Significant related party transactions:
The auditor shall inquire of the management and others within the entity and perform
other risk assessment procedures considered appropriate, to obtain an understanding
of the controls, if any, that management has established to:
 identify, account for, and disclose related party relationships and transactions in
AT A GLANCE
accordance with the applicable financial reporting framework;

 authorize and approve significant transactions and arrangements with related
parties; and transactions and arrangements outside the normal course of business.
During the audit, the auditor shall remain alert, when inspecting records or documents,
for arrangements or other information that may indicate the existence of related party
relationships or transactions that management has not previously identified or
disclosed to the auditor.
The auditor shall consider the susceptibility of the financial statement to risk material
misstatement due to fraud or error that could result from the entity’s related party
relationships and transactions.
The auditor shall obtain the data from the management in respect of:
 associated companies
SPOTLIGHT
 Subsidiaries
 list of related parties’ personnel (as per the definition) in the International Financial
Reporting Standards;
The auditor shall inspect the following for indications of the existence of related party
relationships or transactions that management has not previously identified or
disclosed to the auditor:
 Bank and legal confirmations obtained as part of the auditor’s procedures;
 Minutes of meetings of shareholders and those charged with governance; and
 Any other records or documents as the auditor considers necessary (e.g. Form A,
Form 29, Register of members, Documents related to compliance with Code of
Corporate Governance etc.).
The auditor shall inquire of management regarding the following:
 The identity of the entity’s related parties, including changes from the prior period;
 The nature of the relationships between the entity and these related parties;
 Whether the entity entered into any transactions with these related parties during
the period and, if so, the type and purpose of the transactions;
 Ensure that all key management personnel and known related parties are included
therein.

The auditor shall review the extent and nature of business transacted with major
customers, suppliers, borrowers and lenders for indications of previously undisclosed
relationships.
The auditor shall review the significant transactions outside the normal course of
business, paying particular attention to the transaction recognized at or near end of the
reporting period and inquire of management:
 the nature of these transactions
 whether related parties are involved in these transactions
The auditor shall ensure that all related party transactions are disclosed appropriately
in the financial statements as per applicable financial reporting framework.
Where the controls over related party transactions are ineffective or non-existent and
the auditor is unable to obtain sufficient appropriate audit evidence about related party
relationships and transactions, the auditor will issue a qualified or disclaimer of opinion
as appropriate.
If the above procedures performed by auditor identify a material misstatement in the financial
statements, then the auditor will ask the management to make appropriate adjustment and in
case of disagreement will issue a qualified or adverse opinion as appropriate.
AT A GLANCE
You have been assigned the area of related parties in an audit of the financial statements of a
listed company where there are significant related party transactions.
Required:
Highlight what controls you would expect to be present in the company for the related party
transactions.
 Solution:
Ability of entity’s information systems to record, process and summarize related party
relationships and transactions to meet the accounting and disclosure requirements of the
framework;
SPOTLIGHT
Appropriateness of internal ethical codes communicated to the entity’s personnel and their
enforcement. They should also govern the circumstances in which the entity may enter into
specific types of related party transactions.
Policies and procedures for open and timely disclosure of the interests that management and
those charged with governance have in related party transactions.
Timely disclosure and discussion between management and those charged with governance
of significant related party transactions outside the entity’s normal course of business,
including whether those charged with governance have appropriately challenged the
business rationale of such transactions (for example, by seeking advice from external
professional advisors).
Clear guidelines for the approval of related party transactions involving actual or perceived
conflicts of interest, such as approval by a subcommittee of those charged with governance
comprising individuals independent of management.
Periodic reviews by the internal audit function.
Proactive actions taken by management to resolve related party disclosure issues, such as
by seeking advice from the auditor or external legal counsel.
The process for assessing whether the transaction is at arm’s length price or not.

8.3 Maintaining Alertness for Related Party Information When Reviewing Records or Documents (15-
16, A22-A25)
 Examples of Records or Documents Records or Documents That the Auditor May Inspect
 Third-party confirmations obtained by auditor (in addition to bank and legal
confirmations).
 Entity income tax returns.
 Information supplied by the entity to regulatory authorities.
 Shareholder registers to identify the entity's principal shareholders.
 Statements of conflicts of interest from management and those charged with
governance.
 Records of the entity's investments and those of its pension plans.
 Contracts and agreements with key management or those charged with governance.
 Significant contracts and agreements not in the entity's ordinary course of business.
 Specific invoices and correspondence from the entity's professional advisors.
 Life insurance policies acquired by the entity.
AT A GLANCE
 Significant contracts re-negotiated by the entity during the period.

 Internal auditors' reports.
 Documents associated with the entity's filings with a securities regulator (for example,
prospectuses).
 Examples of Arrangements that may indicate such existence
 Participation in unincorporated partnerships with other parties.
 Agreements for the provision of services to certain parties under terms and conditions
that are outside the entity's normal course of business.
 Guarantees and guarantor relationships.
In particular, the auditor shall inspect the following for indications of the existence:
SPOTLIGHT
 Bank and legal confirmations obtained as part of the auditor's procedures;

 Minutes of meetings of shareholders and of those charged with governance; and
 Such other records or documents as the auditor considers necessary in the circumstances of the entity.
Identification of Significant Transactions outside the Normal Course of Business

If auditor identifies significant transactions outside entity's normal course of business, the auditor shall inquire
management about:
a) The nature of these transactions; and
b) Whether related parties could be involved.
8.4 Identification and Assessment of the Risks of Material Misstatement Associated with Related Party
Relationships and Transactions (18-19, A29-A30)
Auditor shall identify and assess the risks of material misstatement associated with related party relationships
and transactions and determine whether any of those risks are significant.
In making this determination, auditor shall treat identified significant related party transactions outside the
entity's normal course of business as giving rise to significant risks.

8.5 Responses to Risks of Material Misstatement Associated with Related Party Relationships and
Transactions (20-22, A31-A33, A36)
Auditor designs and performs further audit procedures to obtain sufficient appropriate audit evidence about
the assessed risks of material misstatement associated with related party relationships and transactions.
Management has not appropriately accounted for or disclosed specific related party relationship /
transactions
The nature, timing and extent of the further audit procedures that the auditor may select to respond to the
assessed risks of material misstatement associated with related party relationships and transactions depend
upon the nature of those risks and the circumstances of the entity.
Diversified Businesses Limited is a listed company engaged in the business of manufacturing
paints, pharma and chemicals. During the planning stage of an audit, the auditor has found that:
The company has advanced a significant amount of Rs. 2.5 billion to a related party, for
construction of an office tower. In the notes to the financial statements, it has been stated that
transactions with related parties were carried out on arm’s length basis.
Required:
AT A GLANCE
Evaluate and discuss how the auditor should deal with the above situations.
Tutorial Notes:
Common errors could be mentioning the procedures except the following:
 Verifying the source of the internal or external data supporting the assertion and testing
the data to determine its accuracy, completeness and relevance.
 Evaluating the reasonableness of any significant assumptions on which the assertion is
based.
 Solution:
The auditor need to ascertain whether transactions with the related party have been
SPOTLIGHT
appropriately accounted for and disclosed in accordance with the IFRS and Companies Act, 2017.
Management’s assertion that the transactions were conducted on terms equivalent to those
prevailing in an arm’s length transaction may be materially misstated due to practical difficulties
that limit the auditor’s ability to obtain audit evidence that all aspects of the audit evidence are
equivalent to those of the arm’s length transaction.
 In order to address the above factors, the auditor shall:
- Inspect the underlying contracts or agreement.
- Determine the business rationale behind the transaction.
- Determine whether the terms of the transactions are consistent with management’s
explanations.
- Obtain audit evidence that the transactions have been appropriately authorized and
approved.
 The auditor will evaluate management’s support for the assertion of arm’s length
transaction, which may involve one or more of the following:
- Considering the appropriateness of management’s process for supporting the assertion.
- Verifying the source of the internal or external data supporting the assertion and testing
the data to determine their accuracy, completeness and relevance.
- Evaluating the reasonableness of any significant assumptions on which the assertion is
based.
 In addition to the above, we shall seek representation that management has disclosed all the
facts and documents related to the above transaction.

Identification of Previously Unidentified or Undisclosed Related Parties or Related Party Transactions

If auditor identifies arrangements or information that suggests existence of related party relationships or
transactions that management has not previously identified or disclosed, auditor shall determine whether the
given circumstances confirm the existence of those relationships or transactions.
If the auditor identifies related parties or significant related party transactions that management has not
previously identified or disclosed, auditor shall:
a) Promptly communicate the relevant information to other members of engagement team;
b) Where applicable financial reporting framework establishes related party requirements:
 Request management to identify all transactions with the newly identified related parties;
 Inquire why entity's controls failed to identify or disclosure such relationship or transaction;
c) Reconsider risk of existence of other related parties/transactions and perform additional audit
procedures;
d) If non-disclosure by management appears intentional, evaluate implications for the audit;
e) Perform appropriate substantive audit procedures.
AT A GLANCE
The financial statements of Modern Equipment (Pvt) Limited reveal that the company has paid a
donation of Rs. 15 million to a charitable organization where one of the directors of the company
is a trustee. The company has earned a gross profit of Rs. 40 million. The selling and
administration expenses including the donation amount to Rs. 60 million and as a result the
company has incurred a net loss of Rs. 20 million.
Required:
Discuss the possible impact of the above issue on the auditor’s report.
 Solution:
Since appropriate business consideration does not seem to be involved, mere approval by the
Board would not confirm that the expenditure has been incurred for the purpose of the
SPOTLIGHT
company’s business. If the auditor is unable to satisfy himself on the above issue he will have to
qualify the report by:
stating the brief facts of the case.
using the “except for” type of qualification, while certifying that the business has been
conducted in accordance with the objects of the company.
As the audit partner responsible for the audit of Mubashar Limited (ML), you have recently
issued an audit report on ML’s annual financial statements.
The audit senior involved in the audit of another client Salman Limited (SL) has informed you
that SL’s records indicate that it has made purchases worth Rs. 37 million from ML. Since the
same audit senior was also involved in the audit of ML he knows that SL and ML are associated
companies and ML had not disclosed any related party transactions in its financial statements.
This fact has also been confirmed from the working papers of both the companies. Payments
against these purchases were made in the name of ML by way of crossed cheques.
Required:
Discuss the factors that you will consider with reference to above and specify the action that you
would take in this regard.

Tutorial Notes:
Points to focus more may be as follow:
 Discrepancy mentioned in the situation could have been intentional as well as
unintentional.
 Some key issues like re-assessment of the risk of material misstatement in SL, possibility
of withdrawal from the engagement and the impact on audit report are also required.
 Solution:
Factors that should be considered and actions to be taken:
a) The amount of sales made to SL a related party is material (by nature) to the financial
statements.
b) We need to consider the reason for this event. The possible reasons are as follows:
i. It may be a deliberate attempt by ML to fraudulently siphon off funds by suppressing
the sales probably by the management itself or by any other employee.
ii. ML may have recorded the sale in the name of any other party with the intention of
non-disclosure of related party transaction.
AT A GLANCE
iii. The non-disclosure of related party transactions may be due to unintentional error
made by the management.
c) We shall discuss the issue with the management and if necessary with those charged
with governance and ask them to:
 revise the financial statements
 take steps to ensure that those in receipt of the previous financial statements are
informed of the situation.
d) If we establish that the revised audit report should be issued and the management has
not yet issued the financial statements to the shareholders, in this case we shall:
i. Carry out the audit procedures necessary for verification of amendment in the
SPOTLIGHT
ii. Extend the audit procedures regarding subsequent events, to the date of the new
audit report.
iii. Provide a new auditor’s report on the amended financial statements.
iv. Include an emphasis of matter paragraph or other matter paragraph reflecting such
amendment.
e) If financial statements have already been issued to the shareholders then we should, in
addition to the above audit procedures:
i. Review the steps taken by the management to ensure that those in receipt of the
previous financial statements together with the auditor’s report thereon are
informed of the situation.
ii. Notify the management and where necessary those charged with governance that
we would seek to avoid future reliance on the audit report, if the management does
not take appropriate steps to ensure that those in receipt of previously issued
financial statements are informed of the situation and does not amend the financial
statements.
iii. Seek legal advice in order to prevent the reliance on the audit report on the financial
statements, if in spite of our communication, ML’s management or those charged
with governance fail to take necessary steps to prevent reliance on the audit report
issued on the financial statements.

f) Under the specific law, regulation or the financial reporting framework where we are
permitted to restrict the audit procedures on subsequent event specific to the
amendment, we will mention an additional date in the audit report restricted to the
amendment that indicates that the audit procedures on subsequent events are restricted
to that specific amendment as mentioned in the relevant note. We would also mention
the fact in the emphasis of matter paragraph or the other matter paragraph that our
audit procedures on subsequent events are restricted solely to the amendment of the
financial statements as described in the relevant note to the financial statements.
g) If as a result of a misstatement resulting from fraud or suspected fraud, we feel that our
ability to continue performing the audit has been affected, we should:
i. Determine the professional and legal responsibilities applicable in the
circumstances, including the requirement to report the matter to the shareholders
or the regulatory authorities.
ii. Consider whether it is appropriate to withdraw from the engagement, and if we
decide to withdraw:
 Discuss with appropriate level of management and those charged with
governance, our withdrawal from the engagement and the reasons for the
withdrawal.
AT A GLANCE
 Determine whether there is a professional or legal requirement to report to the

shareholders about the withdrawal from the audit or the responsibility to
report it to the regulatory authorities.
 Discuss with the legal advisor about withdrawal from the engagement. Being an
associated company the management of ML may be in a position to influence
the decision of SL also. Therefore, the auditor should reassess the risk of
material misstatement in SL.
8.6 Identified Related Party Transactions Outside Normal Course of Business (23-24, A38)
Auditor shall:
SPOTLIGHT
a) Inspect the underlying contracts or agreements, if any, and evaluate whether:

i. The business rationale of the transactions suggests that they may have been entered into to engage
in fraudulent financial reporting or to conceal misappropriation of assets;
In evaluating the business rationale of such related party transaction, auditor may consider
following:
 Whether the transaction:
¯ Is overly complex (e.g. it may involve multiple related parties within a consolidated group).
¯ Has unusual trade terms e.g. unusual prices, interest rates, guarantees and repayment
terms.
¯ Lacks an apparent logical business reason for its occurrence.
¯ Involves previously unidentified related parties.
¯ Is processed in an unusual manner.
 Whether management has discussed nature of, and accounting for, such transaction with those
 Whether management is placing more emphasis on a particular accounting treatment rather
than giving due regard to the underlying economics of the transaction.

If management's explanations are materially inconsistent with the terms of related party transaction,
auditor is required to consider reliability of management's explanations and representations on other
significant matters. (ISA 500)
ii. The terms of the transactions are consistent with management's explanations; and
iii. The transactions have been appropriately accounted for and disclosed in accordance with the
applicable financial reporting framework
b) Obtain audit evidence that the transactions have been appropriately authorized and approved.
Assertions That Related Party Transactions Were Conducted on Terms Equivalent to Arm's Length
Transaction
If management has made an assertion in financial statements that a related party transaction was conducted on
terms equivalent to arm's length transaction, auditor shall obtain sufficient appropriate audit evidence about the
assertion.
Mr. Burhan is working as audit manager in a firm of Chartered Accountants. The audit teams have
brought the following matters to his attention:
AT A GLANCE
During the audit of Moon Limited, it has been noted that 40% sales are made to an associated
company on credit. The management claims that the prices charged by the company to the
associated company are set in accordance with the prevailing market. (06)
Required:
Explain how the audit teams should deal with the above situations.
Tutorial Notes:
Along with the issue of sales price and its comparison with market prices, credit terms and its
related implications should also be given weightage.
 Solution:
SPOTLIGHT
 The terms of the transactions with the associated company need to be obtained and
compared with market terms.
 If the price charged to the related party is not the market price seek justification from
the management and document, it appropriately.
 If credit terms are not comparable with those prevailing in the market, the transaction
with the related party may be construed as a financing transaction. In such case, ensure
that approval of shareholders through special resolution in accordance with Companies
Act has been obtained.
 If the entity is unable to produce relevant approval of the shareholders in respect of loan,
it will constitute a non-compliance with laws and regulations.
 The auditor shall consider the need to obtain legal advice.
 The auditor shall also evaluate the implications of non-compliance in relation to other
aspects of the audit, including the auditor’s risk assessment and the nature, timing and
extent of audit procedures.
 Ensure that transactions with associated company are approved and authorized by the
board of directors.
 If the transaction with associated company lacks logical business rationale, then
reassess the management integrity.
 Check whether the transaction has been disclosed as required under IAS 24 and other
statutory requirements.

8.7 Evaluation of Accounting for and Disclosure of Identified Related Party Relationships &
Transactions (25, A47)
In forming an opinion in accordance with ISA 700, the auditor shall evaluate:
a) Whether the identified related party relationships and transactions have been appropriately accounted
for and disclosed in accordance with the applicable financial reporting framework; and
b) Whether the effects of the related party relationships and transactions:
i. Prevent the financial statements from achieving fair presentation (for fair presentation
frameworks); or
ii. Cause the financial statements to be misleading (for compliance frameworks).
8.8 Written Representations (26)

Where the applicable financial reporting framework establishes related party requirements, the auditor shall
obtain written representations from management and, where appropriate, those charged with governance that
they have:
a) Disclosed to the auditor the identity of the entity's related parties and all the related party relationships
and transactions of which they are aware; and
AT A GLANCE
b) Appropriately accounted for and disclosed such relationships and transactions in accordance with the
requirements of the framework.
 Related Party Checklist - Extracts from ICAP Audit Practice Manual
System Evaluation
1. Inquire of management regarding:
 The identity of the entity’s related parties, including changes from the prior period
 The nature of relationships between the entity and these related parties
 Whether the entity entered into any transactions with these related parties during
the period and, if so, the type and purpose of the transactions
SPOTLIGHT
2. Inquire of management and others within the entity such as those charged with
governance, internal auditors, legal counsel and those dealing with significant
transactions outside of normal course of business, to obtain an understanding of the
controls, if any that management has established to:
 Identify, account for, and disclose related party relationships and transactions in
accordance with the applicable reporting framework
 Authorise and approve significant transactions and arrangements with related
parties
 Authorise and approve significant transactions and arrangements outside normal
course of business
Related Parties
1. Obtain from management personnel (or prepare) a list of all related parties (detailing
the name of related party, relationship with each party) and compare with the previous
year’s list and the shareholder’s records. Distribute the list of related parties to all staff
assigned to the engagement for their consideration while performing various audit tests,
and attach copy to this checklist.
2. If secondary auditors, consider obtaining representation from parent company
management as to the existence of related parties, consider enquiring of predecessor
auditors, or other firms involved in the audit, as to their knowledge of RPTs.

3. Document any affiliations directors or senior management have with other entities.
Related Party Transactions
1. Inquire of appropriate management personnel whether there were any transactions
with related parties (including significant transactions that occurred but were not given
accounting recognition).
2. Perform procedures to identify additional related parties and significant (over ____),
unusual, or nonrecurring transactions or balances involving related parties. Such
procedures could include:
 identifying major customers, suppliers, borrowers, and lenders, and significant
changes to these relationships.
 review of lawyer billings
 review of bank guarantees
 review of contract awards
 review of overdue receivables or payables

AT A GLANCE
review of investment transactions
 transactions at, or near, the year end
 review of transactions with unusual terms of trade
 consider where RPTs may have occurred but not changed
3. Where RPTs have been identified prepare (or obtain) a schedule, or a summary where
appropriate of these and obtain an understanding of the business purpose of the
transaction(s).
 examine invoices, agreements etc.
 examine approval for the transaction both by management and local shareholders
SPOTLIGHT
 obtain confirmation of any outstanding balances
 obtain information as to the financial standing of the related parties regarding out
 indicate whether disclosure is required or not
 agree with management
4. Where it is uncertain if the transaction is a RPT or not consider:
 obtaining confirmation of significant information directly from third parties
 obtaining further information and references on supplies or customers that
appearing
Transactions outside the Entity's Normal Course of Business
1. For identified significant related party transactions outside the entity’s normal course of
business:
 Inspect the underlying contracts or agreements, if any, and evaluate whether:
i. The business rationale (or lack thereof) of the transactions suggests that they
may have been entered into to engage in fraudulent financial reporting or
conceal misappropriation of assets.
ii. The terms of the transactions are consistent with management’s explanations.

iii. The transactions have been appropriately accounted for and disclosed in
accordance with the applicable financial reporting framework.
 Obtain evidence that transactions have been appropriately authorised & approved.
Arm's Length Assertion
2. If management has made an assertion in the financial statements to the effect that a
related party transaction was conducted on terms equivalent to those prevailing in an
arm’s length transaction, obtain sufficient appropriate audit evidence about the
assertion by performing procedures such as:
 Comparing the terms to those with unrelated parties.
 Engaging an external expert to determine market value and verify market terms and
conditions.
 Comparing the terms to known market terms for similar transactions.
Consider impact on the audit report
3. In forming an opinion, evaluate:
 Whether the identified related party relationships or transactions have been
AT A GLANCE
appropriately accounted for and disclosed in accordance with the applicable

financial reporting framework.
 Whether the effects of the related party relationships and transactions prevent the
financial statements from achieving fair presentation.
Communication with those charged with governance
Unless all of those charged with governance are involved in managing the entity, communicate
with those charged with governance significant matters arising during the audit in connection
with the entity’s related parties
You are the audit manager responsible for the audit of Mechanic Engineering Limited, (MEL)
SPOTLIGHT
which provides mechanical parts to different industries. The draft financial statements for the
year ended 30 September 2016 show profit before taxation of Rs. 150 million (2015: Rs. 200
million) and total assets of Rs. 1.2 billion (2015: Rs. 1.1 billion).
Presently following matters are under your consideration:
During the year, MEL has sold one of its buildings to Natasha (Private) Limited (NPL) at a loss of
Rs. 20 million. The building was purchased at a cost of Rs. 80 million seven years ago and was
depreciated @ 5% per annum on straight line basis. The minutes of the meeting of the Board of
Directors at which the sale was approved indicate that a director of MEL holds 20% shares in
NPL. However, the minutes also indicate that he did not vote on the transaction due to conflict of
interest.
Required:
Evaluate the above situations and determine the course of action in respect of each of the above
independent situations. (Reporting implications are not required)
 Solution:
The loss on disposal has reduced profit before tax by Rs. 20 million and is approximately 13.33%
of profit before tax and is therefore material. Moreover, the transaction is a related party
transaction due to 20% director’s holding in NPL.

Course of action:
Consider reasons for disposal of building.
Promptly communicate the relevant information of the related party transaction to
other members of the audit team.
Request management to identify all transactions with NPL for further evaluation.
Reconsider the risk that other related parties or significant related party transactions
may exist that management has not previously identified or disclosed to the auditor, and
perform additional audit procedures.
Review the appropriateness of depreciation policy. If it is not appropriate, then review
the remaining non-current assets to ensure that they are not impaired.
Investigate the influence of director with respect to the said transactions even though
he did not participate in the voting.
Inquire as to why the entity’s control over related party relationships and transactions
failed to enable the identification or disclosure of the related party relationships or
transactions.
If the non-disclosure by management appears intentional (and therefore indicative of
risk of material misstatement due to fraud), evaluate the implications for the audit.
AT A GLANCE
Obtain the following evidence:
 A copy of the sale agreement
 A copy of any valuation report carried out on the asset
 Evidence of receipt of the proceeds through the bank
 The calculation of the loss (this should be checked for accuracy)
 Ensure proper disclosure of related party transaction in the financial statement.
SPOTLIGHT

9. RISK ASSESSMENT - MIX QUESTIONS (ISA 315,240,550,520 & 570)

You are the audit manager in a firm of chartered accountants responsible for the statutory audit
of Hackney Pharma Limited (HPL) which is principally engaged in the business of manufacturing
and sale of pharmaceutical products.
Extracts from HPL’s statement of profit or loss for the year ended 31 May 2021 are as follows:
Description 2021 2020

---------- Rs. in '000 --------------
Sales 3,343,214 3,213,435
Sales returns (72,519) (73,202)
Sales - net 3,270,695 3,140,233
Cost of sales (1,895,590) (1,860,579)
Selling & marketing expenses (94,089) (93,629)
AT A GLANCE
During the planning meeting for the year ended 31 May 2021, HPL’s management informed you
about the recall notice issued in respect of HPL’s flagship product ‘Azteca’. The notice was
published in a local newspaper on 1 May 2021. The notice was issued on the advice of the drug
regulatory authority following complaints received with regard to development of unexpected
side effects in some users of the product.
Azteca is a patent product under the licensing agreement with Global Healthcare Laboratories
(GHL), a multinational company, signed in year 2017. Under the agreement, HPL manufactures
and sells Azteca for 10 years against payment of upfront license fee of Rs. 300 million. HPL is also
subject to penalties in case of use of substandard raw material in the manufacture of Azteca. The
raw material is imported from foreign countries. Currently, GHL is investigating the reason for
the defect/unexpected side effects.
SPOTLIGHT
The management has also informed you that this product recall has not only affected HPL’s sales
but has also created working capital issues. HPL took immediate steps such as commenced
negotiation with the bank for financing working capital and launched aggressive marketing
campaign in May 2021 to boost the sale of its other products.
Required:
Discuss the audit risks that exist in the above scenario and suggest the key audit procedures to
be performed in respect of identified risks.
 Solution:
S. No. Audit Risks Key Audit Procedures

(i) Understatement of  Inquire management and where applicable
provision for claim filed others within the entity including in-house legal
by the customers due to counsel about any court notices issued.
side effects developed  Read BOD minutes and correspondence
from the use of Azteca. between the entity and its external legal counsel.
 Review the legal confirmations to assess
whether all liabilities have been appropriately
disclosed.
 Obtain the list of claims filled by the consumers.


 Review legal expense accounts.
 Ask the management to make appropriate
adjustment/disclosure in the financial
statements if the legal advisor confirms the
existence of liability or contingent liability which
have not been disclosed in the financial
statements.
(ii) No provision or  Inquire management about any correspondence
understatement of or notice received from regulator.
penalties imposed by  Check whether management has recorded any
the regulator due to provision for penalties and review management
product recall notice. working to evaluate the reasonableness of
provision.
(iii) Understatement of  Review license agreement for clauses related to
provision of penalties fines and penalties.
from GHL due to use of  Read BOD minutes about discussion in this
AT A GLANCE
substandard raw regard.
material in
 Review management correspondence with GHL.
manufacturing of
product Azteca.
(iv) Understatement of  Inspect sales return ledger subsequent to year
provision of sales end.
return despite increase  Inquire management about the number of
in gross sales and batches for which product recall notice was
product recall. issued.
 Verify through production records and gate
inward notes that all the returned quantities
have been recorded as sales returns.
SPOTLIGHT
(v) Overstatement of sales  Obtain monthly sales break up from
to depict better picture management to check any significant increase in
to secure working sales close to year end.
capital financing from  Obtain monthly sales report from distributor to
bank. get reliance on secondary sales to retailers’ / end
users.
 Check collections from customers subsequent to
year end.
 Perform cut off testing of goods delivery note
and sales invoices.
Understatement of  Check vendor invoices subsequent to year end to
selling expense despite ensure management accrued all the expenses in
sales growth and current period.
aggressive marketing  Obtain the details of aggressive marketing
strategy. In fact, selling campaign launched and how much has been
expenses are expensed out this year.
approximately the same
as last year.
Incorrect foreign  Check that appropriate exchange rates used in
exchange translation translation of foreign currency.


while recording import  Check on a sample basis that any gains/losses
of raw material from arising on the translation of foreign currency are
foreign countries. correctly recognized as per the requirements of
IAS-21.
Impairment in  Check subsequent sales of product Azteca post
intangible license fees year end to access whether sales affected due to
due to recall of flagship product recall.
product Azteca and a  Assess the reasonableness of assumptions taken
significant decrease in by the management and discount rate used.
its sales.
 Ask the management to carry out the
Impairment in the value impairment test and review the work performed
of plant and machinery by the management.
due to decline in sales of
 Review the source data used by the
flagship product.
management for impairment testing.
 Consider involving auditor’s expert.
Overstatement in the  Ask management to perform the NRV testing of
AT A GLANCE
value of inventory of finished goods of Azteca.

product Azteca for not  Check whether provision for obscelence is
being recorded at lower recorded for entire lot of raw material held in
of cost or NRV. stock, if it is concluded that substandard raw
material was procured.
 Inquire from the management that whether the
raw material can be retuned back to its supplier.
 Inquire management whether it would dispose
the entire inventory now or it can re-sell the
inventory after rework.
 Verify the management’s working to assess the
SPOTLIGHT
authentication of estimated re-work cost.

You are the audit manager at Haroon Rahim and Company, Chartered Accountants responsible
for the audit of Fit Bit Limited (FBL) for the year ended 30 November 2020. FBL is a listed
company and is engaged in the manufacturing of fitness equipment and related accessories. FBL
sells its products all over the country through a chain of distributors.
The extracts from the draft financial statements for the year ended 30 November 2020 are as
follows:
2020 2019
------ Rs. in million ------
Revenue from sale of fitness equipment 71,000 70,000
Revenue from subscription of plans 30,000 -
Profit before tax 500 400
Property, plant and equipment 6,600 6,900
Intangible assets 1,000 250
Advance from customers 10,000 200
Stock in trade 16,000 15,800

During the month of October 2020, due to faulty pad used in a newly manufactured fitness
equipment, 60 accidents were reported where FBL had paid compensation aggregating Rs. 30
million. Upon identification of fault, the sale of this equipment was immediately suspended until
the matter was resolved in a month’s time. The entire compensation amount paid to customers
has been reported in the financial statements as receivable from a supplier who had supplied
such faulty pads.
On 1 January 2020, FBL launched a mobile application that generates personalized exercise and
diet plans considering an individual user’s physical and medical conditions. The application has
received an overwhelming response as large number of domestic and foreign customers have
subscribed for it. Following information is available in this respect:
The application was developed in-house with the support of a leading software house.
Each customer has an option to subscribe biannual or annual plan.
All the subscription plans are paid in advance; however, each subscriber has an option
to cancel the plan within 30 days and claim the refund of the entire subscription amount.
Required:
be performed in respect of the identified risks.
AT A GLANCE
Tutorial Notes:
Some of the students may fail to identify the risks relating to refund liability, warranty provision,
segment reporting, foreign tax regulation and their related audit procedures.
 Solution:
Litigations and claims:
Risks:
 Audit team might not be aware of any further claims filed against FBL despite the fact
that the company paid Rs. 30 million in damages to the customers.
Procedures:
SPOTLIGHT
 Send confirmation requests to FBL’s legal advisors.
 Consider engaging auditor’s expert for assessing the impact of the cases filed against the
company.
 Inquire the management or FBL’s legal counsel about how the management would deal
if any further claims are filed against FBL.
 Assess the potential impact of recognizing a charge or disclosing a contingent liability in
the light of IAS 37.
 Assess whether a penalty may be imposed on FBL by any government authority.
 Verify current and subsequent legal expenses incurred by FBL for identification of any
damage claim.
Write down of inventory to NRV:
Risk:
FBL might not be able to sell the affected equipment at current price levels or witness decline in
its sale price. Consequently, net realizable value of the equipment may be lower than its cost.
Procedures:
 Evaluate the cost of necessary changes required to be made in the current inventory of
the equipment, to bring them in a saleable condition.

 Review and test the procedures in place for comparing NRV with cost for each item of
inventory and assess whether appropriate changes have been made in the light of
current situation.
Refund liability:
Risks:
 The customers might return the faulty equipment or FBL may have to recall the sold
equipment.
 Provision of refund liability for cancellation of subscription plans may not be
appropriately made.
Procedures:
 Obtain management’s assessment and projections of the number of equipment which
may be returned by the customer or FBL may have to call them back.
 Obtain the number of subscribers whose trial period is yet to expire at the year end.
 Assess the adequacy of projections and assumptions used.
Warranty Provision:
AT A GLANCE
Risks:
Due to the faulty pads in newly manufactured fitness equipment, customers may file warranty
claims therefore the existing provision may not be adequate.
Procedures:
 Review warranty claims / payments after the balance sheet date
 Review any revised working which the client may have prepared.
 Consider the appropriateness of the model and assumptions used in the light of current
situation.
 Consider involving an expert to calculate the warranty provision to be included in the
SPOTLIGHT
Receivable from supplier:

Risk:
The receivable from supplier may need to be written off unless it is virtually certain that the
amount will be received.
Procedures:
 Discuss with the client the basis on which it has decided to book the receivable.
 Obtain the legal advisor’s opinion on the matter and the notice issued to the supplier.
 Review correspondence with the supplier.
 Review the contract with the supplier for identification of any clause related to
indemnification of damages.
 Send confirmation request to the supplier with regard to the receivable balance.
Segment reporting:
Risk:
New business segment i.e. offering monthly and annual subscription plan for customized
exercise plan may not have been disclosed in the financial statements as per IFRS-8.

Procedures:
 Obtain an understanding of the methods used by the management in determining
segment information.
 Ensure proper allocation of assets and costs among each segment.
 Review the reconciliations between segment information and consolidated information
to assess whether significant items are properly disclosed.
Intangible asset:
Risk:
Cost incurred for research and development of mobile application may not have been
appropriately accounted for.
Procedures:
 Ensure that all research has been recorded as period cost.
 Ensure that the criteria mentioned by IAS - 38 for capitalization of development cost has
been met.
 Inquire management about the completion of research phase and commencement of the
AT A GLANCE
development phase to evaluate appropriateness.
Foreign exchange translation:
Risk:
Since the company is exposed to foreign exchange translation due to subscription income from
foreign customers, gains and losses on translation of foreign currencies related to revenue
recognition and refund liability from customer may not be recorded correctly.
Procedures:
 Check on a sample basis that any gains/losses arising on the translation of foreign
currency are correctly recognized as per the requirements of IAS-21.
 Check that appropriate exchange rates are used in translation of foreign currency.
SPOTLIGHT
Revenue:
Risks:
 Revenue from sale of equipment may be misstated. This may be established from the
fact that despite there was no sales in an entire month, the annual sales revenue from
sale of equipment has increased from previous year.
 Advance received in respect of exercise plan subscription may inappropriately be
recognized as revenue in the current year.
Procedures:
 Perform analytical procedures over revenue from sale of equipment.
 Perform cut-off procedures to ensure that revenue has been recorded in the correct
period.
 Inspect the sales return after the year end and assess that whether they need to be
recorded in the current accounting period.
 Obtain the schedule of advance received from customers and ensure that timely
transfers are being made to revenue account.

Foreign tax regulation:

Risk:
Receiving of foreign subscription may lead to potential tax issues particularly as regards sales
tax. This could lead to unrecorded liabilities for sales taxes payable and potential misstatement
of revenue as a result.
Procedures:
 Obtain the details of countries in which the subscribers exist.
 Obtain an understanding of the tax laws applicable in those countries or the tax treaties
with those countries.
 Involve the firm’s tax specialist to obtain the knowledge of the foreign tax laws
applicable to FBL.
 Obtain a sample of foreign subscription and ensure that proper tax is
deducted/collected.
While conducting the audit of financial statements of Ghurair Limited, it has been discovered that
AT A GLANCE
the company has received a material amount in bank, recorded as sales. On inquiry, the finance
department has informed that this amount represents a price increase claim received from a
foreign customer. It has also confirmed that there is no previous history of receiving such claim
from any foreign customer. Documentary evidence relating to the transaction has been
requested but has not been provided yet.
Required:
Discuss the implications of the above transaction on the completion of the audit. Also recommend
the action(s) in this regard which the firm should take.
Tutorial Notes:
Students should not miss to identify the scenario as a possibility of money laundering.
SPOTLIGHT
 Solution:
Implications on the completion of the audit
There is a possibility that the above transaction may be illegal transfer of funds which may attract
the provisions of Anti-Money Laundering Act. Care must be taken during the remaining audit that
no-one tips off the client that their activity is being treated as suspicious.
The firm may take following further action in this regard:
Send direct confirmation to the customer to ascertain whether the amount received is
actually the price increase.
Communicate with those charged with governance if management is unable to provide
the records/information providing sufficient appropriate audit evidence.
Consider engaging some specialist within the firm who have the adequate knowledge of
dealing with and investigating money laundering activates.
Consider obtaining a legal advice on how to proceed with this matter and how to report
it to the relevant authorities.
If it is concluded that it is money laundering or have strong suspicion of money
laundering and there is doubt on management integrity, the firm may consider
withdrawing from the engagement.


You are the audit manager assigned to the audit of Astron Computers Limited (ACL) for the year
ended 30 November 2019. Following information is available:
The main business of the company is the importation of servers, laptops, desktop
computers, LCD screens and related accessories for sales to large customers and
retailers. ACL was incorporated in 2002 and operated profitably until 2016 when it
turned into a loss-making entity due to increased availability of refurbished computers
in the market.
Extracts from the draft profit and loss account:
2019 2018
Rs. in million
Sales 430 648
Cost of sales (388) (583)
Loss before taxation (32) (64)
Draft statement of financial position:
AT A GLANCE
Assets 2019 2018 Equity & liabilities 2019 2018
Rs. in million Rs. in million
Non-current assets Equity and reserves
Fixed assets 45 51 Share capital 6 6
Deferred tax 27 24 Reserves 27 50
72 75 33 56
Current assets Non-current liabilities
Inventories - in hand 97 90 Warranty provision 9 16
Inventories - in transit 12 7
Trade receivables 90 81 Current liabilities
SPOTLIGHT
Cash and bank 1 2 Payables 50 30
200 180 Provisions 172 138
Running finance 8 15
230 183
272 255 272 255
In June 2019, ACL decided to discontinue import and sale of desktop computers and LCD
screens and to concentrate selling servers and laptops. It also decided to introduce an
All-In-One PC which is not currently available in the refurbished market. To further
boost the sales, ACL has started offering extended warranties in addition to a two-year
warranty period for all of its products at a nominal increase in price. ACL is presently
negotiating with its bank to enhance the running finance facility in order to meet the
additional working capital requirements.
In September 2018, ACL had entered into contracts with two leading chains of schools
for supplying 20,000 desktop computers and LCD screens at a nominal margin. ACL has
already supplied 6,000 units before deciding to discontinue this product segment. ACL
is presently negotiating with the management of both schools to change the contract
from the supply of desktop computers and LCD screens to All-In-One PC. One of the
schools has agreed to this change while negotiations with other school is in progress. In
case, the other school does not agree to the change, ACL would either terminate the
contract by paying a penalty of Rs. 6 million or procure the remaining units from any
other supplier whose cost might be even more than the contract price.

In May 2019, ACL ordered desktop computer accessories at a landed cost of Rs. 20
million from a company based in Hong Kong. Due to the political unrest in Hong Kong,
the shipment was delayed for more than five months despite the ordered units were
manufactured on time. On discontinuance of the business of desktop computers and LCD
screens, ACL asked the manufacturer to cancel the order. However, the manufacturer
refused to cancel the order. In November 2019, the manufacturer shipped the ordered
units which were received by ACL on 2 December 2019. CEO has informed that
they are under negotiation with a local distributor to dispose of the entire desktop
computer accessories.
Required:
Discuss the audit risks that exist in the above scenario and suggest the key audit procedures that
you would perform to address those risks.
Tutorial Notes:
Students should not miss to identify the risks related to inventories in transit and their related
audit procedures.
 Solution:
AT A GLANCE
Going concern:
There is a risk that there is a material uncertainty related to going concern of ACL since:
 it is the third consecutive year in which the company is making loss and the revenue
has also fallen by 34% as compared to previous year.
 current liabilities exceed the current assets and the current ratio has decreased from
0.98 to 0.87.
Audit procedures:
 Obtain management assessment / future projections prepared justifying the use of
going concern assumption as appropriate in the financial statements of the
company.
 Analyse the assumptions used therein. The underlying assumptions used by the
SPOTLIGHT
management needs to be supported by the pertinent facts.

 Ensure that proper disclosure is given in the financial statements of the material
uncertainty and the management’s assessment.
 Read the minutes of the board meeting in which above issues were discussed.
Fraudulent financial reporting:
Since the company is planning to enhance the running finance facility and the results of
the company have also not been encouraging, there exists a risk of fraudulent financial
reporting to present better results for obtaining the loan.
Audit procedures:
 Understand and evaluate ACL’s financial reporting process and the controls over
journal entries and other adjustments.
 Review accounting estimates for consistency/reasonableness/un-biasness.
 Evaluate business rationale for significant transaction outside the normal course of
business.
 Evaluate the change in policies especially those related to subjective measurements.
 Perform analytical review of revenue and expenses.
 Perform cut-off test to check that the transactions have been recorded in the correct
period.
 Perform extensive substantive testing in areas with low control reliance.

Warranty provision:
There is a risk that ACL has not recognized the warranty provision correctly because the
warranty provision has decreased by almost the same percentage of the decrease in
revenue, despite the fact that ACL is offering extended warranties. Further, even if the
revenue decreases it is not necessary that the warranty provision would also decrease
because it also covers the sales of prior years.
There is also a risk that the price at which extended warranty is offered is recognized as
revenue at the time of sale.
Audit procedures:
 Obtain the working prepared by the management and consider the appropriateness
of source data and the assumptions used.
 Review the contracts/orders for the terms of warranty.
 Perform analytical procedures to compare the level of warranty provision year on
year.
 Consider involving an expert to calculate the warranty provision to be included in
the financial statements.
 Obtain an understanding of the management process for recording of revenue of the
AT A GLANCE
extended warranty.
 Ensure that the revenue for extended warranty is recognized over the warranty
period.
Inventories - in transit
The inventories in transit reported in the financial statements is Rs. 12 million whereas
the inventories ordered from Hong Kong only is worth Rs. 20 million. It appears that ACL
have not yet accounted for such inventory.
It also needs to be ascertained the value of the inventory at which it needs to be reported,
i.e. (either at cost or NRV).
Audit procedures:
 Obtain the documents of the import and shipment to assess whether the title has
SPOTLIGHT
passed to ACL or not.
 Obtain the correspondence with the local distributor to assess the price at which it
would be sold.
 Obtain the management assessment of the price at which it could be sold in the local
market.
 If the agreed price is lower than the cost, then request management to record the
inventory at the net realizable value.
Onerous contracts:
There is a risk that due to the increased cost, the pending orders may result in an
onerous contract and ACL would have to recognize a provision for the present
obligation.
Audit procedures:
 Obtain the correspondence with the school which has agreed to buy the new
product.
 Obtain and review the agreements with the other school and verify the termination
clause including the amount of penalty.
 Obtain and verify the price at which the desktop along with the LCD screens could
be purchased from some other suppliers.
 Ensure onerous contracts are appropriately recorded and disclosed in the financial
statements.

Deferred tax
Deferred tax asset can only be recognized to the extent that ACL expects that it would
generate sufficient profits to realize the benefit. In the given scenario it seems difficult
for the company to generate sufficient taxable profits in the near future to realize the
deferred tax assets.
Audit procedures:
 Review the management’s future projection of taxable profits.
 Assess the reasonableness of the assumptions used.
Foreign exchange translation:
Since the company is exposed to foreign exchange risk due to significant imports, there
is a risk that gains and losses on translation of foreign currencies are wrongly
credited/debited to purchases instead of charging to profit and loss account.
Audit procedures:
 Check, on a sample basis, that any gains/losses arising on the translation of foreign
currency are correctly recognized as per the requirements of IFRS.
AT A GLANCE
Trade receivables
Despite a significant decrease in sales, the debtor balances have increased. Furthermore,
the debtor collection period has increased from 1.5 months to 2.5 months.
Audit procedures
 Obtain aging of the receivable balances.
 Obtain confirmation from major customers.
 Review the subsequent recovery of trade receivables.
 Assess the adequacy of provision against overdue balances.
Inventory obsolescence
The inventory in hand has almost remained same despite a 34% decrease in sales.
SPOTLIGHT
Furthermore, the inventory turnover rate has increased to 3 months as compared to 1.8
months in the previous years.
Audit procedures
 Obtain aging of inventory and identify obsolete inventory.
 Review and test the procedures in place for comparing NRV with cost for each item
of inventory and assess whether appropriate changes have been made.
 From the inventory list, identify inventory from discontinued operations which
would have to be written down to the net realizable value.
Your firm has been appointed as the auditor of Best Industries Limited (BIL) for the year ending
30 June 2019. BIL is a listed company and has three production plants. Plants A and B
manufacture industrial chemicals whereas Plant C is used in manufacturing of various cosmetic
and skin care products.
The following information has been gathered by the audit team:
Ghufran is the CEO and holds, directly and indirectly, majority of the shareholdings in
BIL. There are seven other directors on the board who meet four times a year to approve
the quarterly financial statements and endorse the decisions taken by Ghufran during
the quarter.

Considering the decline in demand of the products, BIL has taken the following decisions
during the year:
 Close Plant B with effect from 31 August 2019. The public announcement of this
decision was made on 15 April 2019.
 Introduce a new incentive package for distributors in January 2019 to boost the
sales of industrial chemicals. The sales commission rate is dependent on achieving
the various annual target levels set by the BIL’s management.
 Launch a customer loyalty program in February 2019 in which customers are
awarded loyalty points on each purchase of cosmetic and skin care products from
selected retail outlets and online stores. The management believes that this
initiative would increase the demand of cosmetic and skin care products.
Staff at production and marketing departments are hired at low salaries but they are
given high annual bonuses on achieving their targets.
Last year, BIL was selected for tax audit in which the income tax department had
disallowed certain business expenditures. BIL filed an application against the order
issued by the income tax department. However, it lost the first appeal and has recently
filed a second appeal to the relevant income tax authority.
AT A GLANCE
Required:
Discuss the audit risks that exist in the above scenario and suggest the key audit procedures that
Tutorial Notes:
 Students should not miss to identify the risks of in-effective governance structure,
misstatement in opening balances, restructuring provision, impairment of inventory and
accrual of sales commission.
 Irrelevant risks (e.g. risk of going concern, etc.) should not be included in the answer.
 Logical rationale behind the risks also need to be discussed.
 Solution:
SPOTLIGHT
Opening balances
It is the first year audit and there is the possibility that prior year balances are materially
misstated, are not correctly brought forward and the accounting policies are not
consistently applied.
Procedures:
 Review the previous period’s accounting records and schedules to ensure that
opening balances have been correctly brought forward to the current period.
 If the predecessor auditor permits, review his working papers to ensure the
correctness of the opening balances.
 Obtain evidence from the procedure performed in the current period to provide
evidence relating to the correctness of opening balances and the consistent
application of accounting policies.
Ineffective governance structure
Ghufran being the majority shareholder and taking all the decisions, which are later on
endorsed by the board indicates that the board may be overly influenced by Ghufran.
This ineffectiveness may affect the company’s operational efficiency, control
environment, exposure towards legal and regulatory risks, etc.
The Board of Directors meets four times only for approving the accounts, there is a risk
that BIL may be in non-compliance of Code of Corporate Governance which require the
board to have other sub-committees of HR, risk, etc. and their related meetings.

Procedures:
 Inquire whether there is a formal and effective mechanism for an annual evaluation
of the board’s own performance, members of board and of its committees.
 Obtain the meeting minutes and evaluate involvement of other directors in the
decision making process.
 Obtain minutes of the different committees such as audit committee, HR committee,
etc., and evaluate their effectiveness in the strategic and operational decision
making.
 Inquire about the independent directors and their role on the board of directors.
 Inquire about the competencies, skills, knowledge and experience of the board of
directors.
Fraudulent financial reporting / management override of controls
Due to the dominant nature of Ghufran and ineffective governance structure there is a
risk of management override of controls.
Furthermore, there is an increased risk of fraudulent financial reporting as the staff in
production and marketing department receive low salaries but are given high annual
bonuses on achieving their annual targets.
AT A GLANCE
Procedures:
 Understand and evaluate BIL’s financial reporting process and the controls over
business.
 Perform analytical review of revenue.
 Perform cut-off test to check that the vouchers have been completely recorded.
 Evaluate the selection and application of accounting policies by the entity,
particularly those related to subjective measurements.
 Obtain the details of sales return after the year end.
SPOTLIGHT
Assets held for sale

There is a risk that the criteria for classification of non-current assets as held for sale is
not met resulting in in-appropriate accounting and disclosures.
In case the criteria for recognition as held for sale is met there is an inherent risk, due to
the high level of judgment, involved in estimating the fair value and the significant
carrying amounts of the assets and liabilities associated with it.
Procedures:
 Inquire from the management if any decision has been finally made for sale of the
plant.
 Read the minutes of the board meetings for confirmation of the above.
 Inspect the correspondence file or agreement if any with the prospective buyer.
 Assess whether plant is available for immediate sale and disposal within 12 months
is highly probable.
 Involve our own valuation expert to assist in evaluating the fair value of the plant.
 Evaluate the adequacy of the accounting and financial statement disclosures,
including disclosures of key assumptions, judgment and sensitivities.
Restructuring costs and liabilities
Since BIL has decided to close one of the chemical production plant and public
announcement has been made in this regard, there exists a risk that restructuring
provision might not be appropriately recorded and disclosed.

There is also a risk that the criteria for recognition of restructuring provision is not met
resulting in in-appropriate accounting and disclosures.
Procedures:
 Inquire from the management whether it has a detailed formal plan for
restructuring.
 Inquire whether the main features of the plan have been communicated to the
affected employees/parties.
 Inquire from the management whether they have started to implement the
restructuring plan.
 Review the working prepared by the client for restructuring provision and ensure it
has been prepared in accordance with IAS-37 along with the related assumptions.
 Obtain a list of all employees who have been made redundant and ensure that all of
them are included in the calculation.
 With the permission of the client, inquire from the terminated employees regarding
any agreed termination payments.
Sales commissions
Since the commission paid to distributors depends on achievement of annual targets,
AT A GLANCE
judgement would be required in assessing whether they would be able to meet their
targets and accruing the sales commission accordingly.
Procedures:
 Obtain an understanding of the contracts with the distributors.
 Observe the sales made subsequent to the year end.
 Inquire the process being followed by the management for recording sales
commission and assessing the reasonableness of management assumptions.
Loyalty programs
There is significant judgement involved in determining whether customers would make
future purchases and redeem their loyalty points. Therefore, there is a risk of material
misstatement in recoding revenues and associated liabilities resulting from such
SPOTLIGHT
transactions.
Procedures:
 Obtain an understanding the of the customer loyalty program and the management
process for recording revenues and the related obligations.
 Evaluate reasonableness of management assumption regarding the expectation of
point redemptions.
 Ensure that accounting has been done in accordance with IFRS-15.
 Consider using an expert for calculating the liability related to points redemption.
Tax liabilities
There is a risk of material misstatement due to the high level of judgment required to
assess the outcome of tax litigations.
Procedures:
 Obtain the opinion of Company’s tax advisor about the allowability of such
disallowances.
 Consider involvement of own tax specialist to understand the nature of these
disallowances and their point of view about the success in such type of cases.
 Evaluate the nature of disallowances and compare it with the company’s historical
track record in such types of cases.
 Evaluate the adequacy of the accounting / disclosure in the financial statement.

Impairment of plant and machinery

Decline in demand of BIL’s products is an indicator of impairment of the plant and
machinery. Therefore, there is a risk that the plant and machinery may have been
impaired.
Procedures:
 Obtain an understanding of management process related to identifying, estimating
and recording impairments for PPE
 Review the source data used by the management for impairment testing.
 Assess the reasonableness of assumptions taken by the management and discount
rate used.
 Consider involving auditor’s expert.
Inventory
There is a risk that that due to decline in the demand of BIL’s product, there may be
obsolete inventory which require to be written down to net realizable value.
Procedures:
 Obtain the aging analysis of inventory to identify any obsolete inventory which
needs to be written down to its NRV.
AT A GLANCE
of inventory and assess whether appropriate changes have been made in the light of
current situation.
You are the engagement manager in Hasan Abdali and Company, Chartered Accountants. One of
your clients is Falcon Limited (FL) which owns six shopping malls and four office building
complexes in different cities for rental purposes. FL also constructs and sells residential
apartments in major cities of Pakistan.
The following matters were discussed in the planning meeting of the audit for the year ending 31
December 2018:
SPOTLIGHT
CFO informed that FL has implemented a new enterprise resource planning system
(ERP). He stated that FL has successfully revamped the entire accounting system
through this new ERP.
A shopping mall located in Multan has been witnessing low turnout of customers. FL has
been trying to persuade its tenants for not vacating their shops and have offered that
they pay 50% of the rent and pay the remaining amount when conditions improve. Some
of the tenants have accepted FL’s offer and have formally negotiated a two-year
relaxation period.
FL’s head office was shifted to a central location in a newly constructed building. Two
floors of the building which were surplus to FL’s need have been rented out to MM
Limited (MML) which is owned by a director of FL. MML provides maintenance services
to various building projects. FL and MML have agreed that FL will not charge any rent
for the two floors in consideration for free maintenance of Multan shopping mall and the
head office.
Construction of four residential projects started during the year. The projects are in
various stages of completion. About 70% of the apartments have already been booked.
FL offers different terms to its customers depending upon which option they choose.
The balcony of one of the apartments constructed in 2012 fell off, severely injuring three
persons. The news surfaced in the media and caused severe criticism on FL and a show-
cause notice was also received by FL from a regulatory authority. FL’s management is of
the view that the construction was up to the required standards and the residents had
made some modifications which caused this incident.

Required:
be performed in respect of the identified risks.
Tutorial Notes:
Please read tutorial notes to this question only after attempting this question in writing. Some
of the common issues identified by examiner in the relevant examiner comments to this
“Majority of the students were able to identify the risks correctly but a common error was the
identification of going concern issue as a risk as there was no indication in the question which
could lead to doubt over the going concern status of the company. This error had serious
repercussions for the erring students as all their focus got shifted to this risk and they wasted
time in mentioning a number of audit procedures related to this risk and ignored some very
pertinent issues.
Majority of the students showed lack of clarity in identifying the audit procedures. At this stage
the students should realize that when they have identified any particular risk, they need to list
down discrete, appropriate and relevant audit steps to address the risk. For example, if a risk of
under provisioning for a specific obligation is present, the audit step can’t just say that auditor
AT A GLANCE
will ensure that proper provision has been made by the client.
A common error was with regard to implementation of ERP. The risk of improper
implementation was identified by almost all the students but procedures to address this risk
were not up to the mark. Many answers listed procedures to be done during testing phase of the
new ERP ignoring the fact that the system was already live and operational. Associated risk of
incorrect capitalization and amortization were also missed out generally.
Many students appeared confused about correct accounting treatment of the given situations.
The candidates cannot suggest appropriate audit procedures unless they clearly understand the
correct accounting treatment of a given scenario. This was obvious in case of revenue recognition
especially where company had offered tenants to pay 50% of the rent at a later time. Most of the
students failed to realise that this would give rise to long- term receivables which would have to
SPOTLIGHT
be classified as non-current asset and would also need recognition after discounting. Majority of
the students were of the view that only 50% of the rent which is actually paid would be
recognised as revenue.
Majority of the candidates were also not clear about the accounting issues to be faced where two
floors of the building were rented out to a related party i.e. that these floors could be classified
as property plant and equipment or as investment property, depending upon certain conditions.”
 Solution:
Risk of improper implementation of ERP:
Improper implementation of new ERP system creates the risk of generating incorrect
financial information and records.
There is a risk of improper capitalization of the cost of new ERP or the useful live for
calculating the amortization may not be appropriate.
Audit procedures:
 Check whether appropriate user testing was performed.
 Ensure that necessary action was taken on the basis of users’ testing results.
 Ensure that system was retested after incorporation of changes, if any, on the basis
of users’ testing.
 Ensure whether appropriate training was provided to users.
 Ensure that account balances have been properly brought forward in the ERP.

 Perform walkthrough and test of controls of the ERP.

 Involve the firm’s IT team for assessing the implementation and proper functionality
of the ERP.
 Ensure that criteria mentioned by IAS 38 for capitalization of cost has been met.
 Assess the reasonableness of the useful life of the new ERP.
Risk of decrease in fair valuation of investment property:
There is an inherent risk in the fair valuation of investment property because of the
estimates and judgements involved.
Audit procedures:
 Obtain an understanding of management process related to valuation of investment
property.
 Review the source data used by the management for the valuation.
 Assess the reasonableness of assumptions taken by the management.
 Assess the competence and objectivity of external valuers appointed by the
management.
AT A GLANCE
Risk of classification and impairment of receivables:

There is a risk that amounts due from tenants who have not availed the offer may have
incorrectly been classified as non-current assets and vice versa.
Furthermore, due to low turnout of customers and the fact that the tenants won’t be
paying 50% of the rent for two years, a provision of doubtful receivables may need to be
made against rent receivable.
Audit procedures:
 Inquire from the management how many tenants have agreed on the revised terms
and obtain the new agreements.
 Ensure that 50% of the amount agreed to be paid after one year is re-classified as
non-current assets.
SPOTLIGHT
 Ensure that long term receivables have been recorded at the discounted amount.
 Consider the reasonableness of the discount rate used.
 Ensure that appropriate provision has been made for doubtful receivables.
 Confirm the outstanding balance from the tenants.
 Ensure the reasonableness of the assumption used by the management for
forecasting the improvement.
Risk of related party transactions:
There is a risk of inappropriate classification of the two floors given to MML. The two
floors could be classified as PPE as well as investment property, depending upon the
conditions specified in the IFRS.
Letting out two floors to MML is a related party transaction. There is a risk that the
transaction with MML may have not been made on arm’s length. Moreover, the way the
agreement has been made poses a risk of incorrect determination of the amount of
revenue and expenses to be recognized.
Audit procedures:
 Obtain the agreement made with MML and evaluate whether the terms of the
contract are consistent with the management’s explanation.
 Consider whether the two floors are capable of being leased or sold separately to
assess that these have been classified correctly.

 If these floors are classified as investment property, assess whether the fair value of
the property has been determined appropriately. In this regard, assess the
competence and objectivity of the valuer, appropriateness of the assumptions used
and also consider hiring the services of auditor’s expert.
 Assess whether the transaction has been recorded at an appropriate amount.
 Consider whether the transaction has been made at arms-length and where these
are not at arms-length, appropriate disclosure is given.
 Ensure that the consideration in kind has been accounted for as per the
requirements of IFRS-15
 Ensure that proper disclosures are made in the financial statements, in respect of
this transaction.
Risk of revenue recognition:
There is a risk of error in recognizing the revenue from the construction of residential
apartments as different basis of recognition have been specified by the IFRS i.e. it is
either recognized at a point in time or over the period of completion. In case the terms
of sale agreement suggest that revenue should be recognized over the period then there
is a risk that the stage of completion may not be correctly assessed, resulting in over or
under statement of revenue.
AT A GLANCE
Audit procedures:
 Review the sale agreement and check that the basis of recording of revenue is
correct.
 Where the revenue is being recognized over the period of completion:
¯ Obtain an understanding of management process related to assessing the stage
of completion.
¯ Assess the reasonableness of assumptions taken and estimates made by the
management expert.
¯ Assess the competence and objectivity of the management expert.
¯ Consider engaging the auditor’s expert to assess the stage of completion.
SPOTLIGHT
 Ensure correct accounting and disclosure of the revenue, costs, assets and liabilities.
Litigation and claim:
There is a risk that a provision for damages may be required to be made in the financial
statements for injuries caused by fall of the balcony.
Further, if fault in construction is proved, a provision for repair cost/fine related to other
apartments may also be required.
Audit procedures:
 Send confirmation requests to FL’s legal advisors.
 Review the correspondence with the regulators and the minutes of the meeting to
gain an insight in the matter.
 Consider engaging own legal counsel.
 Ensure appropriate disclosure or provision in the financial statements, as the case
may be.
Risk related to negative publicity:
Due to the falling of balcony and the resultant media criticism, there is a risk of serious
damage to the reputation of the company.
Audit procedures:
 Discuss with the management, the impact of this event on the marketability of the
company’s existing projects.

 Review subsequent events to see whether there are any unreasonably high number
of cancellations or decline in bookings.
 Assess the impact of the above on the financial statements.
You are the audit manager of Saqib Shaukat and Company, Chartered Accountants, responsible
for the audit of Modern Electronics Limited (MEL) for the year ended 31 May 2018. MEL is a
listed company and is engaged in manufacture of wearable sports sensors, smart watches, GPS
navigation systems, vehicle cameras and fleet management system, and sells it through a chain
of distributors throughout the country.
The extracts of segment information as disclosed in the draft financial statements for the year
ended 31 May 2018 is as follows:
GPS Wearable All Total

navigation sports other
system sensors segments
2018 2017 2018 2017 2018 2017 2018 2017
-------------------- Rs. in million --------------------
AT A GLANCE
Revenue 6,323 7,978 4,119 5,319 3,480 2,346 13,922 15,643

Cost of sales (3,830) (5,158) (3,234) (4,149) (2,749) (1,643) (9,813) (10,950)
Gross profit 2,493 2,820 885 1,170 731 703 4,109 4,693
Net profit 1,141 1,244 257 351 133 282 1,531 1,877
Fixed assets 1980 2,329 2,395 2,661 2,777 1,662 7,152 6,652
Debtors 633 685 361 488 334 196 1,328 1,369
Inventory 640 665 378 444 294 196 1,312 1,305
The following information is also available:

SPOTLIGHT
MEL was witnessing a shift of customers from wearable sports sensors to smart watches
which have additional features as compared to the features being offered by sports
sensors. Therefore, to maintain its customer base MEL started developing its own smart
watch and successfully launched it in 2018. MEL intends to expand its product range in
the smart watch segment by expanding its manufacturing facility which would be
financed through a right issue.
On 10 April 2018 MEL publicly announced that it was closing an old (fully depreciated)
plant which was used to manufacture a component used in the wearable sports sensors
and will instead import it from China at cheaper rates. The management is considering
various options in respect of this plant. However, the affected employees were
communicated about the decision on the same date and negotiations with the labour
union were started for agreeing on the termination payments.
A significant portion of the sale of GPS navigation system consists of sale to the tourism
industry. The government had made it mandatory for all tour operators to install GPS
navigation system. The compliance has to be made by all tour operators over a period of
four years. Association representing the country’s tour operators had signed a four-year
agreement in April 2016 with MEL under which discounted sale price has been offered
to the tour operators which cannot be raised. A natural disaster destroyed the supplier’s
plant which supplied several components of the GPS navigation system and
consequently MEL has to import these components from Malaysia at twice the cost of
local purchase. At the year-end 200 contracts for supply of 4,000 GPS navigation systems
are still pending.

Required:
Identify the audit risks in the above situation and specify the key audit steps which you will
perform in respect thereof.
Tutorial Notes:
“Majority of the candidates were able to identify some of the risks but were unable to identify the
relevant audit procedures. Further, risks related to segment reporting, onerous contract and
foreign exchange translation were identified by few students only. A major issue with many
students was that they gave generalized steps such as “ensure that appropriate provision has
been made” instead of specifying what steps have to be taken in this regard. Some of the other
common issues are discussed below:
 With regard to overstatement of revenue / understatement of expenses, hardly any
student mentioned that the intention may be to show better results to be able to issue
right shares at a much higher premium. Moreover, the students seemed to be unaware
of the areas which should be scrutinized when such a risk is identified and only few could
AT A GLANCE
mention steps related to review of journal entries, accounting estimates, transactions
outside the normal course of business, etc.
 With regard to assets held for sale the review of board minutes and criteria for
classification of non-current assets as held for sale were rarely discussed.
 Somehow, a number of students wasted a lot of time in discussing the issue of going
concern which was hardly relevant as the company had earned substantial profits this
year as well as in the past also.
 With regard to segment reporting procedures for ascertaining whether any other
segment had fulfilled the criteria for being reported as a separate segment was
mentioned by few students only”
 Solution:
SPOTLIGHT
Following are the risks in the given situation and the related procedures which may be
undertaken:
Impairment of plant and machinery of wearable sports sensors
Risk:
A continuous decline in sales of this segment and the shift of customers towards smart
watches is an indicator of impairment of the plant and machinery of the wearable sports
sensors segment. Therefore, there is a risk that value in use of the plant and machinery
may have been reduced.
Procedures:
 Ask the management to carry out an impairment review (if not done already) and
obtain the working prepared by the management.
 Obtain an understanding of management process related to identifying, estimating
and recording impairments for PPE
 Review the source data used by the management for impairment testing.
 Assess the reasonableness of assumptions taken by the management and discount
rate used.

Overstatement of revenue / understatement of expenses:

Risk:
 MEL may be inclined to show better results so that it would be able to issue right
shares at a much higher premium.
Procedures:
 Understand and evaluate MEL’s financial reporting process and the controls over
 Review accounting estimates for consistency/reasonableness/unbiasness
business
 Evaluate the selection and application of accounting policies by the entity,
particularly those related to subjective measurements.
 Perform analytical review of revenue and expenses.
 Perform cut-off test to check that the vouchers have been completely recorded.
 Perform extensive substantive testing in areas with low control reliance.
Segment reporting:
AT A GLANCE
Risk:
The assets of all other segments are 34% of the total assets. There is a risk that fleet
management system, vehicle cameras or smart watches may fulfill the quantitative
criteria of being reported as a separate segment and management may not have
disclosed it as per IFRS 08.
Procedures:
 Inquire the total assets and revenues of each regularly reviewed segment of MEL
and verify the quantitative thresholds of being reported as a separate segment.
 Ensure that any segment meeting the criteria specified by IFRS is separately
disclosed.
 Review the reconciliations between segment information and consolidated
information to assess whether significant items are properly disclosed.
SPOTLIGHT
Assets held for sale

Risk:
There is a risk that the criteria for classification of non-current assets as held for sale are
met after the reporting period but disclosures in this respect are not made in the
Procedures:
 Inquire management if any decision has been finally made for sale of the plant.
 Read the minutes of the board of director’s meeting subsequent to the year end.
 Inspect the correspondence file or agreement if any with the prospective buyer.
 Assess whether plant is available for immediate sale and disposal within 12 months
is highly probable.
 If the criteria for classification of non-current assets as held for sale are met
subsequently, ensure that it is adequately disclosed in the financial statements.
Provision for staff termination
Risk:
Since MEL has made a public announcement of closure of the plant and has also
communicated the affected employees, a constructive obligation exists for recognizing a
restructuring provision. As the negotiations with the labor union has not yet been
concluded, there exist a risk that restructuring provision might not be appropriately
recorded.

Procedures:
 Obtain any working prepared by the client for restructuring provision.
 Ensure that the restructuring provision has been recorded in accordance with IAS-
37 and cost related to retraining & relocating of continuing staff has not been
included in the provision.
 Obtain a list of all employees who have been made redundant and ensure that all of
them are included in the calculation.
 Review correspondence with employees to establish the date, when the closure of
the facility was communicated to them in order to establish if this was before the
year-end.
 With the permission of the client, inquire from the terminated employees regarding
any agreed termination payments.
 Obtain the minutes of meeting held with the labor union to identify whether any
agreement has been reached subsequent to year end.
 Obtain management representation in respect of agreement with the labor union.
Onerous contract
Risk:
AT A GLANCE
There is a risk that due to the increased cost, the pending orders of GPS navigation
systems may result in an onerous contract and MEL would have to recognize a provision
for the present obligation.
Procedures:
 Inspect the Purchase agreement to identify the purchase cost. Also assess whether
all cost has been included that are part of inventory as per IAS-2.
 Check whether the revised landed cost exceeds the agreed sale price.
 If yes, then review the assumptions made by the management for the calculation of
expected future sales.
statements.
SPOTLIGHT
 Review the agreement and assess, whether MEL has a right to cancel the current or
future orders and any cancellation clause or penal provision for exiting the
agreement.
 Ensure that penalties if any and other legal costs etc. and duly considered in
determining the amount of provision required.
Inventory
Risk:
There is a risk that that due to the increased cost of manufacturing GPS navigation
system, the cost of inventory in hand may exceed it’s selling price and would require to
be written down to its net realizable value.
Procedures:
current situation.
Development cost
Risk:
Due to launch of smart watches, there is a risk that cost incurred for research and
development may not have been appropriately accounted for.

Procedures:
 Ensure that all research has been recorded as period cost.
 Ensure that the criteria mentioned by IAS - 38 for capitalization of development cost
has been met.
 Inquire from management about the ending of research phase and commencement
of the development phase and evaluate its appropriateness.
Foreign exchange translation risk
Risk:
Since the company is exposed to foreign exchange risk due to significant imports, there
is a risk that gains and losses on translation of foreign currencies are wrongly
credited/debited to purchases instead of charging to profit and loss account.
Procedures:
 Check on a sample basis that any gains/losses arising on the translation of foreign
currency are correctly recognized as per the requirements of International Financial
Reporting Standards.
Other risk
AT A GLANCE
The gross profit of all other segments has declined from significantly from 31% to 21%.
Procedures:
 Inquire from management and evaluate the reasons for such a decline.
You are the audit manager of Mehmood Auto Limited (MAL), a listed company, for the year
ending 31 December 2017. MAL assembles and manufactures a wide range of motor vehicles. All
motor vehicles sold by MAL are under warranty up to a mileage of 50,000 km and are also eligible
for free service every quarter for two years.
The extracts from the draft financial statements prepared by the management are as follows:
SPOTLIGHT
2017 2016
Rs. in million
Revenue from sales of motor vehicles 54,000 70,000
Revenue from sales of spare parts 1,500 1,000
Cost of sales (49,950) (63,190)
Gross profit 5,550 7,810
Assets
Property, plant and equipment 6,600 4,510
Deferred tax 233 194
Instalment sales receivables 1,200 700
Stock in trade 16,000 13,000
Other assets 13,817 15,476
37,850 33,880
During the course of the audit, you came to know that there have been 37 instances of serious
accidents involving newly manufactured cars where MAL had to pay compensation aggregating
Rs. 145 million plus cost of repairs amounting to Rs. 14 million.

An investigation into the matter has revealed that 15 such accidents were because of failure of
the brakes. The management has assured you that the fault has been identified and appropriate
corrective measures have been taken in this regard. However, you have noted that the entire
compensation amount is being shown as receivable from a supplier who has provided the brake
system.
Required:
Identify the audit risks in the above situation and specify the key audit steps which you will
perform in respect thereof.
Tutorial Notes:
While answering the question, major probable errors to be avoided are as follows:
 Not being able to identify the risks related to installments receivable, write down of
inventory, impairment of plant and proper segregation of revenue between revenue
from sale of cars and services revenue.
 Wrongly identifying the issue of going concern and deferred tax as the risks which is
inappropriate as the company is still earning substantial profits.
 Audit steps aimed at obtaining evidence to support completeness assertion might be
overlooked by many students.
AT A GLANCE
 Solution:
Following are the risks in the given situation and the related procedures which may be
undertaken:
Litigations and claims:
Risk:
 Even though the company has to pay Rs. 145 million in damages and Rs. 14 million
in repairs, there is still a risk that our audit team might not be aware of further
damage claims filed against MAL.
 There is also a risk that further accidents may occur or further cases are filed against
MAL after the balance sheet date.
SPOTLIGHT
Procedures:
 Send confirmation requests to MAL’s legal advisors.
 Consider engaging own legal counsel for assessing the impact of the cases filed
against the company.
 Inquire the management and MAL’s legal counsel about how the management would
deal if any further damage claims are filed against MAL.
 Assess potential impact of recognizing a charge or disclosing a contingent liability
in light of IAS 37.
 Assess whether a penalty may be imposed on MAL by any government authority.
 Verify current and subsequent legal expenses incurred by MAL for identification of
any undisclosed damage claim.
Impairment of plant and machinery
Risk:
 Sales of MAL has declined by 23% and is expected to remain under pressure in the
future also, because of the situation. Therefore, there is a risk that value in use of the
plant and machinery may have been reduced.
Procedures:
 Review the working prepared by the client relating to value in use.

 Assess reasonableness of assumptions taken by the management and discount rate

used.
 Consider involving auditor’s expert and obtaining a report about nature of fault in
production process and whether management’s claim, that it has been fixed can be
relied upon.
Warranty provision
Risk:
 In the given scenario, the probability / size of warranty claims may exceed the initial
estimate and therefore the existing provision may not be adequate.
Procedures:
 Review warranty claims / payments after the balance sheet date.
 Review any revised working which the client may have prepared.
 Consider the appropriateness of the MAL’s model and assumptions used in the light
of current situation.
 Consider involving an expert to calculate warranty provision to be included in
AT A GLANCE
Write down of inventory to NRV:

Risk:
 There is a risk that the company might not be able to sell the affected cars or witness
decline in its price, therefore there is a risk that net realizable value of the inventory
may be lower than its cost.
Procedures:
 Evaluate the cost of necessary changes required to be made in the current inventory
of the cars, to bring them in a saleable condition.
current situation.
Refund liability:
SPOTLIGHT
Risk:
 There is risk that the customers might return back cars or MAL may have to recall
sold cars.
Procedures:
 Obtain management’s assessment and projections of the number of cars which may
be returned by the customer or MAL may have to call them back and assess the
adequacy of projections and assumptions used.
Receivable from supplier:
Risk:
 MAL cannot record a receivable from the supplier until it is virtually certain that the
amount will received, therefore, there is a significant risk that receivable may need
to be written off.
Procedures:
 Discuss with the client the basis on which it has decided to book the receivable.
 Obtain the legal advisor’s opinion on the matter and the notice issued to the supplier.
 Review correspondence with the supplier.
 Review the contract with the supplier for identification of any clause related to
indemnification of damages
 Send confirmation request to the supplier with regard to the receivable balance.

Provision for doubtful installment sales receivable:

Risk:
 The sales for the year have decreased but the installments sales receivable has
increased. It indicates that there is a risk that more than usual number of
installments may have become overdue and might not be recoverable.
Procedures:
 Check aging of installments receivable and identify any overdue installments.
 Obtain confirmation from major debtors.
 Assess the adequacy of provision against overdue installments.
 Review the subsequent recovery of installment sales receivable.
Separate revenue for free service:
Risk:
 Providing free service after a certain mileage is a separate performance obligation.
As it is provided to all customers, it’s revenue should be recorded separately by
appropriately bifurcating the revenue from sale of cars. There is a risk that the
revenue may have been included in the revenue from sale of motor vehicles.
AT A GLANCE
Procedures:
 Identify the price at which such services are regularly provided to the customers to
assess whether the bifurcation has been made appropriately.
 Ensure that revenue from sale of cars has been appropriately recognized by
excluding the amount pertaining to provision of services which should have been
recorded as a liability.
Your firm is the external auditor of Namura Limited (NL), a listed company. Following
information has been made available to you at the planning stage:
Extracts from statement of comprehensive income
SPOTLIGHT
for the year ended 31 March 2017
2017 2016
Rs. in ‘000
Profit/(loss) before tax 161,990 (241,075)
Taxation (50,000) 74,000
Profit/(loss) after taxation 111,990 (167,075)
Extracts from statement of financial position

as at 31 March 2017
2017 2016
Assets Rs. in ‘000
Property, plant and equipment 1,472,690 1,475,000
Intangible assets 650,000 750,000
Investment in PCL Limited 75,000 250,000
Deferred tax asset 175,000 199,000
3,222,690 3,397,015

2017 2016
Equity and liabilities Rs. in ‘000
Share capital 700,000 700,000
Reserves (378,010) (490,000)
Long term debt 1,652,000 1,920,000
Current liabilities 1,248,700 1,267,015
3,222,690 3,397,015
In February 2017, the company has increased its product prices by 20% after consultation with
its legal advisor, which has resulted in additional revenue of Rs. 200 million. However, in March
2017, a Regulatory Authority has issued a show cause notice against the price increase and has
fixed a date for hearing at 28 June 2017.
In 2013, NL had developed a product, Vital, at a cost of Rs. 350 million. Vital is a premium product
which has a very large market with no significant competition. It was registered with the patent
registration authority in the same year. The total useful life of the intangible is estimated as 10
years. A competitor has recently announced the successful development of a product which is
expected to reduce the market share of Vital. NL’s marketing director has informed that the
AT A GLANCE
product would be launched by the end of next year.

Required:
a) Specify the information which you would like to obtain for evaluating the key issues
arising from the above scenario.
b) Assuming that all matters identified by you have been resolved to a larger extent and
you intend to issue an unqualified report, draft points to be included in the letter to those
charged with governance specifying the significant matters which you would like to
highlight.
Tutorial Notes:
The following mistakes should be avoided:
SPOTLIGHT
Part (a)
1. Instead of stating the information which the auditor would like to obtain, students may
try to identify the risks and in some cases, the procedures which would need to be
performed.
2. Not considering the need to obtain information about the lawyer’s opinion.
3. Some other key points may not be identified by many of the students such as grounds
on the basis of which the notice was issued, disposal of investment and the consequent
issues, information regarding the events occurring up to the date of the auditor’s
report, assumptions used for projecting future profitability and impairment testing,
etc.
Part (b)
1. Students may be unaware of what matters are to be reported to those charged with
governance.
2. Instead of mentioning the specific information based on the given scenario, selected
contents of ISA 260 may be reproduced by some students.
3. Wrongly discussing qualification of report though it is clearly mentioned in the
question that it may be assumed that all issues have been satisfactorily resolved.
4. A key point that the improved performance seemed mainly on account of price increase
and any adverse decision of the regulator with respect to price increase may have
serious consequences, can also be missed by many of the students.

 Solution:
Part (a)
I would like to obtain following information for evaluating the key issues arising from the given
scenario:
Going concern:
(i) Management’s assessment/future projections justifying the use of going concern
assumption.
(ii) Assumptions used therein.
Impairment of intangible assets:
(i) Patent agreement and the amortization policy.
(ii) Working related to impairment testing and the assumptions used therein.
Deferred tax asset:
(i) Projections of future profitability.
(ii) Assumptions used therein.
AT A GLANCE
Show cause notice:
(i) Grounds on which RA has issued the notice.
(ii) Legal advisor’s opinion on the matter.
(iii) Details of previous price increases, their basis and whether any approval was sought /taken.
(iv) Correspondence with the relevant regulatory authorities.
Investment in PCL:
(i) Reason for decrease in investment i.e. disposal, impairment, recording of loss/dividend
under equity method.
SPOTLIGHT
(ii) Gain/loss on such disposal and how was it accounted for.
(iii) Procedure followed to carry out the disposal.
(iv) In case of loss, impact on remaining investments, if any.
Other matters:
Information regarding the events occurring up to the date of the auditor’s report.
Part (b)
The following matters will be reported to those charged with governance:
Going concern:
 The entity has significant brought forward losses.
 Significant amount of liabilities is outstanding. The current liabilities exceed the current
assets of the company and the current ratio is only 0.68.
 Long-term debt is 5.13 times the equity.
 Although, the profitability, debt equity ratio and current ratio has improved this year, the
improvement is mainly due to the price increase. If the decision of the RA goes against the
company, the situation could become much worse.
 Key assumptions of the future projections provided by the management.

Decrease in carrying value of investment in PCL:

 Reason for the decrease and its implication (if any).
 Significance of the matter and any defect in the process followed to carry out the transaction.
Show cause notice by RA:
 Details of the notice issued by RA, its significance to the financial statements.
 Disclosure requirement in the financial statements.
Impairment of intangibles:
 Results of impairment testing and the key assumptions used.
Deferred tax:
 The recognition of deferred tax asset is subject to the availability of future taxable benefits.
 Key assumptions of the working provided by the management in respect of the above.
Your firm has been appointed as the auditor of New Cement Limited (NCL), for the year ended
AT A GLANCE
30 November 2016. NCL is a listed company which owns one of the largest cement plants in the
country. 60% of the company’s shares are owned by the same family. The CEO, CFO and Director
Operations belong to the family. Following are the extracts from the draft financial statements:
Extracts from statement of financial position
Assets Rs. in million

Property, plant and equipment 21,115
Deferred tax 270
Trade debtors 4,700
Other current assets 2,753
SPOTLIGHT
Equity and liabilities

Share capital 6,500
Reserves (1,462)
Surplus on revaluation of fixed assets 2,000
Non-current liabilities 13,000
Current liabilities 8,800
Extracts from statement of comprehensive income
Turnover – net 17,210

Gross profit 1,417
Operating loss (164)
Other income 223
Finance cost (1,560)
Loss before taxation (1,501)

Other information:
Sales have declined during the past two years because of lower exports, however, the
decline in exports has been partially offset by slightly higher local sales. The
management is hopeful of a significant increase in local sales in the coming years.
NCL’s debtors have increased by 25%. The debtors include an amount of Rs. 330 million
due from a government owned entity. The amount became due on 30 June 2016.
However, the amount has been rescheduled and is now recoverable in 6 equal
instalments over a period of three years.
On 1 November 2016, the management entered into a contract with a new supplier for
supply of its main raw material. The new supplier has offered 15% lower prices. The
contract with the previous supplier has been terminated. The audit team has also been
informed that a senior member of purchase department was fired in September 2016.
NCL revalues its plant and machinery after every three years. The last revaluation was
carried out in 2014.
The internal audit department comprises of five staff members including Chief Internal
Auditor, who is a Chartered Accountant. The Chairman of the audit committee is an
independent director. The internal audit department has carried out number of
assignments. The reports of the internal auditor include many good suggestions for
AT A GLANCE
improving the efficiency of the operations; however, they do not contain any serious
deficiencies/adverse comments in any area.
Required:
a) Briefly evaluate the overall control environment of the company.
b) Based on the above information identify areas of risk for the audit and the planned audit
approach.
(Note: Detailed audit procedures are not required)
Tutorial Notes:
The requirement is to evaluate the overall control environment which includes both the positive
and the negative aspects. Solution should cover positive aspects as well which include that
SPOTLIGHT
internal audit department is headed by a chartered accountant and chairman of the audit
committee was an independent member of the Board.
 Solution:
a) Evaluation of control environment:
 The Internal Audit department is headed by a Chartered Accountant whereas the
chairman of the audit committee is an independent director. These two factors are
positive and consequently are evident of strong control environment. However, at
the same time, it should also be kept in consideration that:
¯ NCL is a family owned enterprise and family members of the company are
actively involved in the management of the company. This may lead to the
possibility of management override of controls.
¯ The commitment to competence of management may appear to be weak as the
major positions in the company are assigned to the family members instead of
hiring professionals from the market.
 It seems that internal audit staff is under the influence of the family members as
their reports contain no serious issues or problems identified.
 Procurement policies and procedures appear to be weak as in the last month of the
year a supplier was hired offering 15% less rates as compared to previous rates. The
firing of senior member of the procurement department is an indication in that
direction.

b) Above discussed factors are indicating that NCL may lack effective and efficient internal
controls, resulting in weak control environment.
Risks Audit Approach
Use of going concern assumption  Obtain the management assessment
Although the company’s equity is positive, / future projections prepared
NCL’s current ratio is 0.85, which is quite low justifying the use of going concern
with reference to acceptable benchmarks; assumption as appropriate in the
and debt equity ratio is 65:35 which is very financial statements of the company
high and adverse and has incurred a loss of  Analyse the assumptions used
Rs. 1.501 billion which has completely wiped therein. The underlying assumptions
off the reserves of the company. used by the management needs to be
If the debt due from government is also supported by solid facts.
classified in the non-current assets, it will  Ensure that proper disclosure is
further deteriorate the current ratio. Further, given in the financial statements of
if the debt due from government bears no the material uncertainty and the
interest then it would further deteriorate the management’s assessment.
position.
If NCL’s performance follows the same track
AT A GLANCE
in the coming year then NCL might face

operating difficulties resulting in a material
uncertainty that NCL might not be able to
continue as a going concern in the coming
years.
Increase in receivable despite decrease in  Review the entity’s policy for
turnover: provision of doubtful debts.
Trade receivable might include slow moving  Check aging of debtors and identify
or doubtful debts as these had increased by any slow moving and doubtful debts.
Rs. 610 million excluding the effect of dues  Obtain confirmation from major
from Government entity, which is unusual debtors and check against ledger
SPOTLIGHT
due to decrease in turnover. This might result balances.

in overstated current assets and understated
provisions / bad debts and losses thereof.  Ensure proper disclosure and
accounting of Government owned
Dues from Government owned entity might
debts as per IFRS.
not be accounted for properly and may
exclude the effect of discounting.
Rescheduled loan from Government might be
classified in short term receivables.
Impairment in the value of plant and  Engage experts (management and
machinery: auditor’s) to revalue the property to
Due to decline in sales the value of plant and identify any impairment/decline in
machinery might be impaired which could surplus on revaluation.
result in overstatement of property, plant &  Review working for value in use, if
equipment, understatement of impairment necessary.
and overstatement of profits.
Risk of fraud: Operating results  Understand and evaluate NCL’s
NCL may be inclined to show better results to financial reporting process and the
the financial institutions from which it has controls over journal entries and
obtained financing. other adjustments and determine
whether they have been
implemented.

Risks Audit Approach

 Perform substantive testing in all the
areas with low control reliance.
 Perform cut-off test to check that the
vouchers have been completely
recorded.
Risk of fraud: Management override of  Test the appropriateness,
controls authorization and completeness of
As it is a closely held entity with majority journal entries recorded in the
shareholding owned by a single family and general ledger and other
with key positions occupied by family adjustments.
members, there is always a risk of fraud due  Use professional judgment to
to management override of controls. determine the nature, timing and
There is an increased risk of fraud as evident extent of journal entries testing and
from the termination of employee in other adjustments and assess the
September 2016, and working of internal completeness of the population
audit department as it is evident from their subject to testing
reports.
AT A GLANCE
Risk of misstatement in opening balances:  Review prior year working papers of
It is the first year audit and there is a the previous auditor.
possibility that prior year opening balances  Design audit procedures to provide
are materially misstated and are not evidence relevant to opening
correctly brought forward. balances.
Deferred Tax Asset:  Review the management’s future
Deferred tax asset can only be recognized to projection of taxable profits and
the extent that the company expects that it reasonableness of the assumptions
would generate sufficient profits to realize used.
the benefit. In the given scenario it seems
difficult for the company to generate
SPOTLIGHT
sufficient taxable profits in the near future to
realize the deferred tax assets.

During the course of audit of a brokerage house, following observations were documented in the
working papers.
Journal vouchers were not pre-numbered.
There was no mechanism for recording the phone lines of equity traders.
Margin requirements in case of certain individual clients were below the normal margin
requirements of 30%.
Required:
Identify the implications of the above matters which are to be included in the management letter.
 Solution:
Journal vouchers were not pre-numbered
 There could be no assurance that all JVs have been posted in the ledger.
There was no mechanism for recording the phone lines of equity traders
 In the absence of recording of phone lines, the transparency of deals executed by
the dealers cannot be ensured.
 There would be no recourse in case of a dispute or in case something goes wrong.

Margin requirements in case of certain individual clients is below the normal

margin requirements of 30%
 In case of any default by customer or crash of market, company will be required to
bear the losses.
 Excess financial charges or margin requirements are to be borne by the company.
 Maintaining margin requirements below the prescribed limits may attract legal
implications.
You are the audit manager of Diversified Products Limited (DPL), a listed company. Following
are the extracts from the draft financial statements for the year ended 30 September 2015.
Rs. in billion
Sales 95.0
Cost of sales 62.0
Total assets 150.0
Net equity 15.0
AT A GLANCE
Creditors * 10.4
Debtors * 10.5
Deferred tax asset 1.2
*Debtors and creditors have normal credit terms of 40 days

The company is engaged in polyester, pharmaceutical and fertilizer businesses. Performance of
each segment is discussed below:
Polyester Business (PB)
Major source of revenue is the export of polyester to European countries. PB has been
incurring losses since last five years. In 2014-15, PB incurred a loss of Rs. 600 million.
During the previous year, DPL had made a provision of Rs. 3.5 billion for impairment of
SPOTLIGHT
existing plant.
The major reason for losses is non-availability of gas. Accordingly, DPL had started a
project to convert its plant from gas to coal. The original completion date of the project
was 31 January 2015 but it has been extended by two years due to delay in financing
arrangements. A cost of Rs. 1.5 billion has been incurred on the project up to 30
September 2015.
Pharmaceutical Segment
The major source of revenue is the sale of medicines imported from Xanax International
Plc (XIP). Segment profit for 2014-15 amounted to Rs. 200 million. DPL is currently
negotiating with various suppliers to replace XIP because during the past few years XIP
has significantly increased the prices and has expressed its intention to increase it
further at the time of renewal of the contract, which is due in March 2016.
Fertilizer Business
The main source of income is the supply of fertilizers and pesticides. Segment profit for
2014-15 amounted to Rs. 700 million. Due to major floods in August 2015, the
Government has requested the fertilizer manufacturers to reduce their prices to support
the farmers in the flood affected areas and as an incentive, it has guaranteed the regular
supply of gas for the fertilizer factory.
Required
Discuss the audit risks based on the above situation.

 Solution:
Fraud Risk Factors:
a) Risk of fraud in revenue recognition:
There is a risk of overstatement of revenue as the management may be inclined to
show better results or because it is seeking financing for its Polyester Business.
b) Management override of control:
Management is in a position to perpetrate fraud because of its ability to manipulate
accounting records and prepare fraudulent financial statements by overriding
controls that otherwise appear to be operating effectively
Going concern:
The company might face going concern issues due to following reasons:
 The overall profit is only Rs. 300 million with a gross profit margin of around 35%.
Even a marginal decline in profit margin could bring significant losses.
 Profits would be under pressure in the coming years because of the following:
AT A GLANCE
¯ Impact of floods, as the Gas supply in fertilizer business is subject to lowering
of prices.
¯ Lower margins in pharmaceutical segment, which are not expected to improve
as XIP intends to increase the prices further.
¯ Company is already a highly leveraged company, obtaining more financing for
new plant will also have a negative impact on profitability of the company.
¯ Due to Flood, the fertilizer business of the company can be affected and
situation may not improve as the supplies may be affected in coming period.
¯ Delay in Obtaining funding for conversion of plant from gas to coal may
deteriorate the situation.
SPOTLIGHT
 Creditors’ turnover days are 61 as against the normal credit term of 40 days which
depicts that payment capacity of the company has weakened.
Impairment of plant and machinery:
Because of the delay in completion of coal to gas commission project, the company may
continue to incur losses. However, the value of the capital work in progress as well as
the existing plant and machinery relating to polyester business may have been impaired.
Although impairment was also recorded in 2014, however, since the completion of plant
has been delayed again by two years further impairment is possible.
Provision against value of stock:
Reduction in price of fertilizers as requested by the Government may adversely affect
the prices of company’s products and company may be required to book a provision
against impairment of stock.
Deferred tax assets:
Deferred tax asset can only be recognized to the extent that the company expects that it
would generate sufficient profits to realize the benefit. In the current scenario it seems
difficult for the company to generate sufficient taxable profits in the near future to
realize the deferred tax assets.

Foreign Currency Risk:

As the company is engaged in export of polesyter and import of medicines, the company
is exposed to significant foreign currency exposures which are required to be properly
managed.
You are the manager responsible for the audit of Chaudhry Packaging Limited (CPL) a listed
company, for the year ended 31 March 2015.
During the planning stage, the audit team has presented the following points for your
consideration:
During the year, after the death of previous chief executive, his son was appointed as the
new chief executive.
Sales of the company declined significantly during the first 10 months on account of
general economic downturn. However, sales in the last month showed improvement and
were 20% higher than the average sales of the previous months.
Deferred tax recognized on losses amounted to Rs. 170 million.
Scrap sales showed significant increase during the year.
AT A GLANCE
CPL experienced significant turnover in its management team.

Initial test of controls reveal that list of approved suppliers is not maintained. The
management is of the view that in order to get the lowest quotes any supplier is allowed
to quote prices and therefore a formal list of suppliers is not prepared.
Required
In light of the above facts identify the audit risks and the key audit steps to address them.
(Note: While describing the key audit steps, the answer should be restricted to a maximum of three
major points in case of each risk)
 Solution:
SPOTLIGHT
Audit Risks Audit Steps

(i) From listed company’s point of view,  These would be ensured specially by
the appointment of son of the previous checking that there are no control lapses,
Chief Executive, as a new Chief and controls have not been overridden
Executive is indicative of a closely held by CEO in specific instances.
entity, transparency of business might  Make inquiries about the changes in
be in doubts. control environment during the current
year and assess the latest situation.
 Ensure that legal requirements are
complied with respect to the
appointment/ remuneration of new
Chief Executive.
(ii) Sales may be overstated as it has  Send confirmations to debtors.
suddenly increased during the last  Checking recoveries made subsequent to
month of the year. the year end, analyzing and checking
subsequent sales return, comparing
them with last year and assessing their
reasonableness Checking cut-off.

Audit Risks Audit Steps
(iii) Deferred tax asset can only be  The auditor would be required to review
recognized to the extent that the the management’s future projection
company expects that it would reasonableness of the assumptions used
generate sufficient profits to realize and perform recalculation.
the benefit. There is a risk that the
company might be recording deferred
tax assets to overstate profits.
(iv) Increase in scrap sales may indicate  The auditor would be required to assess
the following: the reasons for increase in scrap sale by
performing the following:
 Abnormal losses and defected
inventory  review the list of Scrap sales to establish
its reasonableness.
 Inventory valuation issues
 Ensure proper procedure such as
 Scrap sales may be used to
obtaining quotations/ auction has been
transfer out funds from the
followed for scrap sales.
company illegally.
AT A GLANCE
 check segregation of duties in the
 Impairment in value of plant and
processing of sales and dispatch
machinery.
documents.
 Review the impairment testing done by
the client.
(v) Significant turnover in management  The auditor would be required to:

can also result in significant risk. In
case of high rotation, the  establish the reasons through inquiry;
responsibilities cannot be fixed. There  review of exit interview of ex-employees
might be some unethical and;
practices/fraud going on in the
SPOTLIGHT
company.  specially performing procedures on the
areas where there have been significant
turnover of employees.
(vi) Frequently switching suppliers is not  Consider changing the audit strategy for
itself a problem, but it does not mean extensive substantive procedures on
that a list of approved suppliers cannot areas such as:
be maintained. If totally new suppliers
really are being used so frequently,  Inventory valuation
then there might be issues with quality  Warranty issues
rather than price.
 Sales return subsequent to year end

You are the auditor of Reliable Generators Limited (RGL) for the year ended 30 September2014.
RGL is primarily engaged in the business of manufacturing and sale of generators. The generators
are supplied all over the country through a network of distributors.
On receipt of order from a distributor, the order is recorded electronically and transmitted to the
factory. 100% payment is received in advance. Following are the extracts from draft financial
statements provided by the client:

Income Statement for the Year Ended 30 September
2014 (Draft) 2013 (Draft)

-----(Rs. In '000')------
Revenue 60,222 59,638
Purchase 42,676 40,848
Gross Profit 21,249 19,681
Statement of Financial Position as at 30 September
2014 (Draft) 2013 (Draft)

-----(Rs. In '000')------
Trade Payable 1,653 1,895
Provision for Warrant Claims 1,265 1,193
Other related information is as follows:

AT A GLANCE
Effective 01 October 2013, in order to match its competitors, RGL has increased the
warranty period from 3 to 5 years.
A discount of 20% was offered to address issue of reduced demand witnessed in 3rd
quarter. As a result of discount situation improved significantly, during 4th quarter.
In August 2014, serious defects were discovered in one of the major components.
Consequently, significant quantity of such components was returned to the supplier.
However, return was recorded in September 2014 on receipt of supplier’s credit note.
Scanning of the suppliers’ ledger accounts revealed various payments for which no
satisfactory reply was given by the management. However, said amounts were
recovered before the year end.
Required
SPOTLIGHT
Identify and evaluate the audit risks in the above situation and how you would respond to these
risks.
(Note: Routine verification steps may not be mentioned)
Tutorial Notes:
“This question was poorly answered and candidates displayed lack of analytical ability. In most
cases, they missed out the fact that the question required them to identify the “risks” involved
rather than just giving comments on the financial information. For example, they mentioned
correctly that increase in gross profit is not in line with the decline in sales and special discount
allowed during the year; but could not assess as to what type of risk it posed and how it may be
addressed. Majority of the students missed an important risk i.e. the risk of misuse of company’s
funds by making payments and showing them as payment to suppliers and re-depositing them
near the year-end.
Further, many among those who were able to identify the risks, failed to mention how such risks
may be addressed. In this regard, a lot of repetition was also observed. Some students mentioned
routine verification steps which were not required.”

 Solution:
Audit Risks Auditor’s response

(i) Revenue  Evaluate and test the system for
There is a risk that revenue is overstated recording revenue
due to:  Inspect post year-end payments/credit
 Early recognition as customers pays notes for significant amounts to ensure
in full when placing an order. whether revenue is overstated or not.
 The increase in revenue by 1%, is  Review last minute adjustments and cut-
although immaterial, but requires offs more carefully to ensure that
attention due low sales between in revenue is not overstated.
3rd quarter and discount allowed.  Review overall sales reconciliation for
 The increase in gross profit margin the year (global) and carry out tests for
from 33% to 35% is also surprising in verification thereof.
light of the 20% discount granted on
sales between July and September
(ii) Purchases and trade payables  Evaluate and test the system for
AT A GLANCE
 There is a risk of understatement as recording suppliers’ invoices and
payables days have fallen from 17 to payments to suppliers
14 days and the gross margin has  Reconcile payables balances in the
increased purchase ledger with supplier
 Fall in payables despite the increase statements or consider direct
in purchase is something exceptional. confirmation where supplier statements
are not available
 On sample basis, match the inventory on
sample basis in the store with inventory
records in the accounts departments,
any difference found should be
investigated.
SPOTLIGHT
(iii) Warranty provision  Discuss with the client as regards lower
 There is a risk of understatement as than expected increase in provision and
the provision as a percentage of verify reasons provided by the client
revenue is the same as the previous with the related workings.
year. By the increase in warranty  Inspect board minutes for an indication
period, the provision of 2% is of problems with any of the company’s
expected to be increased keeping in products
view the quality issues and increased  Compare the warranty provisions with
warranty claims. those of similar companies.
(iv) Impairment of stock:  Discuss with client about the possibility
 The stock in hand might have been of defected components being used in
impaired due to the fact that the finished goods, or their presence in
although the significant quantity of the closing inventory.
defected component is returned to  If the client reply is affirmative, then ask
the supplier, there is a possibility that the management to make impairment
some defected parts might have been testing and accordingly adjust the
used in finished products and some financial statements.
defected parts might have been
remaining in the inventory.


You have been appointed as a manager in the audit department of Sachal Sarmast & Company,
which is a medium size firm of chartered accountants. The audit of Consumer Products Limited
has been assigned to you. This audit was previously assigned to another manager who has
resigned. The predecessor manager has identified a number of risks. Two such risks along with
their classification and related assertions are discussed in the working paper files. The relevant
extracts are as follows:
S. No. Risk Factor Type of Risk Related Assertions

(1) Decentralized operating Inherent Presentation and disclosures–
structure supported by Risk occurrence and right and obligation
different IT applications and completeness
(2) Financial Crises Significant  Accounts payable–rights and
Risk obligations, valuation and
completeness;
 Property and equipment–rights
and obligations;
AT A GLANCE
 Accounts receivable–valuation;
 Inventory–valuation;
 Cash–valuation;
 Turnover –occurrence
Required:
Do you agree with the above risk assessments? Discuss.
 Solution:
Decentralized operating structure supported by different IT applications:
It is classified as inherent risk, which is not correct, because it does not indicate a
SPOTLIGHT
susceptibility of an assertion about a class of transactions or account balance or

disclosures to misstatements.
Decentralized operating structure could potentially lead to misstatements in the
financial statements due to the following:
 Unintentional mistakes due to variety of applications holding the information and
the complexity involved.
 Potential frauds being committed by taking advantage of the complexities of the
system.
Therefore, it may be argued that this risk should be classified as a significant risk and in
certain circumstances even a fraud risk.
The noted assertions are correct, but the following should also be added:
 the occurrence, completeness, classification assertions for the class of transactions.
 The existence, rights and obligations and completeness assertions for yearend
account balances.
Financial Crisis
The classification of risk as a significant risk can be justified on its linkage with the recent
economic development; however, it would be more appropriate to classify the factors of
financial crisis into specific risks, depending upon

 How the financial crisis will affect the client and how does it translate into a risk?
This will vary depending on the industry sector in which the client operates; or
 How the financial crisis will impact certain portfolios/customers related to client?
The linkage with related assertions is too vague, because almost assertions related to all
areas have been included. The auditor should reassess the relevance of the risks to link
to the financial statement assertions and may need to reclassify the Related assertions
with respect to categories of risk.
You are the manager responsible for the annual audit of Tameer Limited (TL) for the year ending
31 December 2013. TL is a listed company and is engaged in the business of construction, renting
and selling of apartments and office buildings to individuals, businesses and government
departments.
Extracts from TL’s draft Profit and Loss Account are as follows:
2013 2012
(Up to Nov)
AT A GLANCE
---Rs. In million----
Revenue 1,520 1,883
Operating Expenses 1,165 -1,470
Operating profit 355 413
Financial charges 190 -225
During planning stage, audit team has presented following points for your consideration:
On 31 January 2014 tenancy agreements of office buildings rented to municipal
corporations in 15 small cities in the province of Sindh, are expiring. The concerned
departments have informed TL that they would not renew the agreements. These
SPOTLIGHT
properties are also held as security with the company’s bankers.
In August 2013, an apartment block which was completed and sold in 2009 was severely
damaged in an earthquake. The residents have filed a claim for damages against TL
amounting to Rs. 400 million. The company denies any liability in this regard. However,
to maintain its goodwill TL has agreed to compensate the residents by making a payment
of Rs. 100 million in four quarterly installments and accordingly this amount has been
provided in the accounts. The residents have rejected the offer and filed a suit against
the company.
During the year, construction equipment costing Rs. 300 million was acquired on lease.
The lease rentals were allocated to the contracts on the basis of time utilized. Lease
rentals pertaining to idle time were charged to financial expenses.
During the year TL sold a two story office building to Ali Limited. According to the
contract of sale, TL is entitled to construct further offices on the third and fourth floors.
Required:
Identify the audit risks that exist in the above scenarios and describe the manner in which you
would address those risks.
Tutorial Notes:

Rent agreements of 15 different properties were expiring subsequent to year end and
were not being renewed. Majority of the students jumped to the conclusion that this
issue may result in failure of the company to continue as going concern. This was not a
valid argument because the company had many other ongoing projects and it had earned
substantial profits during the year under review. However, it did pose the risk of
impairment in the value of properties which majority of the students failed to identify.
A building constructed by the company had been seriously damaged in an earthquake
and the residents had lodged a substantial claim. The company denied any wrongdoing
but as a gesture of goodwill, had offered to pay 25% of the claimed amount. The
performance here was much better as the students were generally able to identify the
risk of over or under statement of liability and the need to seek lawyer’s opinion and the
use of an expert for valuation of the loss. However, many candidates emphasized on
making appropriate provision without appreciating that a provision in excess of the
amount already agreed by the company would only be required if the loss is probable
and can be determined with reasonable accuracy.
The company had obtained a construction equipment on lease and the lease rentals were
being allocated to the contracts on the basis of time utilized whereas rentals pertaining
to idle time were being recorded as financial charges. The candidates were generally
able to identify the risk of misclassification of the lease and the need to verify whether
AT A GLANCE
the treatment was correct. However, many candidates did not identify the error
whereby the lease rentals pertaining to idle time were being charged as financial
expenses.
This was an interesting situation whereby the company had sold a two story building
but retained the right to construct the 3rd and the 4th floors. Majority of the candidates
failed to identify the risk of incorrect valuation of the company’s right of construction
and sale of 3rd and the 4th floors. Majority of them discussed accounting of construction
contracts which was not relevant.
 Solution:
Audit Risks:
The audit risks that exists in the given scenarios and the manner in which the auditor would have
SPOTLIGHT
to deal with them are discussed hereinafter:

Expiry of tenancy agreements
If the management of CL does not find any tenant after the expiry of rental agreements
with the municipal corporation there is a possibility that value of Investment Property
may be impaired.
Manner in which the risk is to be addressed:
 The auditor should ask the management to make impairment testing of the
Investment Property and make appropriate provision, if required.
 The auditor would need to assess the assumptions used by the management in
determining the fair value and whether the management has considered the effect
of expiry of tenancy agreements. If the assumptions applied are unreasonable or
does not include the effect of expiry of tenancy agreements, the auditor should
discuss and resolve the matter with the management.
 In case the auditor is not satisfied with the assumptions applied by the management
or the effect of such assumptions on the valuation he may consider hiring an expert.
Claim against destruction of apartment block
The claim for damages against the company is indicative of contingent liabilities that
may require provision or disclosure in the financial statements and there is a risk that
liabilities related to the alleged claim may not be recognized appropriately in the


 The petition filed by the residents and the basis of their claim would be reviewed.
 The information provided to the prospective buyers during the marketing campaign
would be reviewed to assess whether any claim was made by the company e.g. claim
regarding the building being earthquake proof etc.
 Legal opinion would be obtained from the company’s lawyers.
 A valuer may be consulted to assess the loss.
 If loss is probable and can be determined with reasonable accuracy management
would be asked to make a provision, otherwise a disclosure would be appropriate.
Construction equipment
The accounting treatment of allocation of lease rentals to financial expenses is not
appropriate. There is a risk of wrong classification of lease that may affect the operating
results and financial position of the company.
 It appears that TL is treating the leasing equipment as an operating lease. The
auditor should determine from the leasing agreements whether the lease is a finance
AT A GLANCE
lease or operating lease.
 If the auditor considers that treatment of lease is incorrect, the auditor should ask
the management to recognize the lease appropriately.
 In case of operating lease, recognizing of lease rentals pertaining to idle time in
financial charges is not appropriate. The auditor should ask the management to
charge the rentals to the overhead expenditures.
 If the lease is a finance lease, then the auditor should ask the management to
recognize it accordingly.
Construction of three story building
There is a risk that value of right related to use of land for construction of 3rd and 4th
floor is not valued and is not recognized appropriately.
SPOTLIGHT
 The auditor would need to assess how this right has been valued in TL’s financial
statements.
 The auditor would need to review the terms of the sale agreement relating to the
first two floors and assess the extent of rights available with the TL relating to the
use of building i.e. construction of third and fourth floor. If required a legal opinion
may be obtained.
 If appropriate, the auditor may obtain a valuation report to assess the value of the
rights available with the client regarding the rights presently attached with the
building.
 Based on the above information, the auditor would assess whether the accounting
treatment (carrying value of land) is appropriate.
You are the job in charge on the audit of Ghalib Petroleum Limited (GPL) for the year ending 30
June 2013. GPL is engaged in the exploration and production of crude oil. The last year’s audit
file contains the following information
 In 2005, GPL had entered into an agreement with the Government for exploration and
production of oil for fifteen years. The license for exploration was granted at a fee of Rs.
600 million.

 Under a separate agreement Mir Petroleum Limited (MPL), a 100% government owned
entity, had guaranteed the purchase of all crude oil to be produced by GPL for a period
of ten years from the start of commercial production i.e. 2008.
 The plant and equipment was imported in 2006 at a total cost of Rs. 6 billion which
includes a decommissioning provision of Rs. 500 million. The cost of the plant was
financed by GPL’s parent company by way of a long-term foreign currency loan.
During the current year’s planning stage, you have observed the following conditions:
The problem of circular debts has become severe and as a result GPL as well as MPL have
accumulated huge receivables and payables.
An environmental control agency has filed a suit alleging that at the time of abandoning
one of its oil wells, GPL has failed to restore the site in accordance with the prescribed
standards. The company believes that it has met all its obligations and plans to contest
the case strongly.
Due to law and order situation the Government has not been able to provide
infrastructure facilities as were agreed in the exploration agreement.
The management had budgeted a profit of Rs. 200 million for the current year but latest
AT A GLANCE
estimates suggest that profit would be somewhere between Rs. 100 to Rs. 120 million.
Required:
Identify and evaluate the audit risks in the above situation and specify the audit procedures that
Tutorial Notes:
“The situation given in this question pertained to a company engaged in oil exploration activities.
The company was faced with a difficult situation in which its profits were falling and its
SPOTLIGHT
receivables and payables had increased significantly. Certain other information was also given
such as terms of licensing agreement with the government, governments guarantee for purchase
of entire production of the company, a suit filed against the company and general difficulties
faced by the company in the given business environment.
An average performance was witnessed as the students were able to identify some of the risks
and actions required to be taken by the auditor. However, very few students could identify all the
major risks as the following were rarely mentioned:
 Foreign Exchange Translation Risk (due to long term foreign currency loan).
 Impairment of plant and machinery
 Under or over valuation of assets due to incorrect estimation of decommissioning costs.
 Over statement of profit, due to pressures on account of reduced earnings.
Many students seemed to have little understanding of the implications of the given information.
For example, while discussing that the company’s profits were significantly below the budget,
many students started commenting on the management’s ability to prepare the budgets and
importance of assumptions used etc. instead of relating it to the risk of misstatement in Profit
and Loss because of earning pressure on the management”

 Solution:
Audit risks:
Impairment of assets:
Values of license granted by the Government and the value of plant and machinery for
exploration purposes may be impaired due to the following:
 Government has not been able to provide the required infrastructure facilities due
to which the exploration work might be affected and GPL might not be able to obtain
the expected benefits from the use of plant and machinery.
 Due to the problem of circular debt, MPL may not be able to purchase oil as agreed
in the contract.
 Due to circular debt problem there is a possibility that amount of receivable from
MPL may be impaired.
Actions to be taken to address the risk:
 Review the exploration contract with the Government to assess whether it contains
appropriate clauses to address the situation.
 Ask GPL to carry out the impairment testing of the value of license and check the
AT A GLANCE
working thereof.
 Review the agreement with MPL and check what remedy is available to GPL in case
MPL fails to purchase oil from GPL.
 Ask GPL to calculate value in use, of the plant and machinery and check the working
thereof.
 Discuss with GPL’s its relationship with MPL and what measures MPL is taking to
resolve its liquidity issue and to ensure that it continues to purchase oil and make
regular payments.
 Review the measures that are being taken by the two companies and the
Government to resolve the circular debt issue.
 Ensure that in case there is a doubt about the recoverability of the amount,
SPOTLIGHT
appropriate provision is made in the financial statements.
 If the measures taken above indicate an impairment, ensure appropriate adjustment
Going Concern:
On account of MPL’s inability to purchase oil as agreed or to make payments there
against GPL’s may face going concern issues.
 Ask management to make its assessment of the entity’s ability to continue as a going
concern, if already not performed by the entity.
 Evaluating management’s plans for future actions in relation to its going concern
assessment.
 Where the entity has prepared a cash flow forecast. The auditor shall:
¯ Evaluate the reliability of the underlying data used in preparation of the
forecast.
¯ Determining whether there is adequate support for the assumptions used in
preparation of the forecast.
 Request written representations from management and where appropriate, those
charged with governance, regarding their plans for future action and feasibility of
these plans.

Foreign Exchange Translation Risk:

The company is exposed to foreign exchange risk as a major part of the cost of plant was
financed through foreign currency loan from a parent company and the value of foreign
currency loan may fluctuate due to fluctuation in the exchange rates.
 The auditor should ensure that year-end balance is accurately reported keeping in
view that the year-end balance may differ depending upon whether the client has
helped the risk or is maintaining an open position.
Undervaluation of liabilities:
The alleged suit against the company may be indicative of contingent liabilities that may
require provision or disclosure in the financial statements and there is a risk that
liabilities related to the alleged suits may not be recognized appropriately in the financial
statements.
 Obtain opinion of the legal advisor.
AT A GLANCE
 Ensure that proper disclosure or adjustment is made in the financial statements, in

accordance with IFRS.
Over/ Undervaluation of assets:
In case the undervaluation of liabilities (as discussed above) is probable it may be
indicative of the fact that the decommissioning provision in other case has also not been
estimated correctly and the related plant and machinery may be undervalued or
overvalued.
 Review the suit filed by the environmental agency and what other actions GPL
would need to take to become compliant.
SPOTLIGHT
 Review the prescribed standards related to the requirements of restoring the site.
 Ask the management to review the de-commissioning provision accordingly.
 Review the steps taken by management for re-estimating the amount of
decommissioning provision.
Overstatement of Results:
The latest estimates show that the company would fail to achieve the budgeted profit.
Therefore, there is a possibility that the management may be inclined to overstate or
manipulate the results in order to show better position of the company as compared to
the budgeted profits.
 Increase the extent of substantive procedures because the above factor would
increase the risk of material misstatement.
 Review last minute adjustments and cut-offs more carefully to ensure that the
accounts are not misstated.


You are the Audit Manager of Mustafa and Company, Chartered Accountants, responsible for the
audit of Standard Home Appliances Limited, a listed company.
Extracts from the company’s financial statements are presented below:
30- Sept- 2014 30- Sept- 2013

-----(Rs. In Million)------
Revenue 1,190 1,174
Gross profit 509 537
Operating profit 242 227
Finance charges -77 -69
Statement of financial position
Property, plant and equipment
1,054 833
AT A GLANCE
Inventory 423 260
Trade receivables 417 250
Cash and bank balances 29 54
Total assets 2,063 1,497

Share capital 1,000 1,000
Retained earnings 218 233
SPOTLIGHT
Long-term borrowings 277 50
Liabilities against assets subject to finance lease 180 -
Bank overdraft 185 52
Trade and other payables 203 162
Total equity and liabilities 2,063 1,497
During the year, the company has introduced various products based on latest technologies.
These new products are being manufactured on a new plant which has been acquired under a
lease agreement for a period of four years. The plant commenced operations on 01 January
2012.The useful life of the plant is 5 years.
Intangible assets represent cost of software installed and designs which have been acquired from
a renowned multinational company.
Required: Identify and evaluate the audit risks in the above situation.
Tutorial Notes:

“Extracts from financial statements were given along with information pertaining to acquisition
of a new plant and intangible assets (software installed). Students delved a lot on horizontal
changes with little focus on vertical analysis. Most of them were able to identify the apparent
risks such as impairment in inventories and debtor, liquidity issues, understatement of financial
charges. However, they were found lacking as regards the following:
 While discussing the liquidity, most of the students were concerned about the concept
of ‘going concern’. Although the liquidity position of the company seemed to have
worsened, yet, apparently there was no indication that it may lead to a going concern
issue.
 Most of the students were unable to identify the fact that operating expenses have
declined as compared to the previous year which was quite unusual in the given
scenario, i.e. when the company had introduced new products.
 Most of the students pointed out the risk of impairment of plant and intangible assets
but did not provide any significant reason to support their point of view. In fact, there
was quite an imminent risk of impairment in the value of plant because of the fact that
the overall sales had increased by only Rs. 16 million i.e. 1.5% despite the fact that
several new products were being manufactured on the new plant”
 Solution:
AT A GLANCE
Audit Risks:
Impairment of assets:
 A meager increase in sales by Rs. 16 million i.e. 1.4% against a capital expenditure
of approximately Rs. 200 million in property, plant and equipment and in intangible
assets, indicates that the new products have generated minimal sales or the sales of
existing products have declined.
 The minimal increase may indicate the impairment of plant specifically bought for
the manufacturing of new products or impairment in the value of existing assets and
of intangible assets including the software and designs which have been acquired
for new products.
SPOTLIGHT
Understatement of operating expenses: Operating expenses have declined by

13.87%. This seems unrealistic because the company had introduced new products and
installed a new plant, which should have resulted in an increase in the operating
expenses such as on advertisement costs and other sales related costs incurred on
launching of new product. Hence there is a risk of understatement of expenses.
Finance charges: The financial charges have increased by approximately 11.59%
whereas the debt on the company has increased by 6.20 times. This seems unrealistic
and there is a risk that some of these charges may have remained unrecorded.
Liquidity: The company’s liquidity position has weakened which is normal i.e. on
account of heavy expenditures on new product/plant. However, the situation has
worsened on account of a disproportionate increase in receivables and inventories as
compared to increase in sales.
MPCL is clearly relying on its overdraft to fund operating cash flows. Liquidity issues
may arise in future, especially when repayment of long term loan and lease payments
becoming due.
Current Assets: Inventories and receivables both have increased. As compared to
increase in sales amounting to Rs. 16 million the receivables have increased by Rs. 167
million and inventory Rs. 163 million which is approximately 67% and 63%,
respectively. Therefore, there is a risk that inventories and receivables might be
overstated. (Necessary provision may not have been made)


You have been appointed as the auditor of Tee Pharmaceuticals Limited (TPL) for the year
ended31 March 2012. An extract from the draft financial statements is presented below:
During the planning process, you have gathered the following information:
TPL’s operations were highly successful until 2008. However, due to increased
competition the profitability has reduced significantly over the last four years.
Consequently, the company has embarked upon an ambitious plan whereby it has taken
the following steps:
 Three new products have been introduced for which patent rights have been
purchased. The new products were introduced in the market in December 2011.
 A new plant has been acquired which is expected to reduce the cost of production
significantly.
 The above measures have been financed through a bank loan against hypothecation
of stocks and trade receivables.
TPL has had a dispute with a major distributor who alleges that products were delivered
in damaged packets and the quantities therein were short as compared to the numbers
AT A GLANCE
mentioned on the packets.
A franchisor has initiated a legal action against the company on grounds of
infringements of patent rights.
TPL had entered into a one-year agreement with a foreign supplier for supply of raw
material. On 20 April 2012 the government of the country in which the supplier is
registered, has initiated legal proceedings against that supplier for breach of quality
standards. Consequently, the government of the country in which TPL is operating has
banned all imports from that supplier.
Required
Identify the audit risks that exist in the above scenario and the manner in which you would
address those risks, during the audit under the following headings:
SPOTLIGHT
(i) Raw materials (ii) Intangibles(iii) Trade receivables (iv) Liquidity issues
 Solution:
Raw Material:
 Inventory of raw material may be overvalued and require provision for
obsolescence because raw material acquired from the foreign supplier may not be
used in production due to breach of quality standard.
 TPL may face shortage of raw material, if it is unable to find alternative supplier
from which the raw material can be obtained. The shortage of raw material may
affect the operations of the company.
 Review the reasons and reports based on which the Foreign Government has acted
against the concerned supplier;
 Ask client to determine the net realizable value of the raw material keeping in view
the risks identified above and review the clients working.
 Discuss with management about extent of reliance on the foreign supplier and any
alternative source of supplies.

 If the extent of reliance on foreign supplier is significant and TPL is unable to find
alternative supplier, assess the impact thereof on TPL’s operations.
Trade Receivables:
 An increase of about 20% in trade receivables and significant dispute with a
customer over packaging and short delivery issues indicate that some accounts
receivable might not be recoverable.
 An increase in Debtors Turnover days from 87 days to 101 days indicates the
existence of slow moving and doubtful debts, which may require provisioning.
 Obtain age analysis from the management to identify any long outstanding debts.
 Check subsequent recovery of debtors and obtain confirmation from major debtors.
 Discuss with management about the reason for increase in debtors’ turnover days
i.e. is it on account of lower collection or on account of change in collection policy.
 Consider adequacy of provisions.
AT A GLANCE
Intangibles:
 Legal case filed by the franchisor on account of alleged patent infringements
indicates that the value of intangibles may be impaired.
 Valuation of inventory may be also be impaired on account of patent infringements
 The legal case may lead to substantial fines and penalties.
 Review the agreement of patent with the franchisor and assignment deed.
 Obtain confirmation from the legal advisor relating to the possible outcome of the
case filed by the franchisor.
SPOTLIGHT
 Ask the client to calculate value in use, of the patents and check the working thereof.
 Consider the opinion of legal advisor to assess the impact of patent violation on the
valuation of finished goods.
Liquidity Issues:
 Although TPL had successfully negotiated with the bank by obtaining long and short
term loans, interest expense as a percentage of profit has increased significantly. It
could hamper the company’s ability to pay the finance charges and the principal.
Short term loans were obtained by hypothecation of the stocks and receivables. A
significant decline in the value of stock in trade and trade receivables is probable as
discussed in (i) and (ii) above. TPL’s bankers may ask the company to provide
further securities or to pay off the loan amount.
 Review the steps taken by the management of the company to counter the liquidity
problems faced by it.
 Review the projections of the company to assess whether the company will be able
to overcome the current liquidity crisis.
 If the steps taken by the management are not considered satisfactory consider the
impact thereof on the company’s ability to continue as a going concern.


Your firm has recently been appointed as the statutory auditor of Chaudhry Limited (CL) for the
year ending 31 December 2011. The previous auditors, from whom your firm has received
professional clearance, did not wish to be re-appointed as auditors.
CL is involved in the supply of imported consumer products. The company has its own retail
outlets in all major cities. It also supplies goods to large retailers most of whom are allowed 45
days’ credit.
Time required to import the goods is approximately two months. 50% of the amount is paid at
the time of booking of order and the remaining amount is paid at the time of receipt of goods.
The goods are required to be insured by CL.
CL’s suppliers are mainly based in Middle East. Due to political disturbances, a major supplier
has recently ceased its operations.
All imported goods are initially placed in a warehouse in Karachi. Supplies are made against
orders which are mostly received over telephone by the sales department. The warehouse in-
charge prepares a summary of all dispatches which is approved by the sales manager, on a daily
basis. Stock records are computerized. Physical stock taking is carried out on a regular basis, at
the warehouse as well as retail outlets. Therefore, a 100% physical count is not undertaken at
AT A GLANCE
the year-end.
Day to day expenses of the retail outlets are paid out of cash receipts from customers. Balance
cash is deposited into the bank on a daily basis.
The management accounts show that the company has not been able to achieve the sales target
for the current year although the sales have increased by 12% as compared with the same period
in 2010.Stocks and trade debtors have significantly increased and the management attributes
this to be on account of increase in sales.
CL is planning to expand its business and intends to fund the expansion through a bank loan. CL’s
existing bankers have declined to increase the borrowing limits and therefore, the company has
approached another banker for the loan. The management has requested you to complete the
audit by 15 February 2012 to enable it to submit the audited financial statements to the new
SPOTLIGHT
bankers.
Required
Identify and evaluate the audit risks in the above situation and specify the audit procedures that
 Solution:
Audit Risks
Opening Balances:
 There is a risk that opening balances may not have been brought forward correctly
from the previous year’s financial statements as this is the first year of audit.
 This risk is compounded by the fact that the retiring auditor was not willing to be
re-appointed.
 We need to review the previous period’s accounting records and schedules to
ensure that opening balances have been correctly brought forward to the current
period.
 If the predecessor auditor permits, review his working papers to ensure the
correctness of the opening balances.
 Audit procedures performed in the current period may provide evidence relating to
the correctness of opening balances.

 We also need to consider the reasons on account of which the retiring auditor is not
willing for re-appointment.
Foreign Currency Transactions:
As the imports of consumer goods will involve transactions in foreign currencies, there
is a risk that gains or losses on translation of foreign currencies are wrongly credited/
debited to purchases instead of charging to Profit and Loss Account.
Perform test of controls to ensure that any gains/ losses arising on the translation of
foreign currency are correctly recognized as per the requirements of International
Financial Reporting Standards and appropriate exchange rates are used in translation of
foreign currency.
Overstatement/ Understatement of purchases/ stocks/ liabilities:
Since all goods are imported and 50% advance is paid at the time of ordering, the amount
of purchases may be misstated resulting in misstatement of stock as well as payables.
 Check that purchases are recorded when all the risk and rewards of ownership are
transferred to the company.
AT A GLANCE
 Ensure that the amount of deposit is properly reconciled with the pending orders
and goods in transit.
Insurance in transit:
Goods in transit may not be adequately insured.
Review the insurance policies at year end and match them with the consignments in
transit.
Going Concern/Liquidity Issues:
 The company’s existing bankers have declined to provide financing facilities to the
company, which is indicative of a weakening relationship and risk of non-fulfillment
of covenants of borrowing.
SPOTLIGHT
 One of the major suppliers of the company has ceased operations. If the company is
unable to find a suitable replacement, the company’s results and liquidity may
suffer.
 Discuss with management and assess the significance of the supplies from that
particular supplier and the impact of disruption in supplies on the company’s
operations.
 Discuss and review the related documentation to ascertain the reasons on account
of which the company bankers had declined to provide further financing facility to
the company, and assess its impact on the company’s operations.
Overstatement of assets:
Increase in stock in trade and debtors may not be on account of increase in sales only.
There may be other reasons, such as obsolete stocks and uncollectible debtors.
 Review the stock count procedures and the related documentation and assess
whether adequate controls exist.
 Ascertain the management’s system of identification of obsolete and slow moving
stock and assess whether appropriate controls exist.
 Review age analysis of debtors to ensure that any long outstanding debt that
requires provisioning is appropriately identified and adjusted.

 Carry out substantive procedures (Confirmation, Aging Analysis etc.) based on your
assessment of controls.
Misstatement of sales/ stock in trade:
Sales and stock in trade can be misreported/ misappropriated due to the fact that sales
orders are taken over telephone and in the absence of strong controls over the
processing of orders, there is a risk that sales/stock in trade can be misappropriated/
misreported through collusion among staff members.
 Check whether summary of dispatches is confirmed with the list of orders by an
independent person.
 In the absence of proper segregation of duties between the approving and
initializing authorities and other related controls, we need to consider the impact
thereof on the extent of substantive procedures.
Unrecorded cash sales/ Misappropriation of cash:
 Cash sales can easily be misappropriated.
 Teaming and lading is possible since day to day expenses are adjusted before the
deposit of cash into bank.
AT A GLANCE
 Evaluate and test the controls over cash receipts, at the retail outlets.
 Perform analytical review on profit margins to identify any unusual trends.
 In case of weak controls, or unusual results of the analytical procedures the extent
of substantive testing may be enhanced.
Time schedule for audit:
Tight audit deadlines may restrict the:
 Extent of procedures that may be carried out.
 Time available for review of subsequent events.
Being a new client the restriction may represent a more serious threat.
SPOTLIGHT
Working papers should be independently reviewed by second partner, especially those
related to judgmental and high risk areas.
You are the audit manager responsible for the audit of Laila Pharmaceuticals Limited (LPL), a
listed company, for the year ended March 31, 2011. During your initial meeting with the chief
executive officer and the chief financial officer of the company the following issues have been
brought to your attention:
At the year end, the net assets of LPL have reduced to Rs. 270 million (2010: Rs. 310
million). A comparison of the draft income statement with the declared results for the
nine months ended December 31, 2010 is as follows:
Nine month ended Year ended
December 31, 2010 March 31, 2011
Revenue 500 530
cost of sales -400 -477
gross profit 100 53
operating expenses -70 -90
financial charges -15 -20
operating profit /(Loss) 15 -57
gain on sale of property 0 20
net profit/(Loss) 15 -37

On April 1, 2010 LPL had acquired 45% shareholdings in Sohni (Private) Limited (SPL).
The spouse of a director of LPL is a director in SPL.
On May 1, 2010 LPL purchased new office premises from SPL for Rs. 40 million. In
January 2011these premises were sold to Anarkali Limited (AL), an associated
undertaking of LPL, for Rs. 60million. Subsequent to the sale, LPL signed a five years’
agreement with AL to acquire the office premises on a rent of Rs. 12 million per annum.
Required
Assess the above matters and discuss how you would address the related implications during the
course of the audit.
Tutorial Notes:
“In this question, a practical scenario was given. The students were required to identify the
important issues that they as an auditor, would need to consider and to elaborate as to how could
they address these issues during the course of audit. The performance was poor mainly on
account of the following:
AT A GLANCE
 Interim figures for the nine months were given along with the figures pertaining to the year-
end. Many students failed to read the question carefully. They produced the whole answer
on the presumption that these were comparative figures for two different years.
 Many students restricted their answers to issues pertaining to related party transactions.
Other issues were ignored.
 The fact that the sale for the last quarter, as depicted by the information provided, was only
6% of the annual sales, was seldom identified.
 Most of the students were able to pick the very obvious issues only. Very few candidates
seemed to have the ability to explore those issues which were not very apparent”
 Solution:
SPOTLIGHT
Following are the important matters that the auditor would have to deal with:
a) Drastic reduction in sales:
Drastic reduction in sales indicates that the management may have misstated the
operating results disclosed in the financial statements for the nine months ended
December 31, 2010.
The auditor should evaluate the situation and if a misstatement is confirmed, the auditor
would need to reassess his initial risk assessment and revise the audit procedures
accordingly.
b) Inability of the company to generate operating cash flows:
Following are the factors that may indicate the inability of the company to generate
adequate cash flows from its operations:
i. Decline in net assets value by 13% because of net loss for the year;
ii. Selling of property to the associated undertaking under sale and leaseback
arrangement in order to generate cash inflows.
The auditor would discuss the matter with the management and those charged with
governance about their future course of action regarding the cash flows issues. If the
matter is not resolved or remains uncertain, the auditor should perform the additional
procedures to evaluate the appropriateness of going concern assumption.

c) Sale and leaseback transaction:

This transaction raises the following issues:
i. Whether it is an arm’s length transaction, especially in view of the fact that it
involves a related party.
ii. Whether the accounting treatment is in accordance with IAS-17
The above issues are discussed hereunder:
i. It seems that the transaction has not been entered in the ordinary course of business
as it is evident that:
 LPL earns 50% profit in a short period.
 Annual rental amount represents 20% of the sale proceeds.
The auditor would need to assess whether any undue favour has been allowed to
the associated company in order to book profit or to resolve the immediate liquidity
issue. If the answer is in the affirmative, the auditor would need to reassess his
initial risk assessment and consider revising the audit procedures accordingly.
ii. In view of the given information it seems that LPL has recorded the transaction as
AT A GLANCE
an operating lease. If this is the case, the decision to book the entire profit in the
current year may have been justified. However, the auditor needs to assess whether
the sale proceeds represent the fair value of the premises, on the date of transaction.
In case this is not true, the auditor should advise the management to record the sale
and profit, based on fair value and defer the remaining amount and amortize it over
the lease period.
In case, the auditor believe that the transaction should be recorded as a finance lease
the entire difference of Rs. 20 million should be amortized over the lease period.
d) Consolidation of Sohni (Private) Limited:
The auditor should be mindful of the fact that LPL may be exercising control over more
than 50% of voting power in SL through the spouse of the LPL’s director.
SPOTLIGHT
The auditor should discuss the above possibility with the management. If it is
established that the control exists either through the spouse of the director or due to any
other similar situation, he should advise the management to present consolidated
accounts.
e) Impairment testing of Investments in Sohni (Private) Limited:
Purchase of 45% investment in Sohni (Pvt.) Ltd. where spouse of a director of LPL is also
a director creates the doubt that transaction had not been made in the ordinary course
of business and its value may have been impaired
The auditor should ask the management to perform test of impairment and make
appropriate provision, if required.
f) Investment in associated undertaking:
The auditor should also verify whether all the requirements of the Companies
Ordinance, 1984 relating to investment in associated undertaking have been complied
with.
In this regard he should discuss the matter with the management and corroborate the
discussion with the relevant documents (e.g. minutes of the shareholder’s meetings).


You are planning the statutory audit of the financial statements of Mahiwal Limited (ML) for the
year ending June 30, 2011. ML sells and distributes networking equipment and accessories to
corporate and retail customers. Since January 1, 2009 ML has exclusive country-wide
distribution rights of ‘Bisco’ and ‘Portel’, which are the leading international brands of
networking equipment.
Your review of the prior year’s working papers has disclosed that ML has expanded its operations
significantly after securing the distribution rights of ‘Bisco’ and ‘Portel’. By June 30, 2010 there
had been a 60% increase in its customer base whereas the number of its branches had increased
from 3 to 10and the number of employees had risen from 30 to 115. The latest available draft
financial statements show that the sales of ‘Bisco’ and ‘Portel’ represent 90% of its total sales.
During a recent meeting with the finance director, you have been informed as follows:
ML has shifted its warehouse and customer service center to larger premises in order to
handle increased inventory level and the rising level of after sales warranty claims.
ML has witnessed a slight fall in sales of ‘Bisco’ and ‘Portel’ because of tough competition
from other low priced brands.
A review of the draft financial statements has also disclosed that ML had revalued a property in
accordance with the requirements of the International Financial Reporting Standards. The
AT A GLANCE
property was acquired many years ago to earn rental income.

Required:
a) Identify and evaluate the audit risks in the above situation.
b) Discuss an audit strategy to take into account identified risks in overall audit plan.
 Solution:
a)
Excessive reliance on two products
Sales of Bisco and Portel constitute 90% of its turnover. If ML is not able to sell any of its
product due to any reason (e.g. withdrawn of distribution right, launching of new
product by the competitor, etc), it would be difficult for ML to continue as a going
SPOTLIGHT
concern entity.
Rapid Growth
ML has experienced rapid growth over the period. This raises the following audit risks
 Effectiveness of internal control
ML increased its customer base significantly, increased its branch network, taken on
significantly more staff and moved its warehouse and customer service centre to
new premises. All these factors require appropriate changes in the control. If control
and systems have not grown with the company or internal control has been
inadequate there is a significant risk of errors and even fraud in the financial
statements;
 Cash flow considerations
¯ Because of the rapid expansion ML may have been overtrading, creating a risk
that it may not be able to generate enough working capital to finance its
operations.
¯ The situation will be further deteriorated by the additional fixed costs that ML
has committed while carrying out the expansion.
Inventory
 Obsolescence
¯ Increase in rising level of after sales warranty claims may be on account of
increased sales however it may also be indicative of manufacturing fault in the

quality of equipment. This may affect the value of inventory in-hand

particularly if the drop in sales experienced recently is indicative of the defect
being publicized.
¯ If the main products or products are ultimately found to be defective, it may
result in following issues:
 Impact on valuation of inventories decline in sales which may result in
accumulation of slow moving items
 high level of sales returns
 The risk of obsolescence will be considered “High” if ML does not have
recourse to the manufacturer in respect of defective inventory.
Provision for Warranty Claim
There has been an increase in sales warranty claim which may require significant
material provisions in the financial statements.
Valuation of Investment Property
Revaluation generally involves making estimates based on a number of assumptions.
Because of this reason, there is the chance that:
 professional valuer/ management may not be sufficiently experienced to make the
AT A GLANCE
assumption.
 assumptions may be manipulated by the Management to obtain the most favorable
fair value in the financial statements
b) Audit Strategy
i. The auditor should not seek to place heavy reliance on controls, and instead
undertake more substantive testing.
ii. A major audit risk in the income statement is the cost of wages and salaries,
particularly if controls have not been strong. There has been a high number of new
staff and if controls are weak, there is scope for errors and even fraud to have been
perpetrated.
iii. Risk related to cash flows as discussed above may have raised the going concern
SPOTLIGHT
issues. The auditors should carry out extensive going concern procedures.
You are the manager responsible for the statutory audit of Parrot Limited (PL), a listed company
engaged in the business of manufacture and sale of sports goods. It has three factories located at
Karachi, Lahore and Sialkot.
Summarized statement of financial position as of September 30, 2010 (unaudited) and
2009(audited) are as follows:
2010 2009
Assets
Property, Plant and Equipment 1960 2130
Investment in a subsidiary 520 590
2,480 2,720
Stocks 720 510
Debtors 530 330
Other current assets 280 210
1,530 1,050
Total assets 4,010 3,770

2010 2009
Paid-up capital 1,800 1,800
Accumulated losses -1,650 -1,350
150 450
Long-term bank borrowings 2,350 2,310
Creditors and other payables 1,510 1,010
Total equity and liabilities 4,010 3,770
PL acquired a subsidiary in 2005 which is engaged in the business of manufacture and
export of sportswear. The investment is recorded in PL’s financial statements under the
equity method. The last dividend was paid by the subsidiary in 2007.
During the physical count of stocks at Karachi on September 30, 2010 it has been
observed that stocks worth Rs. 100 million is obsolete and would require a provision of
20% to 30% of the carrying value.
AT A GLANCE
During the year, PL and its bank agreed to reschedule the loan on the following terms:
 Repayment date was extended from 3 years to 6 years.
 Rate of interest was increased from 1-year KIBOR + 3% to 1-year KIBOR + 4%.
 PL shall be required to maintain a current ratio of 1:1. In the event of non-
compliance of this requirement, the loan would become immediately payable.
However, on October 25, 2010, the bank agreed to waive this requirement.
Required:
a) Identify the risks that may result in material misstatements in PL’s financial statements.
b) Discuss the key areas on which you should place emphasis upon, to address the risks
identified in (a) above.
SPOTLIGHT
 Solution:
(a)Audit Risk (b) Key Areas on which emphasis to be placed

Investment in subsidiary:  The management should be asked to carry out
As the carrying value of the impairment testing by comparing recoverable amount of
subsidiary is declining, the subsidiary with the carrying amount of investment.
there is a risk that value of  The assumptions used in the impairment testing specially
investment appearing in for determining the value-in-use needs to be analyzed for
the books may be impaired. reasonableness.
 The management should also be asked to state the
investment in subsidiary in its Financial Statements at
cost or as per requirement of IAS-39.
Debtors: There is a  The ageing of the debtors needs to be carefully analyzed
significant increase in the and long outstanding debtors needs to be inquired with
debtors. Therefore, there is the management.
a risk of material  Circularize confirmations to the debtors and evaluate the
misstatement in case the response.
company fails to make
appropriate provision  Check subsequent payments received from debtors.
against doubtful debts.  Review the basis of provision against doubtful and assess
its reasonableness.

(a)Audit Risk (b) Key Areas on which emphasis to be placed

Stocks in trade: The  The need to employ an independent valuer may be
valuation of stocks at its considered.
NRV creates a risk that the  Check subsequent sale of obsolete stock in order to assess
company may not be able the amount of provision required.
to determine the degree of
obsolescence on a  Discuss the reasons of obsolescence of stock at Karachi
reasonably accurate basis and assess whether similar situation may be prevailing at
resulting in misstatement. other locations also.
 Review movement in stocks of material items.
Bank borrowings: The  All current assets and current liabilities should be
bank has rescheduled the analyzed for their completeness.
loans after imposing tough  In case any adjustment is required which resultantly (e.g.
conditions. There is a recording the stocks at NRV) reduce the current ratio
likelihood that FL will not from 1: 1, the loan should be classified as current
be able to comply with the liability.
term of borrowings related
to current ratio and loan  Reviewing outstanding creditors and assess:
AT A GLANCE
may become payable ¯ the company’s dependence on such creditor
immediately. ¯ risk of litigation
Going concern issue: The  Ensure that management performs an assessment of the
financial position and entity’s ability to continue as a going concern.
erosion of significant equity  Evaluate management’s plans for future actions in
creates the doubt that FL relation to its going concern assessment.
may not be able to continue
in business for foreseeable  If the entity has prepared a cash flow forecast, and
future. analysis of the forecast is a significant factor in
considering the future outcome of events or conditions in
the evaluation of management’s plans for future action:
¯ Evaluate the reliability of the underlying data
SPOTLIGHT
generated to prepare the forecast; and
¯ Determine whether there is adequate support for
the assumptions underlying the forecast.
 Request written representations from management and,
where appropriate, those charged with governance,
regarding their plans for future action and feasibility of
these plans.
 Consider whether any additional facts or information
have become available since the date on which
management made its assessment.

You are the manager in-charge on the annual audit of Decimal World Limited (DWL) for the year
ended December 31, 2009. DWL is a leading manufacturer of electrical appliances.35% of its
shares are held by Binary Pakistan Limited (BPL). However, with the help of some consenting
shareholders, BPL has been able to nominate 5 out of 8 directors on the Board.
During the planning phase of the audit you became aware of the following matters:
a) A foreign investor has made a public offer to purchase 51% shares of DWL at a price of Rs.
13 per share. The share price has ranged between Rs. 12 to Rs. 14 per share during the past
six months.

b) The company’s statement of financial position includes a deferred tax asset of Rs. 30million
on account of unutilized tax losses which have accumulated during the lossmaking period
1999-2004. The management is of the view that future taxable profits would be sufficient to
utilize the available tax losses.
c) DWL has established an e-commerce division to sell its products through internet. This new
division is administered centrally by the head office. This step has been quite successful as
the online sales have risen to 20% of the total sales during the year.
Required:
Identify and explain the audit risks which the auditor should consider while planning the audit
of DWL. Also highlight the key areas on which the auditor should place emphasis upon, to address
the above risks.
 Solution:
a) Audit risk
Pressure to maintain the earnings
i. The management of DWL is under pressure to maintain the earnings of the company
in order to keep the share price of the company over Rs. 12.5 so that the offer of
foreign investor will not attract the small investors.
AT A GLANCE
ii. The areas requiring the auditors’ attention are as follows:

iii. revenues are recorded correctly as to amount and period.
iv. inventories are properly valued and recorded in the correct period.
v. all expenses and provisions are recorded correctly as to amount and period.
b) Audit risk:
Recoverability of deferred tax assets
i. Under IAS-12, deferred tax assets can only be recognized when it is probable that
taxable profits will be available against which the deductible temporary differences
can be utilized. The company will therefore need to show that future profits will be
generated for the unutilized tax losses to be offset against. If this is not possible, the
deferred tax asset should be limited to the amount of profits that can be measured
with reasonable certainty.
SPOTLIGHT
ii. The main areas which require auditors’ attention are as follows:
a) The income tax provisions related to carry forward of tax losses and their
adjustment against future profits.
b) Amount of future profits and reasonableness of such forecast.
c) Audit risk
Issues relating to e-commerce sales
i. Risk of non-compliance with taxation, legal and other regulatory issues
ii. Risk of technological failure resulting in business interruption
iii. Loss of transaction integrity
iv. Risk of frauds by customers and employees
v. Risk of application of improper accounting policies in respect of capitalization of
costs such as website development, translation of foreign currencies, allowances for
returns, revenue recognition., etc.
vi. The main areas which require auditors’ attention are as follows:
 The effect of e-commerce model on the existing accounting policies
 The adequacy of internal controls in place.
 Process alignment. It refers to the way various IT systems are integrated with
one another and thus operate, in effect, as one system.
 Key security issues and how the management intends to address them
 Legal issues and opinion of the legal advisors.


Mr. Ansari who represents ABC & Company, Chartered Accountants, is the manager responsible
for the first year audit of Stello Limited (SL) for the year ending December 31, 2009. Previously
the financial statements were audited by a very well reputed audit firm. ABC & Company has now
been appointed as the auditors, in pursuance of SL’s policy according to which the statutory
auditors are to be rotated after every five years.
While reviewing the working papers at the planning stage, Mr. Ansari became aware of the
following facts:
Background
The main business of the company is the operation of smelting plants that produce steel from
iron ore. The company was founded almost five years ago by a group of entrepreneurs. Its
managing director is Mr. Sami who has vast experience of working in reputed national and
international companies. Since inception, the company has experienced exceptional growth. To
generate funds for some of its future plans, the management is considering to get the company
listed before December 2010. The management expects to raise Rs. 700 million by issuing 50
million ordinary shares at a premium of Rs. 4 per share.
Management Policies
AT A GLANCE
The company has developed a sound system of Corporate Governance. Most of the executive
heads are experienced professionals. The company believes in employing a satisfied workforce.
In addition to competitive market based salaries, it also offers performance based bonuses at all
levels, including the senior management.
System of Accounting and Controls
The review of working papers indicates that the company has developed a sound accounting and
reporting system. The company has recently installed a state of the art accounting software.
However, as regards the system of disposal of scrap, the concerned engagement team member
had made the following observations:
 The sale and disposal of scrap is managed by Mr. Sultan who is an Assistant Manager and
SPOTLIGHT
reports to the Senior Manager Marketing.
 The scrap generated is collected by a local merchant on a daily basis. The rate is
negotiated by Mr. Sultan once every three months.
 Only Mr. Sultan is authorized to sign the gate pass but quite often, in his absence, it is
signed by the delivery clerk.
Operating Results and Projections
The compound annual growth in company’s earnings over the last three years has exceeded20%
per annum and the projected earnings growth for the year ending December 31, 2009 is in excess
of 35%. The growth is mainly on account of profitable contracts which the company has secured
with two local manufacturers. Some of the important events that have taken place during the
current year are as follows:
Acquisition of Neptune Enterprise
On July 1, 2009 Stello Limited acquired 80% shares of Neptune Limited, a company based in
Argentina. This company manufactures steel products that are sold in its local markets. The
purchase was financed by means of a foreign currency loan. The loan is repayable in five equal
annual installments, commencing on July 1, 2010. The financial year-end of Neptune Limited is
June 30.

Major Capital Expenditure

The company has increased the production capacity of one of its plant. Land was acquired for the
purpose from a company in which a friend of Mr. Sami is the majority shareholder. Plant and
machinery was supplied by Big Manufacturer (Pvt.) Ltd. (BMPL). Although a lower quote was
received from another supplier, the Board decided in favour of BMPL as it had a long standing
business relationship with Stello whereas the other supplier was considered to be too
inexperienced.
Required:
a) Evaluate the above situation and briefly discuss the key risk areas that Mr. Ansari should
consider while planning the audit.
b) List three key audit procedures which the auditors may like to undertake, in the above
circumstances, in respect of each of the following:
i. Foreign currency loan
ii. Capital expenditure
 Solution:
a) Key Risk Areas
AT A GLANCE
i. Since it is the first year of audit there is a risk of misstatement of opening balances.
The auditor will also have to make arrangements for communication with the
predecessor auditor.
ii. To generate funds to support exceptional growth, the management is planning to
get the company listed and wants to issue shares on premium. This aspect might
create risk that assets and profits figures could be manipulated as the company has
to fulfill the conditions of SECP according to which (besides other conditions)
company shall have profitable operational records of at least one year and full
justification for premium need to be disclosed in the prospectus.
iii. Company offers performance based bonuses at all levels, including the senior
management. This aspect might create risk that revenue/ profits figures could be
SPOTLIGHT
manipulated to show the desired performance by the management.

iv. The company has recently installed a state of the art accounting software. New
system could lead to errors in reports / statement derived from it.
v. lack of segregation of duties in the scrap sales process.
vi. Significant sales of the company are to few major customers with whom the
company seems to have close relationship. There is a risk of manipulation in
revenue, since the close relationship with the customers might lead to fraudulent
connivance.
vii. Accounting and taxation implications of the acquisition of the foreign subsidiary,
complexity of which may cause misstatement due to error. These include:
¯ Consolidation as per Companies Ordinance, 1984.
¯ Different year-end of the Argentinean subsidiary.
¯ Foreign currency translation
¯ Non-compliance with (IAS 21)
¯ Impairment of Goodwill.
viii. The purchase of a foreign subsidiary was financed by means of a foreign currency
loan. Related implications are.
¯ Initial recognition as per IAS 39.
¯ Prevailing exchange rate application for conversion

ix. Land was acquired from a company in which a friend of Mr. Sami is the majority
shareholder. Hence, there is a risk that this relationship may have resulted in a non-
arm’s length transaction.
x. Risk of inappropriate valuation of land.
b) Foreign Currency Loan
 Check the conversion of the foreign currency loan into presentation currency.
 Obtain direct confirmation from the lender.
 Review the foreign currency agreement to ensure that the loan has been
appropriately disclosed in the financial statements.
 Review compliance with foreign exchange regulation/registration with SBP. Capital
Expenditure
 Assess the value of land and plant and machinery using available resources/data or
consider hiring an expert.
 Review the necessary documentation including minutes of meetings of the directors,
to assess that each of them is an arm’s length transaction.
 Check title deeds and other related documents.
AT A GLANCE
 Check physical existences
 Check whether feasibility of the plant has been made.
You are involved as a senior in auditing the financial statements of Blue Limited (BL), a listed
company, for the year ended December 31, 2008. While reviewing draft financial statements you
have noted that BL has material investments in two local private limited companies and a joint
venture company operating in the UAE. You have identified the following risk indicators:
 the investee companies have different year end than the investor company;
 one of the investees is a foreign operation;
 significant transactions between the investee and investor companies;
SPOTLIGHT
 poor operating results and financial condition of one of the investee company;
 the investor has guaranteed the debts of one of the investee company;
 one of the investee’s financial statements are audited by another firm.
Required:
In view of the above Risk Indicators, identify the possible implications that might be of
significance to the audit team in assessing the risk of misstatements affecting the investments
made by the company.
 Solution:
Risk Indicator Significance/ possible Implication

i The investee companies Failure to account for or disclose significant
have different year end than transactions occurring between the investees’ and
the investor company; investor’s year end.
ii One of the investees is a Due to Foreign currency fluctuations, translations
foreign operation; may not have been done accurately potential
expropriation of assets potential lack of reliable
information regarding the investee’s operations
different basis of accounting

Risk Indicator Significance/ possible Implication

iii Significant transactions improper elimination of intercompany profits, (in
between the investees and case of consolidation) increased risk of inadequate
investor companies; disclosure of related-party transactions
Risk of non-arm’s length transactions
iv Poor operating results and Uncertainty regarding the realisability of investment
financial condition of one of in such company.
the investee company;
V The investor has guaranteed Inadequate disclosure of guarantees.
the debts of one of the Failure to disclose or provide for any liability that may
investee company; have been due under the guarantee agreement.
vi The investees’ financial Misstatement due to the audit team’s reliance on
statements are audited by these financial statements and failure of the other
another firm. auditor to follow the appropriate standards.

AT A GLANCE
Sea view Limited is a manufacturing company. Behroze& Co., Chartered Accountants are their
auditors. The audit of financial statements of the Company for the year ended November 30, 2008
is in progress. Sami, the senior in charge on the audit has received the first draft of the financial
statements from Kamil, the CFO of the Company.
The abridged financial information of the Company for the year ended November 30, 2008 is as
follows:
2008 2007
-----(Rs. In '000')------
Property, Plant and Equipment 2,325 1,210
intangible assets 100 50
SPOTLIGHT
inventories 650 460

trade debts 210 80
sales 4,300 6,700
cost of sales 3,800 5,100
gross profit 600 1,600
Sami had a meeting with the CFO of the Company which revealed the following matters:
The Company’s sales have suffered on account of depressed economic conditions in the
country;
The Company has introduced a new product ‘Cherry’ during the year in place of ‘Merry’
and incurred substantial cost in the acquisition of property, plant and equipment; and
This year’s physical verification of stocks had not been carried out on November 30 on
the plea that the relevant staff was on leave. The stock check will now be carried out on
December 15, 2008.
Required:
Given the above data and circumstances, identify the following:
a) the risks that may result in material misstatements in the financial statements; and
b) The implications of the risks identified along with audit procedures that would be most
suitable to mitigate those risks.

 Solution:
The following are the risks that may result in material misstatement in the financial
statements and the procedures that may be performed to mitigate those risks:
Audit procedures to
Risk Implication
mitigate risks
i) Overstatement of Although, the sales have decreased Noting of last document as

sales / Sales cut from Rs. 6,700 million in 2007 to on 30 June 2008 such as
off may not be Rs. 4,300 million in 2008, resulting invoices, gate passes,
proper. in a net decrease of Rs. 2,400 delivery challans etc.
million, still there is a significant
Sales cut off procedures
risk that even this sales may have
should be performed.
been overstated because, the
Company was facing earning
pressure and physical inventory
observation has been delayed by
15 days. (correlate with point iv)
AT A GLANCE
ii) Revenue expenses During the year, PPE has almost Detailed test of transaction
may have been doubled to Rs. 2,325 million. There should be performed on
capitalized. is a significant risk that revenue additions of PPE. This may
expenses may have been include vouching and
capitalized with the cost of PPE for verification of source
new product “Cherry”. documents and physical
verification of PPE acquired
during the year.
Impairment of With the introduction of new Identify items of PPE

items of property, product, impairment of PPE items acquired for “merry” in
plant and that belong to the old product may prior years from Fixed Asset
SPOTLIGHT
equipment not have been provided for. Register, ascertain their
carrying values and assesses
the amount of unrecorded
impairment loss if any.
iii) Existence/ Trade debts have more than Circularization of

validity of trade doubled in spite of decrease in independent confirmation
receivable. sales. There is a risk that these requests to the debtors.
receivables may have been
overstated as of the balance sheet
date. The sales relating to next year
may have been recorded in the
year under audit.
Indication of In spite of lower sales, trade Analysis of Debtors aging

doubtful/ receivables have increased schedule, Company’s credit
uncollectable significantly by Rs. 130 million. policy and provision for
accounts. There might be old outstanding doubtful debts.
debts.
Scrutinize the amount of
sales recorded in the last
week to identify undue
increase if any.

Audit procedures to
Risk Implication
mitigate risks
iv) Understatement This year, the management has At the time of stock take, roll
of inventory/ requested to carry out physical back working should be
Inventory cut off verification of inventories 15 days prepared and verified and
may not be after the balance sheet date. There cross matched with the cut
proper/Inventory is a risk of understatement of off documents to ensure that
valuation may not inventory and overstatement of inventory movements are
be correct. sales as the Company might have recorded in correct
tried to recognize sales of accounting period. Cut off
subsequent period in the period procedures should be
under audit. performed. NRV of the old
product “Merry” need to be
considered.
v) Impairment of The Company has abandoned the Detailed verification of

intangible assets product “merry”. The intangible intangible assets to identify
assets might include unamortized those costs from which
AT A GLANCE
cost of intangibles related to future economic benefits are

“merry” which should have been no more expected to flow to
charged off. the Company.

The financial statements of Modern Equipment (Pvt) Limited reveal that the company has paid a
donation of Rs. 15 million to a charitable organization where one of the directors of the company
is a trustee. The company has earned a gross profit of Rs. 40 million. The selling and
administration expenses including the donation amount to Rs. 60 million and as a result the
company has incurred a net loss of Rs. 20 million.
Required:
SPOTLIGHT
(a) Discuss the significance of the above donation, to the auditor and design appropriate audit
procedures to address the issue.
 Solution:
The following issues are significant in respect of the donation of Rs. 15 million:
 Donations represent 25% of the total selling and administration expenses.
Such a huge amount of donation by a company which has already incurred a loss casts
serious doubts about the motive behind such donation.
Audit procedures to address the issue may involve the following:
Obtain information about the charitable institution i.e. its name, nature, registration and
reputation.
Scrutinize possibility of any relationship between the two organizations, their
directors/trustees and their spouses and relatives etc.
Verify mode of payment i.e. cash, bearer cheques, crossed cheques etc.
Verify approval and authorization.
Assess the relevance of the donation to the nature of business of the company.

CHAPTER 8
USING THE WORK OF OTHERS
AT A GLANCE
IN THIS CHAPTER:
As per the requirements of ISA 600, Group engagement partner
is responsible for the direction, supervision and performance of
AT A GLANCE
the group audit engagement in compliance with professional
standards and applicable legal and regulatory requirements,
SPOTLIGHT
and issuance of an appropriate auditor report.
1. Audits of group financial Group engagement team shall obtain an understanding of group,
statements (ISA 600) its components, and their environments.
AT A GLANCE
2. Using the Work of Internal Group engagement partner shall agree on the terms of the group
Auditors (ISA 610) audit engagement in accordance with ISA 210.
3. Using the work of an Group engagement team shall establish an overall group audit
auditor’s expert (ISA 620) strategy and shall develop a group audit plan in accordance with
ISA 300.
4. Introduction to group audits
As per ISA 610, External auditor may make use of internal
5. Group audits: preliminaries
audit function for audit purposes in following ways:
6. Working with component
 To obtain information relevant to risk assessment (ISA
auditors
315); or
7. Auditing the consolidation  May decide to use work of internal audit function in partial
SPOTLIGHT
process substitution for own work.
8. Documentation and ISA 620 defines Auditor's expert as an individual or
communication with organization possessing expertise in a field other than
management and those accounting or auditing, whose work in that field is used by
charged with governance auditor to assist auditor in obtaining sufficient appropriate
audit evidence.
An auditor's expert may be either an auditor's internal expert
(who is a partner or staff, including temporary staff, of auditor's
firm or a network firm), or an auditor's external expert.
The said ISA deals with how the auditor can use the work of an
expert.
This chapter also encompasses the guidance provided by ICAP
on the group audits in addition to the requirements of the ISA
600.

CHAPTER 8: USING THE WORK OF OTHERS CFAP 6: AARS
1. AUDITS OF GROUP FINANCIAL STATEMENTS (ISA 600)

Group engagement partner is responsible for the direction, supervision and performance of the group audit
engagement in compliance with professional standards and applicable legal and regulatory requirements and
issuance of an appropriate auditor report.
Auditor’s report on group financial statements shall not refer to a component auditor:
 Unless required by law or regulation to include such reference.
 If required by law, auditor’s report shall indicate that the reference does not diminish the group
engagement partner’s / firm’s responsibility for the group audit opinion.
1.1 Acceptance and Continuance

Group engagement team shall obtain an understanding of group, its components, and their environments as
follows:
 Group structure, including legal & organizational structure.
 Components' business activities significant to the group.
 Use of service organizations, including shared service centers.
AT A GLANCE
 A description of group-wide controls.

 Complexity of the consolidation process.
 Component auditors.
 Whether the group engagement team:
¯ Will have unrestricted access to those charged with governance and management of group &
components.
¯ Will be able to perform necessary work on components.
For continuing engagement, group engagement team's ability to obtain sufficient appropriate audit evidence may
be affected by:
 Changes in group structure.
SPOTLIGHT
 Changes in components' business activities significant to group.

 Changes in composition of those charged with governance of group, group management, or key
management of significant components.
 Concerns with regard to integrity and competence of group or component management.
 Changes in group-wide controls.
 Changes in the applicable financial reporting framework.
If the group engagement partner concludes that:
a) It will not be possible to obtain sufficient appropriate audit evidence due to restrictions imposed by group
management (to obtain information of component or work on it); and
b) Possible effect of inability will result in a disclaimer of opinion on group financial statements, the group
engagement partner shall:
 For new engagement; Not accept the engagement
 For continuing engagement; Withdraw from engagement,
 Disclaim opinion If withdrawal is not possible or practicable

CFAP 6: AARS CHAPTER 8: USING THE WORK OF OTHERS
 Appendix 3: Examples of Conditions or Events that May Indicate Risks of Material Misstatement of Group
 A complex group structure.
 Poor corporate governance structures.
 Non-existent or ineffective group-wide controls.
 Components operating in foreign jurisdictions.
 Business activities of components that involve high risk.
 Uncertainties regarding which components' financial information.
 Unusual related party relationships and transactions.
 Prior occurrences of non-matching intra-group account balances.
 Complex transactions accounted for in more than 1 component.
 Components' application of accounting policies that differ from those applied to group financial
statements.
 Components with different financial year-ends.
 Prior occurrences of unauthorized or incomplete adjustments.
 Aggressive tax planning within the group.
AT A GLANCE
 Frequent changes of auditors.
Group engagement partner shall agree on the terms of the group audit engagement in accordance with ISA 210.
Additional matters may be included in terms of a group audit engagement, such that:
 The communication between the group engagement team and the component auditors should be
unrestricted to the extent possible under law or regulation;
 Important communications between the component auditors, those charged with governance of the
component, and component management, including communications on significant deficiencies in
internal control, should be communicated as well to the group engagement team;
 Important communications between regulatory authorities and components related to financial
reporting matters should be communicated to the group engagement team; and
SPOTLIGHT
 To the extent the group engagement team considers necessary, it should be permitted:
¯ Access to component information, those charged with governance of components, component
management, and the component auditors (including relevant audit documentation sought by the
group engagement team); and
¯ To perform work or request a component auditor to perform work on the financial information of
the components.
1.2 Overall Audit Strategy and Audit Plan

Group engagement team shall establish an overall group audit strategy and shall develop a group audit plan in
Group engagement partner shall review the overall group audit strategy and group audit plan.
Your firm Gul Khan and Company, Chartered Accountants (GK) is the auditor of Yameen
Corporation Limited (YCL), a listed company which has three subsidiaries. In the planning
meeting, the Chief Financial Officer of YCL informed you about the following developments which
took place during the year ending 31 December 2018:
Asia Power Limited (APL) was incorporated in a foreign country named Blueland in January
2018. YCL is the main sponsor and holds 75% shares in APL. Rest of the shares are held by a local
sponsor. APL is being audited by a firm in Blueland.

APL is providing project management services to a power plant in Blueland. The fee for project
management services is agreed at USD 30 million while the expected cost is USD 22.5 million.
The revenue is being recognized on identified milestone basis in the books of APL.
Required:
In light of the above mentioned information what considerations should be taken into account
while devising the over-all audit strategy. (Note: Audit procedures are not required)
 Solution:
Consideration related to audit of component:
i. The financial reporting framework used by APL to prepare the financial statements,
including any need for reconciliation to another reporting framework.
ii. The size of operation of APL, it’s materiality for YCL and who are the auditors.
iii. The extent of involvement in the audit of APL and whether the working papers will be
available to the firm.
iv. The nature of the business of APL and whether any specialized knowledge is required
for the component.
v. Expected types and timing of reports to be issued by the auditor and the component
AT A GLANCE
auditor.
vi. How the competence of the component auditors would be confirmed along with the
acceptability of the ethical standards and quality control policies followed by them.
vii. The preliminary identification of material classes of transactions, account balances and
disclosures of APL.
Consideration for engaging expert:
Audit team should consider whether they have the expertise of calculating or estimating the
agreed milestones or would they require the services of an expert.
1.3 Understanding the Group, Its Components, and Their Environments

SPOTLIGHT
Auditor is required to identify and assess the risks of material misstatement through obtaining an understanding
of the entity and its environment. The group engagement team shall:
 Enhance its understanding of the group, its components, and their environments, including group-wide
controls, obtained during the acceptance or continuance stage; and
 Obtain an understanding of the consolidation process, including the instructions issued by group
management to components ordinarily including:
¯ The accounting policies to be applied;
¯ Statutory and other disclosure requirements applicable to the group financial statements.
Group engagement team’s understanding of the instructions may include following:
 The clarity and practicality of the instructions for completing the reporting package.
 Whether the instructions:
¯ Adequately describe the characteristics of the applicable financial reporting framework;
¯ Provide for disclosures that are sufficient to comply with requirements of the applicable financial
reporting framework;
¯ Provide for the identification of consolidation adjustments, for example, intra-group transactions
and unrealized profits and intra-group account balances; and
¯ Provide for the approval of the financial information by component management.

Discussion among Group Engagement Team Members & Component Auditors regarding risks of Material
Misstatement of Group financial statements, Including Risks of Fraud provide an opportunity to:
 Share knowledge of components and their environments, including group-wide controls.
 Exchange information about the business risks of the components or the group.
 Exchange ideas about where group financial statements may be susceptible to material misstatement
due to fraud or error, how group management and component management could perpetrate and
conceal fraudulent reporting and how component’s assets could be misappropriated.
 Identify practices followed by group or component management that may be biased or designed to
manage earnings that could lead to fraudulent financial reporting, for example, revenue recognition
practices that do not comply with the applicable financial reporting framework.
 Consider known external and internal factors affecting group that may create an incentive or pressure
for group management, component management, or others to commit fraud, provide the opportunity
for fraud to be perpetrated, or indicate environment that enables group management, component
management, or others to rationalize committing fraud.
 Consider the risk that group or component management may override controls.
 Discuss fraud that has been identified in components, or information that indicates existence of a fraud
in a component.
AT A GLANCE
 The group engagement team shall obtain an understanding that is sufficient to:
¯ Confirm or revise its initial identification of components that are likely to be significant;
¯ Assess risks of material misstatement of group financial statements, whether due to fraud or error
through:
o Information obtained from understanding of group, components and environments and of
consolidation process, including group-wide controls.
o Information obtained from the component auditors.
1.4 Understanding the Component Auditor

If the group engagement team plans to request a component auditor to perform work on the financial information
SPOTLIGHT
of a component, group engagement team shall obtain understanding of:
 Whether the component auditor understands and will comply with the ethical requirements that are
relevant to the group audit and, in particular, is independent. (Ref: Para. A37)
 The component auditor’s professional competence; whether he:
¯ Possesses an understanding of auditing and other standards applicable to group audit that is
sufficient to fulfill the component auditor’s responsibilities in the group audit;
¯ Possesses the special skills (for example, industry specific knowledge) necessary to perform the
work on the financial information of the particular component; and
¯ Where relevant, possesses an understanding of the applicable financial reporting framework that is
sufficient to fulfill the component auditor’s responsibilities in the group audit.
 Whether group engagement team will be able to be involved in the work of the component auditor to
the extent necessary to obtain sufficient appropriate audit evidence.
 Whether he operates in a regulatory environment that actively oversees auditors.
Such understanding may be obtained in a number of ways:

In the first year of involving a component auditor, group engagement team may, for example:
 Evaluate the results of quality control monitoring system where the group engagement team and
component auditor are from a firm or network that operates under and complies with common
monitoring policies and procedures;

 Visit the component auditor to discuss the above matters;

 Request component auditor to confirm the above matters (Appendix 4);
 Request the component auditor to complete questionnaires about the above matters;
 Discuss the component auditor with colleagues in the group engagement partner’s firm, or with a
reputable third party that has knowledge of the component auditor; or
 Obtain confirmations from professional body or bodies to which the component auditor belongs, the
authorities by which the component auditor is licensed, or other third parties.
In subsequent years, the understanding of the component auditor may be based on the group engagement team’s
previous experience with the component auditor. The group engagement team may request the component
auditor to confirm whether anything in relation to above understanding has changed since the previous year.
If a component auditor does not meet such independence requirements, or group engagement team has serious
concerns about his competence and independence etc., they shall obtain sufficient appropriate audit evidence
relating to financial information of component without requesting that component auditor to perform work on
financial information of that component.
1.5 Materiality
The group engagement team shall determine the following:
AT A GLANCE
 Materiality for the financial statements as a whole;

 Materiality of particular class of transaction, account balances or disclosure (if any);
 Component materiality for those components where component auditors will perform an audit or a
review for purposes of the group audit;
 Threshold above which misstatements cannot be regarded as trivial to group financial statements.
Group engagement team shall evaluate the appropriateness of performance materiality determined at the
component level.
If a component is subject to audit by statute, regulation or other reason, and the group engagement team decides
to use that audit to provide audit evidence for the group audit, the group engagement team shall determine
whether:
SPOTLIGHT
 Materiality for the component financial statements as a whole; and

 Performance materiality at the component level meet the requirements of this ISA.
1.6 Responding to Assessed Risks

Auditor is required to design and implement appropriate responses to address assessed risks of material
misstatement of the financial statements.
Group engagement team shall determine the type of work to be performed by the group engagement team, or
the component auditors on its behalf, on the financial information of the components (see flow chart below).
Group engagement team shall also determine nature, timing and extent of its involvement in the work of the
component auditors
Such determination of the type of work and its involvement in the work is affected by:
 The significance of the component;
 The identified significant risks of material misstatement of the group financial statements;
 The group engagement team’s evaluation of the design of group-wide controls and determination
whether they have been implemented; and
 The group engagement team’s understanding of the component auditor.

 Definition: Component
An entity or business activity for which group or component management prepares financial
information that should be included in the group financial statements
 Definition: Significant Component
A component identified by the group engagement team
 That is of individual financial significance to the group, or
 That, due to its specific nature or circumstances, is likely to include significant risks of
material misstatement of the group financial statements.
If group engagement team does not consider that sufficient appropriate audit evidence will be obtained from
work performed on financial information of significant components, and related procedures performed at group
level; they shall select components that are not significant components and perform, or request a component
auditor to perform, one or more of the following on financial information of individual components selected:
 Audit of financial information of component using components materiality
 Audit of one or more of the class of transactions, account balances or disclosures
 Review of financial information of component using components materiality
AT A GLANCE
 Specified procedures
SPOTLIGHT

AT A GLANCE
SPOTLIGHT

Above decision of selecting non-significant components depends on:

 Extent of audit evidence expected to be obtained from them.
 Whether the component has been newly formed or acquired.
 Whether significant changes have taken place in the component.
 Whether an adequate internal audit function has performed work at the component.
 Whether the components apply common systems and processes.
 The operating effectiveness of group-wide controls.
 Abnormal fluctuations identified by analytical procedures performed at group level.
 Individual financial significance or the risk of the component in comparison with other components
within this category.
 Whether component is subject to audit required by statute, regulation etc
Significant Components—Risk Assessment
Group engagement team shall be involved in component auditor’s risk assessment to identify significant risks of
material misstatement of the group financial statements. Nature, timing and extent of this involvement are
affected by understanding of the component auditor, including at a minimum:
AT A GLANCE
 Discussing with component auditor or component management those of the component’s business
activities that are significant to the group;
 Discussing with component auditor susceptibility of component to material misstatement of the
financial information due to fraud or error; and
 Reviewing component auditor’s documentation of identified significant risks of material misstatement
of group financial statements.
1.7 Consolidation Process

Group engagement team shall:
 Design and perform further audit procedures on the consolidation process
 Evaluate whether all components have been included in the group financial statements.
SPOTLIGHT
 Evaluate the appropriateness, completeness and accuracy of consolidation adjustments etc
 Evaluate fraud risk factors or indicators of possible management bias including
¯ Evaluating whether significant adjustments appropriately reflect the underlying events and
transactions;
¯ Determining whether significant adjustments have been calculated, processed and authorized by
group management and, where applicable, by component management;
¯ Determining whether significant adjustments are properly supported and documented
¯ Checking the reconciliation and elimination of intra-group transactions and unrealized profits, and
intra-group account balances.
 If financial information of a component has not been prepared as per same accounting policies applied
to the group financial statements, group engagement team shall evaluate whether financial
information of that component has been appropriately adjusted for group financial statements.
 Group engagement team shall determine whether financial information identified in the component
auditor’s communication is incorporated in the group financial statements.
 For a component with different period-end from group, group engagement team shall evaluate
whether appropriate adjustments have been made to those financial statements as per applicable

Subsequent Events
If group engagement team or component auditors perform audits on components, they shall perform procedures
to identify and apply procedures on subsequent events.
If component auditors perform work other than audits of components, group engagement team shall request him
to notify group engagement team if they become aware of subsequent events that may require an adjustment to
or disclosure in the group financial statements.
1.8 Communication with the Component Auditor

Group engagement team shall communicate its requirements to component auditor on a timely basis.
This communication shall set out work to be performed, use to be made of that work, and form and content of
component auditor's communication with group engagement team.
 Request that component auditor confirms that he will cooperate with them.
 Ethical and independence requirements relevant to audit.
 Component materiality.
 Request him to communicate any identified significant risks of material misstatement of group
AT A GLANCE
 A list of related parties.
Group engagement team shall request component auditor to communicate matters relevant to group
engagement team's conclusion with regard to the group audit.
 Whether he has complied with relevant ethical and independence requirements;
 Whether he has complied with our requirements;
 Identification of financial information of the component;
 Information on instances of non-compliance with laws;
 List of uncorrected misstatements;
 Indicators of possible management bias;
SPOTLIGHT
 Description of significant deficiencies in internal control;

 Other significant matters (e.g. fraud or suspected fraud);
 Any other matters;
 Component auditor's findings, conclusions or opinion.
You are the audit manager of a listed company having seven subsidiaries. Three of them are
audited by other audit firms.
Required:
State the key matters / instructions which you would communicate to the component auditors.
 Solution:
The following matters may be communicated to the auditor of the subsidiaries (component
auditor):
 Work to be performed, the use to be made of that work, and the form and content of the
component auditor’s communication with the group engagement team
 A request for confirmation from the component auditors that they would cooperate with
group engagement team.

 The ethical requirements that are relevant to the group audit and, in particular, the
independence requirements.
 Component materiality and the amount lower than the materiality level for particular
classes of transactions, account balances or disclosures, if applicable and the threshold
above which misstatements cannot be regarded as clearly trivial to the group financial
statements.
 Already identified significant risks of material misstatements in the group financial
statements, due to fraud or error that are relevant to the work of the component auditor.
 Request to the component auditor to communicate on a timely basis any other
significant risks of material misstatement of the group financial statements, due to fraud
or error, in the component, and the component auditor’s responses to such risks.
 A list of related parties prepared by group management, and any other related parties of
which the group engagement team is aware. Request the component auditor to
communicate on a timely basis related parties not previously identified by group
management or the group engagement team.
 Request the component auditor to communicate mattes relevant to the group
engagement team’s conclusion with regard to the group audit.
 Reporting deadlines by which the component auditor is required to comply.
AT A GLANCE
1.9 Evaluating the Sufficiency and Appropriateness of Audit Evidence Obtained
Group engagement team shall:
 Discuss significant matters arising from that evaluation with the component auditor, component
management or group management, as appropriate; and
 Determine whether it is necessary to review other relevant parts of the component auditor’s audit
documentation.
If group engagement team concludes that the work of the component auditor is insufficient, the group
engagement team shall determine additional procedures to be performed.
Group engagement partner shall evaluate the effect on group audit opinion of any uncorrected misstatements
SPOTLIGHT
and any instances where there has been an inability to obtain sufficient appropriate audit evidence.
Your firm is the auditor of Noor Group of Companies which has three subsidiaries namely Venus
Limited, Jupiter Limited and Sun Limited. Your firm is the auditor of all the group companies
except for Sun Limited, which is incorporated in a foreign country.
Required:
Explain the procedures you would perform to decide the extent of reliance on the work of the
auditor of Sun Limited.
Tutorial Notes:
Students should be careful in reading the requirement of the question i.e. how to assess the extent
of reliance to be placed on the work of the component auditor, else, wrong procedures may be
identified (e.g. meeting with component auditor to obtain 0understanding of the component and
its environment, discussing with component auditor about risk of material miss- statement, etc).
Another mistake can be over emphasizing on qualification and experience of the auditor and
ignoring the remaining aspects.

 Solution:
i. Assess whether the degree of access to be provided to us by the component auditor is
sufficient.
ii. Assess the professional competence of Sun Limited’s (SL) auditor by obtaining
information about his membership with relevant professional bodies.
iii. Obtain confirmations from professional bodies under which the auditor of SL is
registered with and his good standing etc.
iv. Obtain a statement from the auditor of SL that it has complied with the relevant ethical
requirements.
v. Review the code of ethics followed by the auditor of SL, and assess whether ethical
requirements of that code are in agreement with the ethical requirements relevant to
the group audit.
vi. Ascertain the competence and qualification of staff assigned by the auditor of SL to
assess whether they have necessary skills to address the issues related to the group
audit.
vii. Ascertain the quality control policies and procedures used by the auditor of SL.
viii. Determine whether the auditor of SL’s is a member of network of audit firms and inquire
AT A GLANCE
whether the network firm carries out regular quality reviews.

ix. Discuss the audit methodology to be used by SL’s auditor and whether it would be
sufficient for the group audit and determine the necessary audit instructions to be
issued.
x. Identify the differences in the applicable financial reporting framework of the group and
the component, if any and obtain a statement that the component auditor understands
the applicable financial reporting framework.
xi. Request any results of monitoring or inspection visits conducted by the regulatory
authority.
1.10 Communication with Group Management and those charged with governance of the Group
SPOTLIGHT
Group engagement team shall determine which identified deficiencies in internal control to communicate to
those charged with governance and group management in accordance with ISA 265 regarding:
 Group-wide internal control that the group engagement team has identified;
 Internal control that group engagement team or component auditor has identified.
If fraud has been identified by group engagement team or component auditor or information indicates that a
fraud may exist, group engagement team shall communicate this on a timely basis to the appropriate level of
group management.
In addition, group engagement team shall communicate these matters with those charged with governance of
group:
 An overview of type of work to be performed on the components.
 An overview of nature of the group engagement team’s planned involvement in work to be performed
by component auditors on significant components.
 Instances where the group engagement team’s evaluation of the work of a component auditor gave rise
to a concern about the quality of that auditor’s work.
 Any limitations on the group audit (e.g. restriction on group engagement team’s access).


Group engagement team shall include in the audit documentation the following matters:
 An analysis of components, indicating those that are significant, and the type of work performed on the
financial information of the components.
 Nature, timing and extent of the group engagement team’s involvement in work performed by
component auditors on significant components including, group engagement team’s review of relevant
parts of component audit documentation and conclusions thereon.
 Written communications between group engagement team and the component auditors.
1.12 Components Subject to Audit by Statute, Regulation or Other Reason (Ref: 3, A1)
A component auditor may be required by statute, regulation or for another reason, to express an audit opinion
on the financial statements of a component.
Group engagement team may decide to use the audit evidence on which the audit opinion on the financial
statements of the component is based to provide audit evidence for the group audit, but the requirements of this
ISA nevertheless apply.
Factors that may affect the decision of whether to use an audit required by statute, regulation or for another
AT A GLANCE
reason to provide audit evidence for group audit include:
 Differences in the applicable financial reporting framework applied in preparing the financial
statements of the component and that applied in preparing the group financial statements.
 Differences in the auditing and other standards applied by the component auditor and those applied in
the audit of the group financial statements.
 Whether the audit of the financial statements of the component will be completed in time to meet the
group reporting timetable.
 Appendix 1
(Ref: Para. A19)
“Independent Auditor’s Report Where the Group Engagement Team Is Not Able to Obtain
SPOTLIGHT
SufficientAppropriate Audit Evidence on Which to Base the Group Audit Opinion”
INDEPENDENT AUDITOR’S REPORT
To the Shareholders of ABC Company [or other Appropriate Addressee]
Report on the Audit of the Consolidated financial statements
Qualified Opinion
We have audited the consolidated financial statements of ABC Company and its subsidiaries (the
Group), which comprise the consolidated statement of financial position as at December 31,
20X1, and the consolidated statement of comprehensive income, consolidated statement of
changes in equity and consolidated statement of cash flows for the year then ended, and notes to
the consolidated financial statements, including a summary of significant accounting policies.
In our opinion, except for the possible effects of the matter described in the Basis for Qualified
Opinion section of our report, the accompanying consolidated financial statements present fairly,
in all material respects (or give a true and fair view of), the consolidated financial position of the
Group as at December 31, 20X1, and (of) their consolidated financial performance and
consolidated cash flows for the year then ended in accordance with International Financial
Reporting Standards (IFRSs).

Basis for Qualified Opinion

ABC Company’s investment in XYZ Company, a foreign associate acquired during the year and
accounted for by the equity method, is carried at $15 million on the consolidated statement of
financial position as at December 31, 20X1, and ABC’s share of XYZ’s net income of $1 million is
included in the consolidated statement of comprehensive income for the year then ended. We
were unable to obtain sufficient appropriate audit evidence about the carrying amount of ABC’s
investment in XYZ as at December 31, 20X1 and ABC’s share of XYZ’s net income for the year
because we were denied access to the financial information, management, and the auditors of
XYZ. Consequently, we were unable to determine whether any adjustments to these amounts
were necessary.
We conducted our audit in accordance with International Standards on Auditing (ISAs). Our
responsibilities under those standards are further described in the Auditor’s Responsibilities for the
Audit of the Consolidated financial statements section of our report. We are independent of the Group
in accordance with the International Ethics Standards Board for Accountants’ Code of Ethics for
Professional Accountants (IESBA Code), and we have fulfilled our other ethical responsibilities in
accordance with the IESBA Code. We believe that the audit evidence we have obtained is sufficient
and appropriate to provide a basis for our qualified audit opinion.
Other Information [or another title if appropriate such as “Information Other than the financial
AT A GLANCE
statements and Auditor’s Report Thereon”]

[Reporting in accordance with the reporting requirements in ISA 720 (Revised)
Responsibilities of Management and those charged with governance for the Consolidated
[Reporting in accordance with ISA 700 (Revised)
Auditor’s Responsibilities for the Audit of the Consolidated financial statements
Report on Other Legal and Regulatory Requirements
SPOTLIGHT
[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]
If, in the group engagement partner’s judgment, the effect on the group financial statements of
the inability to obtain sufficient appropriate audit evidence is material and pervasive, the group
engagement partner would disclaim an opinion in accordance with ISA 705 (Revised).
 Appendix 2 (Ref: Para. A23)
“Examples of Matters about Which the Group Engagement Team Obtains Understanding”
Group-Wide Controls
 Regular meetings between group and component management.
 Monitoring of components' operations and financial results.
 Group management's risk assessment process.
 Monitoring, controlling, reconciling, and eliminating intra-group transactions and
unrealized profits etc.
 Process for monitoring the timeliness and assessing the accuracy and completeness of
financial information from components.

 A central IT system and the control activities within an IT system.

 Monitoring of controls.
 Consistent policies and procedures, including group financial reporting procedures
manual.
 Group-wide programs, such as codes of conduct and fraud prevention programs.
 Arrangements for assigning authority and responsibility to component management.
 Understanding about internal Audit Function (if it is centralized).
Understanding of the applicable financial reporting framework and the Consolidation Process
 The extent to which component management has an understanding of the applicable
 The process for identifying and accounting for components.
 Process for identifying reportable segments for segment reporting.
 Process for identifying related party relationships & transactions for reporting.
 Accounting policies applied to group financial statements, changes from last financial
year, and changes resulting from new or revised standards under the applicable financial
AT A GLANCE
 Procedures for dealing with components with different financial year-ends.
 Group management’s process for obtaining an understanding of the accounting policies
used by components, and, where applicable, ensuring that uniform accounting policies
are used to prepare the financial information of the components for the group financial
statements.
 Group management’s process for ensuring complete, accurate and timely financial
reporting by the components for the consolidation.
 Process for translating financial information of foreign components into currency of
group.
 How IT is organized for consolidation, including manual and automated stages of
process, and manual and programmed controls in place at various stages of
SPOTLIGHT
consolidation process.
 Group management’s process for obtaining information on subsequent events.
 Matters relating to consolidation adjustments:
¯ Process for recording consolidation adjustments, including preparation,
authorization and processing of related journal entries, & experience of
personnel responsible for that
¯ The consolidation adjustments required by the applicable financial reporting
framework.
¯ Business rationale for events and transactions that gave rise to consolidation
adjustments.
 Frequency, nature and size of transactions between components.
 Procedures for monitoring, controlling, reconciling and eliminating intra-group
transactions and unrealized profits, and intra-group account balances.
 Steps taken to arrive at the fair value of acquired assets and liabilities, procedures for
amortizing goodwill (where applicable), and impairment testing of goodwill.


Examples of a Component Auditor’s Confirmations
[Component Auditor Letterhead]
[Date]
[To Group Engagement Partner]
This letter is provided in connection with your audit of the group financial statements of [name
of parent] for the year ended [date] for the purpose of expressing an opinion on whether the
group financial statements present fairly, in all material respects (give a true and fair view of)
the financial position of the group as at [date] and (of) its financial performance and cash flows
for the year then ended in accordance with [indicate applicable financial reporting framework].
We acknowledge receipt of your instructions dated [date], requesting us to perform the specified
work on the financial information of [name of component] for the year ended [date].
We confirm that:
 We will be able to comply with the instructions. / We advise you that we will not be able
to comply with the following instructions [specify instructions] for the following reasons
AT A GLANCE
[specify reasons].
 The instructions are clear and we understand them. / We would appreciate it if you could
clarify the following instructions [specify instructions].
 We will cooperate with you and provide you with access to relevant audit
documentation.
 We acknowledge that:
¯ The financial information of [name of component] will be included in the group
financial statements of [name of parent].
¯ You may consider it necessary to be involved in the work you have requested us to
perform on the financial information of [name of component] for the year ended
[date].
¯ You intend to evaluate and, if considered appropriate, use our work for the audit of
SPOTLIGHT
the group financial statements of [name of parent].

In connection with the work that we will perform on the financial information of [name of
component], a [describe component, for example, wholly-owned subsidiary, subsidiary, joint
venture, investee accounted for by the equity or cost methods of accounting] of [name of parent],
we confirm the following:
 We have an understanding of [indicate relevant ethical requirements] that is sufficient
to fulfill our responsibilities in the audit of the group financial statements, and will
comply therewith. In particular, and with respect to [name of parent] and the other
components in the group, we are independent within the meaning of [indicate relevant
ethical requirements] and comply with the applicable requirements of [refer to rules]
promulgated by [name of regulatory agency].
 We have an understanding of International Standards on Auditing and [indicate other
national standards applicable to the audit of the group financial statements] that is
sufficient to fulfill our responsibilities in the audit of the group financial statements and
will conduct our work on the financial information of [name of component] for the year
ended [date] in accordance with those standards.
 We possess the special skills (for example, industry specific knowledge) necessary to
perform the work on the financial information of the particular component.
 We have an understanding of [indicate applicable financial reporting framework or
group financial reporting procedures manual] that is sufficient to fulfill our
responsibilities in the audit of the group financial statements.

We will inform you of any changes in the above representations during the course of our work
on the financial information of [name of component].
[Auditor’s signature] [Date]
[Auditor’s address]

Required Additional Matters Included in Group Engagement Team’s Letter of Instruction
 A request for component auditor, knowing the context in which his work would be used,
to confirm that component auditor will cooperate with group engagement team.
 The timetable for completing the audit.
 Dates of planned visits by group management and the group engagement team, and
dates of planned meetings with component management and the component auditor.
 A list of key contacts.
 Work to be performed by the component auditor, the use to be made of that work, and
arrangements for coordinating efforts at the initial stage of and during the audit,
including the group engagement team’s planned involvement in the work of the
AT A GLANCE
component auditor.
 Ethical requirements relevant to the group audit and, in particular, independence
requirements.
 In case of an audit or review of the financial information of the component, component
materiality, and threshold above which misstatements cannot be regarded as clearly
trivial to group financial statements.
 A list of related parties prepared by group management, and any other related parties
that the group engagement team is aware of, and a request that the component auditor
communicates on a timely basis to the group engagement team related parties not
previously identified.
 Work to be performed on intra-group transactions and unrealized profits and intra-
group balances.
SPOTLIGHT
 Guidance on other statutory reporting responsibilities, for example, reporting on group
management’s assertion on the effectiveness of internal control.
 Where time lag between completion of the work on components and the group
engagement team’s conclusion on the group financial statements is likely, specific
instructions for a subsequent events review.
 Matters that are relevant to the conduct of the work of the component auditor:
 The findings of the group engagement team’s tests of control activities of a processing
system that is common for all or some components, and tests of controls to be performed
by the component auditor.
 Identified significant risks of material misstatement of the group financial statements
that are relevant to the work of the component auditor, and a request that the
component auditor communicates on a timely basis any other significant risks of
material misstatement of the group financial statements, due to fraud or error, identified
in the component and the component auditor’s response to such risks.
 Findings of internal audit function, based on work performed on controls at components.
 A request for timely communication of audit evidence obtained from performing work
on components that contradicts the original audit evidence.
 A request for a written representation on component management’s compliance with
the applicable financial reporting framework, or a statement that differences between
the accounting policies applied to the financial information of the component and those
applied to the group financial statements have been disclosed.

 Matters to be documented by the component auditor.

 Other information.
 A request that the following be reported to the group engagement team on a timely basis:
¯ Significant accounting, financial reporting and auditing matters, including
accounting estimates and related judgments.
¯ Matters relating to the going concern status of the component.
¯ Matters relating to litigation and claims.
¯ Significant deficiencies in internal control that the component auditor has identified
during the performance of the work on the financial information of the component,
and information that indicates the existence of fraud.
 A request that group engagement team be notified of any significant or unusual events
earliest
 A request that the matters listed in Para 41 be communicated to the group engagement
team when the work on the financial information of the component is completed
You are the audit manager in a firm of chartered accountants. The audit of a client TC Limited
(TCL) is in the finalisation stage. TCL has a foreign subsidiary, WCL.
AT A GLANCE
The financial statements of WCL are not in compliance with IFRS-15 as the regulator in foreign
country has deferred adoption of IFRS-15. Your audit team has asked TCL’s management to
assess the impact due to non-adoption of IFRS-15 and revise the financial statements
accordingly. According to the management of TCL, the local auditor of WCL has expressed an
unqualified audit report on WCL’s financial statements. They believe that the auditor should rely
on the report issued by WCL’s auditor. In this respect they have referred to previous year’s audit
report which clearly states that the firm’s opinion was based solely on the report issued by the
subsidiary’s auditor.
Required:
Discuss how you will respond to the argument presented by TCL’s management.
SPOTLIGHT
Tutorial Notes:
Majority of the students can miss the point that Auditors (Reporting Obligations) 2018
Regulations have eliminated the previous concept of division of responsibilities, thus making the
group auditor solely responsible for the audit opinion on the consolidated financial statements.
 Solution:
Even though regulators of foreign subsidiary have granted relaxation for the implementation of
IFRS-15 but still, the financial statements need to be converted as per financial reporting
framework of the group.
Since the group auditor is responsible for obtaining sufficient appropriate audit evidence
regarding the financial information of the entities within the group to express an opinion on the
consolidated financial statements, we would need to verify the impact of IFRS-15.
Furthermore, if the impact is material to the group financial statements then it would need to be
adjusted otherwise we would express a qualified opinion.
With regards to audit report, issuance of 2018 Regulations eliminates the previous concept of
division of responsibilities, thus making the group auditor responsible for the audit opinion on
the consolidated financial statements, without making reference in the audit report to any other
auditor involved in the audit of subsidiaries.


HT Ragib and Company, Chartered Accountants (HTRC) is a member firm of an international firm
of chartered accountants, HT Network. HTRC has offices in Karachi, Lahore and Islamabad.
You are the audit manager at Karachi office of HTRC. You are responsible for the audit of Health
Pharma Limited and its group financial statements for the year ended 30 November
2019. The extracts of the draft planning memorandum for the group audit prepared by the audit
senior are as follows:
Name of company Revenue Profit/(loss) Total Materiality Remarks

before tax Assets
------------------ Rs. in million ------------------
Health Group (Consolidated) 70,127 4,764 58,304 286
Health Pharma Limited Refer

(HPL) 38,487 5,850 36,563 322 note 1
AT A GLANCE
Fair Cosmetics Limited Refer
(FCL) 24,773 (2,371) 24,484 129 note 2
Services (Private) Limited Refer

(SPL) 273 (47) 155 2 note 3
Quality Chemicals Limited Refer

(QCL) - - - - note 4
Note 1: HPL is the holding company and owns 100% shareholdings in FCL and SPL.
Note 2: FCL is audited by HTRC’s Lahore office. Since FCL is being audited by HTRC’s Lahore
office, no further procedures have been planned for obtaining the understanding of the
SPOTLIGHT
component auditor.
Note 3: SPL was incorporated in 2014 in United Arab Emirates (UAE) and is being audited by a
member firm of HT Network in UAE. Since SPL operates in foreign jurisdiction, detailed
audit procedures have been planned and confirmation will be sent to assess the
component auditor’s ethics, competence and the regulatory environment.
Note 4: HPL has disposed-off its entire shareholdings in QCL, a wholly owned subsidiary on 30
June 2019 at a gain of Rs. 450 million. QCL is being audited by HTRC’s Islamabad office.
Since QCL is no more part of the group as at 30 November 2019, no procedures have
been planned at the group level.
Required:
Critically evaluate the extracts of the planning memorandum prepared by the audit senior and
advise the course of action.
Tutorial Notes:
 Examinees may fail to realize that the materiality of the component was greater than the
materiality of the group and consequently they might not provide any discussion from
this aspect.
 Examinees might also ignore that even if Fair Cosmetic Limited was audited by the
Lahore office, the group auditor still needs to plan procedures for obtaining the
understanding of the component auditor.

 Examinees may fail to identify Services Private Limited as an in-significant component

and consequently would be failed to mention that only analytical procedures were
required to corroborate conclusions that there are no significant risks.
 Solution:
Health Pharmaceuticals Limited:
Audit senior has determined the materiality of the group at Rs. 286 million, whereas the
materiality of HPL has been determined at Rs. 322 million. It seems that the audit senior has
either calculated a higher materiality level for HPL or a lower materiality at the group level.
To reduce to an appropriate low level, the probability that the aggregate of uncorrected and
undetected misstatements in HPL’s separate financial statements exceeds materiality for the
group financial statements as a whole. HPL materiality shall be lower than materiality for the
group financial statements as a whole.
Fair Cosmetics Limited:
Even though the Lahore office would be sharing common policies, procedures, and quality
control procedures, it is still not a guarantee of competence for group audit purposes. Multiple
offices within the same firm may have their own variations on the firm’s quality control, training,
AT A GLANCE
recruitment and independence policies and procedures. Therefore, we still need to document our
understanding of component auditors, and for component auditors to acknowledge their
compliance with our requests.
Even if the past experience with the Lahore office has been satisfactory, we at least need to
confirm whether anything related to the previous questionnaires has changed since the previous
years.
Service Private Limited:
SPL can be considered as an in-significant component as its revenue is 0.39% of the group’s
revenue, and its total assets are only 0.27% of the group’s total assets. Furthermore, the total
revenue and total assets of SPL are below the group materiality level. Furthermore, we should
also consider the group wide controls before concluding SPL as in-significant component.
SPOTLIGHT
Since SPL may be treated as an in-significant component we are required to perform analytical
procedures at group level covering non-significant component to corroborate conclusions that
there are no significant risks. When no additional risks are identified as a result of analytical
procedures, we may document that there is nothing to indicate a need for the performance of
additional procedures.
However, if the results of analytical procedures indicate that there may be a risk of material
misstatement, we need to document the nature, timing and extent of the procedures that will be
performed to address the identified risks.
Furthermore, we will obtain understanding of a component auditor only when we plan to request
the component auditor to perform work on the financial information of a component for the
group audit. If analytical procedures are to be used, then it won’t be necessary to obtain the
understanding of the component’s auditor.
Quality Chemicals Limited:
The audit senior conclusion regarding the fact that no procedure is to be performed on the
disposed-off component is also not correct. The revenue from 1 December to 30 June would be
consolidated in the group financial statements. After considering the significance of the revenue
of that period audit guidelines must be communicated to the component auditor.
Group auditor would also have to obtain and document the understanding of QCL auditors.


You are the audit manager at Salman, Pervez and Company, Chartered Accountants. You are
responsible for the audit of United Health Limited and its group financial statements for the year
ended 31 May 2021. Following information have been provided to you by the audit team:
Name of company Revenue Profit before tax Total assets
-------------- Rs. in million ------------------
United Health Group (Consolidated) 75,000 11,000 69,000
United Health Limited 24,773 2,900 24,484
Quality Labs Limited 54,000 8,100 44,000
United Health Limited (UHL):

Due to COVID-19 pandemic, UHL has witnessed significant decline in sales. In order to meet the
sales target, UHL entered into five large contracts with its customers for supply of its products.
AT A GLANCE
All these customers carried risks of either non-payments or delayed payments.
In addition to the above, UHL also entered into a contract for supply of lab equipment. UHL had
agreed to a pricing model in which 80% of the contract amount will be received as the regular
price of the equipment and 20% will be received as performance bonus subject to timely delivery
of equipment. UHL has always been able to deliver all its equipment within the agreed time.
However, due to COVID-19 lockdown in the country of import, UHL may not be able to receive
the lab equipment on time and consequently UHL may not be able to timely supply it to the
customer.
Quality Labs Limited (QLL):
Up to last year, the group audit team made local site visit to the component auditor team in Spain
to review key audit working papers and attended closing meetings with local management as
SPOTLIGHT
Spain does not allow the cross border sharing of health data. However, due to COVID-19, Spain
has imposed a strict lockdown and has placed travel restrictions which may continue for at least
next 30 days.
Required:
a) Critically evaluate the issues brought to your notice and advise the course of action.
b) Discuss the reporting implications on the group financial statements due to the auditor’s
inability to obtain sufficient appropriate audit evidence regarding QLL’s financial
statements.
 Solution:
a) United Health Limited (UHL):
Customers with risk of non-payment and delayed payment:
Evaluation:
For customers with risk of non-payment, recording of revenue is not correct. If collecting
the consideration is not probable at contract inception, the IFRS 15 guidance does not
apply. Instead, the revenue will be recognized only when it is collected and no remaining
obligations is to be performed. In effect, the entity should account for transactions of this
nature on receipt basis. For the customers having risk of late payment the audit team
needs to ensure that adequate provisioning has been made by UHL.

Course of action:
 Inquire with the management about their assessment of the financial health of their
doubtful customers and their ability to pay.
 Check subsequent payment of these customers to assess whether any recovery has
been made.
 Inspect any correspondence made with such customers for recovery of receivable
balances.
 Obtain the financial statements of the customers to assess their financial viability.
 Ask the management to reverse the revenue recognized, receivable booked and
instead record a contract asset equivalent to the cost of the inventory sold.
 Obtain the age analysis of these customer receivables and ensure that adequate
provision has been made as per the company policy.
Onerous contract:
Evaluation:
AT A GLANCE
The delivery has not been made and the probable loss of performance bonus may render
the contract as onerous contract due to a decrease in consideration. The audit team
should review contracts to determine if there are any special terms (e.g. force majeure)
that may relieve either party to the contract of its obligations under it.
Course of action:
 Inquire with the management and assess whether the sale of equipment would still
be profitable without the performance bonus.
 Inquire with the management about their intention of fulfilling the contract or to exit
the contract by paying the penalty amount.
 Obtain and review the agreement to verify the termination clause including the
amount of penalty.
SPOTLIGHT
statements.
Quality Labs Limited (QLL):
Evaluation:
The management may be enquired regarding amending reporting timescales. A delay in
the reporting timetable could allow easing/lifting of travel restrictions.
Since cross-border sharing of data is not allowed, the auditor should consider alternative
activities to demonstrate the review and evaluation of the component team where
originally a visit by the group auditor was planned:
Course of action:
 Consider video calls and/or screen sharing software be used to talk through the
work with the component auditor.
 Gain an understanding of what work has been performed as interim audit work and
to what extent could it be used.
 Consider asking the component auditor to complete a detailed questionnaire or
clearance on the work they have performed.

 Consider the past work of the component auditor - have there been significant errors
or issues, or has work been to a high standard?
 Request the component auditor to provide a detailed reporting memorandum;
 Corroborate it through discussions with the component auditor, especially on the
significant risks of material misstatement and areas of significant estimates and
judgements.
The group auditor should also ensure that the response of component auditor in the
reporting memorandum is sufficiently detailed and appropriate to conclude on the
adequacy of the work performed by the component auditor.
The group auditor should document the discussions with the component auditor as part
of audit documentation.
b) QLL’s assets are 63.7% of the group and its revenue is 72% of the total revenue of the
group. Therefore, the auditor’s in-ability to obtain sufficient appropriate audit evidence
regarding QLL’s financial statements would be a scope limitation whose impact would
be material and pervasive to the group financial statements.
Being material and pervasive, this would require the group auditor to disclaim the
AT A GLANCE
opinion.
Auditor will need to include a basis of disclaimer of opinion section in the audit report.
This section needs to explain the specific reasons for the disclaimer of opinion and make
clear why the possible effects on the financial statements could be both material and
pervasive.
Since the auditor is disclaiming the opinion, the auditor should not report on key audit
matters when disclaiming an opinion.
ISA 705 states that unless required by law or regulation, when the auditor disclaims an
opinion on the financial statements, the section on ‘Other Information’ should also be
deleted.
Auditor should change the statement which indicates that the financial statements have
SPOTLIGHT
been audited, to state that the auditor was engaged to audit the financial statements.
The auditor responsibility paragraph will now only briefly discuss the fact:
i. that auditor’s responsibility is to conduct an audit and issue report thereon (ii) that
auditor was not able to obtain evidence to provide basis for audit opinion; and
ii. about auditor’s independence.
As the auditor has identified an issue that is so pervasive and is therefore unable to
conclude on the financial statements as a whole, it is not appropriate for the auditor
to conclude on whether the use of the going concern basis of accounting is
appropriate. Therefore, the section on ‘Conclusions relating to going concern’ is not
required.

2. USING THE WORK OF INTERNAL AUDITORS (ISA 610)

External auditor may make use of internal audit function for audit purposes in following ways:
 To obtain information relevant to risk assessment (ISA 315); or
 May decide to use work of internal audit function in partial substitution for own work.
2.1 Definition of Internal Audit Function

Function of an entity that performs assurance and consulting activities designed to evaluate and improve
effectiveness of entity's governance, risk management and internal control processes.
 Activities Relating to Governance
 Assess governance process in its accomplishment of objectives
Activities Relating to Risk Management
 Identifying and evaluating significant exposures to risk and contributing to improvement of risk
management and internal control - including effectiveness of financial reporting process
 Assist the entity in detection of fraud.
Activities Relating to Internal Control
AT A GLANCE
 Evaluation of internal control.

 Examination of financial and operating information.
 Review of operating activities.
 Review of compliance with laws and regulations.
In this ISA “internal audit function” also includes relevant activities of other functions similar to internal audit or
outsourced third-party service providers
Salman Limited (SL), a listed company, is engaged in the manufacturing and sale of Fast Moving
Consumer Goods. SL has approached your firm for conduct of internal audit.
Required:
SPOTLIGHT
Write a letter to SL to briefly explain the scope of the proposed internal audit assignment. (You
may assume necessary details).
Tutorial Notes:
It is important to consider that students are allowed to assume necessary details. Main focus
should be on explaining the scope of internal audit which may include developing understanding
of risks associated with various audit areas and the related controls, control evaluation, control
testing, comparison of policies and procedures, reporting and seeking comments,
communication with audit committee and external auditor, etc. Most of the time can be wasted
on copying the general points from Application and Explanatory Material given in ISA-610 which
are not required. Moreover, you may confusingly state the contents of Agreed upon procedures’
report. Another typical mistake can be converting engagement letter of external audit to that of
internal audit without appreciating that their scope and objectives are significantly different.
 Solution:
Salman Limited
RE: SCOPE OF INTERNAL AUDIT ASSIGNEMENT
Dear Sir,
Based on the discussion and the understanding derived therefrom, we understand that we are
required to conduct a comprehensive internal audit assignment. Therefore, the scope of our work
would be as under:

SCOPE OF INTERNAL AUDIT ASSIGNMENT:

 Developing understanding of risk associated with audit areas and the related controls.
 Controls evaluation, controls testing, potential substantive testing and the formulation
of findings in all areas.
 Comparison of policies and procedures adopted by the Company with the best practices
and procedures based on our study for improvement in the existing procedural
framework.
 Redesigning of procedures in consultation with management, to achieve the desired
objective, in case if the specific test / procedure fails to address a desired objective.
 Issuance of a detailed report presenting our schedule of findings / observations and
recommendations for improvements thereof.
 Seeking comments from the management and issuing formal reports.
 Investigate cases of misappropriation, misconduct, fraud.
 Keep audit committee and Board fully informed on a timely basis of the activities of the
Internal Auditing Department.
 Communicating with the external auditors to the extent required by the management.
AT A GLANCE
 Review and monitor corrective actions to be taken by the management.
We hope that the above information will suffice your need with respect to scope of our internal
audit assignment.
ABC & Company
Chartered Accountants
2.2 Determining Whether, in Which Areas, and to What Extent the Work of Internal Audit Function Can
Be Used (Ref: 15-16, A5-A14)
Professional judgment is exercised in determining whether the work of internal audit function can be used for
audit, and the nature and extent of the work. External auditor evaluates the following:
SPOTLIGHT
i. The extent to which the internal audit function's organizational status and relevant policies and
procedures support the objectivity of the internal auditors;
 Objectivity
Objectivity refers to the ability to perform those tasks without allowing bias, conflict of interest
or undue influence of others to override professional judgments.
Factors that may affect external auditor evaluation include whether:
 Organizational status of internal audit function, including authority and accountability,
supports the ability to be free from bias, conflict of interest or undue influence of others
to override professional judgments. E.g. whether they reports to those charged with
governance or management
 (if reports to management, whether it has direct access to those charged with
governance)
 They are free of any conflicting responsibilities
 those charged with governance oversee employment decisions of internal audit
function.
 There are any restrictions placed by management or those charged with governance.
 Their internal policies or relevant membership of professional bodies require their
compliance with relevant professional standards relating to objectivity
ii. The level of competence of the internal audit function;

 Competence
Attainment and maintenance of knowledge and skills at the level required to enable assigned
tasks to be performed diligently and accordance with professional standards.
Factors that may affect external auditor evaluation include whether:
 They are properly resourced relative to size of entity and nature of operations.
 There are established policies for hiring, training & assigning them to their engagements.
 They have adequate technical training and proficiency in auditing.
 They possess required knowledge and skills relating to the entity's financial reporting
and the applicable financial reporting framework.
 They are members of relevant professional bodies that oblige them to comply with
relevant professional standards including continuing professional development.
iii. Whether the internal audit function applies a systematic and disciplined approach, including quality
control.
Factors for such determination include the following:
 Existence, adequacy and use of documented internal audit procedures or guidance covering such areas
AT A GLANCE
as risk assessments, work programs, documentation and reporting, nature and extent of which is
matching with size and circumstances of an entity.
 Whether they have appropriate quality control policies and procedures. (e.g. leadership, human
resources and engagement performance) or quality control requirements in standards set by relevant
professional bodies for internal auditors. Such bodies may also establish other appropriate
requirements such as conducting periodic external quality assessments
External auditor shall not use the work of the internal audit function if he evaluates that some or all of the above
3 factors are not present.
2.3 Factors Affecting the Determination of the Nature and Extent of the Work of the Internal Audit
Function that Can Be Used (Ref: 17-20, A15-A23)
Examples of work of internal audit function that can be used by external auditor
SPOTLIGHT
 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.
 Audits or reviews of financial information of subsidiaries that are not significant components to the
group (ISA 600)
External auditor shall make all significant judgments in audit engagement and shall plan to use less of the work
of the internal audit function and perform more of the work directly.
Amount of judgment needed in planning, performing and evaluating such work and the assessed risk of
material misstatement at the assertion level are inputs to the external auditor's determination.
External auditor shall also communicate with those charged with governance how the external auditor has
planned to use the work of the internal audit function.
2.4 Using the Work of the Internal Audit Function (Ref: 21-25, A24-A30)
The external auditor is required to evaluate whether:
 The work was properly planned, performed, supervised, reviewed and documented;

 Sufficient, appropriate evidence was obtained to draw reasonable conclusions;

 Appropriate conclusions were reached, consistent with any reports prepared;
 Any exceptions or unusual matters were properly resolved.
It useful for the external auditor to agree the following in advance with internal audit:
 Nature, timing and extent of such work
 Materiality and performance materiality
 Methods of item selection and sample sizes
 Documentation of work performed
 Review and reporting procedures.
After evaluating specific areas of work, external auditor may then perform further procedures:
 Making inquiries of appropriate individuals within the internal audit function;
 Observing procedures performed by internal audit;
 Reviewing the internal audit function’s work program and working papers;
 Re-performing a sample of the procedures to validate conclusions reached.
AT A GLANCE
Nature, timing and extent of testing specific work of internal audit function will depend upon:
 External auditor’s judgment of the risk and materiality of each area concerned;
 Preliminary assessment of the internal audit function; and
 Evaluation of specific work of the internal audit function.
Documentation
 Conclusions about the adequacy of the internal audit function and its work.
 The audit procedures performed by him on that work.
2.5 Direct assistance (Ref: 26-32, A31-A41)
Direct assistance is defined as the use of internal auditors to perform audit procedures under the direction,
SPOTLIGHT
supervision and review of the external auditor.
Internal auditors may not provide direct assistance if:
 There are significant threats to the objectivity of the internal auditor; or
 The internal auditor lacks sufficient competence to perform the proposed work.
When determining nature and extent of work to be assigned, external auditor shall consider:
 Amount of judgment involved;
 Assessed risk of material misstatement;
 External auditor’s evaluation of the existence of threats to the objectivity and level of competence of
the internal auditors;
 Whether in aggregate the external auditor would remain sufficiently involved in the audit.
ISA 610 precludes the use of internal audit to perform direct assistance procedures that:
 Involve making significant judgements in the audit;
 Relate to higher assessed risks of material misstatement where higher judgment is required in
performing relevant audit procedures or evaluating audit evidence gathered;
 Relate to work with which 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
 Relate to the decisions of using work of internal auditor or using his direct assistance.

2.6 Using internal auditors to provide direct assistance (Ref: 33-35, A24-A30)
Prior to using internal auditors to provide direct assistance, the external auditor shall:
 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
that work; and
 Obtain written agreement from internal auditors that they will keep confidential specific matters as
instructed by the external auditor and inform external auditor of any threat to their objectivity.
2.7 Direction, supervision and review by external auditor

 It must be sufficient in order to be satisfied that internal auditors have obtained sufficient appropriate
audit evidence to support the conclusions based on that work.
 External auditor shall remain alert for indications that existence and significance of threats to
objectivity and level of competence of the internal auditors are no longer appropriate.
2.8 Documentation (Ref: 36-37)

The external auditor is required to document:
AT A GLANCE
 The evaluation of existence and significance of threats to objectivity of internal auditors, and the level
of competence of the internal auditors used to provide direct assistance;
 Basis for decision regarding nature and extent of the work performed by internal auditors;
 Who reviewed the work performed and the date and extent of that review;
 Written agreements obtained from an authorized representative of entity and the internal auditors;
and
 Working papers prepared by internal auditors who provided direct assistance on the audit.
2.9 Communication with those charged with governance

External auditor shall communicate the planned use of the work of the internal audit function to those charged
with governance for their understanding of the proposed audit approach.
SPOTLIGHT

3. USING THE WORK OF AN AUDITOR’S EXPERT (ISA 620)

 Definition: 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 auditor to assist auditor in obtaining sufficient appropriate
audit evidence.
An auditor's expert may be either an auditor's internal expert (who is a partner or staff, including
temporary staff, of auditor's firm or a network firm), or an auditor's external expert.
3.1 Determining the Need for an Expert (Ref: 7, A4-A9)

An auditor may obtain an understanding of the field of expert through:
 Experience in auditing entities that require such expertise.
 Education or training in particular field.
 Discussion with auditors having performed similar engagements
Whether to use Auditor’s expert (Considerations)
 Nature and significance of the matter, including its complexity.
AT A GLANCE
 Risks of material misstatement in the matter.
 Expected nature of procedures including auditor's knowledge of and experience with the work of
experts
 Availability of alternative sources of audit evidence.
 Whether management has used a management's expert
¯ Nature, scope and objectives of his work.
¯ Whether he is employee or outsourced
¯ Extent of possible control or influence of entity over him.
¯ His competence and capabilities.
SPOTLIGHT
¯ Whether he is subject to technical performance standards or other professional or industry
requirements
¯ Any controls within entity over his work.
Benefit of using Auditor’s expert
 Understanding of entity & environment including internal control.
 Identifying and assessing the risks of material misstatement.
 Determining and implementing further audit procedures.
 Designing & performing tests of controls or substantive procedures
 Evaluating sufficiency & appropriateness of audit evidence.
3.2 Nature, Timing and Extent of Audit Procedures (Ref: 8, A10-A13)

Auditor shall consider matters including:
 Nature of the matter to which that expert's work relates;
 Risks of material misstatement;
 Significance of expert's work in context of audit;
 Auditor's knowledge of and previous experience with that expert
 Whether internal expert is subject to firm quality control policies

¯ Competence and capabilities (Recruitment & training)

¯ Objectivity (Ethical Requirements).
¯ Evaluation of the adequacy of the expert's work
¯ Adherence to regulatory and legal requirements.
¯ Agreement with the expert.
Need for different or more extensive procedures (factors):
 Work of expert involving subjective and complex judgments.
 Auditor has not previously used expert’s work, and has no prior knowledge of his competence,
capabilities and objectivity.
 Expert is performing procedures that are integral to the audit
 He is external expert (not subject to firm quality control policies)
3.3 Competence, Capabilities and Objectivity of Expert & Obtaining an Understanding of the Field of
Expertise of Expert (Ref: 9, A14-A20)
Similar to that of Management Expert (Please Refer to ISA-500)
AT A GLANCE
3.4 Agreement with the Expert (Ref: 11, A23-A31)

Following factors may suggest need for more detailed agreement or for the agreement to be set out in writing:
 Expert will have access to sensitive or confidential information.
 Respective roles or responsibilities of auditor and expert are different from those normally expected.
 Multi-jurisdictional legal or regulatory requirements apply.
 The matter to which the expert's work relates is highly complex.
 Auditor has not previously used work performed by that expert.
 Greater extent of expert's work, and its significance for audit.
SPOTLIGHT
 Agreement between the Auditor and External Expert (Appendix)

Nature, Scope and Objectives of External Expert's Work
 Nature and scope of procedures to be performed.
 Objectives of the external expert's work in context of audit
 Any relevant technical performance standards or other requirements.
 Assumptions and methods, including models, expert will use.
 Effective date and testing period (if applicable) for the subject matter.
The Respective Roles and Responsibilities of the Auditor and the Expert
 Relevant auditing & accounting standards, and regulatory requirements
 Expert's consent to intended use of his report, including any reference
 Nature and extent of the auditor's review of expert's work.
 Whether the auditor or the expert will test source data.
 Expert's access to records, files, personnel and management’s experts.
 Procedures for communication between the expert and the entity.
 Auditor's and the expert's access to each other's working papers.
 Ownership and control of working papers during & after engagement.
 Expert's responsibility to perform work with due skill and care.

 Expert's competence and capability to perform the work.

 Expectation that expert will use all knowledge for subject matter.
 Any restriction on expert's association with auditor's report.
Communications and Reporting
 Methods and frequency of communications, including:
¯ How expert's findings or conclusions will be reported.
¯ Identification of team members who will coordinate with expert.
 When expert will complete work and report findings or conclusions.
 Expert's responsibility to communicate
¯ Promptly any potential delay in completing work and any potential reservation or
limitation.
¯ Instances of scope limitation imposed by management.
¯ All information that expert believes may be relevant to the audit.
¯ Circumstances that may create threats & any relevant safeguards.
AT A GLANCE
Need to observe Confidentiality
 Relevant ethical requirements of confidentiality applicable to auditor.
 Additional requirements that may be imposed by law or regulation.
 Specific confidentiality provisions requested by the entity, if any.
If there is no agreement, evidence of agreement may be included e.g.:
 Planning memoranda or related working papers
 Policies and procedures of the auditor's firm.
SPOTLIGHT
Quail & Company, Chartered Accountants has recently been appointed as the external auditor of
Penguins Limited (Penguin) for the year ending December 31, 2010. Penguin uses a fully
automated integrated accounting system which meets all its operational and financial reporting
requirements. Quail & Company is considering to hire a firm of consultants to assist it in
evaluating the IT related controls and procedures in order to attain a level of comfort over the IT
controls employed by Penguin.
Required:
a) List any five important matters which Quail & Company should consider while deciding
upon the need to hire a firm of IT consultants.
b) Specify the important matters which should be clarified in the agreement with the
consultants
Tutorial Notes:
a) You should focus on the requirement more precisely. Students are expected to highlight
the following matters:
 The degree of complexity of the client’s system
 How much audit evidence is available through electronic forms?
 The extent to which the data is shared among different applications
 The changes that have been made to the existing systems and new systems that have
been put into operation, if any
 Client’s plans to use emerging technologies

b) being an easy question require no additional consideration

 Solution:
a) While employing an IT Consultant, Quail & Co. should consider the following:
i. The degree of complexity of the client’s system
ii. Determine how much audit evidence is available through electronic form
iii. Ascertain the extent to which the data is shared among different applications
iv. Determine the changes that the client has made to existing systems and whether any
new systems have been put into operation
v. Ascertain client’s plans to use emerging technologies
b) The following terms would need to be clarified with the IT Consultant:
i. The scope and objective of the work of the IT Consultant
ii. The auditor’s intended use of the Consultant’s work
iii. Nature of information that would be required by the Consultant
iv. The assumptions, methods and procedures that the Consultant would use
v. The extent of the Consultant’s access to client files and record
AT A GLANCE
vi. The nature and extent of the firm’s review of the Consultants work
vii. Ownership and control of working papers during and after the engagement
including any file retention requirement
viii. Reporting time lines
ix. An outline of contents of the reports of IT Consultant including form and content of
findings
x. Compliance of the IT Consultant with the firm’s ethical requirement including
independence
xi. Maintenance of client confidentiality
xii. The Consultant’s relationship with the client
SPOTLIGHT
3.5 Evaluating the Adequacy of the Expert's Work (Ref: 12-13, A32-A40)
a) Relevance and reasonableness of expert's findings or conclusions and consistency with other audit evidence
 Findings and Conclusions of the Expert
 Inquiries of the expert.
 Reviewing the expert's working papers and reports.
 Corroborative procedures, such as:
¯ Observing the expert's work;
¯ Examining published data e.g. authentic statistical reports etc;
¯ Confirming relevant matters with third parties;
¯ Performing detailed analytical procedures; and
¯ Re-performing calculations.
 Discussion with another expert with relevant expertise (if inconsistent)
 Discussing the expert's report with management.

Relevance and Reasonableness

 Presented in a manner consistent with standards of expert's profession;
 Clearly expressed, including reference to objectives agreed, scope of the work performed
and standards applied;
 Based on appropriate period and take into account subsequent events
 Subject to any reservation, limitation or restriction on use;
 Based on consideration of errors or deviations encountered.
b) If that expert's work involves use of significant assumptions and methods, 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.
INADEQUATE WORK
If auditor determines that work of expert is not adequate, he shall:
 Agree with that expert on nature and extent of further work; or
 Perform additional audit procedures
AT A GLANCE
¯ If auditor concludes that he cannot resolve matter through additional procedures, he may express a
modified opinion
3.6 Reference to the Expert in the Auditor's Report (Ref: 14-15, A41-A42)
Auditor shall not refer to work of an expert in auditor report containing an unmodified opinion unless required
by law
 If such reference is required by law, auditor shall indicate in report that reference does not reduce
auditor's responsibility.
If auditor makes reference to work of expert in report because such reference is relevant to explain modification
to the opinion,
SPOTLIGHT
 Indicate that reference does not reduce auditor's responsibility.
 May need the permission of expert before making such reference.
3.7 Tutorial note

Core Paragraphs: 8, 11, 12, 14 and 15
Explanatory Paragraphs: A4, A7 to A10, A13, A15, A20, A24, A33 and A34

4. INTRODUCTION TO GROUP AUDITS

4.1 Introduction
A group audit is the audit of a group’s consolidated financial statements. For this topic, you need to be aware of
the requirements of the following accounting standards:
 IFRS 3 Business combinations
 IFRS 10 Consolidated financial statements
 IFRS 11 Joint arrangements
 IFRS 12 Disclosure of interests in other entities
 IAS 27 (revised) Separate financial statements
 IAS 28 Investments in associates
In addition, IAS 24 Related party disclosures is also of particular relevance because companies within a group are
related parties.
4.2 Group audits and the audit of individual group companies

AT A GLANCE
Much of the basic audit work for groups of companies consists of auditing the financial statements of the
individual companies in the group. The parent company and subsidiaries are referred to (for audit purposes) as
the ‘components’ of the group.
The audit work on the financial statements of the components of a group will follow normal auditing principles
and practice.
This chapter is concerned with the additional audit considerations that arise in connection with the preparation
of the group financial statements.
4.3 Possible problems with group audits

The organisation and planning of a group audit is usually more complex than the planning of the audit of a single
company, for the following reasons:
SPOTLIGHT
 Groups may include a large number of companies. Some group companies may be foreign subsidiaries
that report in their own currency and perhaps use their national accounting practices to prepare their
financial statements, rather than international financial reporting standards.
 Some companies in the group may have a different year-end accounting date from other companies.
 It will be necessary to make or audit the adjustments that are made to the financial statements of
individual group companies, for consolidation purposes.
 Some group companies may be audited by an audit firm that is not the auditor of the parent company.
 Direction, supervision, review and communication protocols need to be set bearing in mind the local
laws and regulation applicable to each component separately (this implies that data protection laws
for example, may prohibit sharing of certain information with group auditors).
4.4 Terminology in group audits

Some special terms from ISA 600 (see below) are used for group audits.
 Definition: Group engagement team
The group engagement team is the audit team responsible for the audit of the group financial
statements (and will usually also be the audit team responsible for the audit of the parent
company). ISA 600 in fact refers to the ‘group audit’, the ‘group engagement partner’ and the
‘group engagement team’ whilst a number of other ISAs use the term ‘group auditor’ as a
synonym for group engagement team.

The group engagement team will:

 establish the overall group audit strategy
 communicate with component auditors (see below)
 perform work on the consolidation process, and
 evaluate the conclusions drawn from the audit evidence obtained in order to form
an opinion on the group financial statements.
Each of the above stages is considered in more detail in this chapter.
 Definition: Component auditor
A component auditor is an auditor who, at the request of the group auditor, performs work on
the financial information of a component. For example, the audit of an individual subsidiary,
associate or joint venture may be performed by Audit firm A, when the group auditor is Audit
firm B. Audit firm A is a ‘component auditor’
 Definition: Component
A component is an entity or business activity for which group or component management
prepares financial information that should be included in the group financial statements.
AT A GLANCE
 Definition: Group
All the components whose financial information is included in the group financial statements. A
group always has more than one component.
 Definition: Group audit
The audit of group financial statements.
 Definition: Component materiality
The materiality for a component determined by the group engagement team.
 Definition: Group-wide controls
Controls designed, implemented and maintained by group management over group financial
SPOTLIGHT
reporting.
The following definitions are reminders from IAS and IFRS of the accounting terms particularly relevant to group
audit:
 Definition: Key accounting terms relevant to group audit
Business combination
A transaction or other event in which an acquirer obtains control of one or more businesses.
Parent
An entity that has one or more entities (IFRS 10).
Subsidiary
An entity that is controlled by another entity (IFRS 10).
Control
An investor controls an investee when the investor is exposed, or has rights, to variable returns
from its involvement with the investee and has the ability to affect those returns through its
power over the investee (IFRS 10).
Power
Existing rights that give the current ability to direct the relevant activities of the investee.

Associate
An entity over which the investor has significant influence.
Significant influence
The power to participate in financial and operating policy decisions of the investee, but is not
control or joint control over those policies.
Joint arrangement
An arrangement of which two or more parties have joint control.
Joint control
The contractually agreed sharing of control over an arrangement, which exists only when the
decisions about the relevant activities require the unanimous consent of the parties sharing
control.
Joint venture
A joint arrangement whereby the parties that have joint control of the arrangement have rights
to the net assets of the arrangement.
AT A GLANCE
SPOTLIGHT

5. GROUP AUDITS: PRELIMINARIES

5.1 The relationship between the group auditor and component auditors
ISA 600 regulates situations where group financial statements include financial information of components that
are audited by other audit firms. The group auditor is required to determine how the work of the component
auditors will affect the audit of the group financial statements.
The group engagement partner is responsible for:
 the direction, supervision and performance of the group audit, and
 issuing an appropriate group audit report.
The group auditor is solely responsible for the audit report on the group financial statements (although ISA 600
does not in fact use this term). The group audit report does not therefore refer to any component auditors, unless
such a reference is required by local law. If it is required, the group audit report must indicate that such a
reference does not reduce the group auditor’s responsibility for the opinion on the group financial statements.
Because of this sole responsibility, ISA 600 contains very specific guidance on:
 the direction that the group auditor should give to the group audit.
AT A GLANCE
 the group auditor’s involvement in the work of component auditors, and
 the extent of review which the group auditor can carry out of the component auditor’s work.
5.2 Accepting an appointment as group auditor

It is normal practice for the auditor of the parent company to act as the group auditor. However, this is
‘technically’ a separate appointment. As in the case of all appointments, the audit firm should consider whether
it is in a position to accept the appointment as group auditor.
Before accepting appointment as group auditor, the audit firm should ensure that all the procedures relating to
acceptance of an engagement per ISA 220 are met and that they have a ‘reasonable expectation’ of obtaining
sufficient appropriate audit evidence about the consolidation process and the financial information of
components to reduce audit risk to an acceptable level.
SPOTLIGHT
The firm does this by obtaining an understanding of the group and its components and their environment
sufficient to determine:
 which components are significant to the group
 which significant components are audited by others, and
 whether as group auditor, the firm will be able to be sufficiently involved in the audit of significant
components to obtain sufficient appropriate evidence about them.
If the group auditor is not able to be involved in the audit of a significant component, then it is unlikely that the
group auditor can obtain sufficient appropriate evidence in respect of that component and it should not accept
(or should resign from) the engagement. If the auditor is prevented from resigning from the engagement by the
law, they should issue a disclaimer of opinion on the group financial statements.
 Definition: Significant components
Significant components are those that:
 are of individual significance to the group (i.e. individually material in a group
context), or
 have been identified as likely to include significant risks of material misstatement of
the group financial statements.

5.3 Understanding the group, its components and the component auditors
In accordance with ISA 315, the group auditor must identify and assess the risks of material misstatement
through obtaining an understanding of the entity and its environment. This will mean:
 enhancing the understanding of the group, its components and their environments, obtained at the
acceptance or continuation stage, and
 obtaining an understanding of the consolidation process, including the instructions issued by
management to its components.
This will enable the group auditor to confirm or revise its initial assessment of components which are likely to
be significant.
When the group auditor plans to request a component auditor to perform work on the financial information of a
component, they must assess the following issues:
 Whether the component auditor understands and will comply with the ethical requirements that are
relevant to the group audit (in particular that they are independent).
 The component auditor’s professional competence.
 Whether the group engagement team will be able to be involved in the work of the component auditor
to the extent necessary to obtain sufficient appropriate audit evidence.
AT A GLANCE
 Whether the component auditor operates in a regulatory environment that actively oversees auditors.
The group auditor cannot simply rely on the work performed by the component auditor without assessing the
likely quality of that work.
If the component auditor is not independent or there are serious concerns about any of the other matters above,
the group auditor will need to obtain evidence relating to the financial information of the component without
requesting the component auditor to perform any work.
5.4 Materiality
The group auditor will need to set:
 group materiality for the group financial statements as a whole, and
SPOTLIGHT
 component materiality for those components where component auditors will perform an audit or a
review for the purposes of the group audit.
Component materiality will usually be lower than group materiality. If a component has been audited in its own
right (e.g. because of local laws or regulations) and the group auditor decides to use that audit to provide audit
evidence for the group audit, the materiality threshold used on that audit will need to be assessed. If the threshold
was too high, then additional work may be needed where component materiality is lower than the overall
materiality level used in the local statutory audit for the individual component.
Different risk profiles for different components would mean separate materiality levels would be set for each
component; these could be higher or lower than the materiality set for the components’ individual audit. Thus,
the aggregate of components’ materiality would not likely equal the materiality for the consolidated financial
statements. The group auditor is particularly concerned with items that affect the consolidated financial
statements, hence there could be items of significance to a component that may not affect the consolidated
financial statements at all, or in an immaterial manner.
5.5 Planning and controlling a group audit

The principles and guidelines for planning and controlling a group audit are similar to those for the audit of an
individual company. However, additional considerations arise, in regard to the complexities of a group audit.
These additional considerations will require the group auditor to do the following:
 Familiarise themselves with the client’s procedures for preparing group financial statements (for
example, the client may use standard consolidation schedules).

 Ascertain the client’s timetable for the preparation of the group financial statements.
 Establish an audit strategy and audit plan for the entire group audit, including the audit of components.
This should include:
¯ staffing requirements for the group audit
¯ a timetable for the audit of the company financial statements and the group financial statements
¯ an action plan for possible problem areas (for example, foreign subsidiaries)
¯ arrangements for communication and co-operation with component auditors.
AT A GLANCE
SPOTLIGHT

6. WORKING WITH COMPONENT AUDITORS

6.1 Determining the type of work to be performed on components
Where a component is of individual financial significance to the group, the group auditor or a component
auditor must perform an audit using component materiality.
Where a component is significant because of likely significant risk of material misstatement, the group
auditor or a component auditor must perform one or more of the following.
 An audit using component materiality.
 An audit of one or more account balances, classes of transactions or disclosures (depending on where
the risk of material misstatement lies).
 Specified audit procedures to address the risk of material misstatement.
For non-significant components the group auditor should perform analytical procedures at a group level.
However, the performance of such procedure may indicate a previously-unidentified significant risk. In this case,
the component classification may have to change to significant component and the procedures stated above
would have to be performed.
If the group auditor does not consider that sufficient appropriate audit evidence will be obtained from the sum
AT A GLANCE
of the above work, then additional work should be performed on non-significant components (similar to that for
significant components). The selection of such components should be varied from year to year.
6.2 Communication with component auditors

If there is not effective communication between the group auditor and the component auditor, there is a risk that
the group auditor may not obtain sufficient appropriate audit evidence on which to base the group audit opinion.
It is therefore vital that there is clear and timely two-way communication between the group auditor and the
component auditor. The group auditor’s requirements are usually communicated in a letter of instruction. The
component auditor’s communication with the group auditor will usually be in the form of a memorandum or
report of work performed.
However, such communication may not necessarily be in writing. For example, the group engagement team may
SPOTLIGHT
visit the component auditor to discuss identified significant risks or review relevant parts of the component
auditor’s audit documentation. In such cases, matters must be properly documented in accordance with ISA 230.
In co-operating with the group auditor, the component auditor will provide the group engagement team with
access to relevant audit documentation provided this is not prohibited by law or regulation.
Letter of instruction
The group auditor’s letter of instruction to the component auditor should set out:
 the work required,
 the use to be made of that work, and
 the form and content of the component auditor’s communication with the group engagement team.
It should also include:
 a request for co-operation,
 ethical requirements, including independence,
 component materiality,
 identified significant risks,
 a list of known related parties,
 protocols and approval process for providing non-audit services to the component that could have an
effect on the independence at group level.

Evaluating the work of the component auditor

The group auditor is required to evaluate the work performed by component auditors. This is typically achieved
by reviewing a report or questionnaire completed by the component auditors and engaging in appropriate
discussion with the component auditors.
The group auditor must:
 Discuss significant matters arising from their evaluation with the component auditor, component
management or group management, as appropriate; and
 Determine whether it is necessary to review other relevant parts of the component auditor’s audit
documentation.
If the group engagement team concludes that the work of the component auditor is insufficient, the group
engagement team shall determine what additional procedures are to be performed, and whether they are to be
performed by the component auditor or by the group engagement team.
The component auditor’s report of work performed should include:
 a statement of compliance with ethical and group auditor requirements
 identification of the financial information on which the component auditor is reporting
AT A GLANCE
 any instances of non-compliance with laws and/or regulations which could lead to a material
misstatement of the group financial statements
 a list of uncorrected misstatements of the financial information of the component
 indicators of possible management bias
 any identified material weaknesses in internal control
 any other significant matters the component auditor expects to communicate to those charged with
governance of the component
 any other matters that may be relevant to the group audit
 the component auditor’s overall findings, conclusions or opinion.
6.3 Involvement of the group auditor in the work performed by component auditors
SPOTLIGHT
It is the group auditor’s responsibility to decide what work is to be performed on the financial information of the
component by the component auditor.
The group auditor then has to decide the extent of their involvement in that work. For significant components
they must, as a minimum:
 discuss with component management or the component auditor the business activities of the
component that are significant to the group
 discuss with the component auditor the risk of material misstatement of the financial information of
the component, and
 review the component auditor’s documentation of identified significant risks of material misstatement
of the group financial statements.
Where significant risks of material misstatement of the group financial statements have been identified at a
component the group auditor should:
 evaluate the further audit procedures to be performed to address such risks, and
 consider whether it is necessary to be involved in those procedures.
 Such involvement might include:
 meeting with component management/auditors to obtain an understanding of the component
 reviewing the component auditor’s overall audit strategy and plan
 performing risk assessment procedures at the component

 designing and/or performing further audit procedures

 participating in closing/other key meetings between component auditors/management
 reviewing other relevant parts of the component auditor’s documentation.
For other components, the extent of the group auditor’s involvement will depend on their understanding of that
component auditor. If they have concerns about that particular component auditor’s competence, or a lack of
local regulation, they may decide that they need to be involved in that component auditor’s risk assessment.
In all cases the group auditor is required to evaluate the report of the work performed by the other auditor. If,
after such evaluation and after discussion with the component auditor/management, the group auditor
concludes that the work is insufficient they should:
 determine what additional procedures are needed;
 establish whether such procedures should be performed by the component auditor or themselves, and
 understand the possible impact on the audit report on the group financial statements (if any).
6.4 Joint auditors

A joint audit involves two (or more) audit firms being appointed to audit the financial statements of an entity.
AT A GLANCE
Joint audits may occur in other situations, but they are most commonly found in group audits. In particular, when
a group acquires a new subsidiary, it is not unusual to appoint the group’s auditors jointly with the subsidiary’s
existing auditors, at least for a period of time after the acquisition.
The joint audit provides a joint opinion on the financial statements of the subsidiary.
Advantages of joint audits

The reasons why joint auditors might be appointed include the following issues:
 The client company may be so large that it requires the services of more than one firm of auditors.
 After the acquisition of a large subsidiary, using joint auditors may help the transition process while
the group auditors become familiar with the new subsidiary. The ‘old’ auditors should be familiar with
the business of the subsidiary and should pass their knowledge over to the parent company auditors.
SPOTLIGHT
For the parent company auditors, this should accelerate the process of getting to know the business of
the new subsidiary.
 Joint auditors may provide a higher level of technical expertise than either audit firm could provide
individually.
 Improved geographical coverage may be obtained for the audit, where each of the joint auditors on its
own does not have offices that cover all the geographical locations of the component companies in the
group.
 It has been suggested that two medium-sized accountancy firms might ‘join forces’ and tender for the
audit of a company for which the auditors would normally be one of the ‘Big 4’ accountancy firms. This
is possibly a way in which medium-sized firms might try to ‘break the monopoly’ of the Big 4 on large
company audits.
Disadvantages of joint audits

Possible disadvantages of joint audits include the following:
 The extra cost to the client. It is likely to cost more to use two accountancy firms than to use one.
 Possible inconsistencies between the two joint auditors in the audit methods that they use. If so, there
may be problems in reaching agreement on whose audit method to use.
 The possible difficulty the two firms may have in agreeing the division of work.
 Additional problems that will arise in monitoring and controlling the audit work of two different firms.

 The two firms may find it difficult to work well together, and each firm may try to become the leading
firm in the joint audit.
 If there is a claim against the auditors for negligence in the conduct of the audit, there may be some
difficulty in identifying which of the joint auditors is potentially liable.
The key to a successful joint audit is good communication between the firms, including joint planning meetings
and regular discussions between the firms at all key stages of the audit process. The meetings and discussions
should be fully documented.
AT A GLANCE
SPOTLIGHT

7. AUDITING THE CONSOLIDATION PROCESS

7.1 Role of the group auditor with regard to consolidation
As discussed above, ISA 600 requires the group auditor to obtain an understanding of the consolidation process,
including the instructions issued by management to its components. This will allow an assessment of the risks
involved in the consolidation process.
The group auditor will want to confirm that the following actions have been taken correctly by the client group:
 There has been a full and accurate transfer of information from the individual financial statements of
the components of the group to the final consolidated financial statements.
 Appropriate consolidation adjustments have been made.
However, the amount and type of detailed audit procedures to be carried out will depend on the group auditor’s
assessment of risk in this area.
7.2 The main audit procedures relating to consolidation

The table below sets out the main audit procedures that could be performed in relation to the consolidation
process i.e. preparing the consolidated financial statements from the financial statements of the individual
AT A GLANCE
components in the group.
Topic Audit procedures

Clerical  Confirm that figures have been transferred accurately from the financial statements of
accuracy the components (individual conmpanies in the group) to the consolidation schedules.
 Check the arithmetical accuracy of all consolidation calculations, such as the
consolidation total balances and total transaction values.
Status of  Confirm that the parent company has correctly classified investments as a subsidiary,
investments associate, joint venture or simple investment, in accordance with standard accounting
practice.
 Confirm that the appropriate accounting treatment has been adopted for each of these
SPOTLIGHT
classifications of investment in the group accounts.

Changes in  For acquisitions: confirm fair values, the calculation of purchased goodwill and
the group accounting treatment in accordance with IFRS 3 and any other relevant standards.
 Where there has been an acquisition during the year involving deferred consideration
as part-payment, check that the amount of the deferred consideration has been
included in the cost of the acquisition at discounted present value, using a current pre-
tax cost of capital as the discount rate. (Note: The cost of the acquisition affects the
amount of the purchased goodwill.)
 Where there has been an acquisition during the year involving a possible contingent
consideration as part-payment, check the reasonableness of the assumption that the
recent value of the contingent consideration should be included in the cost of the
acquisition.
 For disposals: confirm the sale proceeds, and the calculation of the gain or loss on sale.
 Check that the correct accounting treatments of items are applied in the consolidated
income statement/statement of comprehensive income and the consolidated. For
example, when a subsidiary has been acquired during the year, check that the
calculation of pre-acquisition and post-acquisition profit is correct.
Consolidation  Reconcile the inter-company transactions and balances (or review the reconciliation
adjustments* of the inter-company transactions and balances that has been made by the client’s
staff).

Topic Audit procedures

 Confirm the inter-company balances.
 Check calculations of the adjustments for unrealised profit.
 Check the calculations and disclosure of non-controlling interests.
 Check the accounting treatment of inter-company dividends and other dividends.
Loss-making  Consider whether any goodwill on acquisition has suffered an impairment.
investments  Consider whether a write down of the investment in the books of the parent company
is needed.
 If a subsidiary makes losses consistently, its going concern status may be in question.
 However, the group may take a formal decision to provide financial support to the
subsidiary. This decision, in effect, would protect the going concern status of the
subsidiary, even if it is making losses. In such a situation, the group auditor will
normally request a ‘comfort letter’ (or ‘support letter’) to this effect from the directors
of the parent company.
Related  Ensure the provisions of IAS 24 are complied with.
parties
AT A GLANCE
 (Most components of the group will be ‘related’ to most other components.)
 Sometimes, one component or the parent may have provided financial support to, or
letters of guarantee on behalf of, other components to bank or financial instituions.
These need to be considered for disclosure.
Reporting  Reach a conclusion about whether the group financial statements present a true and
fair view. (The principles relating to group audit reports are dealt with in a later
chapter.)
*(Note: Consolidation adjustments are adjustments that are made after the financial statements of the individual
group companies have been prepared. The adjustments are needed to consolidate the financial statements of the
individual companies into a single set of group financial statements. Consolidation adjustments may therefore
include adjustments to the financial statements of individual group companies, to achieve consistency of
SPOTLIGHT
accounting policies. There are also adjustments for inter-group balances and closing inventory from intra-group
sales, for goodwill impairment, and so on.)
ABC and Company, Chartered Accountants are faced with the following situations:
i. On the audit of Jalal Holdings Limited, the auditor of a subsidiary has issued a qualified
report.
ii. On a joint audit, there is a difference of opinion whereby ABC wants to issue a qualified
report whereas the joint auditors are convinced with the client’s explanation and intend
to issue an unmodified report.
Required:
Explain how the above situations should be dealt with.
Tutorial Notes:
i. A common error in this part can be that the students may suggest that the auditor should
consider the materiality of the subsidiary to the group instead of mentioning that the
impact of the qualification on the group as a whole should be considered. Furthermore,
discussing with subsidiary’s auditor is totally irrelevant.
ii. This part can confuse the students having lessor practical knowledge about the situation

 Solution:
i. When a component auditor presents a qualified audit report on the financial statements
of a subsidiary, the principal auditor has to first assess whether:
 The modification is material from the view point of the group as a whole.
 If the qualification is material to the group’s financial statements, the modification
should be carried forward to the auditor’s report on the group’s financial
statements. However, the type of modification may need to be changed depending
upon the degree of materiality for the group.
 If the qualification is not material with a view point of group’s financial statements,
the group auditor will make no reference to them in the audit report.
ii. In order to resolve the difference of opinion, discuss the matter with the joint auditor. In
case the matter is not resolved, both the joint auditors should express their own opinion.
You are the audit manager at HTC and Company, Chartered Accountants. Following matters
relating to a joint audit of Petro Oil Limited are brought into your attention by audit team:
AT A GLANCE
a) The joint auditors have agreed upon an audit strategy through which they have
segregated audit areas for both the firms.
Required:
Discuss how your firm can ensure before finalization of the audit report that the work
carried out by the other joint auditor has been in accordance with the agreed audit
strategy.
b) There is a difference of opinion on impairment of intangible assets. Your firm wants to
issue a qualified report whereas the joint auditor is convinced with the management’s
explanation and intend to issue an unmodified report.
Required:
SPOTLIGHT
Discuss the course of action available to your firm.

Tutorial Notes:
a)
 It is important to mention how it is to be ensured that work was performed in
accordance with the agreed audit strategy.
 Course of action should be prescribed if the work carried out by the other joint auditor
is insufficient or inappropriate.
b)
 Discussing the difference of opinion with those charged with governance should be
considered.
 A possibility of “other matter paragraph” should also be looked into.
 Solution:
a) HTC should at the planning stage agree with other joint auditor regarding procedures
for carrying out review of the work of each other before finalization of the audit opinion.
The review may include evaluating whether:
 audit procedures have been executed according to the agreed audit strategy and
plan;

 sufficient and appropriate audit evidence has been obtained and properly
documented from the audit procedures performed; and
 the conclusions drawn by the other joint auditor are generally appropriate and
consistent with the audit evidence obtained.
If HTC, after carrying out the review, evaluates and concludes that the work of the other
joint auditor is insufficient, HTC should then highlight the observations to the other joint
auditor requesting to make arrangements for performing additional work as
appropriate.
If the other joint auditor disagrees on carrying out additional procedures, HTC should
perform these additional procedures to obtain sufficient appropriate audit evidence
required to form an opinion on the financial statements.
b) The difference of opinion, if any, that may arise between HTC and joint auditor should
first be discussed among the joint engagement partners for resolution of the matter.
Where the differences of opinion between the joint auditors cannot be resolved, the joint
auditors should inform management and/or those charged with governance as soon as
possible.
AT A GLANCE
Under the joint audit arrangement, entered into between the joint auditors and the
entity, it is expected that an auditor’s report containing the audit opinion is issued by the
joint auditors. However, where this is not possible, each joint auditor should issue
separate auditor’s report and include under the heading ‘other matters’ reference to the
other joint auditor report and explain reason for issuing separate audit report. Both
these reports will be taken jointly as auditors’ report on the financial statements and
attached accordingly.
7.3 Subsequent events

The subsequent events review will need to include procedures to identify events at components that occur
between the dates of the components’ financial information and the date of the group audit report. These
procedures could be carried out by the group auditor or by component auditors.
SPOTLIGHT

8. DOCUMENTATION AND COMMUNICATION WITH MANAGEMENT AND

THOSE CHARGED WITH GOVERNANCE
8.1 Documentation
In addition to meeting the requirements of ISA 230 Audit documentation the group auditor must also document
the following matters.
 An analysis of components, identifying significant components.
 The type of work performed on the financial information of components.
 The extent of the group auditor’s involvement in the work performed by component auditors on
significant components.
 Written communications between the group auditor and component auditors concerning the group
auditor’s requirements.
8.2 Communication with group management

The group auditor should make group management aware, on a timely basis, of the following matters.

AT A GLANCE
Material weaknesses in the design or operating efficiency of group-wide controls.

 Material weaknesses which are significant to the group that the group auditor has identified at
components.
 Material weaknesses which are significant to the group that component auditors have identified at
components and have brought to the attention of the group auditor.
 Any fraud or suspected fraud identified by the group or component auditors.
 The distinction between management and “those charged with governance” (see below), who could in
fact be the same, is covered in a later chapter.
8.3 Communication with those charged with governance of the group

In addition to the matters required to be communicated within ISA 260 Communication with those charged with
SPOTLIGHT
governance, ISA 600 requires the group auditor to communicate the following matters to those charged with the
governance of the group:
 The type of work to be performed on the financial information of components.
 The group auditor’s planned involvement in the work to be performed by component auditors.
 Any concerns over the quality of any component auditor’s work.
 Any limitations on the group audit (e.g. a lack of access to information).
 Any fraud or suspected fraud involving group management, component management, or employees with
significant roles in group-wide controls where the fraud resulted in a material misstatement of the group

CHAPTER 9
AUDIT EVIDENCE
AT A GLANCE
IN THIS CHAPTER:
ISA-230 deals with the auditor’s responsibility to prepare audit
AT A GLANCE documentation for an audit of financial statements. The
Appendix to this ISA also lists other ISAs that contain specific
SPOTLIGHT documentation requirements and guidance.
ISA-500 explains what constitutes audit evidence in an audit of
1. Audit documentation (ISA financial statements, and deals with the auditor’s responsibility
230) to design and perform audit procedures to obtain sufficient
AT A GLANCE
appropriate audit evidence to be able to draw reasonable
2. Audit evidence (ISA 500) conclusions on which to base the auditor’s opinion.
ISA-501 deals with specific considerations by the auditor in
3. Audit evidence - specific
obtaining sufficient appropriate audit evidence regarding the:
considerations for selected
items (ISA 501) (a) Existence and condition of inventory;
(b) Completeness of litigation and claims involving the
4. External confirmations (ISA
entity; and
505)
(c) Presentation and disclosure of segment information in
5. Analytical procedures (ISA accordance with the applicable financial reporting
520) framework.
SPOTLIGHT
ISA-505 deals with the auditor’s use of external confirmation
6. Audit sampling (ISA 530)
procedures to obtain audit evidence in accordance with the
requirements of ISA 330 and ISA 500
7. Auditing accounting
estimates & related ISA-520 deals with the auditor’s use of analytical procedures
disclosures (ISA 540) as substantive procedures. It also deals with the auditor’s
responsibility to perform analytical procedures near the end of
the audit that assist the auditor when forming an overall
conclusion on the financial statements.
ISA-530 applies when the auditor has decided to use audit
sampling in performing audit procedures. It deals with the
auditor’s use of statistical and non-statistical sampling when
designing and selecting the audit sample, performing tests of
controls and tests of details, and evaluating the results from the
sample.
accounting estimates, including fair value accounting estimates,
and related disclosures in an audit of financial statements

CHAPTER 9: AUDIT EVIDENCE CFAP 6: AARS
1. AUDIT DOCUMENTATION (ISA 230)

 Definition: Audit documentation
Record of audit procedures performed, relevant audit evidence obtained, and conclusions the
auditor reached (terms such as "working papers" or "work papers" are also sometimes used).
1.1 Nature and Purposes of Audit Documentation (Ref: 2-3, A2-A20)

Audit documentation serves a number of purposes, including:
 Assisting the engagement team to plan and perform the audit.
 Assisting supervisors of engagement team to discharge their review responsibilities (ISA 220)
 Enabling the engagement team to be accountable for its work.
 Retaining a record of matters of continuing significance to future audits.
 Enabling conduct of QCR and inspections in accordance with ISQC 1 or national requirements
 Conduct of external inspections.
1.2 Timely Preparation of Audit Documentation (Ref: 7, A1)

AT A GLANCE
 Auditor shall prepare sufficient and appropriate audit documentation on a timely basis.
 Oral explanations by auditor may be used to explain information contained in documentation but it does
not represent adequate support for work performed or conclusions reached
1.3 Form, Content and Extent of Audit Documentation (Ref: 8-11, A2-A19)
Form, content and extent of audit documentation depend on:
 Size and complexity of the entity.
 Nature of the audit procedures to be performed.
 Risks of material misstatement.
 Significance of the audit evidence obtained.
SPOTLIGHT
 Nature and extent of exceptions identified.

 The audit methodology and tools used.
 Need to document a conclusion or the basis for a conclusion not readily determinable from the
documentation of the work performed or audit evidence obtained.
Auditor need not include superseded drafts of working papers and financial statements, previous copies of
documents corrected, and duplicates.
QUALITY OF DOCUMENTATION
Prepare audit documentation that is sufficient to enable experienced auditor, having no previous connection with
the audit, to understand:
 Nature, timing and extent of audit procedures performed
 Results of the audit procedures, and audit evidence obtained
 Significant matters arised, conclusions reached, and significant professional judgments made
Significant Matters:
 Matters that give rise to significant risks
 Results of audit procedures indicating
¯ That financial statements could be materially misstated, or

CFAP 6: AARS CHAPTER 9: AUDIT EVIDENCE
¯ Need to revise auditor's previous risk assessment and responses to those.

 Circumstances causing difficulty in applying procedure
 Findings that could result in modification of report.
Auditor may consider it helpful to prepare and retain a summary (completion memorandum)
 Significant matters identified during the audit,
 How they were addressed, or
 Cross-references to other relevant supporting documentation.
Documentation of Audit Procedures Performed & Audit Evidence Obtained
 Nature, timing and extent of audit procedures performed
¯ The identifying characteristics of the specific items or matters tested (e.g. invoice numbers, date,
amount of transaction etc.);
¯ Who performed audit work and the date such work was completed; and
¯ Who reviewed audit work performed and date and extent of such review.
 Discussions of significant matters with management, those charged with governance, and others
¯ Records prepared by auditor;
AT A GLANCE
¯ Minutes of meetings prepared by management and agreed by auditor etc.
 How inconsistencies have been addressed
 Departure from a relevant requirement
Document how alternative audit procedures performed achieve the aim of that requirement, and the reasons for
such departure.
Documentation requirement applies only where relevant. A requirement is not relevant only in cases where:
¯ Entire ISA is not relevant.
¯ Requirement is conditional and condition does not exist.
 Matters arising after the date of the auditor's report
SPOTLIGHT
¯ The circumstances encountered;
¯ New or additional audit procedures, audit evidence obtained, and conclusions reached, and their
effect on auditor's report;
¯ When and by whom the resulting changes to audit documentation were made and reviewed.
1.4 Assembly of the Final Audit File (Ref: 14-16, A21-A24)
Definition: 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.
 Assemble 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.
 (Normally it’s not more than 60 days after auditor’s report)
 Completion of final audit file does not involve performance of new audit procedures
 Changes may be made to audit documentation during final assembly process if they are administrative
in nature. E.g.:
¯ Deleting or discarding superseded documentation.
¯ Sorting, collating and cross-referencing working papers.
¯ Signing off on completion checklists relating to file assembly process.

¯ Documenting audit evidence that auditor has obtained, discussed and agreed with the relevant
members of the engagement team before the date of the auditor's report.
Auditor shall not delete or discard documentation of any nature before end of its retention period. (larger of 5
years or local requirement; In Pakistan its 10 years)
if auditor finds it necessary to modify existing documentation or add new documentation after assembly of
final audit file, auditor shall document
 Specific reasons for making them; and
 When and by whom these were made and reviewed.
AT A GLANCE
SPOTLIGHT

2. AUDIT EVIDENCE (ISA 500)

2.1 Sufficient Appropriate Audit Evidence (Ref: 6, A1-A25)
Sufficiency is the measure of the quantity of audit evidence.
Appropriateness is the measure of the quality of audit evidence. (Includes Relevance & Reliability)
a) RELEVANCE
Logical connection with purpose of the audit procedure and the assertion under consideration.
b) RELIABILITY
Reliability is influenced by its source and nature, and circumstances under which it is obtained, including controls
over its preparation and maintenance.
Generalizations about the reliability

1. Evidence from independent sources is more reliable than outside the entity.
2. Evidence generated internally is increased when related controls are effective.
3. Evidence obtained directly by auditor is more reliable than obtained indirectly.
4. Evidence in documentary form is more reliable than evidence obtained orally.
AT A GLANCE
5. Evidence provided by original documents is more reliable than photocopies or facsimiles etc.
2.2 Information produced by entity and used for auditor's purposes (Ref: 7)
When using information produced by entity, auditor shall:
 Obtain audit evidence about accuracy & completeness.
 Evaluate whether information is sufficiently precise and detailed for auditor's purposes.
2.3 Audit Procedures for Obtaining Audit Evidence (Ref: A10-A25)

 Risk assessment procedures; and
 Further audit procedures, which comprise:
SPOTLIGHT
¯ Tests of controls; and
¯ Substantive procedures including:
o Tests of details and
o Substantive analytical procedures.
Inspection  Examining records or documents.
 Physical examination of an asset.
Observation  Looking at a process or procedure being performed by others.
 It is limited to the point in time at which the observation takes place.
 It may be affected by knowledge of the fact that it is being observed.
External Direct written response to the auditor from a third party. (Account balances
Confirmation ,confirmation of the terms of agreements or transactions)
Recalculation Checking the mathematical accuracy of documents or records.
Re- Independent execution of procedures or controls that were originally performed as
performance part of the entity's internal control.
Analytical Evaluations of financial information through analysis of probable relationships among
Procedures both financial & non-financial data.
Inquiry Seeking information of knowledgeable persons within entity or outside entity.
Inquiries may range from formal written inquiries to informal oral inquiries.

2.4 Reliability of Information Produced by a Management's Expert (Ref: 8, A35-A52)

 Definition: 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 financial statements.
(a) Evaluate competence, capabilities and objectivity of expert
 Competence relates to nature and level of expertise.
 Capability relates the ability of expert to exercise that competence.
 Objectivity relates to possible effects that bias, conflict of interest or the influence of others may have
on the professional or business judgment of the expert.
Information regarding competence, capabilities and objectivity may come from:
 Personal experience with previous work of that expert.
 Discussions with that expert.
 Discussions with others who are familiar with that expert's work.
 Knowledge of expert's qualifications, membership of professional body, license to practice etc.
AT A GLANCE
 Published papers or books written by that expert.

 Auditor's expert used to assist auditor for management's expert.
Matters relevant to such evaluation may include:
 Whether expert's work is subject to technical standards or other industry requirements.
 Relevance of competence, including any areas of specialty within that expert's field.
 Competence with respect to relevant accounting requirements.
 Whether it may be necessary to reconsider the initial evaluation of competence, capabilities and
objectivity of the management's expert as the audit progresses.
(b) Obtain an understanding of the work of that expert
 Whether that expert's field has areas of specialty within it that are relevant to the audit.
SPOTLIGHT
 Whether any professional or other standards, and regulatory or legal requirements apply.
 What assumptions and methods are used by the management's expert, and whether they are generally
accepted within that expert's field and appropriate for financial reporting purposes.
 The nature of internal and external data or information he uses.
Evaluating engagement letter etc. between entity and that expert may assist auditor in determining the
appropriateness of:
 Nature, scope and objectives of that expert's work;
 Respective roles and responsibilities of management and expert
 Nature, timing and extent of communication between them.
(c) Evaluate appropriateness of expert work as audit evidence

 Relevance & reasonableness of expert's findings or conclusions, their consistency with other audit
evidence, and whether they have been appropriately reflected in financial statements;
 Relevance & reasonableness of assumptions and methods used;
 Relevance, completeness, and accuracy of source data used.
Nature, timing and extent of audit procedures in relation to Part (a) – (c) may be affected by
 Nature and complexity of the subject matter.

 Risks of material misstatement in the matter.

 Availability of alternative sources of audit evidence.
 Nature, scope and objectives of the management's expert's work.
 Whether management's expert is employed or is outsourced
 Extent to which management can exercise control or influence over work of that expert.
 Nature and extent of any controls within entity over management's expert's work.
 Auditor's knowledge and experience of expert's field of expertise
 Auditor's previous experience of the work of that expert.
You are the audit manager of Paidar Tameerat Limited (PTL) for the year ended 31 May 2012.
PTL is a listed company and is engaged in the construction of high rise buildings including
residential and commercial complexes.
Last year serious differences of opinion had arisen with the management of PTL while
determining the stage of completion of certain projects. The matter was ultimately resolved after
an independent value had rendered a report and on which the auditor had placed reliance. This
year the management has employed an engineer to monitor the various projects. The engineer
AT A GLANCE
has reported minor discrepancies in the estimates provided by various project managers.
Required: Assess the above situation and discuss how you would address the related issues
during the course of the audit.
Tutorial Notes:
The words “discuss the related issues” takes the question a bit beyond to only mentioning the
competence and associated things. You should also point out that:
 The auditor will determine the extent of substantive procedures for verification of
estimated cost of completion if he can place reliance on the reports prepared by the
engineer.
 If the auditor cannot place reliance on the work performed by the engineer, he will
SPOTLIGHT
reassess the initial risk assessment and consider the need for involvement of an
independent expert.
 Solution:
Discrepancies in the estimates provided by the project managers:
i. The auditor would need to determine whether he can rely on the reports of the engineer
hired by the management.
ii. In determining the extent of reliance on the work of the engineer, the auditor would:
 Evaluate the competence, capabilities and objectivity of the engineer,
 obtain an understanding of the procedure followed by the engineer, and
 evaluate the appropriateness of using the engineer ‘s reports as an audit evidence
for verification of stage of completion and the estimated cost of completion.
iii. Subsequent receipts/costs/completion status would be reviewed to assist the
reasonableness of the engineer’s estimate.
iv. The auditor will determine the extent of substantive procedure for verification of
estimated cost of completion if he can place reliance on the reports of the engineers.
v. If the auditor cannot place reliance on the work performed by the engineer, he will
reassess the initial risk assessment and consider the need of involvement of independent
external engineer.


Rentals Limited (RL) is a real estate company engaged in the business of renting of office
buildings and shopping centers across the country. The investment properties are carried at fair
value. The fair values are determined by an internal valuer at the end of each reporting period.
Required:
Considering the inherent complexities involved in the determination of fair values of investment
properties, discuss the key controls that RL is expected to employ while carrying out the
valuation internally.
Tutorial Notes:
An important thing is also to specify the controls that are employed in such situations such as:
controls over the development and use of evaluation model, segregation of duties, completeness,
relevance and accuracy of data, etc.
 Solution:
Following could be the examples of relevant controls while determining the fair value through
internal evaluation:
AT A GLANCE
i. Proper procedures are in place to ensure completeness, relevance and accuracy of the
data used to determine the fair value of investment properties.
ii. Proper procedures are in place for evaluation of competence, capabilities and objectivity
of that expert.
iii. The valuation including the assumptions or inputs used in their development are
reviewed and approved at an appropriate level or when required by those charged with
governance.
iv. Proper procedures are in place to refine the estimate when comparisons of the actual to
the estimated results indicate such a need.
v. Proper segregation of duties exists between persons committing the entity to underlying
transactions and those responsible for determining the fair value of investment
properties.
SPOTLIGHT
vi. Specific policies and procedures are in place for specific models used for making
accounting estimates. Relevant controls may be established over:
 The design and development or selection of a particular model for a particular
purpose
 The use of the model
 The maintenance and periodic validation of the integrity of the model
You have been the auditor of Venus Limited (VL) for past few years. During the current year’s
audit, the report of the valuation expert shows that the fair value of buildings of VL is slightly
above their carrying amount. However, during the course of audit, you discovered a copy of a
draft report by the same valuer in which the value assigned to the buildings was lower by Rs. 20
million. While investigating the matter, the audit senior has identified that had the assets been
valued on the basis of the unsigned valuation report, it would have resulted in breach of a loan
covenant. You have also noted that the same valuer has been used by VL for the last many years.
Required:
Specify the steps that you would take in the above situation and discuss the possible effects on
the audit report, if the materiality limit on this audit is Rs. 80 million.

Tutorial Notes:
The major mistakes while answering could be:
 Ignoring the issue of overall materiality. It is important to note that that materiality limit
mentioned in the question was Rs. 80 million and the amount in doubt was only Rs. 20
million, which was much below the materiality level, accordingly student may wrongly
perceive that the matter is material and pervasive and hence resulting adverse opinion.
 Breach of loan covenant usually entitles the bank to demand an immediate repayment
and therefore the loan is converted into a short-term liability. In such situation, in case
of disagreement with the management, auditor has to qualify the report despite the
amount not crossing the materiality threshold, because, such disclosure is qualitatively
material. This aspect might be missed by some students while answering the question.
 Directly jumping on the extreme steps like disclaiming an opinion and withdrawal.
 Solution:
 Although the amount of Rs. 20 million is not individually material, but, we will need to
discuss the values reported in the draft report with the management and the valuer and
why and on what basis the value was changed.
AT A GLANCE
 We will have to consider the independence of the management’s expert due to the long
association with VL.
 We may consider hiring our own expert for assessing the value.
 If the value assigned by our expert is different from the value assigned by the
management’s expert, we will strive to resolve the differences through discussions with
both experts and the management.
 We will have to reassess the risk of material misstatement due to fraud and its impact
on the nature, timing and extent of audit procedures.
 If the adjustment would result in breach of loan covenants the consequence may be
qualitatively material due to conversion of long term loan into short term.
 If we are unable to resolve the differences, it will cause disagreement with the
management and although the amount is not material, however, due to qualitative
SPOTLIGHT
materiality, we may have to issue a qualified report. Moreover, we will have to determine
whether uncorrected misstatements are material, in aggregate.
 If the changes in the valuer’s report creates doubts as to the integrity of the management,
we may consider appropriate action which may include withdrawing from engagement,
disclaiming an opinion, etc. depending upon the applicable laws and regulation.
You are the audit manager of Dreams Limited (DL), a listed company, for the year ended 31 May
2015. DL has significant investments in two securities, which are listed on the Over the Counter
(OTC) market.
While planning the audit procedures, it has been observed that there was a liquidity concern in
the OTC market and therefore no trading has been witnessed in these securities since 26 March
2015. Consequently, DL has finalised the valuation of these securities on the advice of a company,
which specializes in providing pricing services. The company has used a pricing model which it
uses at majority of its clients.
Required:
Explain how the auditor would obtain sufficient and appropriate audit evidence in the above
scenario. (Implications on audit report are not required).

Tutorial Notes:
The question can be answered from IAPN 1000 as well as the management expert portion of the
ISA 500. Answer should not be restricted to discussion on only competency and resources of the
company which provided pricing services, procedures relating to understanding the valuation
method used by the pricing service, controls applied by the client for assessing the reliability of
the pricing service’s valuation, verification of information/data provided by the client to the
pricing services company, etc. should also be discussed.
 Solution:
The detailed steps needed to be performed in the above situation are as follows:
1. Gain an understanding of the controls applied by DL for assessing the reliability of the
pricing service’s valuation.
2. Gain an understanding about pricing service. This includes:
 The reputation and experience of the third party and its experience in providing
similar type of valuation.
 Auditor’s past experience with the third party (if any).
 Objectivity of the pricing service. The objectivity may be impaired if Pricing service
AT A GLANCE
 Company has a close relationship with DL or where has a financial or other interest
in such valuation.
 The processes and controls established by Pricing Services while conducting such
type of valuations.
3. Gain an understanding about Pricing Service’s valuation method. It includes:
 Evaluating Pricing Service’s controls and processes, valuation techniques, inputs
and assumptions used by Pricing Services.
 Testing the controls at DL to assess the reliability of the information provided by
 Pricing Service Company.
 Test the controls and processes, valuation techniques, inputs and assumptions used
by Pricing Service Company.
SPOTLIGHT
 Obtain pricing from other sources and/or carry out own calculations of the
valuation and compare it with valuation provided by Pricing Service.
4. In addition to the above or if the auditor is unable to carry out the above procedures or
if the results thereof do not seem satisfactory, the auditor may consider hiring an expert.
5. Obtain an understanding of information/ input provided by management of DL to
pricing services and verify its reliability and reasonableness.
6. In case the auditor is unable to obtain sufficient and appropriate audit evidence, he
should consider the implications thereof on the audit report.
2.5 Selecting Items for Testing to Obtain Audit Evidence (Ref: 10, A53-A57)
1) Selecting all items (100% examination);
100% examination may be appropriate when:
 Population constitutes a small number of large value items.
 There is a significant risk and other means do not provide sufficient appropriate audit evidence.
 Repetitive nature of a calculation or other process performed automatically by an information system
makes a 100% examination cost effective.

2) Selecting specific items;

 High value or key items. (e.g. items that are suspicious, unusual, particularly risk-prone or that have a
history of error)
 All items over a certain amount.
 Items to obtain information.
3) Audit sampling.
Conclusions to be drawn about an entire population on basis of testing a sample drawn from it.
2.6 Inconsistency in, or Doubts over Reliability of Audit Evidence (Ref: 11, A58)
 If audit evidence obtained from one source is inconsistent with that obtained from another; or
 If auditor has doubts over the reliability of information to be used as audit evidence
Auditor shall determine what modifications or additions to audit procedures are necessary to resolve the matter,
and shall consider the effect of the matter on other aspects of the audit.
2.7 Tutorial note
AT A GLANCE
Core Paragraphs: 8 and 11
Explanatory Paragraphs: A14 to A25, A31, A36, A38, A40, A45, A46, A48, A53 and A54
SPOTLIGHT

3. AUDIT EVIDENCE - SPECIFIC CONSIDERATIONS FOR SELECTED ITEMS (ISA

501)
3.1 INVENTORY (4-8, A1-A16)
If inventory is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence
regarding the existence and condition of inventory by:
 Attendance at physical inventory counting (unless impracticable) to:
¯ Evaluate management's instructions and procedures for recording and controlling the results of the
entity's physical inventory counting
¯ Observe the performance of management's count procedures
¯ Inspect the inventory
¯ Perform test counts
 Performing audit procedures over the entity's final inventory records to determine whether they
accurately reflect actual inventory count results.
3.2 ATTENDANCE AT PHYSICAL INVENTORY COUNTING (Ref: 4, A1-A8)

AT A GLANCE
Management ordinarily establishes procedures for physical count of inventory at least once a year to serve as a
basis for preparation of financial statements and, to ascertain the reliability of entity's perpetual inventory
system (if applicable).
Attendance at physical inventory counting involves:
 Inspecting the inventory to ascertain its existence and evaluate its condition, and performing test counts;
 Observing compliance with management's instructions and performance of procedures for recording
and controlling the results of the physical inventory count; and
 Obtaining audit evidence as to the reliability of management's count procedures.
 Matters relevant in planning attendance at physical inventory counting include:
¯ Risks of material misstatement related to inventory.
SPOTLIGHT
¯ Nature of the internal control related to inventory.

¯ Whether adequate procedures are expected to be established and proper instructions issued for
inventory counting.
¯ The timing of physical inventory counting.
¯ Whether the entity maintains a perpetual inventory system.
 Whether the assistance of an auditor's expert is needed. (ISA 620)
 Locations at which inventory are held, including the materiality of the inventory and the risks of material
misstatement at different locations, for selecting locations for attendance.
3.3 PHYSICAL INVENTORY COUNTING CONDUCTED OTHER THAN AT THE DATE OF THE FINANCIAL
STATEMENTS (Ref: 5, A9-A11)
If physical inventory counting is conducted at a date other than date of financial statements, auditor shall, in
addition to given procedures, perform audit procedures to obtain audit evidence about whether changes in
inventory between count date and date of financial statements are properly recorded.
Relevant matters for consideration when designing such audit procedures include:
 Whether the perpetual inventory records are properly adjusted.
 Reliability of the entity's perpetual inventory records.
 Reasons for significant differences between the information obtained during the physical count and the
perpetual inventory records.

3.4 INABILITY OR IMPRACTICABILITY TO ATTEND PHYSICAL INVENTORY COUNTING (Ref: 7, A12-A14)

If auditor is unable to attend physical inventory counting due to unforeseen circumstances, auditor shall make
or observe some physical counts on an alternative date, and perform procedures on intervening transactions.
If attendance at physical inventory counting is impracticable, auditor shall perform alternative audit procedures
to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory.
(e.g. inspection of documentation of the subsequent sale of specific inventory items acquired or purchased prior
to the physical inventory counting)
If it is not possible to obtain sufficient appropriate audit evidence by performing alternative audit procedures,
auditor shall modify the opinion in accordance with ISA 705.
3.5 INVENTORY UNDER THE CUSTODY AND CONTROL OF A THIRD PARTY CONFIRMATION (Ref: 8, A15-
A16)
If such inventory is material to financial statements, auditor shall obtain sufficient appropriate audit evidence
regarding existence and condition of that inventory by performing one or both of following:
 Request confirmation from the third party as to the quantities and condition of inventory held on behalf
of the entity. (as per ISA 505)
 Perform inspection or other audit procedures appropriate in the circumstances.
AT A GLANCE
Examples of other audit procedures include:
 Attending, or arranging for another auditor to attend, the third party's physical counting of inventory, if
practicable.
 Obtaining another auditor's report, or a service auditor's report, on adequacy of third party' s internal
control for ensuring that inventory is properly counted and safeguarded.
 Inspecting documentation regarding inventory held by third parties, for example, warehouse receipts.
 Requesting confirmation from other parties if inventory has been pledged as collateral.
You are the manager responsible for the audit of Dilawar Paints Limited (DPL). The draft
SPOTLIGHT
financial statements for the year ended 31 March 2013 show revenue of Rs. 1,250 million (2012:
Rs. 1,175 million), profit before taxation of Rs. 100 million and total assets of Rs. 1.2 billion.
The audit incharge has noted the following points for your consideration:
While the tanks in the factory were undergoing modernisation, DPL had made arrangements
with a nearby factory for storage of its chemicals. At the time of stock check you were informed
that it is not possible to segregate DPL’s stock from that of the other factory. According to DPL’s
record, the value of its stock of chemicals as at 31 March 2013 which is lying in the nearby factory
is Rs. 200 million. The value of stock of chemicals as at 31 March 2012 was Rs. 120 million.
Required:
Discuss the matters that you would consider and how would you obtain the necessary audit
evidence.
Tutorial Notes:
Students should realize that this was a limitation of scope situation and auditor needed to apply
alternative means to verify stocks. Most students may not be able to identify or analyze the
extraordinary increase in inventory though sales had only increased nominally, resulting in a
substantial decline in inventory turnover rates.
While discussing the source of audit evidence, most students might remain restricted to
confirmation and subsequent events only, other possible steps might be missed by most.
It is also important to note that impact on Auditor’s report is not required.

 Solution:
Outsourced storage facility- Evaluation of the situation:
Matters to be considered
 Inventory at the end of the reporting period (31 March 2013) represents 16.67% of the
total asset value and is therefore a material item in the statement of financial position.
 The inability of the auditor to carry out a stock check may result in a limitation of scope.
 It can be seen that inventory has increased by 67%, although the revenue has increased
by 6.4% only. Moreover, there is a decline in the inventory turnover from 9.79 times in
2012 to 6.25 times in 2013. This situation when viewed in the light of auditor’s inability
to carry out a stock check may indicate the possibility of material misstatement.
How audit evidence would be obtained
 The management should be asked to provide written representation regarding the value
of inventory as at 31 March 2013, although it does not provide sufficient evidence
regarding its condition or obsolescence.
 Test of control established by the management in respect of quantity, quality and access
to the inventory stored at nearby factory.
AT A GLANCE
 Confirmation from the nearby factory needs to be obtained, relating to the quantity of
the stock held by them.
 Monthly returns / stock details submitted by neighboring factory should be analyzed
and significant movements in inventory should be traced to the material consumption
reports and purchase invoices.
 The auditor may refer to the inventory aging analysis to determine the possibility of
obsolescence of stock.
 Subsequent transfers of chemicals from the neighboring factory to DPL’s premises
should be reviewed.
Litigation and Claims (9-12, A17-A25)

SPOTLIGHT
Auditor shall design and perform audit procedures in order to identify litigation and claims involving the entity
which may give rise to a risk of material misstatement, including:
a) Inquiry of management and, where applicable, others within the entity, including in-house legal counsel;
b) Reviewing minutes of meetings of those charged with governance and correspondence between entity
and its external legal counsel;
c) Reviewing legal expense accounts.
Communication with the Entity's External Legal Counsel

If auditor assesses a risk of material misstatement regarding litigation or claims that have been identified, or
when audit procedures performed indicate that other material litigation or claims may exist, auditor shall, in
addition to procedures required by other ISAs, seek direct communication with entity's external legal counsel.
Auditor shall do seek direct communication through letter of inquiry, prepared by management and sent by
him.
In some cases, auditor may seek communication through a letter of general inquiry requesting external legal
counsel to inform the auditor of any litigation and claims that counsel is aware of, together with an assessment
of outcome of the litigation and claims etc.
If it is considered unlikely that external legal counsel will respond appropriately to a letter of general inquiry
(e.g. if their professional body prohibits such response), auditor may seek direct communication through a letter
of specific inquiry including:

 A list of litigation and claims;

 Where available, management's assessment of outcome of each of the identified litigation and claims
and its estimate of the financial implications, including costs involved; and
 A request that entity's external legal counsel confirm the reasonableness of management's assessments
and provide auditor with further information if list is incomplete or incorrect.
In certain circumstances, auditor also may judge it necessary to meet with the entity's external legal counsel
to discuss the likely outcome of the litigation or claims. This may be the case, for example, where:
 The auditor determines that the matter is a significant risk.
 The matter is complete.
 There is disagreement between management and the entity's external legal counsel.
Ordinarily, such meetings require management's permission and are held in presence of a representative of
management.
Written Representations
Auditor shall request management and, where appropriate, those charged with governance to provide written
representations that all known actual or possible litigation and claims whose effects should be considered when
preparing financial statements have been disclosed to auditor and accounted for in accordance with applicable
AT A GLANCE
Auditor’s Response
Auditor shall modify the opinion in the auditor's report in accordance with ISA 705 where:
 Management refuses to give the auditor permission to communicate or meet with the entity's external
legal counsel, or the entity's external legal counsel refuses to respond appropriately to the letter of
inquiry, or is prohibited from responding; and
 Auditor is unable to obtain sufficient appropriate audit evidence by performing alternative audit
procedures.
SPOTLIGHT
Shakeel Foods Limited (SFL) manufactures a variety of food products. The incharge of the audit
team at SFL has requested you to advise on the following issues:
a) During an informal discussion with a company’s employee, he came to know that SFL is
in litigation with one of its competitors. However, the said case was not included in the
list of cases provided by SFL nor was it mentioned by the legal advisor in his
confirmation. On being confronted, the management has informed that they are in the
negotiation phase with the competitor and intend to settle the dispute through payment
of Rs. 150 million.
b) Stock in trade valuing Rs. 65 million is placed in a warehouse owned by Hameed Limited
(HL). According to news reports, FIA has recently initiated an enquiry against HL for
evading import duties and taxes. HL has confirmed the quantities of stock at year end.
Required:
Discuss how the auditor should deal with the above situations.
Tutorial Notes:
a) Students need to structure their answers well for this question avoiding general
discussion. Some important issues can be whether the management’s omission to
disclose this case was a deliberate act aimed at concealment of facts or it was just an
omission.
b) Some of the issues while answering can be as follows:

 Most of the students may suggest physical verification of stock held with the third
party but may not specify the need to reconcile the physical quantities with the year-
end quantities.
 Need for the auditor to get a latest update on the situation should be referred.
 Re-confirmation could be considered as appropriate audit evidence by most
students which in fact is not the case as the same had already been obtained.
 Solution:
a)
i. The failure to include all the cases in the confirmation depicts that the legal advisor has
not replied appropriately to the general enquiry letter. In this case:
 The auditor may directly communicate with the legal advisor (after client’s
permission) through a letter of specific enquiry, which shall include the following:
- Details of litigation for which the auditor needs to obtain information.
- Management’s assessment of the outcome of the identified litigation and its
financial implications.
AT A GLANCE
- A request for confirming the reasonableness of management’s assessment and

providing further information, if the details of case or management’s
assessment are incorrect.
ii. The auditor’s course of action would depend upon the reply to the specific enquiry and
the auditor will proceed in the matter, as follows:
Legal Advisor confirms the viewpoint of management:
If the legal advisor confirms that he has not included the said case in his confirmation
due to the reasons that the management is in negotiation phase with the competitor and
confirms the amount of loss estimated by the management, it will confirm the viewpoint
of management.
Legal Advisor confirms the view point of management but does not agree with the
SPOTLIGHT
amount provided in the financial statements:

If the legal advisor confirms the viewpoint of management, but disagrees with the
management relating to the amount of settlement, then the auditor will ask the
management to resolve the matter.
In both the above cases, the auditor will:
 review the legal files of the cases to confirm the lawyer’s point of view regarding the
outcome of the case.
 seek management representation that there are no other undisclosed pending cases.
If the matter cannot be resolved or the management fails to make appropriate
adjustments in the financial statements, the auditor would consider the impact on the
audit report and modify the report accordingly.
Legal Advisor negates the viewpoint of management:
 If the legal advisor does not confirm the information provided by the management
or expresses that he does not have any knowledge of the said case, then it will raise
concerns with regard to the integrity of management.
 As it is a significant matter therefore the auditor may contact the legal advisor of the
company, to address the matter.

 The auditor will also communicate the matter to those charged with governance and
asked them to address the situation and determine whether it is possible to perform
alternate audit procedures to obtain audit evidence.
 The auditor will determine the professional and legal responsibilities applicable in
the circumstances, including whether there is a requirement for the auditor to
report to the persons who made the audit appointment or to regulatory authorities.
 If those charged with governance don’t take corrective measures or auditor is
unable to obtain audit evidence from alternative procedures and as the matter
relates to the integrity of management, then the auditor will consider options, as
withdrawing from engagement or disclaiming the opinion.
b)
i. Discuss the news report with the client to assess the authenticity of your information
and what action is the client taking in this regard.
ii. Ask the client for physical verification of stock held by the HL in the presence of an audit
team member.
iii. Review the reconciliation between yearend stock and the quantities verified at the
auditor’s request.
AT A GLANCE
iv. Update your information about the status of FIA’s action so far.
v. In case the severe action against HL is imminent, then consider its impact on the
vi. If the expected impact is significant ask the client to resolve the issue (shifting of stock,
guarantee from HL etc.)
vii. If HL fails to take reasonable action consider its impact on the financial statements and
audit report
SPOTLIGHT
2015 2014
-----(Rs. In '000')------
Sales 1,250,000 1,440,000
Other assets 145,000 135,000
Total assets 470,000 485,000
Equity -50,000 20,000

newspapers, alleging the company of supplying inferior quality spare parts in the month
of April 2015 and claiming damages of Rs. 150 million. The management is of the view
that the allegations are baseless.
138 million to the supplier. However, the liquidator has lodged a claim of Rs. 140 million.
AT A GLANCE
department.
Required:
Specify the procedures to be performed in case of litigation and claims with respect to matters
mentioned above. (Impact on auditor’s report is not required)
Tutorial Notes:
An important point to consider can be that if the legal advisor confirms existence of liability or
contingent liability then the same needs to be appropriately adjusted or disclosed as the case
may be. Some other points could be review of minutes of those charged with governance,
SPOTLIGHT
reviewing legal expense accounts etc.

 Solution:
Audit procedures in case of litigation and claims:
 Inquiring the management and, where applicable, others within the entity, including in
house legal counsel;
 Reviewing minutes of meetings of those charged with governance and correspondence
between the entity and its external legal counsel;
 Reviewing legal expense accounts;
 Review the legal confirmations to assess whether all liabilities have been appropriately
disclosed; and
 If the legal advisor confirms the existence of liability or contingent liability which have
not been disclosed in the financial statements, then the auditor will ask the management
to make appropriate adjustment/ disclosure in the financial statements.
Segment Information (13, A26-A27)

Depending on the applicable financial reporting framework, entity may be required or permitted to disclose
segment information in financial statements. Auditor's responsibility regarding presentation and disclosure of
segment information is in relation to financial statements taken as a whole. Accordingly, auditor is not required
to perform audit procedures to express an opinion on segment information presented on a standalone basis.

Auditor shall obtain sufficient appropriate audit evidence regarding presentation and disclosure of segment
information in accordance with the applicable financial reporting framework by:
 Obtaining an understanding of methods used by management in determining segment information, and:
¯ Evaluating whether such methods are likely to result in the disclosure in accordance with the
applicable financial reporting framework; and
¯ Where appropriate, testing the application of such methods; and
 Performing analytical procedures or other appropriate audit procedures
Understanding of the Methods Used by Management

Examples of matters that may be relevant when obtaining such an understanding include:
 Sales, transfers and charges between segments, and elimination of inter-segment amounts
 Comparisons with budgets and other expected results
 (e.g. operating profits as a percentage of sales)
 The allocation of assets and costs among segments.
 Consistency with prior periods, and adequacy of the disclosures with respect to inconsistencies.
AT A GLANCE
SPOTLIGHT

4. EXTERNAL CONFIRMATIONS (ISA 505)

 Definition
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.
4.1 External Confirmation Procedures (Ref: 7, A1-A7)

Auditor shall maintain following control over confirmation requests:
1. Determining the information to be confirmed or requested (e.g. account balances, confirm terms of
agreements etc.)
2. Selecting appropriate confirming party
Sent to confirming party who is knowledgeable about information to be confirmed
3. Designing confirmation requests
 Including valid addresses, method of reply to auditor etc.
 It may directly affect confirmation response rate, reliability and nature of audit evidence
Factors to consider when designing confirmation requests:
AT A GLANCE
 Assertions being addressed.

 Risks of material misstatement.
 Layout and presentation of the confirmation request.
 Prior experience on audit or similar engagements.
 Method of communication. (e.g. in paper form/electronic/other medium).
 Management's authorization or encouragement to confirming parties to respond to auditor.
 Ability of confirming party to confirm information.
4. Sending requests, including follow-up requests when applicable, to the confirming party.
SPOTLIGHT
Auditor may after verification of original address, send an additional or follow-up request.
4.2 Management's Refusal to Allow Auditor to Send a Request (Ref: 8-9, A8-A10)
 Inquire reasons for refusal, and seek audit evidence about their validity and reasonableness;
 Evaluate implications of refusal on risk assessment and on nature, timing and extent of other audit
procedures;
 Perform alternative audit procedures.
If management's refusal is unreasonable, or auditor is unable to obtain audit evidence from alternative audit
procedures, auditor shall communicate with those charged with governance. Auditor Shall also determine the
implications in accordance with ISA 705.
4.3 Negative Confirmations (Ref: 15, A23)

 Definition: 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.
 Definition: Negative confirmation request
A request that the confirming party respond directly to auditor only if the confirming party
disagrees with the information provided in the request.

Auditor shall not use negative confirmation requests as sole substantive audit procedure unless all of the
following are present:
 Risk of material misstatement is low and auditor has obtained evidence regarding operating
effectiveness of controls;
 Population consists of large number of small, similar items;
 A very low exception rate is expected; and
 Auditor is not aware of any unusual circumstances.
Risks of using negative confirmations:
 Failure to receive a response does not indicate receipt by addressee or verification of information.
 Provides significantly less persuasive audit evidence than positive confirmation request.
 Confirming parties may reply in case of unfavorable balance and may not reply in case of favorable
balance
4.4 Evaluating the Evidence Obtained (Ref: 16, A24-A25)

When evaluating results of confirmation requests, auditor may categorize such results as:
AT A GLANCE
 Response indicating agreement of confirming party;
 A response deemed unreliable;
 A non-response; or
 A response indicating an exception.
4.5 Results of the External Confirmation Procedures
UNRELIABLE RESPONSES
Auditor may conclude that it would be appropriate to revise risk assessment and modify planned audit
procedures.
SPOTLIGHT
NON-RESPONSES
 Definition: Non-response
A failure of the confirming party to respond, or fully respond, to a positive confirmation request,
or a confirmation request returned undelivered.
Shall perform alternative audit procedures to obtain relevant and reliable audit evidence. E.g.
For accounts receivable Examining specific subsequent cash receipts, shipping documentation, and sales
near period end.
For accounts payable Examining subsequent cash disbursements or correspondence from 3rd parties,
and other records, such as goods received notes.
WHEN A RESPONSE TO A POSITIVE CONFIRMATION REQUEST IS NECESSARY

 Information available to corroborate management's assertion(s) is only available outside entity.
 Specific fraud risk factors prevent auditor from relying on evidence from entity.
Alternative audit procedures will not provide assurance. If auditor does not obtain such confirmation, he shall
determine the implications for audit & opinion in accordance with ISA 705

EXCEPTIONS
 Definition: Exception
A response that indicates a difference between information requested to be confirmed, or
contained in the entity's records, and information provided by the confirming party. Some
exceptions do not represent misstatement.
 Investigate exceptions to determine whether or not they are indicative of misstatements.
 Exceptions may indicate misstatements or potential misstatements in financial statements.
¯ When misstatement is identified, auditor shall evaluate whether it is indicative of fraud.
¯ Exceptions may create suspect over responses from similar confirming parties or accounts.
¯ Exceptions also may indicate deficiencies in internal control over financial reporting.
RELIABILITY OF RESPONSES TO CONFIRMATION REQUESTS

 Factors that may indicate doubts about reliability of a response include that:
¯ Response was received by the auditor indirectly; or
¯ Response appeared not to come from the originally intended confirming party.
AT A GLANCE
 If auditor has doubts over reliability of response, he shall obtain further audit evidence to resolve those
doubts.
 Auditor may determine whether to modify or add procedures to resolve such doubts:
¯ May choose to verify source and contents of a response by contacting the confirming party.
¯ If response has been returned to auditor indirectly, auditor may request confirming party to
respond directly to auditor.
Responses received Involve risks as to reliability because proof of origin and authority
electronically may be difficult to establish, and alterations may be difficult to detect
(e.g. Fax or email)  Process used by auditor & respondent creating a secure
environment for electronic responses may mitigate risks.
 If auditor is satisfied that process is secure and properly
SPOTLIGHT
controlled, reliability of related responses is enhanced.

 Process might incorporate various techniques for validating
identity of sender in electronic form e.g. encryption, electronic
signatures etc
Confirming party uses a Auditor may perform procedures to address the risks that:
third party to coordinate  Response may not be from the proper source
and provide responses
 Respondent may not be authorized to respond
 Integrity of transmission may have been compromised.
Oral response  Oral response does not meet definition of external confirmation
 However, auditor may, request confirming party to respond in
writing directly to auditor.
 If no such response is received, auditor seeks audit evidence
through alternate procedures.
Restrictive language in Such restrictions do not necessarily invalidate the reliability of

response response as audit evidence.
(As Its only valid for auditor)


The following situations have arisen at different audit clients of your firm. They year-end in each
A client obtained confirmation of balance through email. The email contains a Word file
attachment which lists the inter-company balance as well as certain other information. The client
has forwarded the email to the audit team.
Required:
Evaluate the above situation and briefly explain the steps that the auditor would be
required to carry out in above situations. (Impact on audit report is not required)
 Solution:
The underlying text in the email string as well as the underlying attachment can be altered by the
person forwarding the email, therefore there is a risk that the attachment file received by the
audit team may not be the same as the original file by the counterparty.
 Contacting the customer to determine whether the customer has in fact sent the e-mail.
 Such confirmation may be acceptable if, the auditor or a member of the audit team is also
AT A GLANCE
copied in the original email.
The audit of Karim Limited (KL) is in progress. The audit team has requested you to advise on
the following issues:
(a) The confirmation request sent to a customer who owed Rs. 35 million was responded by an
e-mail addressed to KL’s CFO.
(b) The management of KL is not allowing auditors to send confirmation to Fareed Limited (FL),
on account of certain disputes, as the sending of confirmation will undermine the ongoing
negotiations with FL. However, the management has offered to provide specific written
representation on the matter.
SPOTLIGHT
Required: Discuss how the auditor should deal with the above situations.
Tutorial Notes:
Confirmation through e-mail carries the risk that it may not have been received from the
intended party and that there is a possibility that the contents of the message may have been
altered during the transmission. Management’s offer of providing written representation should
also be discussed while answering.
 Solution:
a) Since the confirmation has been received via email and that too, indirectly through the
client’s CFO, the situation involves the following risks:
(i) Confirmation may not have been received from the intended party as email does not
contain the signature nor the letterheads of the intended party.
(ii) Since the confirmation has been received through the client, there is a risk that it
may have been tampered before being forwarded to the auditor.
(iii) The possibility that the integrity of the transmission may have been compromised
during electronic transmission.

In view of the above risks, the auditor may consider the following:
(iv) See whether the identity of sender of email and authenticity of the message be
validated using appropriate techniques such as digital signatures etc. If this is not
possible, the auditor may:
- Verify the source and contents of the response by contacting the confirming
party and may request the confirming party to respond in writing directly to
the auditor.
- Carry out other audit procedures such as checking of subsequent receipts or
checking appropriate documents such as invoices, shipping documents etc.
(v) (ii)If the auditor concludes that the response was forged or otherwise tampered
with, the auditor may need to revise the assessment of the risks of material
misstatements and modify planned audit procedures or take other necessary steps.
b) A refusal by management to allow the auditor to send a confirmation request is a
limitation on the audit evidence to be obtained by the auditor.
In such situation, the auditor shall proceed as under:
(i) Inquire and assess whether the reason provided by the management for not sending
confirmation request to ML is correct i.e. the dispute as mentioned in the question
AT A GLANCE
is the only reason.

(ii) If the management’s refusal to send confirmation request seem appropriate, the
auditor may perform alternative audit procedures, such as examining subsequent
cash receipts, shipping documents etc.
(iii) Since the management refusal is on account of a dispute with the customer, the
auditor should:
 Check correspondence etc. to the nature of dispute.
 Obtain lawyer opinion.
 Assess whether provision has been made, as may be appropriate under the
circumstances.
SPOTLIGHT
(iv) Evaluate the implications of management’s refusal on the auditor’s assessment of

the relevant risks of material misstatement, including the risk of fraud and on the
nature, timing and extent of other audit procedures.
(v) If the auditor concludes that the management request for not sending confirmation
is reasonable but alternative audit procedures do not provide appropriate audit
evidence, then the management representation can be used as audit evidence.
However, in above situation the following factors should be kept in perspective:
- The written representation provided by management is less reliable.
- The existence of any other audit evidence that may support the written
representation.
- If controls are operating effectively then the representation provided by
management may be considered as reliable
(vi) If the auditor concludes that:
 Management’s refusal to allow the auditor to send a confirmation request is
unreasonable, it may indicate the existence of a fraud risk factor or;
 If the auditor is unable to obtain relevant and reliable audit evidence from
alternative audit procedures, the auditor shall:
- communicate the matter to those charged with governance.
- consider the impact on the audit and audit opinion.

5. ANALYTICAL PROCEDURES (ISA 520)

 Definition:
Analytical procedures mean evaluations of financial information through analysis of probable
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
Analytical procedures include consideration of comparisons of entity's financial information with:
 Comparable information for prior periods.
 Anticipated results of entity (e.g. budgets or forecasts) or auditor expectations (e.g. depreciation)
 Similar industry information
Analytical procedures also include consideration of relationships, e.g.:
 Among elements of financial information expected to conform to a predictable pattern based on the
entity's experience e.g. gross margin percentages.
 Between financial information and relevant non-financial information.
AT A GLANCE
5.1 Substantive Analytical Procedures (Ref: 5, A4-A16)
May be tests of details, substantive analytical procedures, or a combination of both.
When designing and performing substantive analytical procedures, the auditor shall:
a) Determine suitability of particular substantive analytical procedures for given assertions, taking account
of risks of material misstatement and tests of details, if any, for these assertions;
Some rules regarding suitability of substantive procedure are:
 More applicable to large volumes of transactions that tend to predictable over time
 Suitability of a particular analytical procedure will depend upon the auditor's assessment of how
effective it will be in detecting a misstatement.
SPOTLIGHT
 In some cases, even a straightforward predictive model may be effective.
 Different types of analytical procedures provide different levels of assurance.
 Determination of the suitability is influenced by the nature of the assertion and the auditor's
assessment of the risk of material misstatement.
 Particular substantive analytical procedures may also be considered suitable when tests of details
are performed on the same assertion.
b) Evaluate reliability of data from which expectation of recorded amounts or ratios is developed
Influenced by its source and nature and is dependent on the circumstances under which it is obtained.
Following are relevant when determining reliability of data for analytical procedures:
 Source of the information available.
 Comparability of information available.
 Nature and relevance of the information available.
 Controls over the preparation of the information
c) Develop an expectation of recorded amounts or ratios and evaluate whether expectation is sufficiently
precise to identify a misstatement
 Accuracy with which expected results of substantive analytical procedures can be predicted.
 Degree to which information can be disaggregated.
 Availability & reliability of information (financial & non-financial)

d) Determine amount of any difference of recorded amounts from expected values that is acceptable
without further investigation.
Influenced by materiality and the consistency with the desired level of assurance.
5.2 Analytical Procedures that Assist When Forming an Overall Conclusion (Ref: 6, A17-A19)
Conclusions drawn from results of such analytical procedures are intended to corroborate conclusions formed
during audit of individual components or elements of financial statements. These analytical procedures may be
similar to those that would be used as risk assessment procedures.
5.3 Investigating Results of Analytical Procedures (Ref: 7, A20-A21)

If analytical procedures identify fluctuations or relationships that are inconsistent:
 Inquire management and obtaining appropriate audit evidence relevant to their responses.
 Perform other audit procedures as necessary in the circumstances.

AT A GLANCE
You are involved in audit of Modern Furniture Limited (MFL), for year ended30 September 2014.
The client has provided you a draft profit and loss account which is as follows:
30- Sept- 2014 30- Sept- 2013
Sales 223.14 196.54
cost of sales (151.74) (147.4)
Gross profit 71.4 49.14
operating expenses (43.78) (31.52)
profit before interest and financial charges 27.62 17.62

SPOTLIGHT
Financial Charges (3.82) (3.04)
Profit before taxation 23.8 14.58
Taxation (6.8) (4.96)
Profit after taxation 17 9.62
Certain other information obtained from the management is given below:

i. MFL mainly sells its products through its own retail outlets and franchises. During the
period under review, MFL had established five new retail outlets in different cities.
ii. After a lapse of 18 months, MFL had increased the price of its products by 12%effective
1 April 2014.
iii. The raw material prices increased by 5% in October 2013.
iv. Effect of annual increment in salaries was 8%.
v. Salaries of non-manufacturing employees have increased from Rs. 22 million to Rs. 28.2
million. There were 120 such employees on the payroll on 30 September2014. 15 new
employees were hired for new retail outlets whereas one employee retired during the
year.

Required:
Evaluate the above financial data in the context of information provided by the management and
specify the matters requiring further explanations from the management.
Tutorial Notes:
This requires some excellent analytical skills, ratio analysis and comparisons, probing reasons
for variance and other mathematical calculation and discussions.
 Solution:
Analysis of the information:
Sales:
As sales prices are increased by 12% w.e.f 01 April, 2014, hence the prices are increased
effectively by 6%. Taking the effect of 6% increment on last period sale will give an increased
sale of Rs. 208.33 million, giving a difference of Rs. 14.81 million which can be attributed to the
increase in quantity.
The said difference of 7.11% (223.14÷208.33) represents the increase in quantities sold. The
client should be asked to provide major reasons for such increase.
AT A GLANCE
Cost of sales:
Increase in quantities sold by 7.11% plus 5% increase in prices of raw material means that cost
of goods sold should have been increased by approximately 12.11%. However, the actual
increase is only 3%.
The above variation in cost of sales needs to be investigated further, i.e. why the cost of sales has
not increased in line with the increase in quantity and increase in raw material prices.
Operating expenses:
Increase in operating expenses is Rs. 12.26 million. If the effect of increase in salary i.e. Rs. 6.2
million is excluded, remaining expenses have increased by Rs. 6.06 million i.e. 63.66%, which is
quite significant. Reasons for such a significant increase should be obtained.
SPOTLIGHT
Increase in salary expenses of non-manufacturing employees:
Since number of staff is increased by 11.67% and increment is 8%, gives the expected increase
of 19.67%, whereas salaries have increased by 28% as compared to previous year.
This matter needs to be look into further specifically because new employees are hired in retail
outlets which are usually low salary staff.
Financial charges:
Increase in financial charges by 26% seems reasonable, as the company has opened new
branches, which is supposed to increase the borrowings of the company. Moreover, the amount
is not material.
Taxation:
Current year taxation expense is approximately 28% of profit before taxation as compared to
34% of profit before taxation of previous year. A reconciliation of this difference may be helpful.
You are the engagement manager of Saleem Electronics Limited (SEL). SEL is engaged in
manufacturing and selling of electronic appliances including air conditioners, washing machines,
refrigerators, electric lights and bulbs. The results of analytical review carried out by your team,
based on the draft financial statements, are summarised below:

Profit and loss account

31-12-2015 31-12- Increase/ Note
2014 (decrease) reference
Rupees '000' %
Sales 85,661 78,793 6,868 9 Note (i)
Cost of sales (56,650) (51,029) 5,621 11 Note (ii)
Gross profit 29,011 27,764 1,247 4
Administration expenses (13,594) (14,841) (1,247) (8) Not material
Other operating income 11,000 13,000 (2,000) (15) Not material
Other expenses (24,095) (8,450) 15,645 185 Note (iii)
Interest expense (12,785) (10,716) 2,069 19 Not material
(Loss)/profit before taxation (10,463) 6,757 (17,220) (255)
Taxation (3,690) (1,880) 1,810 96 Note (iv)
(Loss)/profit after taxation (14,153) 4,877 (19,030) (390)
AT A GLANCE
Balance sheet
31-12- 31-12- Increase/ Note
2015 2014 (decrease) reference
----------Rupees in '000'--------- %
PPE 190,903 195,003 (4,100) (2) Note (v)
Current assets:
Receivables 19,961 18,313 1,648 9 Note (vi)
Inventories 45,721 44,403 1,318 3 Note (vii)
SPOTLIGHT
Cash and bank 7,985 8,068 (83) (1) Not material

73,667 70,784
Total assets 264,570 265,787
Share capital 182,000 150,000 32,000 21 Note (viii)
Retained earnings (36,830) (22,677) (14,153) 62 see P&L
145,170 127,323
Long term liabilities:

Loan from related parties 48,192 80,000 (31,808) (40) Note (viii)
Deferred tax liabilities 14,806 12,398 2,408 19 Note (iv)
62,998 92,398
Current liabilities:
Provisions 8,567 9,253 (686) (7) Note (ix)
Creditors and accrued 47,835 36,813 11,022 30 Note (x)
expenses
56,402 46,066
Equity and liabilities 264,570 265,787

Audit team’s notes/comments:

i. The increase in revenue is due to increase in sale of air conditioners by Rs. 12.6 million
because of introduction of instalment sales, which are made at 10% above the normal
price. The price is recovered in 12 equal monthly instalments.
ii. The increase is in line with the increase in revenue.
iii. Other expenses include a loss of Rs. 5 million on disposal of assets of services
department. Remaining amount represents cost of warranty.
iv. The matter has been discussed with our tax team who would give its views shortly.
v. The decrease is due to the disposal of assets of services department of air conditioner’s
division. The services department was outsourced last year.
vi. The increase in receivables is in line with the increase in sales.
vii. The inventory balance is in line with prior year.
viii. The company has converted the loan from related party into equity and issued shares
amounting to Rs. 32 million.
ix. Last year’s provision includes provision for impairment in assets of services department.
AT A GLANCE
The remaining increase of Rs. 1.3 million is immaterial.
x. In December 2014 all the employee related expenses were paid before year end.
Required:
Comment on the analytical review performed by the audit team and specify which explanations
in the analytical review seem unreasonable and/or incomplete.
Tutorial Notes:
Following mistakes might be done by most of the students while answering to this question:
1. Many students might focus on identifying the risks from the comments provided in the
Question which is not required.
SPOTLIGHT
2. Students might go at quiet a length on describing what should be the materiality, what
threshold should be used and the purpose and form of overall analytical review etc.
which is not required at all.
3. Students might not identify the following issues/deficiencies in the comments prepared
by the audit team:
 No comments were offered regarding the fact that the introduction of installment
sales for the first time should have been accompanied by an increase in interest
income and receivables.
 The comment “increase of 3% in inventory balance is in line with prior year” was
unreasonable because the revenues and cost of sales have increased by 9% and 11%
respectively.
 Comments as regards addition to fixed assets were missing.
 No comments have been offered on the fact that warrant expense for the year has
increased by 126% whereas the provision in the balance sheet has increased by
18% only.
 Further break-up and analysis was required in case of some items such as other
income, administrative expenses, creditors and accrued expenses.

 Solution:
Sales:
 The analysis of the audit team does not include any comments on the decrease of sales of
other divisions.
 It is mentioned in the comments that sale of air conditioners has increased due to the
introduction of installment sales, however the interest income on said installment sales has
not been identified in the analytical review.
 Due to interest income on installment sales, other income (if interest income is included in
it) should have increased. However, it has decreased by Rs. 2 million.
Cost of sales:
 Although the variation in cost of sales is in line with the variation in sales, however if the
sales are overstated due to recognition of interest income in the sales revenue then
consequently the cost of sales will not remain in line with the variation in sales amount and
needs to be investigated further.
 If sales are increased due to higher prices as mentioned in the comments, then cost of sales
cannot remain in line with the sales amount.
AT A GLANCE
Administrative expenses:
Although the variation in administrative expenses is Rs. 1.2 million which is not material,
however, data related to administrative expenses is required to be disaggregated and analytical
review should be prepared separately for each individual expense to properly evaluate the
impact of variations.
Other income:
No comments have been offered with regard to the composition of other income, i.e. what items
constitute the other income.
Other expenses: A major constituent is the warranty expenses and reasons for significant
variation in it have not been provided.
SPOTLIGHT
Interest expenses:
Although variation in interest expenses is not material, however, keeping in view the decrease in
amount of loans from related parties, interest expense should have decreased instead of
increasing.
Taxation/ deferred tax liabilities:
 Simply saying that the matter has been discussed with our tax team who would give their
views shortly is not enough. The explanation/ opinion of the audit team with respect to
variation in tax figures should be incorporated in the analytical review.
 Increase in deferred tax liability by Rs. 2.4 million despite the losses incurred by the
company seems unreasonable.
Receivables:
The comment that increase in receivables is in line with the increase in sales is not correct.
Though increase in both cases is 9%, sales have increased due to introduction of installment sales
and therefore the receivables should have increased in much larger proportion.
Inventories:
The comment that increase of 3% in inventory balance is in line with prior year does not seem
appropriate because the revenues and cost of sales have increased by 9% and 11% respectively.

Property, plant and equipment:

The comment is incomplete as there is no mention of the addition to fixed assets during the year.
Provision of warranty:
The variation in warranty provision does not seem to be correct since warranty expenses amount
to Rs. 19.10 million i.e. have increased by 126% whereas the provision has increased by Rs. 1.3
million i.e. 18% only. Creditors and accrued expenses: Creditors and accrued expenses are
required to be analysed further.
AT A GLANCE
SPOTLIGHT

6. AUDIT SAMPLING (ISA 530)

6.1 Sample Design (Ref: 6, A4-A9)
When designing an audit sample, the auditor shall consider
 Specific purpose to be achieved and combination of audit procedures likely to best achieve that purpose.
 Characteristics of the population
¯ Tests of controls
Auditor makes an assessment of expected rate of deviation.
¯ Tests of details
Auditor makes an assessment of expected misstatement.
Auditor may determine stratification or value-weighted selection as appropriate.
 Stratification
 Objective is to reduce variability of items within each group
 Allow sample size to be reduced without increasing sampling risk.
 When performing tests of details, population is often stratified by monetary value.
AT A GLANCE
 Misstatement is projected for each group separately.

 Value-Weighted Selection
 Identify sampling unit as individual monetary units that make up the population.
 Auditor may examine particular items containing those monetary units
 May be used with “systematic selection” and is most efficient with random selection
6.2 Sample Size (Ref: 7, A10-A11)

 Sample size shall be sufficient to reduce sampling risk to an acceptably low level.
 Can be determined by application of statistically-based formula or through exercising judgment.
SPOTLIGHT
Test of Controls Test of Details

Factor influencing Sample Sample Size Factor influencing Sample Sample Size
Size Size
Increase in extent to which Increase Increase in auditor's Increase
auditor's risk assessment takes assessment of the risk of
into account relevant controls material misstatement
Increase in tolerable rate of Decrease Increase in tolerable Decrease
deviation misstatement
Increase in expected rate of Increase Increase in amount of Increase
deviation of the population to be misstatement ,auditor expects
tested in population
Increase in expected rate of Increase Increase in amount of Increase
deviation of the population to be misstatement ,auditor expects
tested in population
Increase in auditor's desired Increase Increase in the auditor’s desired Increase
level of assurance that the level of assurance that tolerable
tolerable rate of deviation is not misstatement is not exceeded
exceeded by actual rate of by actual misstatement in
deviation in population population

Test of Controls Test of Details

No of sampling units in Negligible No of sampling units in Negligible
population population
Increase in use of other Decrease
substantive procedures for
same assertion
Stratification of population Decrease
6.3 Selection of Items for Testing (Ref: 8, A12-A13)
Statistical sampling,
Sample items selected in a way that each sampling unit has a known probability of being selected.
 Random selection
Applied through random number generators, e.g. tables, softwares
 Systematic selection
Number of sampling units in population is divided by sample size
AT A GLANCE
Non-statistical sampling
Judgment is used to select sample items.
 Haphazard selection
Auditor selects sample without following a structured technique.
 Block selection
Block(s) of adjacent items from the population.
Monetary Unit Sampling is a type of value-weighted selection in which sample size, selection and evaluation
results in a conclusion in monetary amounts.
SPOTLIGHT
You have recently joined a medium size chartered accountants firm as their audit manager. While
reviewing the firm’s audit methodology you have observed that the firm follows standard set of
audit work programs. These work programs have been used by the firm for the last many years
and rely extensively on traditional judgment sampling. You are of the opinion that by following
the statistical sampling techniques, you would be able to carry out a more effective and efficient
audit.
Required
Briefly narrate the advantages and disadvantages of judgmental and statistical sampling.
 Solution:
Judgmental Sampling
Advantages Disadvantages
 As the approach is being used for many years  It is not based on any scientific
so it’s well understood and refined by technique.
experience.  No quantitative results are
 The auditor can bring his judgment and obtained.
experience into play.  Personal bias in the selection of
 No special knowledge of statistics is required. sample is unavoidable.

 Time saved form non deployment of statistical  There is no real logic behind the
methods may be spent on carrying out further selection of the sample or its size
audit procedures on different areas.  The conclusion reached is usually
 Saving of extra resources such as computer vague.
soft wares.
 Selecting samples with large amounts
facilitates greater coverage.
Statistical Sampling
 It is based on scientific techniques  It lacks flexibility
 Special software is available to help efficient  Often several attributes of
execution transactions or documents are
 The method is impartial and can be defended tested at the same time
easily  Lacks human judgment and more
AT A GLANCE
 It provides precise mathematical statements reliance is placed on statistical

about probabilities of being correct conclusion
 The method is efficient as the same level of  As the technique is not always
confidence can be achieved with a relatively understood, false conclusions may
smaller sample. Overlarge sample size is not also be drawn.
taken
 The system in different audit firms tend to
become standardized
 It can be used by staff at all levels
6.4 Performing Audit Procedures (Ref: 9-11, A14-A16)

SPOTLIGHT
 Auditor shall perform audit procedures, appropriate to the purpose, on each item selected.
 If audit procedure is not applicable to selected item, he shall perform procedure on a replacement item.
 If auditor is unable to apply designed audit procedures or alternate procedures to a selected item, he
shall
¯ Treat that item as a deviation from prescribed control
(for test of controls)
¯ Treat that item as a misstatement (for tests of details)
6.5 Nature and Cause of Deviations and Misstatements (Ref: 12-13, A17)
 Auditor shall investigate nature and cause of any deviations or misstatements identified, and evaluate
their possible effect on the purpose of audit procedure and on other areas of audit.
 Auditor may observe that many deviations and misstatements have a common feature like type of
transaction, location, product line or time period etc.
¯ Auditor may decide to identify all items in population that possess this common feature, and extend
audit procedures to those items.
¯ These items may also be intentional, and may indicate possibility of fraud. (Risk exists)
 In extremely rare circumstances, auditor may consider a misstatement or deviation in a sample to be an
anomaly
 Obtain high degree of certainty that such misstatement or deviation is not representative of the
population by performing additional audit procedures.

6.6 Projecting Misstatements (Ref: 14, A18-A20)
Tests of controls
Projection of deviations is not necessary as sample deviation rate is also the projected deviation rate for the
population as a whole.
Test of details:
Projected Misstatement in Population = Misstatement in Sample x Projection Rate
For Anomaly:
Projected Misstatement = [(Misstatement in Sample – Anomaly) x Projection Rate] + Anomaly
6.7 Evaluating Results of Audit Sampling (Ref: 15, A21-A23)
Tests of controls
Unexpectedly high sample deviation rate may lead to an increase in the assessed risk of material misstatement.
AT A GLANCE
Tests of details
Unexpectedly high misstatement amount in sample may cause auditor to believe that population is materially
misstated.
Projected misstatement is the auditor's best estimate of misstatement in population.
 If it exceeds tolerable misstatement; sample does not provide a reasonable basis for conclusions
 The closer the projection is to tolerable misstatement, the more likely that actual misstatement in the
population may exceed tolerable misstatement.
 If projected misstatement is greater than auditor's expected misstatement, auditor may conclude that
there is an unacceptable sampling risk.
Where sampling has not provided a reasonable basis for conclusions about population
SPOTLIGHT
 Request management to:
¯ Investigate misstatements that have been identified;
¯ Investigate the potential for further misstatements;
¯ Make any necessary adjustments. or
 Tailor the nature, timing and extent of those procedures to best achieve the required assurance.

7. AUDITING ACCOUNTING ESTIMATES & RELATED DISCLOSURES (ISA 540

REVISED)
Important Definitions:
 Accounting estimate
A monetary amount for which the measurement, in accordance with the requirements of the applicable
financial reporting framework, is subject to estimation uncertainty.
 Estimation uncertainty
Susceptibility to an inherent lack of precision in measurement.
 Management’s point estimate
Amount selected by management for recognition or disclosure in financial statements as an accounting
estimate
 Management bias
A lack of neutrality by management in the preparation of information.
 Auditor’s point estimate or auditor’s range
An amount, or range of amounts, respectively, developed by the auditor in evaluating management’s point
AT A GLANCE
estimate.
 Outcome of an accounting estimate
The actual monetary amount that results from the resolution of the transaction(s), event(s) or condition(s)
addressed by an accounting estimate.
 Accounting estimates are required when monetary amounts cannot be directly observed.
 Measurement of these is subject to estimation uncertainty (which reflects inherent limitations in
knowledge or data).
 These limitations give rise to subjectivity and variation in measurement outcomes.
 Process of making accounting estimates involves selecting and applying a method using assumptions
and data, requiring judgment by management and can give rise to complexity.
SPOTLIGHT
 This process affect accounting estimates’ susceptibility to misstatement. (Ref: Para 2).
7.1 Risk Assessment Procedures and Related Activities (Ref: 13-15)

Auditor shall obtain an understanding of following matters related to accounting estimates:
The Entity and Its Environment

 Transactions and events etc. that may give rise to need for accounting estimates
 Requirements of applicable financial reporting framework related to accounting estimates; and how
they apply in context of this entity and its environment (including inherent risk factors)
 Regulatory factors & frameworks relevant to entity’s accounting estimates
 Nature of accounting estimates and related disclosures that auditor expects in entity’s financial
statements
The Entity’s Internal Control

 Nature and extent of oversight and governance that entity has in place over management’s financial
reporting process relevant to accounting estimates.
 How management identifies need for, and applies, specialized knowledge related to accounting
estimates, including the use of a management’s expert
 How entity’s risk assessment process identifies and addresses risks relating to estimates.

 Entity’s information system as it relates to accounting estimates, including:

i. Classes of transactions etc., events and conditions, significant to financial statements, that give rise
to the need for, or changes in, accounting estimates and related disclosures; and
ii. For such accounting estimates and related disclosures, how management:
 Identifies the relevant methods, assumptions or sources of data, appropriate in the context of
applicable financial reporting framework, including how management:
a) Selects or designs, and applies, methods used, including the use of models;
b) Selects the assumptions to be used, including consideration of alternatives;
c) Selects the data to be used;
 Understands the degree of estimation uncertainty, including the range of possible
measurement outcomes; and
 Addresses estimation uncertainty, including selecting a point estimate
 Control activities relevant to audit over management’s process for making estimates
 How management reviews the outcome(s) of previous accounting estimates and responds to
the results of that review.
AT A GLANCE
Auditor shall also review the outcome of previous accounting estimates, or their subsequent re-
estimation to assist in assessing risks of material misstatement in current period.
 Shall take into account the characteristics of accounting estimates
 Purpose is not to call into question judgments about previous period accounting estimates that were
appropriate based on information available at that time
 Auditor shall determine whether engagement team requires specialized knowledge to perform
procedures in accordance with ISA 540 (revised)
7.2 Identifying and Assessing the Risks of Material Misstatement (Ref: 16-17)
Auditor shall take following into account in identifying the inherent risks:
SPOTLIGHT
 Degree to which accounting estimate is subject to estimation uncertainty; and
 Degree to which following are affected by complexity, subjectivity, or other inherent risk:
¯ Selection and application of method, assumptions and data in making estimate; or
¯ Selection of management’s point estimate and disclosures for inclusion in the financial statements.
Auditor shall determine whether any of risks identified and assessed (as above) are a significant risk; If so,
auditor shall obtain an understanding of the entity’s controls, including control activities, relevant to that risk
7.3 Responses to the Assessed Risks of Material Misstatement (Ref: 18-30)

Auditor’s further audit procedures shall include one or more of the following approaches:
1) Obtaining audit evidence from events occurring up to the date of the auditor’s report
Auditor shall take into account that changes in circumstances and other relevant conditions between event
and measurement date may affect relevance of such audit evidence
2) Testing how management made the accounting estimate; or
Methods
 Whether method selected (and relevant changes) are appropriate in context of applicable financial
reporting framework
 Whether selecting method give rise to indicators of possible management bias;

 Whether calculations are applied in accordance with method and are accurate;
 When method involves complex modeling, whether judgments have been applied consistently and
whether, when applicable:
¯ Design of model meets the measurement objective of applicable financial reporting framework
¯ Adjustments to output of the model are consistent with measurement objective of the applicable
financial reporting framework and are appropriate in the circumstances;
 Whether integrity of significant assumptions and data has been maintained in applying the method.
Significant Assumptions
 Whether significant assumptions (and changes) are appropriate in context of applicable financial
reporting framework
 Whether judgments made in selecting significant assumptions give rise to indicators of possible
management bias;
 Whether significant assumptions are consistent with each other and with those used in other
accounting estimates, or with related assumptions used in other areas of financial statements
 When applicable, whether management has intent to carry out specific courses of action and has the
ability to do so.
AT A GLANCE
Data
 Whether data (and changes) is appropriate in the context of applicable financial reporting
framework;
 Whether judgments made in selecting data give rise to indicators of management bias;
 Whether data is relevant and reliable in the circumstances;
 Whether data has been appropriately understood or interpreted by management, including with
respect to contractual terms.
Management’s Selection of Point Estimate and Disclosures about Estimation Uncertainty
Whether management has taken appropriate steps to:
SPOTLIGHT
 Understand estimation uncertainty; and

 Address estimation uncertainty by selecting an appropriate point estimate and by developing
related disclosures about estimation uncertainty.
If management has not taken appropriate steps, as such, auditor shall:
 Request management to do so, and then evaluate management’s response(s);
 If their response is not sufficient, develop an auditor’s point estimate or range; and
 Evaluate whether a deficiency in internal control exists; if so, communicate it to those charged with
governance.
When indicators of management bias are identified, auditor shall evaluate the implications for audit including
consideration regarding fraud as per ISA 240 (Ref: Para 32)
3) Developing an auditor’s point estimate or range
Regardless of whether auditor uses management’s or auditor’s own methods, assumptions or data auditor shall
evaluate whether these are appropriate in context of the applicable financial reporting framework
If auditor develops an auditor’s range, he shall:
 Determine that range includes amounts that are supported by sufficient appropriate audit evidence and
have been evaluated by auditor to be reasonable in context of applicable financial reporting framework
 Design and perform further procedures to obtain sufficient appropriate audit evidence regarding
assessed risks about disclosures in financial statements describing estimation uncertainty

Test of Controls
As per ISA 330, auditor shall design and perform tests of controls, if:
 Assessment of risks includes expectation that controls are operating effectively; or
 Substantive procedures alone cannot provide sufficient appropriate audit evidence.
Such test of controls shall be responsive to reasons for assessment given to the risks of material misstatement.
Auditor shall obtain more persuasive audit evidence the greater the reliance the auditor places on the
effectiveness of a control
7.4 Disclosures Related to Accounting Estimates (Ref: 31)

Auditor shall design and perform further audit procedures to obtain sufficient appropriate audit evidence
regarding related disclosures, other than related to estimation uncertainty
7.5 Overall Evaluation Based on Audit Procedures Performed (Ref: 33-36)

Auditor shall evaluate, whether:
 Assessments of risks of material misstatement at assertion level remain appropriate, including when
indicators of possible management bias have been identified;
AT A GLANCE
 Management’s decisions relating to recognition, measurement, presentation & disclosure of these
accounting estimates in financial statements are in accordance with applicable financial reporting
framework; and
 Sufficient appropriate audit evidence has been obtained.
In doing so, auditor shall take into account all relevant audit evidence obtained, whether corroborative or
contradictory.
If auditor is unable to obtain sufficient appropriate audit evidence, auditor shall evaluate the implications for the
audit or auditor’s opinion in accordance with ISA 705 (Revised).
In relation to accounting estimates, the auditor shall evaluate:
 For fair presentation framework, whether management has included disclosures, beyond those
specifically required by applicable financial reporting framework, that are necessary to achieve fair
presentation; or
SPOTLIGHT
 For compliance framework, whether disclosures are those that are necessary for the financial
statements not to be misleading.
7.6 Written Representations (Ref: 37)

 Auditor shall request written representations from management and, when appropriate, those charged
with governance about whether the methods, significant assumptions and data used in making estimates
and related disclosures are appropriate and is in accordance with the applicable financial reporting
framework.
 Auditor shall also consider the need to obtain representations about specific accounting estimates,
including in relation to the methods, assumptions, or data used.
7.7 Communication with those charged with governance, Management, or Other Relevant Parties (Ref:
38)
 Auditor shall consider the matters, if any, to communicate regarding accounting estimates and take into
account whether the reasons given to the risks of material misstatement relate to estimation
uncertainty, or the effects of complexity, subjectivity or other inherent risk factors in making accounting
estimates and related disclosures.
 In certain circumstances, auditor is also required by law or regulation to communicate about certain
matters with other relevant parties e.g. regulators or prudential supervisors.


The auditor shall include in the audit documentation:
 Key elements of understanding of entity, its environment, including internal control;
 Linkage of further audit procedures with assessed risks of material misstatement, taking into account
reasons (inherent risk or control risk) given to the assessment of those risks;
 Auditor’s response(s) when management has not taken appropriate steps to understand and address
estimation uncertainty;
 Indicators of possible management bias related to accounting estimates, if any, and the auditor’s
evaluation of the implications for the audit; and
 Significant judgments relating to auditor's determination of whether accounting estimates and related
disclosures are reasonable in the context of the applicable financial reporting framework, or are
misstated.
Alpha Petroleum Limited (APL) has obtained a loan in foreign currency from Asian Development
Bank. APL has entered into currency swaps contract to hedge foreign currency risk. APL carries
its currency swap contract at fair value in the financial statements.
AT A GLANCE
APL also has significant amount of staff retirement benefit liability (defined benefit plan) on the
statement of financial position.
Required:
a) Specify the matters to be considered by the auditor in planning the audit of currency swap
contract.
b) Recommend the audit procedures in respect of the defined benefit plan liability and for
valuation of currency swap contract.
Tutorial Notes:
Part (a) - Common expected errors to be avoided are:
SPOTLIGHT
1. Not appreciating the fact that the question is on planning rather than execution.
2. Mentioning general issues concerning the planning rather than issue specific to foreign
currency swap.
Part (b) - Common expected errors to be avoided are:
1. Steps related to verification of the valuation rates may be missed.
2. Responsibilities of the actuary or the steps to be performed by him may be wrongly stated
instead of the auditor.
3. Over focus on Competence of the valuer while missing other steps.
 Solution:
Part (a)
While planning the audit of currency swap contracts, the auditor is required to obtain the
understanding of the following in order to provide a basis of the identification and assessment
of the risks of material misstatement for estimates used in the valuation of currency swap as per
the requirement of ISAs:
i. The requirements of the applicable financial reporting framework relevant to
accounting estimates, including related disclosures.
ii. Management means / procedures for identification of transactions, events and
conditions that may give rise to new, or the need to revise existing, accounting estimates.

iii. How management makes the accounting estimates, and an understanding of the data on
which they are based, including:
 The method used in making the accounting estimate.
 The assumption underlying the accounting estimates.
 Relevant controls.
 Whether management has used an expert.
 Consider the use of auditor’s expert.
 Whether there has been or ought to have been a change from the prior period in the
methods for making the accounting estimates, and if so, why.
 Whether and, if so, how management has assessed the effect of estimation
uncertainty.
Part (b)
Audit procedures to be performed for valuation of currency swap contract:
i. Obtain the details of the foreign currency swap contracts;
ii. Assess the reasonableness of assumptions used in the foreign currency swap contracts;
AT A GLANCE
iii.Verify the valuation rates used, if available from authentic websites (e.g. Bloomberg);
iv. Check subsequent settlement of contracts, if any, for verification of the valuation rates.
v. In case valuation methodologies have been used in valuation of derivative contracts then
apart from assessing the reasonableness of the assumptions, get the valuation re-
performed for the contract by the auditor.
vi. Evaluate whether the auditor’s expert has the necessary competence, capabilities and
objectivity for the auditor’s purposes.
Audit procedures to be performed for actuarial liability:
i. Assess that the management expert should have relevant competence and capable
enough of doing the tasks assigned.
ii. Evaluate whether the auditor’s expert has the necessary competence, capabilities and
SPOTLIGHT
objectivity for the auditor’s purposes.
iii. Obtain and ensure the completeness and accuracy of the data in respect of staff
retirement benefits provided by the management to the management and auditor’s
expert.
iv. Independently assess the accuracy of assumptions pertaining to salary increase rate,
discount rate, retirement age, pension indexation, if any on basis of historical trend and
current status of things.
v. Discuss and resolve the differences, if significant, between the report of the expert and
report of auditor’s expert.
vi. Ensure that proper disclosure is given in the financial statements in respect of defined
benefit plan liability.

AT A GLANCE
SPOTLIGHT

CHAPTER 10
AUDIT FINALISATION AND REPORTING
AT A GLANCE
IN THIS CHAPTER: ISA-560 deals with the auditor’s responsibilities relating to
subsequent events in an audit of financial statements. It does not
AT A GLANCE deal with matters relating to the auditor’s responsibilities for
other information obtained after the date of the auditor’s report,
SPOTLIGHT which are addressed in ISA 720.
Financial statements may be affected by certain events that
1. Subsequent events (ISA 560) occur after date of financial statements. Financial reporting
AT A GLANCE
frameworks specifically refer to such events. Such financial
2. Written representations (ISA reporting frameworks ordinarily identify two types of events:
580)
- Those that provide evidence of conditions that existed at
3. Forming an opinion and the date of the financial statements; and
reporting on financial - Those that provide evidence of conditions that arose after
statements (ISA 700) the date of the financial statements.
ISA-580 deals with auditor’s responsibility to obtain written
4. Communicating key audit representations from management and those charged with
matters in the independent governance in an audit of financial statements. Although written
auditor’s report (ISA 701) 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.
SPOTLIGHT
ISA-700 deals with the auditor’s responsibility to form an
opinion on the financial statements. It also deals with the form
and content of the auditor’s report issued as a result of an audit
of financial statements. The objectives of the auditor are to:
- Form an opinion on the financial statements based on an
evaluation of the conclusions drawn from the audit
evidence obtained; and
- Express clearly that opinion through a written report.
ISA-701 deals with the auditor’s responsibility to communicate
key audit matters in the auditor’s report. It is intended to
address both the auditor’s judgment as to what to communicate
in the auditor’s report and the form and content of such
communication.
The purpose of communicating key audit matters is to enhance
the communicative value of the auditor’s report by providing
greater transparency about the audit that was performed.
Communicating key audit matters may also assist intended
users in understanding the entity and areas of significant
management judgment in the audited financial statements.

CHAPTER 10: AUDIT FINALISATION AND REPORTING CFAP 6: AARS
1. SUBSEQUENT EVENTS (ISA 560)

1.1 Events Occurring between Date of financial statements and Date of Auditor's Report (Ref: 6-9, A6-
A10)
Auditor shall perform additional audit procedures to identify all subsequent events occurring between date of
financial statements and date of auditor's report.
Auditor shall determine whether each such event is appropriately reflected in financial statements in accordance
with applicable financial reporting framework.
Auditor shall take into account risk assessment in determining the nature and extent of such audit procedures
including following:
 Obtaining an understanding of procedures established by management to identify events.
 Inquiring management (and those charged with governance) about any subsequent events which might
affect financial statements.
 Inquiring the current status of items that were accounted for on the basis of preliminary or incomplete
data and may make specific inquiries about whether:
¯ New commitments, borrowings or guarantees have been entered into.
¯ Sales or acquisitions of assets have occurred or are planned.
AT A GLANCE
¯ There have been increases in capital or issuance of debt instruments or agreement to merge or
liquidate planned.
¯ Any assets have been appropriated by government or destroyed. (e.g. by fire or flood)
¯ There have been any developments regarding contingencies.
¯ Any unusual accounting adjustments have been made.
¯ Any events have occurred or are likely to occur that will bring into question appropriateness of
accounting policies used in financial statements. (e.g. validity of going concern assumption)
¯ Any events have occurred that are relevant to measurement of estimates or provisions made in
¯ Any events have occurred that are relevant to recoverability of assets.
 Reading minutes of meetings of owners, management and those charged with governance held after date
SPOTLIGHT
of financial statements and inquiring about matters discussed at any such meetings for which minutes
are not yet available.
 Reading the entity's latest subsequent interim financial statements. (if any)
In addition to the above mentioned audit procedures:
 Read entity's latest available budgets, cash flow forecasts etc. for periods after date of financial
statements.
 Inquire from entity legal counsel concerning litigations & claims.
 Consider whether written representations may be necessary to support other audit evidence.
Request management (or those charged with governance), to provide a written representation that all events
occurring subsequent to date of financial statements requiring adjustment or disclosure have been adjusted or
disclosed.
Date of the financial statements: The date of the end of the latest period covered by the
Date of approval of the financial statements: The date on which all the statements that
comprise 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.

CFAP 6: AARS CHAPTER 10: AUDIT FINALISATION AND REPORTING
Date of the auditor's report: The date the auditor dates the report on financial statements in
Date the financial statements are issued: The date that the auditor's report and audited
financial statements are made available to third parties.
Subsequent events: Events occurring between the date of 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.
1.2 Facts Become Known after Date of Auditor Report and before Date of issuance of financial
statements (Ref: 10-13, A11-A17)
 No obligation to perform any audit procedures regarding financial statements after date of auditor's
report
 If after date of auditor’s report but before issuance of financial statements, auditor comes to know a fact
requiring amendment of auditor’s report, the auditor shall:
¯ Discuss the matter with management (and where appropriate those charged with governance)
¯ Determine whether financial statements need amendment; if so, inquire how they intends to
address the matter in financial statements.
AT A GLANCE
Where Management Amends financial statements, auditor shall:
 Carry out the audit procedures necessary in the circumstances on the amendment.
 Extend the audit procedures referred in previous section to the date of new auditor's report. (Unless
restricted by law, regulation etc.).
 Provide a new auditor's report on amended financial statements. (Not be dated earlier than date of
approval of amended financial statements)
Auditor is permitted to apply audit procedures on subsequent events to that amendment where:
 Law, regulation or financial reporting framework does not prohibit management (i.e. allows) from
amending the financial statements to the effects of subsequent event; and
 Those responsible for approving financial statements are not prohibited from approving that
SPOTLIGHT
amendment.
In such cases, the auditor shall either:
 Amend report to include an additional date restricted to that amendment indicating that auditor's
procedures are restricted solely to amendment of financial statements; or
 Provide a new or amended report that including an Emphasis of Matter paragraph or Other Matter
paragraph highlighting that auditor's procedures are restricted solely to amendment.
 Illustration of additional date (Dual Dating)
“August 14, 2012, except as to Note 37.1, which is as of September 06, 2012.”
No Amendment of financial statements by Management

In some jurisdictions law, regulation or financial reporting framework may require management not to issue
amended financial statements (Often when issuance of financial statements for the next period are forthcoming)
and, accordingly auditor need not to provide an amended or new auditor's report.
Where management does not amend financial statements that auditor believes to be amended, then:
 If auditor's report has not been provided to entity, auditor shall modify the opinion before providing
report
 If auditor's report has already been provided to the entity, auditor shall notify management and those
charged with governance, not to issue financial statements to third parties before necessary
amendments.

If financial statements are subsequently issued without necessary amendments, auditor shall take appropriate
action to seek to prevent reliance on auditor's report. (Depending upon auditor's legal rights and obligations).
Auditor may consider seeking legal advice.
1.3 Facts Which Become Known to the Auditor after the financial statements have Been Issued (Ref: 14-
17, A18-A20)
 No obligation to perform any audit procedures regarding financial statements after date of auditor's
report
 If after the issuance of financial statements, auditor comes to know a fact requiring amendment of
auditor’s report, the auditor shall:
¯ Discuss the matter with management (and where appropriate those charged with governance).
¯ Determine whether financial statements need amendment; if so, inquire how they intends to
address the matter in financial statements.
Where Management Amends financial statements, auditor shall:

 Carry out the audit procedures necessary in the circumstances on the amendment.
 Review steps taken by management to inform, all parties to whom financial statements are issued, the
AT A GLANCE
situation.
 Extend audit procedures referred in previous section to the date of new auditor's report (Unless
restricted by law, regulation etc.).
 Provide a new auditor's report on amended financial statements. (Not be dated earlier than date of
approval of amended financial statements).
 Include in new or amended auditor's report an Emphasis of Matter paragraph or Other Matter paragraph
referring to a note of financial statements that extensively discusses reason for such amendment.
Auditor Action to Seek to Prevent Reliance on Auditor's Report

If management does not take necessary steps to ensure that anyone in receipt of the previously issued financial
statements is informed of the situation and does not amend financial statements:
SPOTLIGHT
 Auditor shall notify management and those charged with governance that auditor will seek to prevent
future reliance on auditor's report.
 If they do not take these necessary steps, auditor shall take appropriate action to seek to prevent reliance
on the report.
 Auditor's course of action depends upon auditor's legal rights & obligations (may consider legal advice).
The audit report of Bhit Gas Limited (BGL) was qualified on account of recognition of mark-up
on delayed payment from Salim Enterprises Limited (SEL) amounting to Rs. 2.7billion, because
at the time of signing of audit report, SEL had not acknowledged its liability towards mark-up
due to BGL and the matter was pending in the Court.
After the issuance of the financial statements, the matter was decided by the Court and SEL was
ordered to settle the mark-up by paying Rs. 1.5 billion. After the Court’s decision, BGL had filed
an appeal against the order for the remaining amount of Rs. 1.2 billion and the management has
requested the auditor to remove the qualification and issue a revised audit report. The
management has also informed the auditor that subsequent to the Court’s decision, it has decided
to revise the financial statements by making a 25% provision against the remaining amount of
mark-up.
Required:
Discuss the factors that the auditor should consider with reference to the above and specify the
steps that he should take under each of the following circumstances:

i. The management and those charged with governance are prohibited by law and regulation
from restricting the amendment and approval of the financial statements to the effect of the
above event.
ii. The management and those charged with governance are not prohibited by law and
regulation from restricting the amendment and approval of the financial statements to the
effect of the above event.
Tutorial Notes:
Since most of the points are available direct from the Auditing Standard, generally the students
should be able to score well. However, most of the students might miss an important point that
though the court had decided in favor of the company, the auditor needed to assess whether
Salim Limited (the debtor) was in a position to repay the amount.
 Solution:
The decision given by the court confirms the existence of mark-up due from SEL, therefore the
qualified report issued on account of recognition of mark-up amounting to Rs. 2.7 billion does
not hold good and therefore the auditor needs to amend the report.
In view of the above, the auditor needs to take the following steps in each of the two situations
AT A GLANCE
i.e. situation given in para (i) as well as the situation given in para (ii).
 Assess whether Salim Limited is in a position to repay the amount as per court’s decision.
 If the auditor and the management agree on the amount of provision to be made, (Whether
25% or as may be agreed) or if the amount of dispute is not material to the financial
statements, the auditor will issue an unqualified opinion on the amended financial
statements. Otherwise, the auditor would issue a qualified opinion after duly changing the
amounts in the audit report.
 Carryout the audit procedures (as may be necessary under the circumstances) on the
amendment.
 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
SPOTLIGHT
situation.
 If the management does not take the necessary steps to ensure that anyone in receipt of the
previously issued financial statements is informed of the situation, the auditor shall notify
management and where appropriate, those charged with governance, that the auditor will
seek to prevent reliance on the auditor’s report. If despite such notification, management or
those charged with governance do not take necessary steps, the auditor shall take
appropriate action to seek to prevent reliance on the auditor’s report.
When Law and Regulation prohibit management from restricting the amendment of the financial
statements to the effects of subsequent events causing that amendment the auditor will take the
following steps:
 Extend the audit procedures on (all) subsequent events to the date of the new auditor’s
report.
 The new auditor’s report shall not be dated earlier than the date of the approval of the
amended financial statements.
 The auditor shall include in the new auditor’s report an emphasis of matter paragraph or
other matter paragraph referring to a note to the financial statements that more extensively
discusses the reason for the amendment of the previously issued financial statements and to
the earlier report provided.

When Law and Regulation does not prohibit management from restricting the amendment of the
financial statements to the effects of subsequent events causing that amendment, the auditor will
take the following steps:
 Restrict the audit procedures on subsequent events to the decision given by the court.
 Amend the auditor’s report to include an additional date restricted to that amendment that
thereby indicates that the auditor’s procedures on subsequent events are restricted to the
adjustment of an amount of mark-up due from SEL as a result of decision given by the Court;
or
 Provide a new or amended auditor’s report that includes a statement in an Emphasis of
matter paragraph or Other matter paragraph that conveys that the audit procedures on
subsequent events are restricted solely to the amendment of the financial statements as
described in the relevant note to the financial statements. The emphasis of matter paragraph
or other matter paragraph will also include reference to a note to the financial statements
that more extensively discusses the reason for the amendment of the previously issued
financial statements and to the earlier report provided.
 Practice Question 02
Your firm has completed the audit of financial statements of Flora Limited (FL), a public listed
AT A GLANCE
company, as of June 30, 2008 and has issued the audit report on September 30, 2008. While
preparing to attend the Annual General Meeting (AGM), you noted that a particular sub-note was
altogether missing from the published financial statements On scrutiny; you found that the
original signed copy of the financial statements available in your records did contain note.
Required:
a) Explain the auditor’s responsibility in such a situation if the amount involved is
considered material.
b) What difference would it make if the amount is immaterial?
 Solution:
a)
SPOTLIGHT
 The auditor should communicate with the client and inform them about the omission.
 The auditor should also advise the client to inform the Securities and Exchange
Commission of Pakistan the relevant stock exchanges, and other regulatory bodies
wherever the accounts have been submitted.
 The auditor should ensure that the management sends a corrigendum to all the
shareholders before the AGM. If due to time constraint or any other reason it is not
possible, the auditor should see that the management, in addition to sending the
corrigendum, shall also inform the shareholders about the omission at the AGM.
 Under the Companies Ordinance, 1984, the auditors are entitled to attend the Annual
General Meeting therefore they should inform the shareholders themselves if
management fails to do so.
b) The auditor should ensure the same actions as mentioned in(a) even if the amount
involved is not material.
You are the engagement partner of a listed company. After completing audit field work, you have
provided the draft audit report along with the draft financial statements prepared by
management to the Board of Directors with a cover letter stating that the firm will issue its audit
report after the Board has approved the financial statements.

Your manager has brought to your knowledge that last week the client has published its annual
report including Financial Statements and audit report (which had not been signed by the firm).
Notice of Annual General Meeting (AGM) has also been published in the newspapers.
Required:
Explain what course of action should the firm take in the above situation.
 Solution:
As soon as we come to know about the above stated facts, we should immediately contact the
client and inform them that unless the auditors have signed their report on the financial
statements, such financial statements will remain and be deemed unaudited.
SECP should be informed about the situation.
Legal opining should be taken.
The auditor may take necessary steps to inform the shareholders either immediately or in AGM
about the possible impact on the financial statements.
1.3 Tutorial note
AT A GLANCE
Core Paragraphs: 7 and 10 to 15
Explanatory Paragraphs: A8, A9, A12 to A18
SPOTLIGHT

2. WRITTEN REPRESENTATIONS (ISA 580)

2.1 Management from whom Written Representations Requested (Ref: 9, A2-A6)
Management with appropriate responsibilities for the preparation of financial statements and having knowledge
of the matters concerned.
 Management would be expected to have sufficient knowledge of the process followed in preparing
financial statements and the assertions therein.
 Management may decide to make inquiries of others who participate in preparing and presenting
financial statements, including individuals who have specialized knowledge relating to subject matter
(e.g. actuary, engineer, legal advisor or other experts)
 Auditor may accept qualifying wording in representations, if the auditor is satisfied that representations
are being made by relevant management personal.
 Auditor may request that management include confirmation in the written representations that it has
made appropriate inquiries before making the requested written representations.
2.2 Written Representations about Management's Responsibilities (Ref: 10-12, A7-A9)

AT A GLANCE
Shall be described in written representations in the same manner as described in the terms of the audit
engagement.
The auditor shall request management to provide a written representation that
Preparation of the financial statements - Para 10

It has fulfilled its responsibility for preparation of financial statements in accordance with applicable financial
reporting framework, including, where relevant, their fair presentation, as set out in terms of the audit
engagement.
Information Provided & Completeness of Transactions-Para11

a) It has provided the auditor with all relevant information and access as agreed
b) All transactions have been recorded and are reflected in financial statements.
SPOTLIGHT
Auditor may also ask management to reconfirm its acknowledgement and understanding. It is common in
certain jurisdictions however may be particularly appropriate when:
 Those who signed the terms of audit engagement no longer have the relevant responsibilities;
 Terms of audit engagement were prepared in a previous year;
 There is any indication that management misunderstands those responsibilities; or
 Changes in circumstances make it appropriate to do so.
Communication with those charged with governance

Auditor shall communicate with those charged with governance the written representations which the auditor
has requested from management.
2.3 Additional / Other Written Representations (Ref: 13, A10-A13)
About the financial statements

In addition to Para 10, auditor may consider necessary to request representation about following:
 Whether selection and application of accounting policies are appropriate; and
 Whether following or similar matters, where relevant under applicable financial reporting framework,
have been recognized, measured, presented or disclosed in accordance with that framework:

¯ Plans or intentions that may affect carrying value or classification of assets & liabilities;
¯ Liabilities, both actual and contingent;
¯ Title to, or control over, assets, liens or encumbrances on assets, and assets pledged; and
¯ Aspects/Non-compliance of laws, regulations & agreements that may affect financial statements
About Information Provided to the Auditor

In addition to Para 11, auditor may request management to provide a written representation that it has
communicated to auditor all deficiencies in internal control (which they know).
Written Representations about Specific Assertions

When obtaining evidence or evaluating, judgments & intentions, auditor may consider following:
 Entity's past history in carrying out its stated intentions.
 Entity's reasons for choosing a particular course of action.
 Entity's ability to pursue a specific course of action.
 Existence or lack of any other information that might have been obtained during audit that may be
inconsistent with management's judgment or intent.
AT A GLANCE
Your firm has been appointed as the auditors of Star Limited, a well-established consumer goods
manufacturing company. During the audit you were provided with various oral representations
during meetings and discussions. While finalizing the audit you requested the management to
provide such representations in writing.
The management has however informed you that they are not accustomed to providing any
representations to the external auditor in writing. The management is of the view that it has
provided full access to whatever records, documents and evidences were available with it
without any exception and that now it is the auditor’s responsibility to correlate the same with
the oral representations.
The management has further informed that the only signed documents which it will be providing
SPOTLIGHT
to you would be the signed copy of the financial statements and the certified true copy of the
resolution of the BOD approving the financial statements and other significant matters, in line
with the requirements of the corporate law.
Required: You are required to explain the following:
a) Is there any relevance of oral representations for the External Auditors?
b) What are the situations in which written representation from the management is
mandatory?
c) What course of action would you like to take in the above circumstances?
 Solution:
a) Relevance of Oral representation:
An auditor should document the oral representations made by the management during
the course of audit and make them part of audit working papers. However oral
representation is less reliable then written representation.
b) The following types of representations should mandatorily be in writing:
i. Relating to a matter material to the financial statements when other sufficient
appropriate audit evidence cannot reasonably be expected to exist.
ii. Management’s acknowledgement of its responsibility for the design and
implementation of internal controls to prevent and detect error; and
iii. Management’s acknowledgment that

iv. (according to its belief) the effects of uncorrected errors aggregated by the auditor
during the audit are immaterial, both individually and in the aggregate, to the
financial statements taken as a whole. A summary of such items should be included
in or attached to the written representations.
v. Management’s acknowledgement of its responsibility for the design and
implementation of internal controls to prevent and detect fraud;
vi. That the management has disclosed to the auditor the results of its assessment of
the risk that the financial statements may be materially misstated as a result of
fraud;
vii. That the management has disclosed to the auditor its knowledge of fraud or
suspected fraud affecting the entity involving:
 Management;
 Employees who have significant roles in internal control; or
 Others, where the fraud could have a material effect on the financial statements;
and
viii. That the management has disclosed to the auditor its knowledge of any allegations
of fraud, or suspected fraud, affecting the entity’s financial statements as may have
AT A GLANCE
been communicated by employees, former employees, analysts, regulators or

others.
c) An auditor may accept the oral representation provided by the management of Star
limited but these need to be documented in the working papers.
Moreover, since oral representations are less reliable, the auditor should reassess
whether it needs to perform additional procedures in view of the above situation.
However, where written representation is mandatory the auditor should obtain written
representations and in case of management’s refusal, it shall consider appropriate
modification of the auditor’s report.
2.4 Date of and Period Covered by Written Representations (Ref: 14, A15-A18)
Date:
SPOTLIGHT
Shall be as near as practicable to, but not after, date of auditor report
Period:
Shall be for all financial statements and period(s) referred to in auditor report.
Sometimes auditor may obtain a written representation about a specific assertion in financial statements during
the course of the audit. In this case, it may be necessary to request an updated written representation.
2.5 Form of Written Representations (Ref: 15, A19-A21)

Shall be in form of a representation letter addressed to auditor.
In some jurisdictions management may be required by law or regulation to make a written public statement
about responsibilities.
 If auditor determines that such statements provide some or all representations required by this ISA,
relevant matters covered by such statements need not be included in representation letter.
¯ Factors that may affect the auditor's determination include:
¯ Whether statement includes confirmation of responsibilities of Para 10 & 11.
¯ Whether statement has been given or approved by relevant management personnel.
¯ Whether a copy of statement is provided to auditor as near as practicable to, but not after, the date
of auditor's report.
Formal statement of compliance with law/regulation or approval of financial statements would not be a
substitute.

2.6 Doubt as to the Reliability and Requested Written Representations Not Provided (Ref: 16-20)
Doubt as to the Reliability of Written Representations

If auditor has concerns about competence, integrity, ethical values or diligence of management, auditor shall
determine the effect of it on the reliability of representations.
If written representations are inconsistent with other audit evidence, auditor shall perform audit procedures to
resolve the matter.
If matter remains unresolved, auditor shall reconsider the assessment of the competence, integrity etc.
Requested Written Representations Not Provided

Discuss the matter with management;
Re-evaluate 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
Take appropriate actions, including determining the possible effect on opinion (ISA 705)
Written Representations about Management's Responsibilities
AT A GLANCE
The auditor shall disclaim an opinion in accordance with ISA 705 if:
 Auditor concludes that there is sufficient doubt about integrity of management; or
 Management does not provide written representations required by paragraphs 10 and 11.
Note: A modified written representation (with qualifying language) does not necessarily mean that management
did not provide written representation. Accordingly, disclaimer is not appropriate. However, reason for such
modification may affect the opinion in auditor's report (ISA 705)
 Appendix 2 - Illustrative Representation Letter (ISA 580)
(Entity Letterhead)
(To Auditor) (Date)
This representation letter is provided in connection with your audit of the financial statements
SPOTLIGHT
of ABC Company for the year ended December 31, 20XX2 for the purpose of expressing an
opinion as to whether the financial statements are presented fairly, in all material respects, (or
give a true and fair view) in accordance with International 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 the audit engagement
dated [insert date], for the preparation of the financial statements in accordance with
International 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. (ISA 540)
 Related party relationships and transactions have been appropriately accounted for and
disclosed in accordance with the requirements of International Financial Reporting
Standards. (ISA 550)
 All events subsequent to the date of the financial statements and for which International
Financial Reporting Standards require adjustment or disclosure have been adjusted or
disclosed. (ISA 560)

 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. (ISA 450)
 [Any other matters that the auditor may consider appropriate (see paragraph A10 of this
ISA).]
Information Provided
 We have provided you with:
¯ Access to all information of which we are aware that is relevant to the preparation
of the financial statements, such as records, documentation and other matters;
¯ 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
 We have disclosed to you the results of our assessment of the risk that the financial
AT A GLANCE
statements may be materially misstated as a result of fraud. (ISA 240)

 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:
¯ Management;
¯ Employees who have significant roles in internal control; or
¯ Others where the fraud could have a material effect on financial statements. (ISA
240)
 We have disclosed to 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. (ISA 240)
SPOTLIGHT
 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. (ISA 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. (ISA 550)
[Any other matters that the auditor may consider necessary (see paragraph A11 of this ISA).]
Management Management

3. FORMING AN OPINION AND REPORTING ON FINANCIAL STATEMENTS (ISA

700 (REVISED))
3.1 Forming an Opinion on the financial statements (Ref: 10-15)
Auditor shall conclude as to whether he has obtained reasonable assurance.
The conclusion shall take into account:
 Whether sufficient appropriate audit evidence has been obtained;
 Whether uncorrected misstatements are material, individually or aggregate;
 Other evaluations required by this ISA.
Auditor shall form an opinion that financial statements are prepared in accordance with applicable financial
Evaluation shall include consideration of qualitative aspects of accounting practices, including indicators of
possible bias (lack of neutrality) in judgments. Such indicators include following:
 Selective correction of misstatements brought to their attention.
 Possible management bias in the making of accounting estimates.
AT A GLANCE
In particular, auditor shall evaluate whether:
 financial statements adequately disclose significant accounting policies selected and applied;
 Accounting policies are consistent with applicable financial reporting framework and are appropriate;
 Accounting estimates made by management are reasonable;
 Information presented in financial statements is relevant, reliable, comparable, & understandable;
 Terminology used in financial statements is appropriate;
 financial statements provide adequate disclosures enabling intended users to understand the effect of
material transactions and events.
3.2 Description of the Applicable Financial Reporting Framework (Ref: A10-A15)
SPOTLIGHT
Auditor shall evaluate whether financial statements adequately refer to or describe applicable financial reporting
framework.
Such description is appropriate only if financial statements comply with all requirements of that framework that
are effective during the period covered by financial statements.
This description should not contain limiting language.
Reference to More than One Financial Reporting Framework

Where financial statements prepared in accordance with two financial reporting frameworks. Such reference is:
 Appropriate only if financial statements comply with both frameworks simultaneously.
 Not appropriate If financial statements prepared in accordance with one financial reporting framework
contains a reconciliation of results shown under another framework.
3.3 Form of Opinion (Ref: 16-19, A16-A17)

Express an unmodified opinion when concludes that financial statements are prepared, in all material respects,
in accordance with applicable financial reporting framework.
Modify the opinion: If auditor concludes that financial statements as a whole are not free from material
misstatement or he is unable to obtain sufficient appropriate evidence.
When financial statements, prepared in accordance with fair presentation framework, do not achieve fair
presentation, auditor shall discuss matter with management and consider to modify the opinion in accordance
with ISA 705.

When financial statements prepared in accordance with compliance framework,

 Auditor is not required to evaluate whether financial statements achieve fair presentation.
 If in extremely rare circumstances auditor concludes that such financial statements are misleading,
auditor shall discuss matter with management and may determine to communicate in report.
3.4 Auditor's Report (Ref: 20-49, A18-A69)
1 Title "Independent Auditor's Report"

2 Addressee As required by the circumstances of the engagement.
 Sometimes law or regulation specifies the addressee
 Normally it is addressed to shareholders or those charged with governance.
3 Auditor's  Identify entity whose financial statements have been audited;
Opinion  State that financial statements have been audited;
 Identify the title of each statement that comprises financial statements;
 Refer to accounting policies & other explanatory info
 Specify the date or period covered by financial statements.
AT A GLANCE
For Fair presentation framework

Use one of following phrases
 “financial statements present fairly, in all material respects, ... in accordance with
applicable financial reporting framework”; or
 “financial statements give a true and fair view of …. in accordance with applicable
financial reporting framework”
For Compliance framework
“financial statements are prepared, in all material respects, in accordance with
applicable financial reporting framework”
Description of applicable financial reporting framework
SPOTLIGHT
 "... in accordance with IFRS"; or

 "... in accordance with accounting principles generally accepted in Jurisdiction X
..."
If applicable financial reporting framework contains both reporting standards
& legal requirements
"... in accordance with International Financial Reporting Standards and the
requirements of Jurisdiction X Corporations Act."
If financial statements prepared in accordance with two financial reporting
framework (both applicable)
 If financial statements comply with each framework individually, two opinions
are expressed (separately or in a single sentence).
 If financial statements comply with one but fail to comply with other framework
an unmodified opinion can be given for one framework but a modified opinion
given with regard to other framework.
4 Basis for This section:
opinion  States that the audit was conducted in accordance with International Standards
on Auditing;
 Refers to the section of the auditor’s report that describes the auditor’s
responsibilities under the ISAs;

 Includes a statement that the auditor is independent of the entity in accordance

with the relevant ethical requirements relating to the audit, and has fulfilled the
auditor’s other ethical responsibilities in accordance with these requirements.
 The statement shall identify the jurisdiction of origin of the relevant ethical
requirements or refer to the International Ethics Standards Board for
Accountants’ Code of Ethics for Professional Accountants (IESBA Code); and
 States whether the auditor believes that the audit evidence the auditor has
obtained is sufficient and appropriate to provide a basis for the auditor’s opinion.
5 Going Where applicable, auditor shall report in accordance with ISA 570 (Revised).
concern
6 Key Audit For audits of listed entities and other prescribed or selected entities, auditor shall
Matters communicate “Key Audit Matters” in auditor’s report. (as per ISA 701).
(KAM)
7 Other Reporting as per ISA 720 (Revised).
Information
8 Management  Preparation of financial statements in accordance with applicable financial
AT A GLANCE
's reporting framework, and
Responsibilit  Internal control necessary for preparation of financial statements
y
 Assessing entity’s ability to continue as a going concern and whether the use of
the going concern basis of accounting is appropriate as well as disclosing any
matters relating to such.
This section shall also identify those responsible for the oversight of the financial
reporting process, when those responsible for such oversight are different from the
management.
9 Auditor's This section of the report shall state that:
Responsibilit  Objectives of the auditor are to:
y
¯ Obtain reasonable assurance about whether financial statements as a whole
SPOTLIGHT
are free from material misstatement, whether due to fraud or error; and
¯ Issue auditor’s report that includes the auditor’s opinion.
 Reasonable assurance is a high level of assurance, but is not a guarantee that an
audit will always detect a material misstatement when it exists; and
 Misstatements can arise from fraud or error, and either:
 describe that they 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; or
 provide a definition or description of materiality in accordance with applicable
This section shall further:
 State that auditor exercise professional judgment and maintains professional
skepticism throughout the audit; and
 Describe an audit by stating that the auditor’s responsibilities are:
¯ to identify and assess the risks of material misstatement of the financial
statements, whether due to fraud or error.
¯ to 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 internal
control.

¯ to evaluate the appropriateness of accounting policies used and the

reasonableness of accounting estimates and related disclosures made by
management.
¯ to conclude on the appropriateness of management’s use of the going concern
basis of accounting.
This section also shall:
 State that the auditor communicates 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 the auditor identifies during the audit;
 For audits of financial statements of listed entities, state that the auditor provides
those charged with governance with a statement that the auditor has complied
with relevant ethical requirements regarding independence and communicate
with them all relationships and other matters that may reasonably be thought to
bear on the auditor’s independence, and where applicable, related safeguards;
and
 Where “Key Audit Matters” are communicated, state that, from the matters
communicated with those charged with governance, the auditor determines those
AT A GLANCE
matters that were of most significance in the audit of the current period and are
therefore the key audit matters.
This section shall be included:
 within the body of the auditor’s report;
 within an appendix to auditor’s report, (Report shall include a reference to the
location of appendix); or
 By a specific reference within auditor’s report to the location of such a description
on a website of an appropriate authority.
10 Other Such other reporting responsibilities may be addressed in a separate section of the
Reporting report sub-titled “Report on Other Legal and Regulatory Requirements.”
Responsibilit In this case the auditor’s report would be having two separate sections.
SPOTLIGHT
ies
 Content # 3 – 9 of auditor’s report shall be under the sub-title "Report on the
financial statements.”
 "Report on Other Legal and Regulatory Requirements" shall come after "Report
on the financial statements." (May contain sub-headings)
11 Name of the For Listed Companies only:
Engagement If, if in rare circumstances, such disclosure is reasonably expected to lead to significant
Partner personal security threat, auditor should not include the name and shall also discuss
the severity with those charged with governance.
12 Signature of The auditor's report shall be signed; Either in name of audit firm, auditor’s personal
the Auditor name or both (as appropriate).
13 Auditor's Name the location in the jurisdiction where auditor practices. (not the clients’)
Address
14 Date Shall not be dated earlier than date on which the auditor has obtained sufficient
appropriate audit evidence on which to base the auditor's opinion on financial
statements, including evidence that:
 financial statements, including related notes, have been prepared; and
 Those with recognized authority have asserted that they have taken
responsibility for financial statements.


Identify the differences between the auditor’s report on financial statements of a listed company
as compared to an unlisted company, based on International Standards on Auditing.
Tutorial Notes:
This requires a good understanding of the contents of the report and appropriate focus.
 Solution:
Following are the additional matters that have to be included in the audit reports of listed
companies:
 Key audit matters.
 Statement from the auditor that it has provided those charged with governance with a
statement that the auditor has complied with relevant ethical requirements regarding
independence and communicate with them all relationships and other matters that may
reasonably be thought to bear on the auditor’s independence, and where applicable,
related safeguards.
 Statement that from the matters communicated with those charged with governance,
the auditor determines those matters that were of most significance in the audit of the
AT A GLANCE
financial statements of the current period and are therefore presented as the key audit
matters.
 The name of engagement partner.
 Further in the audit report of listed companies the auditor is supposed to include a
separate section named “other information” if at the date of audit report the auditor has
obtained or expects to obtain other information whereas in the case of unlisted company
this paragraph is only given if the auditor has obtained any such information.
3.5 Auditor's Report Prescribed by Law or Regulation (Ref: 50, A70-A75)

If law or regulation require auditor to use specific layout or wording of report, auditor's report shall refer to ISA
only if auditor's report includes, at a minimum above elements (1-9, 11-14).
SPOTLIGHT
3.6 Report in Accordance with Auditing Standards of Specific Jurisdiction and ISA (Ref: 51, A76-A77)
Auditor's report may refer to ISA in addition to national auditing standards, but the auditor shall do so only if:
 There is no conflict between the requirements of both that would lead the auditor to:
¯ Form a different opinion, or
¯ Not to include Emphasis of Matter paragraph that is required by ISAs.
 Report includes, at a minimum, above elements (1-9, 11-14) when the auditor uses the layout or wording
specified by national auditing standards.
Auditor's report shall also identify the jurisdiction of origin of national auditing standards.
3.7 Supplementary Information Presented with the financial statements (Ref: 53-54, A78-A84)
Auditor's evaluation whether unaudited supplementary information is presented in a manner that could be
considered as being covered by auditor's opinion includes its placement and whether it is clearly labeled as
"unaudited."
 If unaudited supplementary information (not required by applicable financial reporting framework) is
presented with audited financial statements, auditor shall evaluate whether such information is clearly
differentiated from audited financial statements.

¯ If it is not clearly differentiated from audited financial statements, auditor shall ask management to
change its presentation
¯ If management refuses, auditor shall explain in report that such information has not been audited.
 Management could change the presentation of unaudited supplementary information by:
¯ Removing any cross-references from financial statements to unaudited supplementary notes so that
segregation between audited and unaudited information is sufficiently clear.
¯ Placing unaudited supplementary information outside financial statements or at a minimum place
unaudited notes together required notes of financial statements and clearly label them
 Illustration 1
Report on financial statements of Listed Entity in Accordance with a Fair Presentation
Framework
To the Shareholders of ABC Company [or Other Appropriate Addressee]
Report on the Audit of the Financial Statements
AT A GLANCE
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
International Financial Reporting Standards (IFRSs).
Basis for Opinion
SPOTLIGHT
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 accordance with the International Ethics Standards Board for Accountants’ Code of Ethics for
Professional Accountants (IESBA Code) 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 IESBA Code. 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 ISA 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 ISA 720 (Revised) - see Illustration
1 in Appendix 2 of ISA 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 IFRSs, 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 ISAs will always detect a material
AT A GLANCE
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 ISA 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 ISAs, we exercise professional judgment and maintain
professional skepticism throughout the audit. We also:
SPOTLIGHT
 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.
 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.

 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.
AT A GLANCE

[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 ISAs 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 ISAs 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 ISAs where such a difference exists.
SPOTLIGHT
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]
 Illustration 4
Report on Financial Statements of an Entity other than a Listed Entity Prepared in
Accordance with a General Purpose Compliance Framework
[Appropriate Addressee]
Opinion
balance sheet as at December 31, 20X1, and the income statement, statement of changes in equity
and cash flow statement 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 of the Company are prepared, in all
material respects, in accordance with XYZ Law of Jurisdiction 3.

Basis for Opinion

in accordance with the ethical requirements that are relevant to our audit of the financial
statements in [jurisdiction], and we have fulfilled our other responsibilities in accordance with
these requirements. We believe that the audit evidence we have obtained is sufficient and
appropriate to provide a basis for our opinion.
[Reporting in accordance with the reporting requirements in ISA 720 (Revised) - see Illustration
1 in Appendix 2 of ISA 720 (Revised).]
Statements
Management is responsible for the preparation of the financial statements in accordance with
XYZ Law of Jurisdiction X,12 and for such internal control as management determines is
necessary to enable the preparation of financial statements that are free from material
AT A GLANCE
misstatement, whether due to fraud or error.
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.
SPOTLIGHT
economic decisions of users taken on the basis of these financial statements. Paragraph 41(b) of
this ISA 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.


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.
[Auditor Address]
AT A GLANCE
[Date]
3.8 Tutorial note

Core Paragraphs: 13, 24, 28, 34, 38, 39 and 41
Explanatory Paragraphs: A4, A6, A44, A73, A74, A79 and A83
 Illustration
Format of Report - Auditors (Reporting Obligations) Regulations 2018
SPOTLIGHT
To the members of ………………… [name of company]

Opinion
We have audited the annexed financial statements (or revised financial statements, if
applicable) of ……..(the Company), which comprise the Statement of Financial Position as at .........,
and the statement of profit or loss ii and other comprehensive income or the income and
expenditure statement, the statement of changes in equity, the statement of cash flows for the
year then ended and notes to the financial statements, including a summary of significant
accounting policies and other explanatory information and we state that we have obtained all the
information and explanations which, to the best of our knowledge and belief, were necessary for
the purposes of our audit.
In our opinion and to the best of our information and according to the explanations given to us,
the statement of financial position, statement of profit or loss and other comprehensive income
or the income or expenditure statement, the statement of changes in equity and the statement of
cash flows together with the notes forming part thereof conform with the accounting and
reporting standards as applicable in Pakistan and give the information required by the
Companies Act, 2017 (XIX of 2017), in the manner so required and respectively give a true and
fair view of the state of Company’s affairs as at ................... and of the profit or loss and other
comprehensive income or loss, or the surplus or deficit iii, the changes in equity and its cash flows
for the year then ended.

Basis of opinion
We conducted our audit in accordance with International Standards on Auditing (ISAs) as
applicable in Pakistan. 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 accordance with the International Ethics Standards Board for
Accountants’ Code of Ethics for Professional Accountants as adopted by the Institute of Chartered
Accountants of Pakistan (the Code) and we have fulfilled our other ethical responsibilities in
accordance with the Code. We believe that the audit evidence we have obtained is sufficient and
Material Uncertainty relating to Going Concern (if applicable)
Emphasis of Matter (if applicable)
Key Audit Matter(s)
Following are the Key audit matter(s):
Sr. No. Key audit matter(s) How the matter was addressed in our audit
AT A GLANCE
Information Other than the Financial Statements and Auditor’s Report Thereon
[Reporting in accordance with the reporting requirements in ISA 720 (Revised)]
Responsibilities of Management and Board of Directors for the Financial Statements
Management is responsible for the preparation and fair presentation of the financial statements
in accordance with approved accounting standards as applicable in Pakistan and the
requirements of Companies Act, 2017 (XIX of 2017) 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.
SPOTLIGHT
the Company or to cease operations, or has no realistic alternative but to do so. Board of Directors
are responsible for overseeing the Company’s financial reporting process.
economic decisions of users taken on the basis of these financial statements.


 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 the board of directors 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 the board of directors with a statement that we have complied with relevant
ethical requirements regarding independence, and to communicate with them all relationships
AT A GLANCE
and other matters that may reasonably be thought to bear on our independence, and where
applicable, related safeguards.
From the matters communicated with the board of directors, 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.
Based on our audit, we further report that in our opinion:
a) proper books of account have been kept by the Company as required by the Companies
SPOTLIGHT
Act, 2017 (XIX of 2017);

b) the statement of financial position, the statement of profit or loss and other
comprehensive income or the income and expenditure account, the statement of
changes in equity and the statement of Cash flows together with the notes thereon have
been drawn up in conformity with the Companies Act, 2017 (XIX of 2017), and are in
agreement with the books of account and returns;
c) investments made, expenditure incurred and guarantees extended during the year were
for the purpose of the Company’s business; and
d) zakat deductible at source under the Zakat and Ushr Ordinance, 1980 (XVIII of 1980),
was deducted by the Company and deposited in the Central Zakat Fund established
under section 7 of that Ordinance viii.
Other Matter(s)
Prior Year Financial Statements Audited by Predecessor Auditor
The engagement partner on the audit resulting in this independent auditor’s report is [name]
[Signature]
[Place/ location]
[Date]

4. COMMUNICATING KEY AUDIT MATTERS IN THE INDEPENDENT AUDITOR’S

REPORT (ISA 701)
4.1 Scope of the ISA 701
This ISA deals with auditor’s responsibility to communicate Key Audit Matters (KAM) in auditor’s report. The
purpose of communicating KAM is to enhance the communicative value of the auditor’s report by providing
greater transparency about the audit that was performed.
 Definition: Key Audit Matters(KAM)
Those matters that, in auditor’s professional judgment, were of most significance in the audit of
the financial statements of current period. KAM are selected from matters communicated with
those charged with governance.
Auditor shall communicate KAM in report for audits of:
 Listed entities
 Entities other than listed entities (if required by law etc.)
 Other entities decided by auditor using his professional judgment
(e.g. those of significant public interest due to large number and wide range of stakeholders and
considering nature and size of the business like Banks, Insurance and charities etc.).
AT A GLANCE
Communicating KAM provides additional information to intended users of 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.
4.2 Determining KAM (Ref: 9-10, A9-A30)
Auditor shall determine, from the matters communicated with those charged with governance, those matters
that required significant attention in performing audit.
In making this determination, auditor shall take into account:
 Areas of higher assessed risk of material misstatement, or significant risks identified (ISA-315)
 Significant auditor judgments relating to areas in financial statements involving significant management
judgment, including accounting estimates that have been identified as having high estimation
SPOTLIGHT
uncertainty.
 The effect on the audit of significant events or transactions that occurred during the period.
 E.g. Auditor may have had extensive discussions with management and those charged with governance at
various stages throughout the audit about the effect of significant transactions with related parties or
significant transactions outside the normal course of business for the entity or that otherwise appear to be
unusual.
Determining the relative significance of a matter
Other considerations that may be relevant to determining the relative significance of a matter communicated
with those charged with governance and whether such a matter is a key audit matter include:
 Importance of the matter to intended users’ understanding.
 Complexity or subjectivity involved in management’s selection of an appropriate policy compared to
other entities within industry.
 Nature and materiality (quantitatively or qualitatively) of the misstatements due to fraud or error
related to the matter, if any.
 Nature and extent of audit effort needed to address the matter, including:
¯ Extent of specialized skill or knowledge needed to apply audit procedures to address the matter or
evaluate the results of those procedures, if any.
¯ Nature of consultations outside the engagement team regarding the matter.
 Severity of any control deficiencies identified relevant to matter.


You are a partner in a firm of Chartered Accountants. Annual audits of various clients are at
finalization stage and since this is the first time that ISA related to Key Audit Matters is to be
applied, several issues have been referred to you for guidance. These include:
a) An adverse report is being issued in the case of Muneer Limited. The draft report also
contains certain matters as Key Audit Matters.
b) A qualified report has been drafted by the audit manager of Nadir Limited as the
company has failed to make adequate provision of contingency. The details of
qualification are mentioned in the Key Audit Matters section.
c) The Key Audit Matters section of audit report of Zia Limited includes details of Key Audit
Matters of only the current period. However, the opinion has been expressed on current
as well as prior year.
d) At one of the listed clients, investigation by a Government agency against some of its staff
members is in progress. Due to sensitivity of the matter the management has requested
you to not to include such information in the Key Audit Matters section.
Required:
Advise the concerned partners/managers with respect to the above matters.
AT A GLANCE
Tutorial Notes:
a) Specific consideration with adverse report is required. A common mistake could be
student identifying that KAM and Adverse opinion cannot go side by side.
b) Specific focus is required from students to the actual definition of KAM.
c) One of the two express exceptions given by the standard.
 Solution:
a) If one or more matters other than the matter(s) giving rise to an adverse opinion are
determined to be key audit matters, it is particularly important that the descriptions of
such other key audit matters do not imply that the financial statements as a whole are
more credible in relation to those matters than would be appropriate in the
SPOTLIGHT
circumstances, in view of the adverse opinion.

b) A matter giving rise to a qualification by their nature is a key audit matter. In such
circumstances, these matters shall not be described in the Key Audit Matters section of
the auditor’s report, rather the matter is to be reported in accordance with the
requirements of related ISA. Reference to the basis for qualified opinion is to be included
in the Key Audit Matter section.
c) The non-inclusion of Key Audit Matters of prior period is appropriate as the auditor’s
determination of key audit matters is limited to those matters of most significance in the
audit of the financial statements of the current period, even when comparative financial
statements are presented (i.e., even when the auditor’s opinion refers to each period for
which financial statements are presented).
d) The auditor can only accept the management request if:
 law or regulation precludes public disclosure about the matter; or
 the auditor determines that the matter should not be communicated in the auditor’s
report because the adverse consequences of doing so would reasonably be expected
to outweigh the public interest benefits of such communication. This shall not apply
if the entity has publicly disclosed information about the matter.

4.3 Communicating KAM (Ref: 11-12, A31-A33)

Auditor shall describe each matter, using an appropriate sub-heading, in a separate section of report under the
heading “KAM,” unless:
 Law or regulation precludes public disclosure about the matter
 Auditor determines that (in extremely rare circumstances) the matter should not be communicated in
report because the adverse consequences of doing so would reasonably be expected to outweigh the
public interest benefits of such communication (not applicable if entity has publicly disclosed
information about the matter).
Introductory language in this section shall state that:
 KAM are those matters that, in auditor’s professional judgment, were of most significance in the audit of
financial statements [of current period]; and
 These matters were addressed in the context of audit of financial statements as a whole, and in forming
the auditor’s opinion thereon, and the auditor does not provide a separate opinion on these matters.
No KAM to communicate
If auditor determines (depending on the facts and circumstances of the entity and the audit) that there are no
KAM to communicate, the auditor shall include a statement to this effect in a separate section of the auditor’s
AT A GLANCE
report under the heading “KAM.”
 Illustration
Suggested wording in case of no KAM to communicate:
[Except for the matter described in the Basis for Qualified (Adverse) Opinion section or Material
Uncertainty Related to Going Concern section,] We have determined that there are no [other]
KAM to communicate in our report.
Note:
Auditor shall not communicate a matter in KAM section, when auditor would be required to modify the opinion
(ISA 705 – Revised)
SPOTLIGHT
4.4 Descriptions of Individual Key Audit Matters (Ref: 13-16, A34-A51)
Description of each matter in the KAM section of the report shall
 Include a reference to the related disclosure(s), if any, in financial statements;
 State that why the matter was considered to be one of most significance in the audit; and
 Specify how the matter was addressed in the audit:
¯ A brief overview of procedures performed;
¯ An indication of the outcome of the auditor’s procedures; or
¯ Key observations with respect to the matter,
Description may also make reference to the principal considerations that led the auditor to determine the matter
to be one of the most significance, for example:
 New or emerging accounting policies (E.g. Entity/industry specific matters on which engagement team
consulted within the firm).
 Changes in entity’s strategy or business model that had a material effect on financial statements.
Reference to the related disclosure(s)

Entity may decide to include new or enhanced disclosures in financial statements or elsewhere in the annual
report relating to a KAM in light of the fact that the matter will be communicated in the auditor’s report. Auditor
may also draw attention to key aspects of them.

4.5 Communication with those charged with governance (Ref: 17, A60-A63)
Communication with those charged with governance enables them to be made aware of the KAM and provides
them an opportunity to obtain further clarification.
Auditor shall communicate with those charged with governance:
 Those matters the auditor has determined to be the KAM; or
 Auditor’s determination that there are no KAM to communicate (depending on facts and circumstances
of entity and audit).
You have recently completed the audit of the financial statements of Rose Limited (RL), a listed
company having a net profit of Rs. 1,500 million. You have identified following matters which
will be reported as key audit matters in the audit report:
i. RL has pending tax litigation in which tax department has raised demand aggregating
Rs. 175 million. The demand has been challenged by RL and the decision in respect of
this matter is currently pending. The amount is disclosed as a contingent liability in the
ii. RL makes significant purchases from related parties and also incurs significant
AT A GLANCE
advertising expenses through related parties. These transactions are properly disclosed
as related party transactions in the financial statements.
iii. RL has decided to sell a manufacturing facility located in Faisalabad having a carrying
value of Rs. 300 million and would replace it with another facility in Gujranwala. The
manufacturing facility has been classified as non-current assets held for sale.
Required:
Draft the key audit matters section to be included in the audit report of RL relating to the above
matters. (You may assume necessary details where required).
Tutorial Notes:
The major errors and problems while answering can be as follows:
SPOTLIGHT
 Handling the format and giving all details rather specifying the audit verification steps
only.
 While discussing the reasons for inclusion of a particular matter in the KAM section,
many students may only think about materiality (and might ignore some other reasons
such as high level of judgment involved and existence of risks, etc.)
 Procedures for ensuring completeness of the disclosure in case of related parties may
get skipped in trying to answer only from ISA 701.
 Solution:
Key audit matter How the matter was addressed in our

audit
Tax Contingency
Refer note x to the financial statements
The company has significant tax We have obtained and assessed the
contingencies which can have a significant management’s contention against the
impact if materialized. Due to the high level demands made by the taxation authorities.
of judgment required to assess the We also had a discussion with the tax advisor
outcome of tax litigations, we consider it to of the Company and his rationale and
be a key audit matter.


audit
justifications against the demands made by
the taxation authorities.
We used our own tax specialist to consider the
level of provision required in light of the
nature of the company’s exposure, applicable
regulation and the company’s correspondence
with the tax authorities.
We have considered any legal precedent or
case law by assessing relevant historical and
recent judgments passed by the courts and
other authorities in similar situation.
We evaluated the adequacy of the disclosure in
the financial statement.
Related Party Transactions
AT A GLANCE
The company has significant purchases We assessed the management controls over
from related parties. Further, significant identification and capturing and recording of
amount of advertising expenses is also paid related party transactions.
to related parties. We also assessed how frequently the related
party listing is updated by the management
Due to the large number of transactions and whether there are any time lags or not.
with the related parties, we consider it as Reviewed filings with the regulatory
an area of significant risk, and hence this authorities for the names of related party in
was identified as a key audit matter. which officers and directors occupy
directorship or management position.
Reviewed contract with related party for
providing advertising and other services.
SPOTLIGHT
Reviewed minutes of meeting of board of
directors for the discussion and authorization
of related party transaction.
Reviewed accounting record for large, unusual
and nonrecurring transactions.
We circulated confirmation request to the
related parties regarding the transactions
carried out with them and their balances as at
year end.
We evaluated the adequacy of the related
party disclosures in the financial statements.
Non-Current Assets Held for Sale
The company is committed to a plan to sell We assessed the company’s commitment to
part of a manufacturing facility. the sale plan through understanding the status
This part of the manufacturing facility has of the sales process and reviewing
been classified as non-current assets held correspondence from purchasers and
for sale and written down to its fair value prospective purchasers.
less costs to sell.


audit
Due to the high level of judgment involved We involved our own valuation specialist to
in estimating the fair value and the assist in evaluating the fair value of the plant.
significant carrying amounts of the assets We evaluated the adequacy of the financial
and liabilities associated with it, we statement disclosures, including disclosures of
considered it to be a key audit matter. key assumptions, judgment and sensitivities.

During the audit of a listed client Pixel Limited (PL), you became aware that a legal action has
been instituted against PL by a competitor, on account of infringement of patent rights. The
company’s lawyer was not able to give any estimate about the outcome of the case.
No provision was made in the financial statements for the possible loss as a result of the claims
(which are considered to be material), although details of those legal claims were fully disclosed
in the notes.
Required:
Draft how the above matter would be reported in the key audit matter section of the audit report.
AT A GLANCE
(You may assume necessary details)

Tutorial Notes:
It is pertinent to note that you are allowed to assume any further details, where necessary.
 Solution;
Contingent liabilities
Refer note x to the financial statements.
Key audit matter How our audit addressed the key audit
matter
SPOTLIGHT
The assessment of the existence of the Our audit procedures included the following:
present legal obligation, analysis of the We had discussions with the Company’s legal
probability of the related payment and advisors in respect of the outcome of the case
determining a reliable estimate, requires and reasonableness of the disclosure.
significant management’s judgment to assess We inquired the management and those charged
whether it should be recognized as with governance and also reviewed the
provisions or disclosing it as a contingent subsequent correspondence with the
liability. competitor.
We also involved our legal expert to assess the
Due to the level of judgement relating to
outcome of the case.
valuation and presentation of contingent
liabilities, this is considered to be a key audit We evaluated the adequacy of the disclosure in
matter. the financial statements, in particular the
disclosure of the uncertainty in estimation and
We have also assessed it as an area of higher
its quantification.
assessed risk of material misstatement as it
could not be measured reliably.

During the audit of consolidated financial statements of Voltage Limited (VL), for the year ended
31 May 2019, you have identified the following matters which will be reported as key audit
matters in the audit report:

i. VL has acquired 65% shares in Pyrus Limited.

ii. VL has entered into a major project in relation to the development and maintenance of
its electricity transmission infrastructure which is expected to be completed over a
three-year period.
Required:
Draft the key audit matters section to be included in the audit report of VL’s consolidated
financial statements. (You may assume necessary details where required)
Tutorial Notes:
Reason for including the matter as key audit matter should be drafted well. Mentioning that it
was included as key audit matter because of the complexity but not mentioning why it was
complex can also be another mistake the students may make.
 Solution;
Acquisition of Pyrus Limited

See note x to the consolidated financial statements
On 01 March 2019, CGL acquired 65% shares in Our audit procedures in this area
AT A GLANCE
Pyrus Limited for consideration of Rs. xxx million. included, among others:
The accounting for this transaction is complex We challenged, with the support of our
due to the significant judgements and estimates own valuation specialists, the key
that are required to determine the values of the assumptions used by the Group to
consideration transferred and the identification determine fair values of assets and
and measurement of the fair value of the assets liabilities acquired;
acquired and liabilities assumed. We discussed these assumptions with the
Due to the size and complexity of the acquisition, Directors and corroborated the
we considered this to be a key audit matter. explanations provided by comparing
them to market data, our past experience
of similar transactions, and the Group’s
business plan supporting the acquisition;
SPOTLIGHT
Where available, we compared the
amounts recognized to supporting
external documentation;
We assessed the appropriateness of the
accounting for significant fair value
adjustments, with reference to the IFRS.
We evaluated the adequacy of the
disclosure of acquisitions in the annual
report and financial statements.
Development of electricity transmission infrastructure
See note x to the financial statements
The Company has undertaken major project in Our audit procedures in this area
relation to the development and maintenance of included, among others:
electricity transmission infrastructure and is Assessed, on a sample basis, costs
installing various grid lines and transmission capitalised during the year by comparing
lines throughout the country in different phases. the costs capitalised with the relevant
This project contains a combination of capital underlying documentation, which
expenditure and maintenance activity which are included purchase agreements and
not distinct and therefore the allocation of costs invoices.

between capital and operating expenditure is Assessed whether the costs capitalised
inherently judgmental. met the relevant criteria for capitalisation
There are a number of areas where significant as per the applicable accounting and
management judgement is involved in connection reporting framework.
with the above expansion. These include: Evaluated management’s estimation of
 Determining which costs are related to economic useful lives and residual values
development of electricity transmission by considering our knowledge of the
infrastructure and thus meet the criteria for business and practices adopted in the
capitalisation and the costs which are related local industries.
to maintenance and needs to be expensed Reviewed the date of transferring capital
out; work-in-progress to operating fixed
 Determining the transmission lines which are assets by examining the completion
completed and the date on which assets certificates and/or project progress
under construction are transferred to reports, on a sample basis.
operating fixed assets and the respective Assessed whether the disclosures are
dates from which their depreciation should made in accordance with the financial
commence; and reporting framework.
 The estimation of economic useful lives and
residual values assigned to property, plant
AT A GLANCE
and equipment.
We consider the above as a key audit matter being
significant transactions and events for the
Company during the year having significant
impact on the financial position of the Company.

You are the audit manager of Zafar Iqbal & Company, Chartered Accountants. You have asked
one of the team members assigned on the audit of Brown Sugar Limited to draft the Key Audit
Matter section of the audit report for the year ended 30 June 2020. The extracts from the draft
report are as follows:
SPOTLIGHT
Key Audit Matters

thereon, and we do not provide a separate opinion on these matters. In addition to the matter
described in the Basis for Adverse Opinion section, we have determined the matter described
below to be the key audit matter to be communicated in our report.
Key audit matter How our audit addressedkey audit

matter
In the course of conducting a sales tax audit for Our key audit procedures in this area
the period from January 2019 to December included amongst others were:
2019, FBR raised certain issues with respect to  We reviewed the correspondence of
the company’s sales. On May 2020, the the company with relevant tax
company received an order in which demand of authorities and taxadvisors including
Rs. 100 million was raised. The company has judgements or orders passed by the
filed an appeal with theappellant board and is competent authorities.
confident that it would bedecided in company’s
favour.  We also obtained and reviewed
confirmations from the company’s
Due to the materiality and significance of the
external tax advisor for the latest
above matter we have considered this tax
status of the case.
contingency as a key audit matter.

Key audit matter How our audit addressedkey audit

matter
 We involved internal tax experts to
assess andreview the management’s
conclusion on this matter.
 We verified all the journal entries
posted in the ledgers related to legal
expenses.
 We obtained representation from
the management regarding the
favourable outcome of the matter.
Based on the procedures performed, we
concluded that there is no material
misstatement and contingency has been
adequately disclosed.
Required:
Critically analyse the Key Audit Matter section of the audit report.
AT A GLANCE
 Solution:
S. No. Analysis of KAM Section Suggestions

(i) No subheading and The description of each key audit matter in the Key
reference has been made Audit Matters section of the auditor’s report shall
to the disclosures in the include a reference to the related disclosures.
financial statements. The auditor shall describe each key audit matter, using
an appropriate subheading.
(ii) A very detailed description Auditor should avoid providing original information
of the entire matter has about the entity because the description of a key audit
been disclosed in the KAM matter is not the original information about the matter.
SPOTLIGHT
section. Instead auditor should have referred it to the relevant
disclosures in the financial statements. If such
information is not disclosed, auditor should ask
management or those charged with governance to
disclose additional information.
(iii) The matter was Rather all the matters which have higher risk of
determined as KAM material misstatement, involve significant judgement
because of being and effect on the audit of significant events or
significant and material is transactions are all significant matters. From these
not correct. matter the auditor will select matters of most
significance and only those will be reported in the KAM
section.
The description of the key audit matter should provide
insight as to why the matter was determined to be a
key audit matter.
(iv) Some general procedures Description of audit procedures should be at a high
such as obtaining level, rather than including a detailed description of
representation and the procedures. Furthermore, auditor should describe
verification of journal only aspects of the auditor response or approach that
entries have been were most relevant to the matter or specific to the
mentioned. assessed risk of material misstatement.

S. No. Analysis of KAM Section Suggestions

(v) By including the indication If one or more matters other than the matter giving rise
of the outcome of the to an adverse opinion are determined to be key audit
auditor’s procedures it matters, then the descriptions of such key audit
appears that opinion on matters should not imply that the financial statements
separate elements of as a whole are more credible in relation to those
financial statement is matters. Therefore, care must be taken so that
being given. language used in the description of the key audit
matter:
 Does not imply that the matter has or has not been
appropriately resolved by the auditor in forming
opinion on the financial statements; and
 Does not contain or imply any discrete opinions on
separate elements of the financial statements.
4.6 Tutorial note

AT A GLANCE
Core Paragraphs: 11 to 18
Explanatory Paragraphs: A7, A12, A29, A41, A45, A46, A54 and A58
SPOTLIGHT

CHAPTER 11
MODIFICATION IN THE AUDIT REPORT
AT A GLANCE
IN THIS CHAPTER: ISA-705 deals with auditor’s responsibility to issue appropriate
report where he concludes that a modification to auditor’s
AT A GLANCE opinion on the financial statements is necessary.
The objective of auditor is to express clearly an appropriately
SPOTLIGHT
modified opinion that is necessary when:
1. Modifications to the opinion in - The auditor concludes, based on the audit evidence
AT A GLANCE
the independent auditor’s obtained, that the financial statements as a whole are
report (ISA 705) not free from material misstatement; or
- The auditor is unable to obtain sufficient appropriate
2. Emphasis of matter paragraphs audit evidence to conclude the same
and other matter paragraphs in
ISA-706 deals with additional communication in the auditor’s
the independent auditor’s
report when the auditor considers it necessary to draw users’
report (ISA 706)
attention to a matter or matters:
3. Going concern (ISA 570) - Presented or disclosed in the financial statements that
are of such importance that they are fundamental to
4. Comparative information - users’ understanding of the financial statements; or
corresponding figures and - Other than those presented or disclosed in financial
comparative financial statements that are relevant to users’ understanding of
SPOTLIGHT
statements (ISA 710) audit, auditor’s responsibilities or auditor’s report
5. Initial audit engagements -
going concern and the implications for the auditor’s report.
opening balances (ISA 510)
Auditor’s responsibilities are to obtain sufficient appropriate
6. The auditor’s responsibilities audit evidence regarding, and conclude on, appropriateness of
relating to other information management’s use of going concern basis of accounting in the
(ISA 720) preparation of the financial statements, and to conclude, based
on the audit evidence obtained, whether a material uncertainty
7. MIX Questions Complete 700 exists about the entity’s ability to continue as a going concern.
series
ISA-710 deals with responsibilities relating to comparative
information in an audit. There are 2 different broad approaches
to in respect of such comparative information: corresponding
figures and comparative financial statements.
When financial statements of prior period have been audited by
a predecessor auditor or were not audited, the requirements
and guidance in ISA 510 regarding opening balances also apply
ISA-720 deals with auditor’s responsibilities relating to other
information, whether financial or non-financial information
(other than financial statements and the auditor’s report
thereon), included in an entity’s annual report.

CHAPTER 11: MODIFICATION IN THE AUDIT REPORT CFAP 6: AARS
1. MODIFICATIONS TO THE OPINION IN THE INDEPENDENT AUDITOR’S

REPORT (ISA 705)
1.1 Types of Modified Opinions (Ref: 2, A1)
Material Material & Pervasive

Materially misstatement Qualified Adverse
Inability to obtain sufficient appropriate audit evidence Qualified Disclaimer
(Scope Limitation)
In extremely rare circumstances involving multiple uncertainties if auditor concludes that it is not possible to
form opinion due to potential interaction of uncertainties and their possible cumulative effect, auditor shall
“Disclaim” the opinion
Modified Opinion
A Qualified opinion, an Adverse opinion or a Disclaimer of Opinion.
AT A GLANCE
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:
 Are not confined to specific elements, accounts or items of the financial statements;
 If so confined, represent or could represent a substantial proportion of the financial
statements; or
 In relation to disclosures, are fundamental to users' understanding of the financial
statements.
SPOTLIGHT
1.2 Nature of Material Misstatements (Ref: 3-10, A2-A12)

 Appropriateness of the Selected Accounting Policies
¯ Selected accounting policies are not consistent with applicable financial reporting framework;
¯ Financial statements do not represent underlying transactions and events to achieve fair
presentation.
 Application of the Selected Accounting Policies
¯ Management has not applied the selected accounting policies consistently; or
¯ Method of application of selected accounting policies.
 Appropriateness or Adequacy of Disclosures in financial statements
¯ financial statements do not include all disclosures required by applicable financial reporting
framework;
¯ Disclosures are not presented in accordance with applicable financial reporting framework;
¯ financial statements do not provide the disclosures necessary to achieve fair presentation.

CFAP 6: AARS CHAPTER 11: MODIFICATION IN THE AUDIT REPORT
1.3 Nature of an Inability to Obtain Sufficient Appropriate Audit Evidence

Inability does not constitute a limitation if auditor is able to obtain sufficient appropriate audit evidence by
alternative procedures. Limitations may have other implications e.g. fraud risks and engagement continuance.
 Circumstances beyond the control of the entity;
¯ Accounting records have been destroyed.
¯ Accounting records seized by Government.
 Circumstances relating to nature or timing of the auditor's work;
¯ Auditor is unable to observe counting of inventories due to timing of auditor's appointment.
¯ Auditor determines that performing substantive procedures alone is not sufficient, but entity's
controls are not effective.
 Limitations imposed by management.
¯ Preventing from observing physical inventory counting.
¯ Preventing auditor from requesting external confirmation.
1.3 Consequence of an Inability to Obtain Sufficient Appropriate Audit Evidence Due to Management-
Imposed Limitation after the Auditor Has Accepted the Engagement (Ref: 11-13, A13-A15)
AT A GLANCE
Auditor shall request management to remove the limitation.
If management refuses to remove the limitation, auditor shall:
 Communicate the matter to those charged with governance; and
 Determine whether to perform alternative procedures.
If auditor is unable to obtain sufficient appropriate audit evidence:
 If possible effects could be material; auditor shall qualify opinion;
 If possible effects on financial statements could be both material and pervasive; the auditor shall:
¯ Withdraw from the audit, where practicable and possible; or
¯ Give disclaimer of opinion (If withdrawal is not practicable or possible).
SPOTLIGHT
 Practicality of withdrawing may depend on stage of completion of the engagement at the time that
management imposes the scope limitation.
 Possibility may depend on legal binding on auditor to continue e.g.
 Auditor appointed to audit public sector entities.
 Jurisdictions where auditor is appointed to audit specific period and is prohibited from withdrawing
before completion of audit.
If auditor decides to withdraws; auditor shall communicate to those charged with governance any matters giving
rise to a modification of the opinion.
1.4 Other Considerations Relating to an Adverse or Disclaimer of Opinion (Ref: 15, A16)
When expressing an adverse opinion or disclaimer, report shall not also include an unmodified opinion.
 Exceptions:
 Unmodified opinion under one financial reporting framework and expression of an
adverse opinion on same financial statements under any other financial reporting
framework.
 Disclaimer of opinion regarding results of operations and cash flows only and
unmodified opinion regarding financial position.

1.5 Form and Content of Auditor's Report When Opinion Is Modified (Ref: 16-29, A17-A26)
Opinion Paragraph
Qualified Except for the effects (or possible effects) of matter(s) described in the Basis for Qualified
Opinion Opinion paragraph:
 financial statements present fairly, in all material respects (or give true and fair view) in
accordance with applicable financial reporting framework (fair presentation framework)
 financial statements have been prepared, in all material respects, in accordance with
applicable financial reporting framework (compliance framework)
Adverse Because of the significance of the matter(s) described in the Basis for Adverse Opinion
Opinion paragraph:
 financial statements do not present fairly (or give a true and fair view) in accordance with
the applicable financial reporting framework (Fair presentation framework); or
 financial statements have not been prepared, in all material respects, in accordance with
applicable financial reporting framework (Compliance framework)
Disclaimer  The auditor does not express an opinion on financial statements.
of opinion  Because of significance of matter(s) described in Basis for Disclaimer paragraph, auditor
AT A GLANCE
has not been able to obtain sufficient appropriate audit evidence to provide a basis for an
audit opinion; and, accordingly.
 Auditor was engaged to audit the financial statements.
Use the heading "Qualified Opinion," "Adverse Opinion," or "Disclaimer of Opinion," for the opinion paragraph.
Basis for Opinion Paragraph

 Amend the heading of “Basis for Opinion” to “Basis for Qualified Opinion,” “Basis for Adverse Opinion,”
or “Basis for Disclaimer of Opinion,” as appropriate; and
 Include a description of the matter, giving rise to the modification in this section.
 Include description & quantification of financial effects.
¯ If it is not practicable to quantify the financial effects, the auditor shall state the fact.
SPOTLIGHT
¯ If it relates to narrative disclosures; include an explanation of how these are misstated.

 If material misstatement relates to non-disclosure of information:
¯ Discuss the non-disclosure with those charged with governance;
¯ Describe in basis for opinion section the nature of the omitted information;
¯ Unless prohibited by law or regulation, include omitted disclosures, if it is practicable to do so.
(Not be practicable where Disclosures not been prepared by management or not available; or it would be
voluminous)
 If modification results from inability to obtain sufficient appropriate audit evidence, auditor shall
include in the basis for opinion section the reasons for that inability.
 Even in case of adverse opinion or disclaimer, auditor shall describe the reasons for any other matters
that would have required a modification to the opinion.
Auditor's Responsibility
Qualified or adverse opinion

Auditor shall amend the description by stating:
“the auditor believes that the audit evidence the auditor has obtained is sufficient and appropriate to provide a
basis for the auditor's modified audit opinion.”

Effect of disclaimer of opinion on “Key Audit Matters”

When auditor disclaims an opinion, the auditor’s report shall not include a KAM section (ISA 701).
1.6 Communication with those charged with governance (Ref: 30, A27)
This enables:
 Auditor to give notice to those charged with governance;
 Auditor to seek agreement of those charged with governance regarding the facts; and
 Those charged with governance to provide further information and explanations.
AT A GLANCE
SPOTLIGHT

2. EMPHASIS OF MATTER PARAGRAPHS AND OTHER MATTER PARAGRAPHS

IN THE INDEPENDENT AUDITOR’S REPORT (ISA 706)
2.1 EMPHASIS OF MATTER PARAGRAPHS (Ref: 8-9)
 Definition: Emphasis of Matter paragraph
A paragraph included in 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.
Emphasis of Matter paragraph is not a substitute for either:
 Modified Opinion (ISA 705).
 Any Disclosure in financial statements.
 Reporting in accordance with ISA 570 when material uncertainty exists that may cast significant doubt
on going concern.
The matter highlighted must not be a matter determined to be a key audit matter to be communicated in report
(ISA 701).
AT A GLANCE
 Examples
 An uncertainty relating to future outcome of exceptional litigation or regulatory action.
 A significant subsequent event that occurs between the date of financial statements and
the date of auditor’s report.
 Early application of a new accounting standard.
 A major disaster having a significant effect on financial position.
Presentation
 Include it as a separate section in auditor’s report;
 Use any appropriate heading including the term “Emphasis of Matter”;
SPOTLIGHT
 Clear reference to matter being emphasized and reference of relevant disclosure; and
 Indicate that auditor's opinion is not modified due to this matter.
2.2 OTHER MATTER PARAGRAPHS (Ref: 10-11)

 Definition: Other Matter paragraph
A paragraph included in auditor's report that refers to a matter other than those presented or
disclosed in financial statements that, in auditor's judgment, is relevant to
 Users' understanding of audit; or
 Auditor's responsibilities; or
 Auditor's report.
“Other Matter para” is not a substitute of the “Other Reporting Responsibilities” (ISA 700)
The matter highlighted must not be a matter determined to be a key audit matter to be communicated in report
(ISA 701)
 Examples
 Where auditor is unable to withdraw from an engagement, auditor may consider it
necessary to include this para to explain why it is not possible for auditor to withdraw
 Reporting on one set of financial statements referring any other financial statements
audited by him
 Restriction on distribution or use of the auditor's report

Presentation
 Shall be included as a separate section in auditor’s report;
 Use “other matters” or any other appropriate heading.
2.3 Placement of the emphasis of matter or other matter paragraph in an auditor’s report (Ref: A16-A17)
Depends on nature of the information to be communicated and the auditor’s judgment of the relative significance
of such information to intended users.
Emphasis of matter paragraph
 When it relates to the applicable financial reporting framework, the auditor may place it immediately
following the Basis of Opinion section
 When a KAM section is presented in auditor’s report, an Emphasis of Matter paragraph may be
presented either directly before or after the KAM section, based on the auditor’s judgment as to the
relative significance of the information included in this para.
 To differentiate it from the KAM section, Auditor may also add further context to its heading
 (e.g. “Emphasis of Matter – Subsequent Event”)
AT A GLANCE
Other Matter Paragraphs
 When a KAM section is presented in auditor’s report, the auditor may add further context to its
heading to differentiate it from the individual matters described in the KAM section.
 (e.g. “Other Matter – Scope of the Audit”)
2.4 Communication with those charged with governance (Ref: 12, A18)
If auditor expects to include an Emphasis of Matter or an Other Matter paragraph, the auditor shall communicate
with those charged with governance regarding this expectation and proposed wording
SPOTLIGHT

 Appendix 3 - Illustration of an Auditor’s Report that Includes a Key Audit Matters Section, an Emphasis of
Matter Paragraph, and an Other Matter Paragraph
Opinion
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
International Financial Reporting Standards (IFRSs).
Basis for Opinion
AT A GLANCE
in accordance 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. We believe that the audit evidence we have obtained is sufficient and
Emphasis of Matter
We draw attention to Note X of the financial statements, which describes the effects of a fire in
the Company’s production facilities. Our opinion is not modified in respect of this matter.
Key Audit Matters
SPOTLIGHT
Other Matter
The financial statements of ABC Company for the year ended December 31, 20X0, were audited
by another auditor who expressed an unmodified opinion on those statements on March 31,
20X1.
[Reporting in accordance with the reporting requirements in ISA 720 (Revised) - see Illustration 1
in Appendix 2 of ISA 720 (Revised).]
Statements
[Reporting in accordance with ISA 700 (Revised) - see Illustration 1 in ISA 700 (Revised).]


The engagement partner on the audit resulting in this independent auditor’s report is [name].
[Auditor Address]
[Date]
2.6 Tutorial note: How to cope with the scenario requiring modification of report in Exam
Step 1
 Identification of Materiality (if any benchmarks are given in question)
 Divide the amount involved with all benchmarks (except loss before tax)
Step 2
 Discuss the issue and auditor’s procedures for verification
Step 3
AT A GLANCE
 Discuss auditor’s action in case of scope limitation or material misstatement
Step 4
 Management Response and Effect on Opinion (See the flow chart)
SPOTLIGHT

 Question
You are audit partner of the firm and your manager has highlighted the following matters:
a) The profit before tax of Tariq Limited (TL) for the year ended 30 June 2017 is Rs. 790
million. TL provides three year warranty to its customers and has made provision of Rs.
80 million in this regard. The management carries out the computation internally. The
process is complex and based on various assumptions. Therefore, your firm has
appointed an expert after following all the necessary procedures for assessing the
competence, capability and objectivity of the expert. (08)
b) Your firm has been appointed as the auditor of Yaqoob Limited for the audit of the year
ended 30 June 2017. The audit team was not able to perform the inventory count at year
end because the appointment was made on 15 July 2017. (07)
Required:
Describe the steps that will be performed in each of the above situation and discuss the possible
implications of the above on the audit report. (Drafting of opinion not required)
 Solution
a)
AT A GLANCE
Since expert has been appointed and matters related to his appointment have already been
considered, we may need to perform following:
 Evaluate the reasonableness of significant assumptions and methods used
 Evaluate the relevance, completeness and accuracy of source data
 Evaluate the reasonableness of the expert's conclusions
 Carry out analytical procedures to assess the reasonableness of the provision as
compared to other relevant items
 Confirm that the accounting provisions of IAS 37 have been complied with, in making
the provision
 In case there is a difference between the valuation of the auditor's expert and the
SPOTLIGHT
valuation of the management, discuss the difference with the management.

 Implications
Reporting implication
In case the difference between the valuation of the auditor's expert and the valuation of the
management is material and cannot be resolved, we will have to give a qualified opinion.
However, if we have obtained sufficient appropriate evidence regarding the valuation and
presentation of the warranty provision, then we will have to include relevant details under the
heading of key audit matters in our audit report, because it is an area of higher assessed risk of
material misstatement due to involvement of high degree of uncertainty and significant auditor
judgment.
b)
Our firm was not appointed as auditors of the YL until 30 June 2017 and thus did not observe
the counting of physical inventories as the end of year 30 June 2017. In this situation, we may
perform the following procedures:
Conduct physical inventory count after the date of the financial statements.
Check whether the changes in inventory between the count date and the date of the financial
statements are properly recorded.

Investigate the reason for significant differences between the information obtained during the
physical count and the inventory records.
Assess the reliability of inventory records.
Reporting implication
If the auditor concludes that it would be impracticable or not possible to work back the inventory
then this would be a scope limitation and depending upon the material and pervasiveness of the
amount of inventory, the auditor should qualify or disclaim his opinion.
Furthermore, the auditor should include other matter paragraph and mention that the prior
period financial statements were audited by another auditor.
AT A GLANCE
SPOTLIGHT

3. GOING CONCERN (ISA 570)

Auditor shall consider whether events or conditions exist that may cast significant doubt on entity’s ability to
continue as going concern.
Examples of such events or conditions

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 creditors.
 Negative operating cash flows (historical or prospective financial statements)
 Adverse key financial ratios.
 Substantial operating losses or deterioration in value of assets used to generate cash flows.
 Arrears or discontinuance of dividends.
AT A GLANCE
 Inability to pay creditors on due dates.

 Inability to comply with the terms of loan agreements.
 Change from credit to cash transactions with suppliers.
 Inability to obtain financing for essential new product development or other essential investments.
Operating
 Management intentions to liquidate entity or to cease operations
 Loss of key management without replacement.
 Loss of a major market, key customer(s), franchise, license, or principal supplier(s).
 Labor difficulties.
SPOTLIGHT
 Shortages of important supplies.

 Emergence of a highly successful competitor.
Other
 Non-compliance with capital or other statutory requirements,
 Pending legal or regulatory proceedings against entity that may result in claims that entity is unlikely
to be able to satisfy.
 Changes in law or regulation or government policy expected to adversely affect the entity.
 Uninsured or underinsured disasters when they occur.
Auditor shall also determine whether management has already performed a preliminary assessment of
continuance as going concern
 If such assessment has been performed, auditor shall discuss with management and determine
whether management has identified such events or conditions and (if so) what are the plans to address
them
 If such assessment has not yet been performed, auditor shall discuss with management basis for the
intended use of the going concern basis of accounting, and inquire whether events or conditions exist
that may cast significant doubt on going concern

3.2 Evaluating Management’s Assessment (Ref: 12-14, A8-A13)

 Auditor shall evaluate management’s assessment
 Auditor shall cover the same period as that used by management to make its assessment as required
by applicable financial reporting framework or law/regulation (if it specifies a longer period)
 If assessment covers less than 12 months from date of financial statements, auditor shall request
management to extend its assessment period to at least 12 months from that date
 Auditor shall consider whether assessment includes all relevant information of which the auditor is
aware as a result of audit.
Period beyond Management’s Assessment (Ref: 15, A14-A15)

Auditor shall inquire management as to its knowledge of events or conditions beyond the period of
management’s assessment that may cast significant doubt on ability to continue as going concern
3.3 Additional Procedures When Events or Conditions are identified (Ref: 16, A16-A20)
Auditor shall obtain sufficient appropriate audit evidence to determine whether or not a material uncertainty
exists related to events or conditions that may cast significant doubt on going concern through additional audit
procedures, including following factors
AT A GLANCE
 Analyzing and discussing cash flow, profit and other relevant forecasts with management.
 Analyzing and discussing latest available interim financial statements.
 Reading the terms of debentures and loan agreements.
 Reading minutes of the meetings of shareholders, those charged with governance and relevant
committees for reference to financing difficulties.
 Inquiring entity’s legal counsel regarding existence of litigation and claims and reasonableness of
management’s assessments of their outcome and estimate of their financial implications.
 Evaluating entity’s plans to deal with unfilled customer orders.
 Performing audit procedures regarding subsequent events.
 Confirming existence, terms and adequacy of borrowing facilities.
SPOTLIGHT
 Obtaining and reviewing reports of regulatory actions.
Where management has not yet performed an assessment of going concern; request management to make its
assessment.
Mr. Burhan is working as audit manager in a firm of Chartered Accountants. The audit teams have
brought the following matters to his attention:
There are multiple uncertainties which impact the ability of Link Telecom Limited to operate as
a going concern. An important assumption in the working provided by the client is the continuous
financial support from the parent company. The team incharge wants guidance as to how the
validity of this assumption can be evaluated. (05)
Required:
Tutorial Notes:
Besides general procedures of doubt on going concern, the ability and the willingness of the
parent company to provide support should also be taken into account while answering.

 Solution:
 Obtain evidence with respect to the financial support from the parent company, such as
support letter/ agreement, etc.
 Review the financial statements of the parent company to assess whether the parent
company is in a position to support LTL.
 Ascertain the form of support i.e. loan or equity injection and ensure that both the
companies would be able to comply with the relevant legal requirements.
 Review the business plans of LTL and assess whether it would be able to continue for
the foreseeable future and generate sufficient future profits/cash flows.
 After performing the above procedures, if there is a doubt about the appropriateness of
the going concern assumption, carryout additional audit procedures (including
discussion with management) depending upon the circumstances.
assessment, whether outcome of these plans is likely to improve situation and whether
plans are feasible (e.g. plans to liquidate assets, borrow money or restructure debt)
AT A GLANCE
You are the audit manager of Bolan Pharmaceuticals Limited (BPL) a listed company. For the
year ended 30 September 2016, BPL has prepared its financial statements which indicate a net
operating loss, current ratio of 0.79 and significant amount appearing as capital work in progress
comprising of expenses incurred on acquisition and installation of plant and machinery. The
following information is also available:
i. The operations of BPL are currently suspended due to Balancing, Modernization and
Replacement (BMR) work.
ii. The decision to carry out BMR was approved by the Board of Directors in 2015 with a
completion deadline of 31 March 2016.
iii. Due to certain technical issues, BPL has not been able to complete project to date.
iv. Because of the above situation, loan from a bank became overdue on 1 September 2016.
Further, BPL had also not complied with certain key covenants.
SPOTLIGHT
v. In this difficult situation BPL has requested its major shareholders to inject additional
equity.
Required:
You have asked the client to give a comprehensive plan explaining the steps to counter the above
situation. Briefly discuss what kind of details you would expect in above plan.
Tutorial Notes:
It is important to understand the crux of the requirement which is to list the details which the
auditor would expect in the management’s plan regarding turnaround of the company. Most of
the students might confuse it with procedures which the auditor would perform to assess the
plan.
 Solution:
I would expect the following details in the plan:
 Probable date of commencement of operations.
 Measures to deal with the technical issue which is faced, either in the form of
correspondence with an expert or minutes of board of directors meeting.
 Financial effects of breach of key covenants of bank loan.
 Cost overruns due to delay in completion of project (till the estimated date of
commencement of operations).

 Negotiation with the banks and how the bank has reacted on default of the company
including information of restructuring (if any) and penalties.
 Plans of the company to recapture its lost customer ship and costs related to unfulfilled
customer orders.
 Employee’s reaction to suspension of operation e.g. employees’ turnover since the
suspension of operations. Calculation of redundancy payments relevant to employee’s
turnover.
 Implications on company of loan default e.g. calling of security by the bank etc.
 Form of equity injection, whether by way of right or subordinated loan. In case of right
shares, probability of subscription.
 Status of regulatory compliances in the case of equity injection e.g. whether necessary
resolutions had been passed or permissions have been obtained from relevant bodies.
 Does company have adequate number of resources other than finance to commence
operations? e.g. technical staff etc.
 Status of other liabilities, whether these had become overdue and if yes what are the
company’s plans to deal with these liabilities.
 Cash flow forecast in support of going concern assumption.
AT A GLANCE
 Assumptions used in support of the cash-flow forecast.
 Evidence of continuous financial support from the major shareholders/ evidence in
support of funding of working capital requirements.
Where entity has prepared a cash flow forecast:
 Evaluating reliability of underlying data to prepare forecast.
 Determining whether there is adequate support for assumptions underlying the
forecast. (auditor may consider requesting written confirmations from 3 rd parties and
may obtain evidence of their ability to provide such support).
Considering whether any additional facts or information have become available since the
date on which management made its assessment.
Requesting written representations from management and those charged with governance
SPOTLIGHT
regarding their plans for future actions and feasibility of these plans.
During the audit of a manufacturing company, you have noted certain conditions that cast
significant doubt on the company’s ability to continue as a going concern. You had a meeting with
the CEO of the Company to discuss the issue and communicated your decision that at least an
emphasis of matter paragraph in the Audit Report is inevitable. The CEO disagreed with your
opinion and shared with you the management’s plan to deal with the potential going-concern
uncertainty. The plan mainly constitutes the following measures:
i. the Company is guaranteed a continuous financial support by the parent company;
ii. it has recently rescheduled its borrowing facilities;
iii. the management has plans to reduce overheads and administrative expenses;
iv. the management has decided to discontinue a segment with non-profitable operations;
v. the management has plans to increase equity; and
vi. the management is expecting profitable operations in the next year.
Required
Describe the audit procedures that should be performed to gather sufficient appropriate audit
evidence to support the validity of the CEO’s claims and assess the viability of the above measures
being taken by the management.

 Solution:
Following Audit Procedures should be performed in the given circumstances:
i. Financial Support from parent company
In support of parent company’s guarantee to provide continuing financial support to the
Company, we should obtain:
 A copy of legally binding agreement between the parties / Board Resolution, and
 Ensure that the parent company is financially capable of supporting the Company
(e.g. historical financial statements, forecasted information).
ii. Rescheduling of borrowing facilities
We should obtain a:
 copy of written agreement, or
 Communication in respect of debts rescheduled by the Company with banks or
financial institutions. / Confirmation from financial Institutions.
iii. Reduction of overheads and Administrative expenses.
AT A GLANCE
 Assess whether it would be feasible to reduce overhead and administrative costs.

For example, such reduction may have serious negative impact on the company’s
ability to provide quality services to the customers.
 Such plans might be evidenced by an approval of board of directors.
iv. Discontinuance of non-profitable segment The auditor should consider the:
 marketability of the segment assets.
 restrictions on their disposal (such as loan agreements or encumbrances).
 possible direct and indirect effects of disposal.
 the Company’s ability to discontinue operations of the segment without any
SPOTLIGHT
negative impact on the other operations.

 sale agreement, letter of intent or an appraisal report in respect of the above.
 approval of the board of directors and the shareholders.
v. Increasing the Equity
 Evaluate management’s feasibility plan to inject further capital or issue of further
capital.
 Examine related documentation and the steps taken so far (Board minutes,
Permission from regulator).
vi. Profitable operation in next year
 Discuss with the management, the basis of estimating the increase in profits such
as new products, customers, markets, etc., that may result in profitable operation
as supported by a detailed marketing plans.
 analyze and discuss the entity’s latest available interim financial statements.
 Consider whether the assumptions underlying the forecast appear appropriate in
the circumstances.
 Compare the prospective data for the current period with results achieved to date.
 Analyze and discuss the profit and other relevant forecast.

General Procedures
We would obtain sufficient appropriate audit evidence that the above plans are likely to be
implemented and that the outcome of these plans will improve the situation. We would seek
written representation from management regarding the above plans.
2015 2014
-----(Rs. In '000')------
Sales 1,250,000 1,440,000
Other assets 145,000 135,000
AT A GLANCE
Total assets 470,000 485,000
Equity -50,000 20,000
SPOTLIGHT
newspapers, alleging the company of supplying inferior quality spare parts in the month
of April 2015 and claiming damages of Rs. 150 million. The management is of the view
that the allegations are baseless.
138 million to the supplier. However, the liquidator has lodged a claim of Rs. 140 million.
department.

Required:
What further information/documents would you require from the management in respect of
matters described in (i), (ii) and (iii) above? State the main reason for acquiring such
information/documents.
Tutorial Notes:
The main points to focus can be the tough competition faced by the company, negative equity,
dispute with customers and bankruptcy of major supplier, clearly depicting that the company is
facing going concern issues and accordingly, certain information/documents would be required
from the management
 Solution:
The tough competition faced by the company, negative equity, dispute with customers and
bankruptcy of major supplier clearly depicts that the company is facing going concern issues.
In order to evaluate the management’s plan for future action in relation to its going concern
assessment, including consideration of mitigating factors, following information/ documents
would be required from management:
 Management assessments of entity’s ability to continue as a going concern:
AT A GLANCE
 Status of negotiation with the foreign customers.

 Reason for offering discounts to suppliers above market rates.
 Status of legal proceedings of the allegations levied by the customers.
 Availability of alternate suppliers to deal with the unfulfilled orders.
 Cash flow, profit and other relevant forecast.
 Latest available interim financial statements.
 Minutes of shareholders’ meeting and those charged with governance.
3.4 Implications for the Auditor’s Report (Ref: 17-24, A21-A35)

SPOTLIGHT
Scenario Implication on Report

Going Concern Basis is Inappropriate Adverse opinion
Going Concern Basis Is Appropriate but a Material Unmodified opinion with a separate section in Report
Uncertainty Exists “Material Uncertainty Related to Going Concern” (ISA
 Adequate Disclosure is made in financial 700)
statements
Going Concern Basis Is Appropriate but a Material Qualified or Adverse Opinion
Uncertainty Exists
 Adequate Disclosure not given in financial
statements
Management Unwilling to Make or Extend Its Qualified or Disclaimer
Assessment

You are the manager in charge on the audit of financial statements of Haroon Private Limited.
During the course of audit, you noticed certain conditions which created significant doubts about
the validity of the going concern assumptions.
You have discussed the issue with the client which further revealed that the management has
developed certain plans to cope with the situation but on the basis of your assessment of their
plans, you concluded that the going concern assumption is no more appropriate.

Required:
a) Advise the client as to what should be done in the above circumstances.
b) What procedures would you perform if the management agrees to your proposals?
c) If the management does not agree, draft appropriate modifications for inclusion in the
audit report. (You may assume necessary details).
 Solution:
a) If it is finally concluded that Haroon Private Limited is not a going concern, advise the
client that the financial statements should be prepared on the alternative authoritative
base as follows:
 assets to be valued at recoverable amounts;
 all assets and liabilities to be classified as current assets;
 a note in the financial statements disclosing that HPL is not a going concern;
 recording of additional liabilities such as redundancy cost etc.
b)
 Auditors will ensure that alternative approach as discussed in (a) above has been
properly applied and adequate disclosures are made accordingly.
AT A GLANCE
If auditors are satisfied by the alternative approach and disclosures, they can issue
unqualified opinion. An emphasis of matter paragraph referring to the note in the
financial statements, describing the going concern situation may be included.
c) Adverse opinion: 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 the
financial position of Haroon Private Limited as of December 31, 2008 and of its financial
performance and its cash flows for the year then ended, in accordance with International
Financial Reporting Standards”.
You are the senior in charge on the external audit of Brown Limited (BL), a company dealing in
consumer products. The draft financial statements for the year ended December31, 2008 show
SPOTLIGHT
profit before tax of Rs. 30.1 million and total assets of Rs. 242.4 million. The following issues have
been identified during the course of the audit:
i. On January 10, 2009, a liquidator has been appointed at Express Pakistan Limited(EPL),
a major customer of the company. Sales to EPL during the year under review amounted
to 35% of BL’s revenue and the balance due from EPL at December 31, 2008 was Rs. 5.89
million.
ii. On January 25, 2009, a direct confirmation was received from BL’s lawyers. He had
informed that because of the complexity of the issues involved in one of the litigation
faced by the company, which was initiated in October 2008; it is not possible to forecast
its outcome. However, he has advised that the possible impact of an unfavorable decision
(if any), ranges between zero to Rs. 10 million. The draft financial statements do not
contain any disclosure in respect of this uncertainty.
Required:
Explain the possible effects of the situations described above, on BL’s financial statements for the
year ended December 31, 2008 and discuss the implications thereof, if any, on the audit report.
Tutorial Notes:
ISA 560 should also be referred to while answering the above question.

 Solution:
Effect on Financial Statement Effect on Audit Report
1 The amount due from Express represents If the management fails to provide for the
19.5% of profit before tax and is therefore outstanding debt or disclose the facts, the
material by size. Consequently, opinion would be qualified on grounds of
disagreement as the amount is material.
 provision should be made for the
outstanding amount to the extent that it
is not recoverable. Or
 Disclosure should be made if there is an
uncertainty as to the outcome of the
liquidation.
2 Express is a major customer of BL as 35% of If disclosure is properly presented, auditor

its revenue is earned from it. Its liquidation shall issue an Unmodified opinion with a
may caste significant doubt on BL’s ability to separate section in Report “Material
continue as going concern. In that case a Uncertainty Related to Going Concern” (ISA
AT A GLANCE
disclosure should be made. 700)
3 The amount involved is potentially material  If the management agrees to include a

as Rs. 10 million is 4% of total assets and note explaining the issue, the report will
around 33% of profit before tax. A be unmodified by including a separate
disclosure should be given describing the section in Report “Material Uncertainty
situation in the financial statements as the Related to Going Concern” (ISA 700).
circumstances give rise to a significant
uncertainty which could have an impact on  If the directors refuse to include a note in
the financial statements. the financial statements or the note is
inadequate, the opinion should be
qualified due to disagreement.
SPOTLIGHT

You are the engagement partner responsible for the audit of Saleem Auto Parts Limited (SAPL),
a listed company. SAPL supplies auto parts to three large motor car assemblers which are listed
on the Karachi Stock Exchange. Your review of the working paper files has disclosed that the
company has been facing liquidity issues for the last few months. You have also been informed
that subsequent to the year-end, SAPL has defaulted on one of its long term loan installments.
SAPL’s directors have assured that this liquidity crunch is for a short span of time. To
substantiate their assertion, they have provided cash flow projections for the next four years. An
important assumption in the cash flow projections is that agreements with all the motor car
assemblers would continue for the foreseeable future. However, during the year, one of the
motor car assemblers, Pannu Motors Limited(PML), has incurred substantial losses and has
announced to close down one of its plants.
Required:
a) State the audit procedures which your firm should perform in the above situation.
b) Identify and explain the implications of the above issues on the audit report.
Tutorial Notes:
a) Following important practical aspects of the scenario should not be missed:
 Assessing the significance of the revenues generated from the loss making customer,
for the business of the client.

 Assessing the viability of that customer and its implications on Company’s future
cash flow projections.
 Consideration of subsequent events in assessing the company’s status as a going
concern.
b) Following important points should not be missed while answering the question:
 There was no clear indication in the given scenario on the basis of which students
can conclude firmly that the going concern assumption was invalid. Consequently,
all the various possibilities should be discussed.
 It is not necessary that if the going concern assumption is not valid, the auditor
would express an adverse opinion i.e. if the client agrees with the auditor and
revises the financial statement in an appropriate manner, an adverse opinion may
not be required.
 Solution:
a) Cash flow problems, default in loan installment and possibility of the use of inaccurate
assumptions in projecting the cash flows indicate a need to review the appropriateness
of the going concern assumption. Therefore, the auditor should carry out the following
audit procedures:
AT A GLANCE
i. Evaluate the reliability of the underlying data and assumptions used in cash flow
projections.
ii. Ascertain the amount of sale to PML and its factory that was closed down and assess
its significance for the business operations of SAPL.
iii. Review the last published financial statements and corporate announcements of
PML to assess future viability of its business operations. In case there are indications
that PML may need to close down or significantly curtail its business operations the
auditor should require the management to revise its cash flow projections.
iv. Consider subsequent events to assess whether any additional fact or information
have become available since the date of management’s assessment. Discuss the
impact thereof, with the management, if required.
SPOTLIGHT
v. Seek written representation from management regarding its plans for future
actions.
vi. After performing the above procedures, if there is a doubt about the
appropriateness of the going concern assumption, auditor will need to carryout
additional audit procedures depending upon the circumstances.
b) Implications on audit report:
i. If it is concluded that going concern assumption is appropriate and no material
uncertainty exists, we shall express an unmodified opinion.
ii. If it is concluded that going concern assumptions is appropriate but a material
uncertainty exists which is adequately disclosed in the financial statements, we shall
express:
 an unqualified opinion
 include a separate section in Report “Material Uncertainty Related to Going
Concern” (ISA 700) to:
¯ highlight the existence of 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
¯ draw attention to the note in the financial statement which contains the
disclosure.

iii. If it is concluded that going concern assumptions is appropriate but a material

uncertainty exists which is not adequately disclosed in the financial statements, we
shall express a qualified opinion or adverse opinion as appropriate.
iv. If it is concluded that the going concern assumption is not appropriate, in the
preparation of the financial statements we should advise SAPL to revise the accounts
appropriately. In the case of disagreement, we shall express an adverse opinion.
Identify and explain the shortcomings in the following paragraph of the draft audit report of
Javed Limited:
Emphasis of Matter:
We draw attention to fact that the company has accumulated losses of Rs. 115,436,540(2011: Rs.
85,365,479) and certain payments against long term loans were overdue as at the reporting date.
As at 30 September 2012, its total liabilities exceeded its total assets by Rs. 15,450,300 (2011:
Rs. 11,542,200). These conditions indicate the existence of a material uncertainty that the
company may be unable to continue as a going concern.
 Solution:
AT A GLANCE
 This scenario does not require the use of ‘emphasis of matter paragraph’ rather we
should be using the specific paragraph as identified by ISA 570 (revised) to call attention
towards the material uncertainty without modifying the report and the opinion
 This para should also indicate that auditor’s opinion is not qualified in respect of matter
referred.
 The audit report should refer to all relevant notes including the note where material
uncertainty has been described. If there is no such note than the opinion should be
qualified.
 The phrase “that the company may be unable to continue as a going concern” is to be
replaced with the phrase “which may cast significant doubt on the company’s ability to
continue as a going concern”.
SPOTLIGHT

Qasmi Steels Limited (QSL) is a manufacturer of steel and iron products. During the year the
company has incurred a net loss of Rs. 306 million. The following information is also available:
i. At the year end, the company’s accumulated losses amounted to Rs. 17 million whereas
its net equity was Rs. 283 million.
ii. During the year, QSL has defaulted in repayment of a loan. The management is however
quite hopeful that the lender would agree to a rescheduling.
iii. The management believes that the company’s profitability has been hampered on
account of soaring electricity prices along with a fall in demand for steel which have had
a negative impact on the prices of its finished products. Moreover, its production has
also suffered on account of the prevailing energy crisis. Consequently, the management
has decided to discontinue its operations temporarily.
iv. To counter the impact of high electricity prices, the company intends to convert its plant
to run on gas as well.
v. The management has informed you that it would need to install a gas converting unit
which would be imported at a cost of Rs. 30 million. However, as the process of installing
the gas conversion unit and completing the necessary formalities would take at least a
year, therefore the management is negotiating to lease the plant to Nadeem Enterprises
for a period of one year.

Required:
a) Evaluate the above situation and state the procedures which you would perform as an
auditor in the above situation.
b) Describe the implications of the above issues on the audit report.
Tutorial Notes:
a) While answering the question, some typical points that might be overlooked are:
 The management had given various plans for the revival of the company which
included leasing the plant for a year and converting it to gas. The auditor is required
to evaluate such plans and the candidates should have commented whether these
plans were realistic.
 Possibility of impairment of plant and machinery.
 The need to carryout additional audit procedures if the uncertainty regarding going
concern assumption persists, even after performing the necessary procedures.
b) Discuss various possible situations leading towards different reporting implications.
 Solution:
AT A GLANCE
a) Although QSL’s accumulated losses are only Rs. 17 million i.e. about 5% of the share
capital yet the following circumstances indicate that QSL is facing going concern issues:
 QSL has incurred huge loss during the past year which is almost equal to its share
capital.
 QSL has defaulted on its loan repayments.
 The management has certain plans to revive the business however these are
subject to major uncertainties as discussed below:
¯ The company plans to convert the plant to make it possible to run it on gas.
However, it would require significant costs whereas QSL is in financial crisis.
¯ It is not certain whether the company’s banker would agree on the
SPOTLIGHT
restructuring of loan.
¯ The above conversion would require a year’s time and the company may be
required to bear the fixed costs for that period.
¯ Due to current energy crisis prevailing in the country it seems doubtful that the
company would be able to secure a gas connection in the first place and whether
sufficient gas would be available to it or not.
¯ The company is negotiating to lease its plant temporarily to reduce losses
during the period of its planned inactivity. However, this plan does not seem
very convincing as the prospective lessee would also be subject to the same
circumstances.
The auditor would need to evaluate the company’s detailed plan by carrying out the
following procedures:
i. Review the cash flow projections provided by QSL and assess their reasonableness
ii. Discuss with the management about the uncertainties described above and assess
whether the management would be in a position to overcome them.
iii. Consider subsequent events and discuss the impact thereof, with the management,
if necessary.
iv. Seek written representation from management regarding its plans for future
actions.

v. After performing the above procedures, if there is a doubt about the

appropriateness of the going concern assumption, auditor will need to carryout
additional audit procedures depending upon the circumstances.
Besides the going concern issues, the discontinuance of operations of company and
reduction in production of steel may result in impairment of plant and machinery, as the
company may not be able to recover the carrying amount of the plant. The auditor needs
to review the value in use of the plant and machinery provided by the client.
b) Implications on the Audit Report:
i. If it is concluded that going concern assumption is appropriate and no material
uncertainty exists, the auditor shall express an unmodified opinion.
ii. If it is concluded that going concern assumptions is appropriate but a material
uncertainty exists which is adequately disclosed in the financial statements, the
auditor shall express:
 an unqualified opinion
 include a separate section in Report “Material Uncertainty Related to Going
Concern” (ISA 700) to: highlight the existence of material uncertainty relating
to the event or condition that may cast significant doubt on the entity’s ability
AT A GLANCE
to continue as a going concern; and draw attention to the note in the financial
statement which contains the disclosure. However, if material uncertainty
exists and is not adequately disclosed in the financial statements. The auditor
shall express a qualified opinion or adverse opinion as appropriate.
iii. If it is concluded that the going concern assumption is not appropriate, in the
preparation of the financial statements the auditor should advise the company to
revise the accounts appropriately. In case of disagreement, the auditor shall express
an adverse opinion.
iv. If the company revises its financial statements, the auditor shall include an emphasis
of matter paragraph referring to the note in the financial statements and explaining
that the financial statements are prepared on estimated realizable settlement values
of assets and liabilities respectively as the company is no longer a going concern for
SPOTLIGHT
the reason stated in the aforesaid note.

If management is unwilling to make or extend its Assessment, the auditor will issue
a qualified opinion or a disclaimer of opinion, as appropriate.
Kabul (Private) Limited (KPL) has advanced Rs. 100 million to Qandhar Limited (QL), one of its
suppliers of raw material. KPL and QL have recently signed an agreement whereby the above
advance has been converted into a loan and QL has agreed to pay mark-up on the outstanding
balance at prevailing market rates. QL has confirmed the amount of loan and the interest accrued
thereon. However, you have acquired some information which suggests that QL is facing financial
difficulties.
Required:
Discuss how you would deal with the above situation and possible implications thereof on the
audit report.
Tutorial Notes:
This is simply a situation of possible non-recovery of loan and evidence was to be gathered in
relation to that and the fact that related party which is a secondary issue in this scenario. Don’t
go for extra remote assumptions like the possibility of failure of the supplier to supply the raw
material resulting in going concern issue for the lending company. Another mistake could be to
misunderstand the whole situation and answer the question as if you are auditors of the supplier
which has taken the loan.

 Solution:
 The balance confirmation provided by QL, will provide sufficient and appropriate audit
evidence with respect to existence and completeness, but not with respect to valuation
and disclosures.
 As QL is facing financial difficulties, there is an indication that the recovery of advance is
doubtful.
 In order to address the issue, the auditor should:
¯ Review latest audited financial statements of QL to determine QL’s ability to pay
back the loan in future.
¯ Review the audited financial statements to determine whether QL has defaulted in
repayment of any loans and advances etc.
¯ Review agreements between KL and QL to check what remedy are available in case
of non-payment by QL.
¯ Inquire as to the steps taken by QL in order to overcome the financial difficulties.
 Discuss the issue with management and consider their assessment about the
recoverability of the amount and assess the reasonability of the assumptions on which
such assessment is based.
AT A GLANCE
 If the above procedures, suggest impairment in the value of advance, the auditor should
ask the management to make appropriate provision in the financial statements.
Impact on Auditor’s Report:
If in the auditor’s opinion the recovery of the loan or mark-up accrued thereon is doubtful and
the client fails to make appropriate provision in the financial statements, the auditor will issue a
qualified opinion or an adverse opinion depending upon materiality and pervasiveness of the
matter.
If the management fails to assess the issue objectively or the auditor is unable to obtain relevant
and appropriate audit evidence, then it would represent a scope limitation, and the auditor will
issue a qualified or disclaimer of opinion depending upon materiality and pervasiveness of the
matter.
SPOTLIGHT
Gems Limited (GL) is a leading manufacturer of jewelry made from precious stones. GL sources
the stones from three suppliers located in Khyber Pakhtunkhwa (KPK). On 10 May 2019,
a severe earthquake struck KPK destroying the mines and the stone extraction units located in
KPK. GL’s plant was also partially damaged due to the earthquake.
Upon discussion with the management, you came to know that one of the GL’s plants was affected
by the earthquake and due to adequate insurance, they would be able to claim the loss amount
from insurance company. They further informed that GL could continue to use the other plants
for production.
The year-end of GL is 31 March 2019.
Required:
Discuss your firm’s course of action along with the implications on the audit report.
Tutorial Notes:
 Remember the basic difference between adjusting and non-adjusting events.
 The fact requires attention that if the business was no longer a going concern, only then
it might become an adjusting event and require the preparation of financial statements
on other than going concern basis.
 Remember to write the procedures for assessing the recoverability of the insurance
claim and how the company would secure the supply of raw material.

 Solution:
The earthquake occurred after the year end and therefore the event is treated as a non-adjusting
event. No immediate adjustments to the financial statements would be required.
Despite being a non-adjusting event, the impact on the business is material and non-disclosure
could influence the economic decisions made by users based on the financial statements. We
should ensure that the management should disclose this fact in accordance with IAS-10.
We will have to ask the management to prepare an analysis of the expected impact such as the
write down of stocks and the loss of machinery.
We will need to assess the appropriateness and completeness of these disclosures by reviewing
the assumptions made by management regarding costs and agree to supporting documents such
as insurance reports and inventory records.
Earthquake is a non-adjusting event but since the supply of raw material has been significantly
affected by the incident, the auditor needs to consider that the business may no longer be a going
concern. In such a case it may become an adjusting event.
Management will need to reconsider their assessment of the company's going concern status. We
will assess whether management's assessments of going concern is appropriate and that the
AT A GLANCE
appropriate disclosures are in place. Extending the going concern testing using revised budgets
and forecasts will help determine, along with discussions with management, as to the
reasonableness and assumptions of its plans regarding future production.
We also need to inquire from management the quantity of un-affected raw material in its
inventory which could be used for production and by when the local extraction unit would
become functional again. Management plans for alternate supply of raw material needs to be
assessed such as importing the raw material or purchasing it from some other region in Pakistan
and whether GL would be able to maintain the price levels to compete in the market.
Whilst GL have an insurance policy it is unlikely that the claim will be agreed before signing of
our audit report and we need to ensure that they do not recognise an asset as this can only be
recognised if it's virtually certain that it is payable. If it is probable that they will receive an
insurance claim this can be disclosed. We will need to carefully review the insurance policy and
SPOTLIGHT
correspondence with the insurance company to obtain evidence over the amount of the claim.
The impact on the audit report due to going concern will need to be carefully considered. If GL
determines that a material uncertainty exists and it is disclosed effectively, we will need to
include a para of “material uncertainty related to going concern”.
If the disclosures made by GL are inappropriate, a qualified or adverse opinion should be
considered.
If GL conclude that they are a going concern and we disagree with this assumption, then an
adverse opinion should be considered.
If management is unwilling to make assessment of going concern a qualified or a disclaimer of
opinion in the auditor’s report would be appropriate.
3.5 Communication with those charged with governance (Ref: 25)

Auditor shall communicate with those charged with governance events or conditions identified that may cast
significant doubt on the entity’s ability to continue as a going concern including:
 Whether events or conditions constitute a material uncertainty;
 Whether management’s use of going concern basis of accounting is appropriate in the preparation of
financial statements;
 Adequacy of related disclosures in financial statements; and
 Where applicable, the implications for the auditor’s report.

3.6 Significant Delay in the Approval of financial statements (Ref: 26)

If there is significant delay in approval of financial statements by management or those charged with governance
after the date of financial statements
 Auditor shall inquire as to the reasons for the delay.
 If auditor believes that delay could be related to events or conditions relating to going concern
assessment, auditor shall perform necessary additional audit procedures
Auditor shall also consider the effect on the auditor’s conclusion regarding the existence of a material uncertainty
AT A GLANCE
SPOTLIGHT

4. COMPARATIVE INFORMATION - CORRESPONDING FIGURES AND

COMPARATIVE FINANCIAL STATEMENTS (ISA 710)
Comparative information: Amounts and disclosures included in the financial statements in
respect of one or more prior periods in accordance with applicable financial reporting
framework
Corresponding figures: Comparative info where amounts and other disclosures for the prior
period are included as an integral part of 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”).
The level of detail presented in corresponding amounts and disclosures is dictated primarily by
its relevance to the current period figures.
Comparative financial statements: Comparative info where amounts and other disclosures for
prior period are included for comparison with the financial statements of current period but, if
audited, are referred to in the auditor’s opinion.
The level of info included in those comparative financial statements is comparable with that of
AT A GLANCE
the financial statements of the current period.
4.1 Audit Procedures (Ref: 7-9, A1)

Auditor shall determine whether financial statements include the comparative info required by applicable
financial reporting framework and whether such info is appropriately classified. Auditor shall evaluate whether:
 Comparative info agrees with amounts and other disclosures presented in prior period or (when
appropriate, been restated)
 Accounting policies reflected in comparative info are consistent with current one
(If there have been changes in policies, whether those changes have been properly accounted for &
adequately disclosed)
SPOTLIGHT
If auditor becomes aware of a possible material misstatement in comparative info, auditor shall perform
additional audit procedures to obtain sufficient appropriate audit evidence about that.
If auditor had audited prior period’s financial statements, auditor shall also follow the relevant requirements
of ISA 560. (If prior period financial statements are amended, auditor shall determine that the comparative info
agrees with amended financial statements).
Auditor shall request written representations (as per ISA 580) for all periods referred to in auditor’s opinion.
Shall also obtain specific written representation regarding any restatement made to correct a material
misstatement in prior period financial statements.
4.2 Audit Reporting – Corresponding figures (Ref: 10 to 12, A2 to A6)

When corresponding figures are presented, auditor’s opinion shall not refer to corresponding figures
(except stated below).
If auditor’s report on prior period included a modified opinion and that matter is still unresolved, auditor shall
modify auditor’s opinion on current period’s financial statements.
In Basis for Modification paragraph, auditor shall either:
 Refer to both current period’s figures and corresponding figures in description of matter (when effects
of matter are material); or
 Explain that audit opinion has been modified because of the effects/possible effects of unresolved
matter on comparability of current period’s and corresponding figures. (In other cases).

If auditor’s report on prior period included a modified opinion and matter is resolved and properly accounted
for in financial statements, auditor’s opinion on current period need not to refer previous modification.
If auditor obtains audit evidence that a material misstatement exists in prior periods on which an unmodified
opinion has been previously issued and corresponding figures have not been properly restated or appropriate
disclosures have not been made, auditor shall express a qualified opinion or an adverse opinion on the current
period financial statements.
However, if corresponding figures have been properly restated or appropriate disclosures have been made in
current period financial statements, auditor’s report may include an Emphasis of Matter paragraph.
Prior Period financial statements Audited by a Predecessor Auditor (Ref: 13, A7)
If auditor is not prohibited by law or regulation from referring to the predecessor auditor’s report on
corresponding figures and decides to do so, auditor shall state in an Other Matter paragraph:
 That financial statements of prior period were audited by the predecessor auditor;
 Type of opinion expressed by the predecessor auditor (if the opinion was modified, the reasons
therefore);
 The date of that report.
AT A GLANCE
Prior Period financial statements Not Audited (Ref: 14, A8)
Auditor shall state in an Other Matter paragraph that the corresponding figures are unaudited. (However such a
statement does not relieve the auditor to obtain sufficient appropriate audit evidence that the opening balances do
not contain misstatements that materially affect current period’s financial statements).
You are the audit partner of Mansoor Noorani and Company, Chartered Accountants. Following
are the audit issues being faced on different clients:
The previous year’s audit report of RP Limited was qualified by the predecessor auditor for not
recording impairment loss of Rs. 67 million on plant and machinery. However, the management
has recorded the impairment in the current year. Profit before tax for current and prior year is
Rs. 500 million and Rs. 300 million respectively.
SPOTLIGHT
Required:
Discuss the auditor’s course of action along with implications on the audit report.
Tutorial Notes:
Remember that even if the management agrees to make the correction, an emphasis of matter
paragraph would have to be given, giving reasons for restatement and reference to the relevant
note to the financial statements. Another mistake could be stating that the matter can only be
rectified by asking the previous auditor to revise the audit report.
It is also interesting to note that procedures to verify the amount of impairment is not the
requirement of this question.
 Solution:
The auditor will include other matter paragraph in his audit report mentioning the fact that the
previous year’s financial statements were audited by another firm of chartered accountants and
they had expressed a qualified opinion along with the reasons of qualification and the date of the
audit report.
Management of RPL has accounted for an impairment of Rs. 67 million in the financial statements
of the current year, whereas it should have been provided in the previous year. Hence the current
year’s profit is understated by the same amount and corresponding figures/opening balances
also contain a material misstatement of Rs. 67 million.

The auditor should ask the management and those charged with governance to restate the
comparative figures and take the effect of the impairment retrospectively.
If the management agrees to make the adjustment retrospectively, an unqualified opinion will be
expressed with an emphasis of matter paragraph giving reasons for restatement of figures and a
reference to the notes to the financial statements.
If the management does not agree then the auditor’s report will be qualified due to the
misstatement in current year as well as the corresponding figures/opening balances.
Discuss the possible implications on audit report with respect to previous year’s modification.
Tutorial Notes:
It’s slightly easier to identify the possible implications on the audit report in case the matter was
resolved and also in case the matter remained unresolved. However, additional clarification is
also required about the fact that if issues related to previous year are not relevant with regard to
AT A GLANCE
current period, the auditor may still have to qualify the report.
 Solution:
If the matter related to previous years’ modification is still unresolved, the auditor shall modify
the auditor’s opinion on the current period financial statements, and in the basis for modification
paragraph, the auditor shall 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.
If the previous years’ matter is resolved and properly accounted for or disclosed in accordance
with the applicable financial reporting framework, the auditor’s opinion on the current period
need not refer to the previous modification.
SPOTLIGHT
If the previous years’ matter is not relevant to the current period figures, it may still be
appropriate for the auditor to qualify the opinion on current period financial statements because
of the effects or possible effects of the unresolved matter on the comparability of the current and
corresponding figures.
You are the engagement partner on the audit of Mars Limited, for the year ended 30 September
2014.
On commencement of the review of working paper file, the audit manager has informed you that
the audit report would need modification. The following draft modification is available in the file:
“We draw attention to note 10 to the financial statements that fully explains that amount of Rs.
70 million due from Utopia Limited (UL), that is outstanding since September 2013, is not
recoverable as UL is in the process of winding up from 20 December 2013. Therefore, the said
amount has been fully provided for in the financial statements of the current year due to which
the company has incurred loss during the year. As the revenue from UL amounts to 40% of total
revenue of 2013, we are of the view that it is fundamental to users’ understanding of the financial
statements. Our opinion is not qualified in respect of this matter. The financial statements for the
year ended 30 September 2013 were audited by another auditor who expressed an unmodified
opinion on those statements on 25 December 2013.”
The draft financial statements show a loss of Rs. 92.4 million (2013: Profit of Rs. 16.4 million)
and total assets of Rs. 395 million (2013: Rs. 410 million).

Required:
Evaluate all the facts from the information available above and state the actions the auditor needs
to take on the basis of evaluation.
Tutorial Notes:
Remember to mention the correct year for rectification (i.e. current vs previous). Note that a
modification paragraph would only be appropriate if the client agreed to the restatement;
otherwise a qualified report would be required. A common mistake could be mentioning that
previous year’s auditors should be asked to give a revised report or report on the corrected
financial statements, which could have been relevant in case of comparative financial statements
approach which is not the case here.
 Solution:
 The inclusion of emphasis matter paragraph in the audit report for explaining the
irrecoverability of amount due from UL is not appropriate.
 As the amount is outstanding since last September, it needs to be provided in the
financial statements of September 2013.
 The auditor will ask the management to restate the prior period figures in the current
AT A GLANCE
financial statements and make appropriate disclosures thereof.
 If the management agrees to restate the figures and make appropriate disclosures in the
financial statements, the auditor report may include an emphasis of matter paragraph
describing the circumstances and referring to the note in the financial statements.
 If the management refuses to restate the financial statements or make appropriate
disclosures, the auditor shall express a qualified opinion or an adverse opinion on the
current period financial statements, modified with respect to the corresponding figures
included therein.
 Furthermore, UL is a major customer of ML as 40% of its revenue is earned from it, as
the company has incurred a loss of Rs. 22.4 million in the absence of sales to UL. The
appointment of a liquidator at UL is an event which (alone or aggregated with other
events) may cast significant doubt on ML’s ability to continue as going concern.
SPOTLIGHT
 If the management has not yet performed an assessment of the entity’s ability to
continue as a going concern, requesting management to make its assessment.
assessment, whether the outcome is likely to improve the situation and whether
management’s plans are feasible in the circumstances.
 If after reviewing management’s plan and performing procedures, it is concluded that
material uncertainty exists as regards the going concern assumption, a note should be
given in financial statements describing the liquidation of UL, which may cast significant
doubt on the company’s ability to continue as a going concern and management’s plan
to deal with the situation and therefore, that it may be unable to realize its assets and
discharge its liabilities in the normal course of business.
 The audit report will be modified in the form of inclusion of an emphasis of matter
paragraph which will explain the uncertainty and draw the shareholders’ attention to
the note in the financial statements.
 If the management does not agree to disclose a note, a qualified or adverse opinion
should be considered.
 It shall also be stated in the audit report that there is a material uncertainty that may
cast significant doubt about the company’s ability to continue as a going concern.
 If the financial statements have been prepared on a going concern basis but, in the
auditor’s judgment, management use of going concern assumption is inappropriate, the
auditor shall express an adverse opinion.

 If the use of going concern assumption is not appropriate, and the management prepares
the financial statements on alternative basis, the auditor will express an unmodified
opinion, provided adequate disclosure is made in the financial statements, but may
consider it appropriate or necessary to include an Emphasis of matter paragraph in the
auditor’s report, to draw user’s attention to that alternate basis and the reasons for its
use.
 If management is unwilling to make or extend its assessment, a qualified or disclaimer
of opinion may be appropriate, because it may not be possible for the auditor to obtain
sufficient appropriate audit evidence regarding the use of the going concern assumption
in the preparation of financial statements.
a) Describe the implications on the audit report where the prior year’s audit has been
conducted by another auditor.
b) You are the audit manager of Wasim Limited for the year ended 30 June 2012. The
previous year’s audit was performed by another firm of chartered accountants who have
expressed an unmodified opinion. The following issue has been brought to your notice
byte audit team:
AT A GLANCE
The company has written off intangible assets amounting to Rs. 30 million in the current
year because the new CEO believes that the expenditure does not meet the criteria for
capitalization as per the International Financial Reporting Standards. The said amount
was capitalized during the year ended 30 June 2011. The profit before tax for the year
ended 30June 2012 is Rs. 52 million (2011: Rs. 91 million).
Required:
Describe the steps which the auditor needs to take in the above situation and explain the
implications on the audit report assuming that the auditor is satisfied with the valuation of
intangibles as on 30 June 2012.
 Solution:
a) The auditor will include other matter paragraph in the auditor’s report stating that:
SPOTLIGHT
 The financial statements of the prior period were audited by the predecessor
auditor
 The type of opinion expressed by the predecessor auditor
 The date of that report
b) In addition to the inclusion of other matter paragraph as in (a) above, the auditor will
need to take the following steps:
 Review the amount capitalized last year to verify that the amount was incorrectly
capitalized as has been claimed by WL’s CEO.
 Consult the previous auditors (with the permission of WL) to know their point of
view on the issue, if possible review the previous auditor’s working papers.
 Discuss the reasons for resignation and removal of the previous CEO.
 If the misstatement in previous financial statement is confirmed it may create
doubts as regards:
¯ Competence and integrity of client’s staff.
¯ The internal control systems in place and the possibility that other material
misstatement may also have gone undetected.
In view of the above, the auditor may like to re-assess the risk of material misstatement and
revise the audit procedures if required.

 Since there exists a material misstatement in the prior period financial statements on
which the predecessor auditor had previously reported without modification, the
auditor shall communicate the misstatement in the prior year financial statements to
appropriate level of management and where appropriate those charged with
governance and ask them to revise the prior year financial statements.
 If the management agrees to correct the misstatement and amend the prior year
financial statements, then the auditor shall request the management that the
predecessor auditor be informed and a revise audit report be obtained if possible.
¯ If the prior period financial statements are amended, and the predecessor auditor
agrees to issue a new auditor’s report on the amended financial statements of the
prior period, the auditor shall report only on the current period.
¯ If the predecessor auditor is unable or unwilling to issue the auditor’s report on the
prior year financial statements, the Other matter paragraph of the auditor’s report
may also indicate that the predecessor auditor reported on the financial statements
of the prior period before amendment.
¯ In addition, the auditor is required to be satisfied with the adjustment and
amendment made in the prior year financial statements, and the auditor’s report
AT A GLANCE
will also include reference to the audit of adjustment/ amendment made in the prior
period financial statements and a disclaimer of opinion with reference to the audit
of prior year.
 If the management does not agree to amend the prior year financial statements:
¯ the auditor may issue a qualified or adverse opinion depending upon the materiality
and pervasiveness of the matter, with respect to prior period and express a clean
opinion on the financial statements of the current period
¯ disclose substantive reasons for the different opinion as compared to the opinion
expressed by the predecessor auditor on prior period financial statements in the
Other matter paragraph.
SPOTLIGHT
You are the auditor of Blue Sky Limited (BSL). The draft consolidated financial statements of BSL
and its subsidiary Sea Green Limited (SGL) for the year ended September 30, 2009show a profit
before taxation of Rs. 10.5 million (2008: Rs. 9.4 million) and net assets of Rs.55.2 million (2008:
Rs. 50.7 million). You have performed the audit procedures you considered necessary for the
year ended September 30, 2009 and are satisfied with the results of those procedures.
However, your firm is also the auditor of Sea Green Limited (SGL). You were appointed as SGL’s
auditors for the year ended September 30, 2009 after BSL acquired 90% shares of SGL on June
30, 2008. SGL’s draft financial statements for the year ended September 30, 2009 show profit
before taxation of Rs. 0.7 million (2008: Rs. 1.7 million) and net assets of Rs. 16.1 million (2008:
Rs. 16.6 million). Both the companies are exempt from tax.
The previous auditors’ report on SGL’s financial statements, for the year ended September30,
2008 was unmodified. However, during the audit of SGL it was discovered that due to an error,
the inventory as appearing in the audited financial statements for the year ended September 30,
2007 was overvalued by Rs. 5.7 million. This amount is now being adjusted by SGL over a period
of three years i.e. over the years ended September 2008 to 2010.
You have approached the management advising them to adjust the full amount in the current
year. However, the management is not willing to accept your point of view.
Required:
Draft the modification paragraph of the report which you would issue on the consolidated
financial statements, in the above situation. (A full report is not required)

 Solution:
On September 30, 2007, the inventory of a subsidiary was overvalued by Rs. 5.7 million. The
overvaluation was adjusted to the extent of Rs. 1.9 million during each of the years ended
September 30, 2008 and 2009. Consequently, the inventory as appearing in the consolidated
financial statements for the year ended September 30, 2009 has been overstated by Rs. 1.9
million. In our opinion, the above adjustment is not in accordance with the International
Accounting Standards which requires that the overstatement should be rectified retrospectively.
Accordingly, the inventory should be reduced by Rs. 1.9 million in the year 2009 and by Rs. 3.8
million in the year 2008, profit for the year should be increased by Rs. 1.9 million in the year
2009 and by Rs. 0.475 million in 2008, accumulated retained earnings should be increased by Rs.
2.1375 million in the year 2009 and by Rs. 0.4275 million in the year 2008, goodwill should be
increased by Rs. 3.8475 million in both the years i.e. 2009 and 2008 and minority interest should
be reduced by Rs. 0.19 million in the year 2009 and by Rs. 0.38 million in the year 2008.
In our opinion, except for the effect on the consolidated financial statements of the matter
referred to in the preceding paragraph, the consolidated financial statements present fairly the
financial position of Blue Sky Limited and its subsidiary as at September 30, 2009 and the result
of their operation for the year then ended.
AT A GLANCE
4.3 Audit Reporting – Comparative financial statements (Ref: 15-16, A9-A11)

When comparative financial statements are presented, auditor’s opinion shall refer to each period for which
financial statements are presented and on which an audit opinion is expressed.
(Auditor may add any modification while expressing a different auditor’s opinion on the financial statements of
the other period)
When reporting on prior period financial statements with the current period’s audit, if auditor’s opinion on such
prior period financial statements differs from the opinion previously expressed, auditor shall disclose the
substantive reasons for the different opinion in an Other Matter paragraph.
Prior Period financial statements Audited by a Predecessor Auditor (Ref: 17-18, A12)
Unless predecessor auditor’s report on prior period’s financial statements is reissued with financial statements,
SPOTLIGHT
Auditor shall state in an Other Matter paragraph:

 That financial statements of prior period were audited by the predecessor auditor;
 Type of opinion expressed by the predecessor auditor (if the opinion was modified, the reasons
therefore);
 The date of that report.
If a material misstatement exists that affects prior period financial statements on which previously unmodified
opinion was expressed, auditor shall:
 Communicate with appropriate level of management and those charged with governance;
 Request that predecessor auditor be informed.
If prior period financial statements are amended, and predecessor auditor agrees to issue a new auditor’s report
on amended financial statements, auditor shall report only on current period. (Ref: Para. A11)
Prior Period financial statements Not Audited (Ref: 19, A13)

Auditor shall state in an Other Matter paragraph that the comparative financial statements are unaudited. (However
such a statement does not relieve the auditor to obtain sufficient appropriate audit evidence that the opening balances
do not contain misstatements that materially affect current period’s financial statements).

5. INITIAL AUDIT ENGAGEMENTS - OPENING BALANCES (ISA 510)

Initial audit engagement: An engagement in which either:
 financial statements for prior period were not audited; or
 financial statements for prior period were audited by a predecessor auditor
Opening balances: Those account balances that exist at the beginning of period. These are based
upon closing balances of prior period and reflect the effects of transactions and events of prior
periods and accounting policies applied in prior period. Opening balances also include matters
requiring disclosure that existed at beginning of period, such as contingencies & commitments.
Predecessor auditor: The auditor from a different audit firm, who audited financial statements
of an entity in the prior period and who has been replaced by the current auditor
5.1 Audit Procedures (Ref: 5-9, A1-A7)

Opening Balances
Auditor shall read most recent financial statements &predecessor auditor report
AT A GLANCE
Auditor shall obtain sufficient appropriate audit evidence about whether opening balances contain
misstatements that materially affect current period’s financial statements by:
 Determining whether prior period’s closing balances have been correctly brought forward / restated
to current period
 Determining whether opening balances reflect application of appropriate accounting policies; and
 Performing one or more of the following:
¯ Where prior year financial statements were audited, reviewing predecessor auditor’s working
papers to obtain evidence regarding opening balances;
¯ Evaluating whether audit procedures performed in current period provide evidence relevant to
opening balances; or
SPOTLIGHT
¯ Performing specific audit procedures to obtain evidence regarding the opening balances.
Nature and extent of audit procedures necessary to obtain sufficient appropriate audit evidence regarding
opening balances depend on:
 Accounting policies followed by the entity.
 Nature of account balances, classes of transactions & disclosures and risks of material misstatement in
current period’s financial statements.
 Significance of opening balances relative to current period’s financial statements.
 Whether prior period’s financial statements were audited and, if so, whether the predecessor auditor’s
opinion was modified.
If prior period’s financial statements were audited by a predecessor auditor, auditor may be able to obtain
sufficient appropriate audit evidence by reviewing his working papers.
If auditor obtains audit evidence that opening balances contain misstatements that could materially affect
current period’s financial statements, auditor shall perform such additional audit procedures appropriate to
determine the effect on the current period’s financial statements.
If auditor concludes that misstatements exist in current financial statements, auditor shall communicate with
appropriate level of management &those charged with governance


Your firm has been appointed as the auditors of Antarctica Limited for the year ended June 30,
2008. The Company was incorporated in the year 2000. Since then, its financial statements have
been prepared in accordance with the approved accounting standards as applicable in Pakistan
and have been audited by a highly reputable professional auditing firm. Since the previous
auditors had never expressed a modified audit opinion, the audit team feels that there is no risk
in respect of comparatives and accordingly did not perform any work in this respect.
Required:
Describe the auditor’s responsibility as regards the verification of opening balances and the steps
that may be needed in the above situation.
 Solution:
Auditor’s Responsibility
I do not agree with the understanding of the audit team. The auditor should obtain sufficient
appropriate audit evidence that:
i. The opening balances do not contain misstatements that materially affect the current
period’s financial statements;
AT A GLANCE
ii. The prior period’s closing balances have been correctly brought forward to the current
period or, when appropriate, have been restated; and
iii. Appropriate accounting policies are consistently applied or changes in accounting
policies have been properly accounted for and adequately presented and disclosed.
Steps needed to be performed by auditor
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
auditors.
SPOTLIGHT
When the auditor is not satisfied by above step, the auditor will need to perform other audit
procedures such as:
i. Current assets and liabilities
Some audit evidence can ordinarily be obtained as part of the current period’s audit
procedures. For example:
 the collection (payment) of opening accounts receivable (accounts payable) during
the current period will provide some audit evidence of their existence, rights and
obligations, completeness and valuation at the beginning of the period.
 Observing a current physical inventory taking and reconciling it back to the
opening inventory items.
 Performing audit procedures on the valuation of the opening inventory items.
ii. Non-current assets and liabilities
 In respect of fixed assets, investments and long-term debt etc., the auditor will
ordinarily examine the accounting records and other information underlying the
opening balances.
 In certain cases, the auditor may be able to obtain confirmation of opening balances
with third parties, for example, for long-term debt and investments. In other cases,
the auditor may need to carry out additional audit procedures.
A combination of the above audit procedures may provide sufficient appropriate audit
evidence.


Your firm has been appointed as the auditor of Jugnu Limited (JL), which is a manufacturer of
consumer products. The auditor’s report on the preceding year’s financial statements was
unmodified. The draft financial statements for the year ended April 30, 2011 disclose a profit
before taxation of Rs.75 million (2010: Rs. 155 million) and total assets of Rs. 2,100 million
(2010: Rs. 1,910 million).
You are the audit manager at JL. The following issues arose during the audit and now require
your attention:
i. JL incurred an expenditure of Rs. 25 million on the development of five new products. It
is expected that these new products would generate future economic benefits.
ii. On July 1, 2008 JL had acquired four high-tech machines for Rs. 200 million which are
being depreciated over a period of 10 years on the straight line method. JL did not have
the expertise to operate the machines and had entered into an agreement with Umer
Limited to operate the machines. The contract is expiring on June 30, 2011 and Umer
Limited has shown its inability to continue after the expiry of the contract.
Required:
Describe the principal audit procedures to be carried out for verifying the opening balances of
AT A GLANCE
the financial statements of Jugnu Limited for the year ended April 30, 2011.
 Solution:
The following audit procedures should be carried out on opening balances:
i. Determine whether the prior year’s closing balances have been correctly brought
forward to the current period or, where appropriate have been restated.
ii. Review accounting policies applied in the previous year and the current year to ensure
consistency and appropriateness of the policies applied.
iii. If working papers of previous auditors are available, review them to obtain evidence
regarding the opening balances.
iv. If working papers are not available, carry out appropriate audit procedures regarding
SPOTLIGHT
the opening balances.
v. Evaluate whether the audit procedures performed in the current year provide evidence
relevant to the opening balances.
vi. Perform additional procedures as are appropriate in the circumstances, if the above
procedures provide audit evidence that the opening balance contain material
misstatement that could materially affect the current period’s financial statements.
vii. If it is concluded that such misstatement exists in the current period’s financial
statements, the auditor shall communicate the misstatements with the appropriate level
of management and those charged with governance and consider their impact
Consistency of Accounting Policies

Auditor shall obtain sufficient appropriate audit evidence about
 Whether accounting policies reflected in opening balances have been consistently applied in current
period’s financial statements; and
 Whether changes in accounting policies have been appropriately accounted for and adequately
disclosed in accordance with applicable financial reporting framework
Relevant Information in the Predecessor Auditor’s Report

If there was a modification in predecessor auditor’s report, auditor shall evaluate the effect of matter giving rise
to modification in assessing the risks of material misstatement in current period’s financial statements

5.2 Audit Conclusions and Reporting (Ref: 10-13, A8-A9)
Opening Balances
If auditor is unable to obtain sufficient appropriate audit evidence regarding opening balances, auditor shall
express a qualified opinion or disclaim an opinion.
If auditor concludes that opening balances contain a misstatement that materially affects current period
financial statements and effect of misstatement is not appropriately accounted for or not adequately disclosed,
the auditor shall express a qualified opinion or an adverse opinion.
Consistency of Accounting Policies

If the auditor concludes that:
 Current period’s accounting policies are not consistently applied in relation to opening balances in
accordance with applicable financial reporting framework; or
 Change in accounting policies is not appropriately accounted for or not adequately disclosed in
accordance with applicable financial reporting framework
Auditor shall express a qualified opinion or an adverse opinion
AT A GLANCE
Modification to the Opinion in the Predecessor Auditor’s Report

If the modification remains relevant and material to current period’s financial statements, auditor shall modify
opinion on current period’s financial statements in accordance with ISA 705 & ISA 710
In some cases, modification may not be relevant and material to current period’s financial statements. (e.g. scope
limitation in prior period has been resolved in current period)
Assume that in XYZ and Company had qualified the previous year’s audit report because it was
unable to physically verify the factory building and to observe physical inventory count, due to
law and order situation. However, during the course of current year’s audit, ABC and Company
was able to observe the physical inventory count and also carry out physical verification of the
SPOTLIGHT
factory building as the law and order situation has improved.

Required:
Discuss the matters which you would consider in the above situation and the possible impact
thereof on the audit report.
Tutorial Notes:
Some key points to consider are:
 Need to include an “other matter paragraph” in the audit report as the previous audit
was conducted by another auditor.
 Impact on current year’s audit report would depend on whether the current auditor is
able to obtain sufficient appropriate audit evidence in respect of opening balances.
 Solution:
The matters that would be considered in the above situation are as follows:
 Whether auditors are in a position to obtain sufficient appropriate audit evidence with
respect to quantities of inventory at the beginning of the year by means of other
operating procedures.
 If auditors are unable to obtain sufficient appropriate audit evidence with respect to
quantities of last year through other audit procedures, it will imply that the matter giving
rise to modification is still unresolved, and the auditor shall modify the auditor’s opinion
on the current period’s financial statements. Impact on the audit report would be as
follows:

 Auditor shall explain in the audit report 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,
although the matter is not relevant to the current period figures.
 Even if the above matters are resolved auditor shall be required to include in the
audit report, another matter paragraph stating that:
¯ The financial statements of the prior period were audited by the predecessor
auditor, who has issued a qualified opinion due to non-observance of inventory
count and date of prior year’s audit report.
 The qualification related to non-verification of building of last year is not relevant as the
auditor is able to physically verify the building.
ABC and Company, Chartered Accountants, have been appointed as the auditor of Neptune
Limited (NL). During the audit it has been revealed that:
The previous auditor’s working papers are available; however, they are not of required
standards.
AT A GLANCE
Required:
Discuss the overall audit approach and related audit procedures to address the above issues. Also
state the possible implications on the audit report.
 Solution:
In view of the fact that prior year’s working papers are not of required standards, these cannot
be used to verify opening balances. Therefore, we should:
 Evaluate whether audit procedures designed for the current period provide evidence
relevant to opening balances; or
 Perform specific audit procedures to obtain evidence regarding opening balances.
The procedures that can be used by auditor in obtaining audit evidence with respect to opening
SPOTLIGHT
balances are:
 Accounts receivable/payable: The collection (payment) of opening accounts receivable
(accounts payable) during the current period will provide some audit evidence of their
existence, rights and obligations, completeness and valuation at the beginning of the
period.
 Inventories: The current period’s audit procedures on the closing inventory balance
provide little audit evidence regarding inventory on hand at the beginning of the period.
Therefore, additional audit procedures may be necessary, and one or more of the following may
provide sufficient appropriate audit evidence:
 Reconciling the current year closing inventory quantities with the opening inventory
quantities.
 Performing audit procedures on the valuation of the opening inventory items.
 Performing audit procedures on gross profit and cutoff.
¯ Property, plant and equipment, investments and long-term debt: Audit evidence
may be obtained by examining the accounting records and other information
underlying the opening balances.
¯ Other items such as reserves and share capital and movement during the year can
be verified through Form A filed with SECP.

The auditor may also be able to obtain some audit evidence regarding opening balance through
confirmation with third parties, for example, long-term debt and investments.
Implications on Audit Report:
After performing above procedures:
 If the auditor is unable to obtain sufficient appropriate audit evidence regarding the
opening balances, the auditor shall express a qualified opinion or disclaim an opinion on
the financial statements, as appropriate.
 If the auditor concludes that the opening balances contain a misstatement that
materially affects the current period’s financial statements, then the auditor will ask the
management to make appropriate adjustment and in case of disagreement the auditor
shall express a qualified opinion or an adverse opinion as appropriate.
Mr. Burhan is working as audit manager in a firm of Chartered Accountants. The audit teams
have brought the following matters to his attention:
On the first audit of Nasir Limited (NL), the Chief Finance Officer of NL has revealed that due to
an error, a material liability was understated in the preceding financial year. (08)
AT A GLANCE
Required:
Tutorial Notes:
It is pertinent to note that accounting treatment under IAS – 8 is not the only requirement of this
question, a confusion should be addressed regarding ascertaining whether it was actually an
error and the related implications if it was an intentional misreporting rather than an error.
 Solution:
The procedure adopted would be as follows:
 Discuss the reasons of understatement with the client’s management and assess
SPOTLIGHT
whether reasonable grounds exist to assume that it was an error.

 If it was an error or due to control weaknesses then consider the impact on overall risk
assessment and nature, timing and extent of audit procedures.
 Obtain the working for re-statement from the client along with the relevant disclosure
 Identify impact, if any, for the current year as well.
 If it appears that the understatement was intentional, then consider the impact on the
assessment on integrity of management.
 If the integrity is doubtful, then consider withdrawing from engagement, if possible.
 If considered appropriate, discuss the matter with the previous auditor.
 Ensure proper accounting and disclosure of the restatements i.e. the re-statement will
have to be made in accordance with the requirements of IAS-8 pertaining to accounting
and disclosures
 Highlight the matter of re-statements to those charged with governance.

6. THE AUDITOR’S RESPONSIBILITIES RELATING TO OTHER INFORMATION

(ISA 720)
 Important Definitions
Other information: Financial or non-financial information (other than financial statements and
auditor’s report) included in an entity’s annual report.
Appendix 1 to this ISA contains examples of other information.
Annual report: A document, or combination of documents, prepared typically on an annual basis
by management or those charged with governance in accordance with law, regulation or custom,
the purpose of which is to provide owners (or similar stakeholders) with information on the
entity’s operations and the financial results and financial position as set out in the financial
statements. An annual report contains or accompanies the financial statements and auditor’s
report thereon and usually includes information about the entity’s developments, its future
outlook and risks and uncertainties, a statement by the entity’s governing body, and reports
covering governance matters.
Law, regulation or custom may define the content of an annual report (e.g. Sec 233 of the Companies
Ordinance 1984).
AT A GLANCE
Depending on law, regulation or custom in a particular jurisdiction, one or more of the following
documents may form part of the annual report:
 Management report, management commentary, or operating and financial review or
similar reports by those charged with governance (e.g. a directors’ report).
 Chairman’s statement.
 Corporate governance statement.
 Internal control and risk assessment reports.
6.1 Obtaining the Other Information (Ref: 13, A11-A22)

The auditor shall:
SPOTLIGHT
 Discuss with management to determine:
¯ Which document(s) comprises the annual report; and
¯ Entity’s planned manner and timing of the issuance of same;
 Make appropriate arrangements with management to obtain (timely and, if possible, prior to date of
auditor’s report), the final version of that document(s); and
 Request management to provide a written representation that the final version of the document(s) will
be provided to the auditor when available, and prior to its issuance by the entity
 (When some or all of the document(s) will not be available until after the date of auditor’s report)
 In addition, auditor may find it useful to request other representations e.g.:
 Management has informed the auditor of all the documents that it expects to issue that
may comprise other information;
 financial statements and any other information obtained prior to date of auditor’s report
are consistent with one another, and other information does not contain any material
misstatements; and
 Management intends to prepare and issue such other information and the expected
timing of such issuance.

Auditor may communicate with management or those charged with governance:

 The expectations in relation to obtaining final version of annual report in a timely manner
 Possible implications when other information is obtained after the date of auditor’s report.
Auditor is not precluded from dating or issuing the auditor’s report if the auditor has not obtained some or all of
the other information.
When other information is obtained after the date of auditor’s report, auditor is not required to update the
procedures performed in accordance with ISA 560
6.2 Reading and Considering the Other Information (Ref: 14-15, A23-A38)
The auditor shall read the other information and, in doing so shall:
Consider whether there is a material inconsistency between the other information and the financial statements
10
¯ Comparing the information to the financial statements.
¯ Comparing the words used and considering the significance of differences in wording used
¯ Obtaining a reconciliation between an amount within the other information and the financial
statements from management along with checking its mathematical accuracy
AT A GLANCE
¯ Evaluating the consistency of presentation compared to financial statements.

 Consider whether there is a material inconsistency between the other information and the auditor’s
knowledge obtained during the audit (e.g. a disclosure of the units produced, information about launch
of new product or business prospects and future cash flows)
¯ Recollection of evidence obtained & conclusions reached
¯ Discussions held with management or those charged with governance
¯ Reading of Board minutes
¯ Referring to relevant audit documentation
¯ Making inquiries of the relevant engagement team members
SPOTLIGHT
 Remain alert for indications that the other information not related to the financial statements or
auditor’s knowledge obtained in the audit appears to be materially misstated.
¯ Differences between other information and the general knowledge (apart from knowledge obtained
in audit), of engagement team member reading other information; or
¯ An internal inconsistency in the other information.
6.3 Responding When a Material Inconsistency Appears to Exist or Other Information Appears to Be
Materially Misstated (Ref: 16, A39-A4)
Auditor shall discuss the matter with management and, if necessary, perform other procedures to conclude
whether:
 A material misstatement of the other information exists;
 A material misstatement of the financial statements exists; or
 The auditor’s understanding of entity and its environment needs to be updated.
Such a discussion may:
 Include requesting management to provide support for the basis of management’s statements in the
other information.
 Provide further information that supports auditor’s conclusion

When auditor is unable to conclude that a material inconsistency no longer appears to exist or that the other
information no longer appears to be materially misstated
 He may request management to consult with qualified 3rd party
(e.g. a management’s expert or legal counsel)
 If (after considering responses from management’s consultation), auditor is still not able to conclude;
he may take following actions:
¯ Obtaining advice from the auditor’s legal counsel;
¯ Considering the implications for auditor’s report
(e.g. whether to describe the circumstances when there is a limitation imposed by management);
or
¯ Withdrawing from the audit
(where withdrawal is possible under law or regulation)
 Definition: Misstatement of the other information
A misstatement of the other information exists when the other information is incorrectly stated
or otherwise misleading (including because it omits or obscures information necessary for a
AT A GLANCE
proper understanding of a matter disclosed in the other information)
6.4 Responding When the Auditor Concludes That a Material Misstatement of the Other Information
Exists (Ref: 17-19, A44-A50)
In such a case, auditor shall request management to correct other information:
 If management agrees to make the correction, the auditor shall determine that the correction has been
made; or
 If management refuses to make the correction, the auditor shall communicate the matter with those
charged with governance and request that the correction be made.
If other information is not corrected after communicating with those charged with governance, the auditor shall
SPOTLIGHT
take appropriate action, including:
 Considering implications for auditor’s report and communicating with those charged with governance
about such implication in auditor’s report (In rare circumstances, a disclaimer may be appropriate when
the refusal casts doubt on the integrity of management and those charged with governance); or
 Withdrawing from the engagement, where withdrawal is possible under applicable law or regulation.
If auditor concludes that a material misstatement exists in other information obtained after date of auditor’s
report, the auditor shall:
 If other information is corrected, perform the necessary procedures (as listed before); or
 If the other information is not corrected after communicating with those charged with governance,
take appropriate action considering auditor’s legal rights and obligations, to brought the matter to the
attention of users of the auditor’s report. These actions may include
¯ Providing a new or amended auditor’s report to management including a modified section in
accordance with this ISA and requesting management to provide this report to same users
¯ Addressing the matter in a general meeting of shareholders;
¯ Communicating with regulator or relevant professional body
¯ Considering the implications for engagement continuance

6.5 Responding When a Material Misstatement in financial statements Exists or Auditor’s

Understanding of Entity etc. Needs to Be Updated (Ref: 20, A51)
In such case auditor shall respond appropriately in accordance with other ISAs.
 ISA 315 for understanding of the entity and risk assessment
 ISA 450 for effect of identified and uncorrected misstatements
 ISA 560 for subsequent events
The following situations have arisen at different audit clients of your firm. The year end in each
Your firm has issued an audit report on the financial statements of Earth Limited. In the published
annual report which was received along with the notice of annual general meeting, you noted
that certain disclosures that were agreed to be included in the directors’ report were missing.
Required:
Discuss the matters which the auditor should consider and the steps that he may need to take, in
each of the above situations.
Tutorial Notes:
AT A GLANCE
Both possibilities should be discussed i.e. where management agrees to a revision and where it
does not agree to the revision.
 Solution:
 The auditor should communicate with the client and inform them about the omission.
 After discussion with the management the auditor will consider the nature of omission,
whether:
¯ A material misstatement of the other information exists;
¯ A material misstatement of the financial statements exists; or
¯ Auditor’s understanding of entity and its environment needs to be updated.
 If revision of the other information is necessary and management agrees to make the
revision, the auditor shall review the steps taken by management to ensure that
SPOTLIGHT
individuals in receipt of the previously issued financial statements, the auditor’s report
thereon and the other information are informed of the revision.
 If management refuses to make the revision of such other information and the auditor
concludes that revision is necessary, the auditor shall notify those charged with the
governance, but if all of those charged with governance are involved in managing the
entity the auditor may obtain advice from the auditor’s legal counsel
 If the management does not take corrective action to the satisfaction of the auditor, then
under the Companies Act 2017, the auditors are entitled to attend the Annual General
Meeting where they should inform the shareholders themselves.
 The auditor should also seek other means of communication to inform the issue to
shareholders who could not attend the Annual General Meeting.
6.6 Reporting (Ref: 21-24, 52-A58)

Auditor’s report shall include a separate section with a heading “Other Information”, or other appropriate
heading, when, at the date of the auditor’s report:
 Auditor has obtained, or expects to obtain, other information
(For audit of listed entity)
 Auditor has obtained some or all of the other information.
(For audit of other than listed entity)

This section shall include:

 A statement that management is responsible for the other information;
 An identification of other information:
¯ Obtained by auditor prior to date of auditor’s report; and
¯ Expected to be obtained after the date of auditor’s report
(For audit of listed entity)
 A statement that opinion does not cover other information and that the auditor is not expressing an
audit opinion or assurance;
 A description of auditor’s responsibilities relating to reading, considering and reporting on other
information; and
 When other information has been obtained prior to the date of the auditor’s report, either a statement
that:
¯ The auditor has nothing to report; or
¯ Describes uncorrected material misstatement of the other information.
When auditor expresses a qualified or adverse opinion, auditor shall consider implications of matter giving rise
to the modification of opinion for the statement required above in following ways:
AT A GLANCE
Qualified Opinion Consideration may be given as to whether the other information is also materially
(Material Misstatement) misstated for the same matter as, or a related matter to, the matter giving rise to
the qualified opinion.
Qualified Opinion Auditor may need to modify the statement to refer to the inability to consider
(Scope Limitation) management’s description of the matter in other information. Auditor is however
required to report any other identified uncorrected material misstatements.
Adverse Opinion Auditor may need to appropriately modify the statement for example, to indicate
that the other information is materially misstated for the same matter as, or a
related matter
Disclaimer of Opinion Auditor’s report does not include a section addressing the reporting requirements
of this ISA
SPOTLIGHT
While reviewing the draft of the director’s report of NPL you have observed that projections of
future profitability in the director’s report with respect to the Health Care Division show much
higher amounts as compared to the amounts shown in the working related to the impairment of
patents. The CFO has explained that on the basis of prudence and to avoid any overstatement of
intangible assets, projections in the working related to impairment have been kept on the lower
side.
Required:
Evaluate above scenario and explain how auditor should deal with the above situation.
Tutorial Notes:
You should not be satisfied with the client’s policy of making over provision on the basis of
prudence. Another wrong approach towards answering could be to confine yourselves to matters
such as qualifying the report or withdrawing from the audit without considering any efforts to
resolve the situation amicably.
 Solution:
Procedures to deal with the situation:
 Discuss the matter with management and inquire the reason for keeping the projections
on lower side for computing the impairment on patents.

 Convince the management that prudence does not allow deliberate understatement of
assets of the company, therefore the management argument that they have kept the
projections on lower side to avoid any overstatement of patent is not correct.
 However, as the different projection provided in the directors’ report creates doubt as
to reliability of projections provided earlier, therefore the auditor is required to verify
the correctness of both the projections.
 Determine whether revision is required in the financial statements (impairment) or in
the directors’ report.
 If impact on the financial statements is material, then discuss the matter with the
management to adjust the financial statements.
 If the management refuses to amend the financial statements, the auditor shall modify
the opinion in the auditor’s report.
 If the impact on financial statements is not material, the matter may be reported in the
management letter.
 If revision of directors’ report is necessary and management refuses to make the
revision, the auditor shall communicate this matter to those charged with governance
and include in “Other Matter” Para as per ISA 720 (Revised) a statement describing the
uncorrected material misstatement of the other information.
AT A GLANCE

The following situations have arisen at an audit client of your firm:
The directors’ report of XCP Limited states without any further explanation that the 20%increase
in profit as compared to the previous year is due to increase in sales and austerity measures
introduced by the management. The income statement for the year shows an increase in profits
and sales amounting to Rs. 20 million and Rs. 8 million respectively whereas the costs have
reduced by Rs. 12 million. A review of your working papers however indicates that costs have
reduced mainly on account of reduction in import duty on certain raw materials.
Required:
Discuss the matter which the auditor should consider for the above situation and the possible
SPOTLIGHT
impact thereof on the audit report.

 Solution:
If there are material inconsistencies in other information presented with financial statements,
auditor should discuss the reasons thereof with the management and ask them to revise the
other information.
 In case of disagreement, auditor shall communicate the matter to those charged with
governance.
 Include in the “Other Information” Para as per ISA 720 (Revised) a statement describing
the uncorrected material misstatement of the other information.
The draft accounts of Kingfisher Pharmaceutical Limited (KPL) for the year ended September 30,
2010 show a profit before taxation of Rs. 115 million and total assets of Rs. 450 million.
Being the audit manager you are currently reviewing the following matters:
 The directors’ report contains a statement that “current year’s increase in profit before
taxation by over 10% is primarily due to the improved operating performance of the
company”. However, the income statement shows that KPL’s profit before taxation
includes a gain on sale of a factory amounting to Rs. 30 million. In the absence of this
gain, the company would have reported a reduction in operating profit by 19%.

Required: In respect of each of the above matters:

a) State with reasons what action you would take; and
b) discuss the implications on the audit report, if any.
 Solution:
Action/reasons
 The inconsistency between the Directors’ Report and the financial statements is material
to the financial statements.
 The firm should ask the directors to amend the report in line with the financial
statements.
Report implications / modification
If directors refuse to amend their report, then an unqualified opinion on the financial statements
can be issued but include in “Other Matter” Para as per ISA 720 (Revised) a statement describing
the uncorrected material misstatement of the other information. The firm may withhold its
report in such case after obtaining legal advice.
On reviewing the published financial statements of RRK Limited, their auditors, Ahmad Mobeen
AT A GLANCE
and Company, Chartered Accountants, noted the following:
i. It has been mentioned in the directors’ report that a material amount which was
provided as a bad debt had been recovered after year end.
ii. Director’s report states that decline in sales, was due to general economic conditions.
However, the auditors’ feel that it was due to inappropriate strategies adopted by the
management.
iii. A graph in the published report depicted the value of last year’s inventory at Rs.
326million, which according to the corresponding figures given in audited financial
statements amounted to Rs. 250 million.
iv. Directors’ report stated that negotiations for expansion of production facilities by
acquiring a sick unit had been finalized, whereas the auditors have definite information
that the company could not strike the deal.
SPOTLIGHT
Required:
Explain how the auditor should resolve each of the above issues. What steps would the auditor
need to take in case the client does not agree with his recommendations?
 Solution:
i. Evidence of subsequent recovery of long outstanding debt will be evaluated.
If the evidence of recovery is sufficient and appropriate, the financial statements will be
revised and issued to the shareholders along with a fresh auditors’ report.
In case of disagreement with the management on this issue, the auditor will issue a
qualified opinion; and will also take necessary actions to prevent reliance on the
previous report.
If the evidence is not sufficient or appropriate, management will be asked to change the
director’s report.
ii. Reason for decline in sales is a matter of opinion and will have no impact on audit.
iii. The figure presented on graph may be due to typographical mistake, correction of which
should be communicated to the users. However, if the figure is correct on the graph, the
error in previous period will have to be rectified retrospectively. In case of disagreement
opinion will be appropriately qualified.
iv. The matter of acquisition of a sick unit will be discussed with the management, as it is a
material misstatement of fact (although not affecting the financial statements). In case
of disagreement, auditor will seek legal opinion.

6.7 Reporting Prescribed by Law or Regulation (Ref: 24, A59)

If auditor is required by law or regulation of a specific jurisdiction to refer to other information in his report
using a specific layout or wording, report shall refer to ISA only if it includes, at a minimum:
 Identification of other information obtained prior to the date of auditor’s report;
 Description of auditor’s responsibilities for other information; and
 An explicit statement addressing the outcome of auditor’s work for this purpose.

 Documentation of the procedures performed under this ISA; and
 The final version of the other information on which the auditor has performed the work required
under this ISA.
 Illustration 7 - Report of any entity when the auditor has obtained all of other information prior to date of
auditor's report and adverse opinion on consolidated financial statements also affects other information
AT A GLANCE

Adverse Opinion
We have audited the consolidated financial statements of ABC Company and its subsidiaries (the
Group), which comprise the consolidated statement of financial position as at December 31,
20X1, and the consolidated statement of comprehensive income, consolidated statement of
changes in equity and consolidated statement of cash flows for the year then ended, and notes to
the consolidated financial statements, including a summary of significant accounting policies.
In our opinion, because of the significance of the matter discussed in the Basis for Adverse
Opinion section of our report, the accompanying consolidated financial statements do not
present fairly (or do not give a true and fair view of) the consolidated financial position of the
Group as at December 31, 20X1, and (of) its consolidated financial performance and its
SPOTLIGHT
consolidated cash flows for the year then ended in accordance with International Financial
Reporting Standards (IFRSs).
Basis for Adverse Opinion
As explained in Note X, the Group has not consolidated subsidiary XYZ Company that the Group
acquired during 20X1 because it has not yet been able to determine the fair values of certain of
the subsidiary’s material assets and liabilities at the acquisition date. This investment is therefore
accounted for on a cost basis. Under IFRSs, the Group should have consolidated this subsidiary
and accounted for the acquisition based on provisional amounts. Had XYZ Company been
consolidated, many elements in the accompanying consolidated financial statements would have
been materially affected. The effects on the consolidated financial statements of the failure to
consolidate have not been determined.
the Audit of the Consolidated Financial Statements section of our report. We are independent of
the Group in accordance with the ethical requirements that are relevant to our audit of the
consolidated financial statements in [jurisdiction], and we have fulfilled our other ethical
responsibilities in accordance with these requirements. We believe that the audit evidence we
have obtained is sufficient and appropriate to provide a basis for our adverse opinion.

Other Information [or another title if appropriate, such as “Information Other than the
Management is responsible for the other information. The other information comprises the
[information included in the X report, but does not include the consolidated financial statements
and our auditor’s report thereon.]
Our opinion on the consolidated financial statements does not cover the other information and
we do not express any form of assurance conclusion thereon.
In connection with our audit of the consolidated financial statements, our responsibility is to read
the other information and, in doing so, consider whether the other information is materially
inconsistent with the consolidated financial statements or our knowledge obtained in the audit
or otherwise appears to be materially misstated. If, based on the work we have performed, we
conclude that there is a material misstatement of this other information, we are required to
report that fact. As described in the Basis for Adverse Opinion section above, the Group should
have consolidated XYZ Company and accounted for the acquisition based on provisional
amounts. We have concluded that the other information is materially misstated for the same
reason with respect to the amounts or other items in the X report affected by the failure to
consolidate XYZ Company.
AT A GLANCE
Key Audit Matters
in our audit of the consolidated financial statements of the current period. These matters were
addressed in the context of our audit of the consolidated financial statements as a whole, and in
forming our opinion thereon, and we do not provide a separate opinion on these matters. In
addition to the matter described in the Basis for Adverse Opinion section we have determined
the matters described below to be the key audit matters to be communicated in our report.
Responsibilities of Management and Those Charged with Governance for Financial
Statements
SPOTLIGHT
[The engagement partner on the audit resulting in this independent auditor’s report is [name].]
[Auditor Address]
[Date]

7. MIX QUESTIONS - 700 SERIES

You are the audit manager responsible for the audit of Kamran Limited (KL) for the year ended
31 May 2021. On 1 October 2020, KL raised Rs. 400 million by issuing convertible bonds (having
par value of Rs. 100 each). The bonds are convertible to KL’s ordinary shares in 5 years' time at
the option of bond holders. The convertible bonds carry coupon rate of 5% payable on 30
September each year.
KL’s total shareholders’ equity as at 31 May 2021 was Rs. 3,250 million.
Required:
Discuss the reporting implication(s), assuming that KL believes that at least 30% of the bonds
would be converted to equity at the end of year 5 and have therefore recorded Rs. 120 million as
equity and the remaining amount as liability.
 Solution:
Convertible bonds should be accounted for as a compound instrument as they have the
characteristics of both a debt component and an equity component. KL should not take into
AT A GLANCE
account the equity component on the basis of company’s expectation about bond holder’s act. KL
should record the liability, calculated as the net present value of the future cash flow discounted
at the interest rate for a similar non-convertible bond and the remaining amount as equity.
Since the impact is material, the auditor should discuss this matter with the management. If
management agrees to revise the financial statements, then an unmodified opinion will be
expressed. However, if the management disagree the auditor will then have to express a qualified
opinion in this regard and describe the reasons in the basis of qualified opinion paragraph.
Your firm has been appointed as the auditor of Helsinki Limited (HL), a listed company, for the
year ended 30 September 2019. The previous year’s audit was performed by another firm of
chartered accountants who expressed an unmodified opinion. In a recent meeting with the client,
it has been agreed that audit report will be signed on or before 20 December 2019.
SPOTLIGHT
The materiality has been determined at Rs. 10 million. Your audit team has brought the following
significant matters to your notice on the completion of audit field work:
i. A receivable balance of Rs. 6 million with a related party has been identified which has
not been disclosed in the financial statements. HL’s management is of the view that since
the balance is not significant, there is no need to disclose the amount, nature of
transaction and nature of relationship.
ii. While reviewing the previous year’s annual report, your team has noticed that there
were number of reports and analysis which formed part of the annual report. On asking
the management regarding the date when the current year’s information would be
available to the audit team, the management responded that directors’ report would be
provided on 10 December 2019 and all remaining reports would be provided on 18
December 2019.
iii. While reviewing the provision for employees’ compensated absences, the audit team has
noticed that the working is prepared on the basis of basic salary, whereas the employees
are entitled for compensated absences on the basis of gross salary. On further
investigation it is found that the same error was made in the last year as well. The
management has agreed to adjust the entire amount in current year.
Required:
Evaluate the above matters and discuss your firm’s course of action along with implications on
the audit report, if any.

Tutorial Notes:
Important points to consider while answering:
 Don’t forget to mention about including the omitted disclosures in the audit report,
provided it is not prohibited by law, it is practicable to do so and sufficient appropriate
audit evidence has been obtained about the omitted information.
 There is still a possibility that all of the other information may not be provided to the
audit team before the issuance of the audit report.
 The reporting implications if after the correction of the prior period error, the
predecessor auditor is willing to issue a new report or is unwilling to reissue the
auditor’s report on the prior period financial statements.
 Solution:
i. Evaluation
Irrespective of the amount of the related party balance, Fourth Schedule of the
Companies Act 2017 requires to disclose all balances with related parties. Not disclosing
the related party balance would be a non-compliance of the Companies Act 2017 and
will be a material misstatement.
AT A GLANCE
Course of action
Since the non-disclosure would lead to a material misstatement of the financial
statements, we shall discuss the non-disclosure with those charged with governance.
 If the disagreement persists, we shall qualify our audit report;
 Describe in the Basis for Opinion section the nature of the omitted information; and
 Unless prohibited by law or regulation, include the omitted disclosures, provided it
is practicable to do so provided we are able to obtain sufficient appropriate audit
evidence about the omitted information.
ii. Evaluation
Since it has been agreed that the audit report will be issued on or before 20 December,
SPOTLIGHT
there is a possibility that all other information may not be provided if the audit report is
to be issued before 20 December.
Course of action
 Determine through discussion, which document(s) comprises the annual report and
when they would be available.
 Communicate with the management regarding:
- our expectations in relation to obtaining the final version of the annual report
in a timely manner prior to the date of auditor’s report; or
- if that is not possible, as soon as practicable and in any case prior to the entity’s
issuance of such information.
- Request management to provide the written representation regarding the
following:
- Management has informed the auditor of all the documents that it expects to
issue that may comprise other information.
- With regard to other information that has not been obtained by the auditor
prior to the date of the auditor’s report, that management intends to prepare
and issue such other information and the expected timing of such issuance.
 Read the other information which have been timely received and evaluate that
whether it is consistent with the financial statements and the auditor’s knowledge
obtained during the audit.

 If any inconsistency is identified the auditor shall discuss the matter with the
management and if they refuse to make the adjustment, it would be communicated
to those charged with governance and they will be requested to make the correction.
 It also needs to be communicated to the management that in case the other
information is not provided before the date of audit report then it would be
impacted in the following manner:
 It would be mentioned in the other information section of the auditor’s report, the
information which is expected to be made available to us after that date.
 When we read the pending other information and if we conclude that there is a
material misstatement therein, we are required to communicate to those charged
with governance.
 If it is concluded that there is uncorrected material misstatement in other
information, then a statement would be added which describes such misstatement
in the other information section of the audit report.
iii. Evaluation
The prior year financial statements are audited by another auditor who expressed
AT A GLANCE
unmodified opinion. Further, management of HL has accounted for the rectification of

error in the financial statements of the current year, whereas it should have been made
in the previous year. Hence the current year’s profit is understated by the same amount
and corresponding figures/opening balances also contain a material misstatement.
Course of action
 The auditor should ask the management and those charged with governance to
restate the comparative figures and take the effect of the rectification of error
retrospectively.
 Request the management that the predecessor auditor be informed about the prior
year error.
 If the management agrees to make the adjustment retrospectively, an unqualified
opinion will be expressed with an emphasis of matter paragraph giving reasons for
SPOTLIGHT
restatement of figures and a reference to the notes to the financial statements.

 If the management does not agree then the auditor’s report will be qualified due to
the misstatement in current year as well as the corresponding figures/opening
balances.
 If the prior period financial statements are amended, and the predecessor auditor
agrees to issue a new auditor’s report on the amended financial statements of the
prior period, the auditor shall report only on the current period.
 After correction of prior year error, if the predecessor auditor is unable or unwilling
to reissue the auditor’s report on the prior period financial statements, an Other
Matter paragraph of the auditor’s report may indicate that the predecessor auditor
reported on the financial statements of the prior period before amendment.
iv. First year of audit
 Since the financial statements of the prior period were audited by a predecessor
auditor, in addition to expressing an opinion on the current period’s financial
statements, we will state in an Other Matter paragraph:
- that the financial statements of the prior period were audited by a predecessor
auditor;
- the type of opinion expressed by the predecessor; and
- the date of that report


You are the audit partner of Mansoor Noorani and Company, Chartered Accountants. Following
are the audit issues being faced on different clients:
The management of DC Limited has informed you that they have not disclosed a material
litigation relating to an oil spill from its vessel as the disclosure would be detrimental to the legal
defense of the entity.
Required:
Discuss the auditor’s course of action along with implications on the audit report.
 Solution:
In extremely rare cases, if disclosure of some or all of the information required by IFRS can be
expected to prejudice seriously the position of the entity in a dispute with other parties then in
such cases, an entity need not disclose the information.
In the given situation, the auditor should assess whether he agrees with the management’s point
of view in the light of the above guideline. If the auditor does not agree, he should qualify the
audit report. However, if the auditor agrees, he needs to ensure that the management discloses
the general nature of the dispute, together with the fact, and reason why, the information has not
AT A GLANCE
been disclosed, as is further provided in the IFRS. If the directors do not agree to disclose the
general nature of the dispute together with the fact and reason why the information has not been
disclosed, the auditor would need to express a qualified opinion. In case of either type of
disagreement, the auditor needs to describe the nature of the omitted information in the basis
for opinion section.
Moreover, unless prohibited by law or regulation, include the omitted disclosures, provided it is
practicable to do so and the auditor has obtained sufficient appropriate audit evidence about the
omitted litigation.
If proper disclosures are made in the financial statements, auditor should consider including it
in the key audit matter section of the audit report.
SPOTLIGHT
The following information relates to the audit of Apex Fertilizer Limited (AFL) for the year ended
31 March 2018:
 AFL has incurred gross loss which is mainly because AFL’s plant was not running on
optimum capacity due to severe shortage of gas supply from the government. However,
AFL has recently made arrangements with a privately owned company for supply of gas.
Management expects that continuous supply of gas would help AFL to convert its gross
loss into gross profit, although achieving net profit would require more efforts.
 Several instalments of the long term loan appearing on the balance sheet were overdue.
AFL entered into a restructuring agreement with the bank on 7 April 2018 whereby the
outstanding interest has been converted into a loan of three years and principal
payments have also been relaxed. The first payment of principal is now due in July 2019
and the amounts have been reclassified on the basis of the restructuring agreement.
 The method for the depreciation of plant and machinery has been changed from straight
line to units of production method.
 The directors’ report includes the following information:
“We have entered into a gas supply arrangement with Karim Gas Limited from August
2018. A continuous gas supply will help us to attain the optimum production level and
record profits in the next financial year. Furthermore, several cost saving measures have
been taken, as a result of which fixed costs have reduced by 15%.

The company has entered into a restructuring agreement whereby the lenders
considering the potential of the company’s vision and strategies have further extended
and relaxed the terms of future payments. As a result, our liquidity position has
improved which is depicted by a much improved current ratio.”
Required:
i. As the audit manager what issues would you like to discuss with the management in
respect of the above (other than the issue of going concern)?
ii. What could be the possible impact on the audit report if the management does not agree
with your point of view about the issues raised in (a) above?
Tutorial Notes:
The obvious points are easy to pick up but the non-obvious ones require careful reading of the
question supported by sound understanding of the standard. Some points are discussed below:
 Restructuring of loan was agreed after year-end and hence was non adjusting event.
 How total number of units which the plant would produce has been estimated.
 Change in depreciation method is to be accounted for as a change in accounting estimate.
AT A GLANCE
 Solution:
(a) (i)
 We will inform the management that the financial liabilities need to be classified as
current when they are due to be settled with in twelve months after the reporting period.
Agreement to reschedule the loan has been completed after the reporting period and
hence classification between short and long term portions should still be based on the
position prior to restructuring.
 The signing of the restructuring agreement after the reporting date, would needs to be
disclosed as a non-adjusting event.
 It also needs to be discussed how the management has calculated the expected units to
be produced by the plant and whether the change in the depreciation would result in a
fairer presentation of the plant’s utilization. Also ask the management that whether the
SPOTLIGHT
change in the depreciation method has been applied prospectively.

 We will also need to discuss with the management, the need to provide disclosures in
the financial statements with respect to change in accounting estimates.
 It also needs to be brought in the management’s information that any depreciation
method once adopted, needs to be consistently applied.
 Due to the gross loss and the uncertainty of gas supply, we will also have to ask the
management, that whether any exercise for determination of impairment has been
carried out.
 We will also inquire whether arrangement of gas with privately owned company
requires any investment (such as construction of pipeline).
 The directors’ report state that fixed costs have been decreased by 15% due to measures
taken by the management, whereas, a significant portion thereof is due to change in
depreciation method. Hence, it needs to be discussed what measures were taken by AFL
which led to reduction in fixed cost by 15%.
 The directors’ report (other information) states the gas supply arrangement with Karim
Gas Limited will help AFL to attain optimum production level and record profits in next
financial year. However, as per management explanation, it would only help the
company to record gross profit rather than recording net profit. Therefore, there is an
inconsistency between Directors report (other information and management
explanation. If other information is materially misstated, we will request management
to amend the directors’ report in this regard.

 We may have to ask the management to change the directors’ report regarding the
improvement of current ratio, as it was because of the restructuring arrangement which
now needs to be classified as a current liability.
 We will have to inform the management that if the identified material misstatement of
other information is not corrected, it may undermine the credibility of the financial
statements and the auditor’s report thereon. Such material misstatements may
inappropriately influence the economic decisions of the users for whom the auditor’s
report is prepared.
(ii)
 If the loan is not classified as a current liability, we will have to express a qualified
opinion and we will also have to describe the financial effects of the material
misstatement in the basis of opinion section of the report.
 Since the directors’ report forms part of the annual report, a statement that describes
the uncorrected material misstatement of the other information should be included in a
separate section under the heading of “Other information”.
Contingent liabilities
Refer note x to the financial statements.
AT A GLANCE
Key audit matter How our audit addressed the key audit
matter
The assessment of the existence of the Our audit procedures included the following:
present legal obligation, analysis of the
We had discussions with the Company’s legal
probability of the related payment and
advisors in respect of the outcome of the case
determining a reliable estimate, requires
and reasonableness of the disclosure.
significant management’s judgment to
assess whether it should be recognized as We inquired the management and those charged
provisions or disclosing it as a contingent with governance and also reviewed the
liability. subsequent correspondence with the
competitor.
SPOTLIGHT
Due to level of judgement relating to
valuation and presentation of contingent We also involved our legal expert to assess the
liabilities, this is considered to be a key outcome of the case.
audit matter.
We evaluated the adequacy of the disclosure in
We have also assessed it as an area of the financial statements, in particular the
higher assessed risk of material disclosure of the uncertainty in estimation and
misstatement as it could not be measured its quantification.
reliably.

You are the audit manager of Zia Yaqoob & Company Chartered Accountants. You have asked
Aslam, one of the team members assigned on the audit of Black Sugar Limited to draft the audit
report for the year ended 31 May 2018. The extracts from the draft report are as follows:
Adverse Opinion
In our opinion, except for the effects of the matter described in the Basis for Adverse Opinion
section of our report, the accompanying financial statements present fairly, in all material
respects the financial position of the Company as at 31 May 2018, and its financial performance
and its cash flows for the year then ended.

Basis for Adverse Opinion

The Company’s stores and spares consist of capital spares of machineries for smooth and
uninterrupted production of sugar during the crushing season. These are carried at lower of cost
and net realisable value as per IAS–2. The Company’s Chief Financial Officer has refused to
reclassify it as capital stores and spares as per IAS–16 as it would adversely affect the current
ratio, as prescribed by the financial institutions. We verified the Company’s records and
ascertained conclusively the value of the capital spare at Rs. 100 million. Had the management
stated them as capital spares, Non–Current assets would have increased by Rs. 100 million and
consequently Current Assets would have reduced by the same amount.
Emphasis of Matter Paragraph
We draw attention to note 2 to the financial statements, which describes the early adoption of
IFRS–2. However, due to time limitation, certain disclosures required by IFRS–2 could not be
provided in the financial statements. Our opinion is not modified in this respect.
Required:
Critically analyse the audit report drafted by Aslam.
Tutorial Notes:
AT A GLANCE
All the relevant things should be highlighted. It is highly advised to first prepare yourself with
the format of above paragraphs (especially the language and the structure) and then attempt the
question.
 Solution:
Adverse opinion:
 When the auditor expresses an adverse opinion, due to the significance of the matter the
auditor states, that financial statements do not present fairly or give a true and fair view.
The “except for” phrase is used when the auditor expresses a qualified opinion due to
 The auditor also needs to mention the applicable framework, which have not been
complied with.
SPOTLIGHT
 Apparently it seems that in this situation a qualified opinion would have been more
appropriate, since the value of capital spare parts and their depreciation may never
represent a substantial portion of the financial statements.
Basis of adverse opinion:
 Reference of the notes to the financial statements where the relevant information is
disclosed/discussed is missing.
 Aslam has stated that the auditors have conclusively assessed the value of stores at Rs.
100 million which is inappropriate. Audit procedures provide reasonable assurance,
which is less than the absolute assurance implied by the word “conclusively”.
 Instead of mentioning the audit procedure performed, only mentioning the value of
capital stores would have been sufficient. The description of audit procedures is only
provided in the key audit matter section.
 It is not appropriate to give the argument offered by the CFO and use his designation in
the audit report.
 Mentioning the CFO may lead to litigations against the firm for defamation. The word
management or company may have been used instead of CFO.
 The financial effect of the misstatement has also not been completely discussed. If the
capital stores and spares would have been reclassified as per IAS - 16 then they may
have been subject to depreciation resulting in impact on profit after tax and equity.

 Reference to International Accounting Standards has been made in an inappropriate

manner which is against the best practices being followed almost universally. It should
have been ensured that full name of those standards are given rather than their
acronyms.
Emphasis of matter paragraph:
 As per ISA 706 early application (where permitted) of a new accounting standard that
has a material effect on the financial statements may be considered as emphasis of
matter paragraph. However, information related to non-disclosure of information which
results in material misstatement in the financial statements shall not be included in
emphasis of matter paragraph.
 A qualified opinion on the basis of inability to obtain sufficient appropriate audit
evidence should be expressed and in the ‘Basis for opinion section’ the nature of the
omitted information should have been described if practicable.
You are the audit manager at the client Lavender Product Limited (LPL). Your team had proposed
various adjustments including the impairment of a plant. LPL’s CFO has agreed to record all the
adjustments including the impairment loss. However, the CFO is reluctant to disclose in the
AT A GLANCE
financial statements, the circumstances that lead to the impairment of plant and machinery.
Required:
Evaluate the above situation and state the implications on the audit report, if any.
Tutorial Notes:
Matter discussed in the scenario is qualitatively material. Impact on audit report if the client
refuses to make the disclosure is important. Moreover, referring the things towards KAM can also
be discussed while taking proper assumptions
 Solution:
These disclosures are mandatory as they are required by the applicable financial reporting
framework.
SPOTLIGHT
The misstatement in qualitative disclosure could be material, because the disclosure of events
that lead to impairment could influence the economic decision of the users of the financial
statements
Since non-disclosure would lead to a material misstatement of the financial statements that
relates to qualitative disclosures, we shall discuss the non-disclosure with those charged with
governance. If the disagreement persists, we shall qualify our audit report and
 Describe in the Basis for Opinion section the nature of the omitted information; and
 Unless prohibited by law or regulation, include the omitted disclosures, provided it is
practicable to do so provided we are able to obtain sufficient appropriate audit evidence
about the omitted information.
However, if the CFO agrees to disclose the circumstances that led to the impairment of plant and
machinery, then we would need to include a key audit matter paragraph in our audit report.
You have recently completed the audit of Naveed Limited, a listed company. Significant matters
concerning the audit include classification of certain debts as long term. The debt covenants of
the loans have been breached but subsequent to the year end the banks have confirmed verbally
that they will not demand immediate repayment.

Required:
Evaluate the above situation and draft the modification, if required, for inclusion in the audit
report. You may assume necessary details.
Tutorial Notes:
While drafting modification, basis for modification should be included (as the question is not
asking to draft the modified opinion).
 Solution:
 The debts should have been shown as current debts in accordance with terms of loan
agreements.
 The verbal confirmation from the banks cannot be a replacement to avoid showing loans
as current liabilities as nothing is in writing.
 Furthermore, even if the bank confirms it even then it is a subsequent non-adjusting
event as this has been done subsequent to year-end, and on balance sheet there was a
breach of loan covenants.
AT A GLANCE
 In addition to this the period of grace should be atleast of twelve months after the
reporting date within which the Naveed Limited can rectify the breach.
Basis for qualified opinion
As more fully explained in note xx to the financial statements, the debt covenants of the loans as
at 30 June 20XX have been breached by the company. Accordingly, the long term loans reflected
in the statement of financial position of the company amounting to Rs. XXX million should have
been classified as “current liabilities” as the terms of the loan require immediate repayment of
loan in case of breach of debt covenants.
Assume that after performing the audit procedures, the auditor is not satisfied with the valuation
and has finally decided to modify the audit report.
SPOTLIGHT
Required:
Draft an appropriate basis of modification paragraph in the above situation, for inclusion in the
audit report. (Assume necessary details)
Tutorial Notes:
Again be sure not to give opinion paragraph when the requirement is a bit different Going
towards limitation of scope situation would not be appreciated as the auditor had carried out the
necessary audit steps.
 Solution:
BASIS OF MODIFICATION PARAGRAPH:
As stated in Note X to the financial statements it is the company’s policy to value its investment
properties at fair value. However, the value determined by the company of properties located at
Lahore, Islamabad and Peshawar is Rs. 25.4 million, Rs. 30.2 million and Rs. 20.2 million
respectively. The values of respective properties determined by DEF Valuers appointed by our
firm are Rs. 16.2, 19.4 and 15.4 million respectively. Management and its experts are unable to
explain the differences in values and has stated the properties at values determined by the
company. Had the said properties stated at values determined by DEF Valuers, profit before
taxation would have been decreased by Rs. 24.8 million and income tax, net
income/shareholders’ equity would have been reduced by Rs. 7.44 million and Rs. 17.36 million
respectively.


You are the engagement partner on the audit of Mars Limited, for the year ended 30 September
2014.
On commencement of the review of working paper file, the audit manager has informed you that
the audit report would need modification. The following draft modification is available in the file:
“We draw attention to note 10 to the financial statements that fully explains that amount of Rs.
70 million due from Utopia Limited (UL), that is outstanding since September 2013, is not
recoverable as UL is in the process of winding up from 20 December 2013. Therefore, the said
amount has been fully provided for in the financial statements of the current year due to which
the company has incurred loss during the year. As the revenue from UL amounts to 40% of total
revenue of 2013, we are of the view that it is fundamental to users’ understanding of the financial
statements. Our opinion is not qualified in respect of this matter. The financial statements for the
year ended 30 September 2013 were audited by another auditor who expressed an unmodified
opinion on those statements on 25 December 2013.”
The draft financial statements show a loss of Rs. 92.4 million (2013: Profit of Rs. 16.4 million)
and total assets of Rs. 395 million (2013: Rs. 410 million).
Required:
AT A GLANCE
Making necessary assumptions on the basis of the above information, draft an appropriate
modification on any one matter, to be included in the audit report.
 Solution:
As described in note X to the financial statements, the company has recognized the provision of
Rs. 70 million against amount due from Utopia Limited in the current year. We consider that the
said provision should have been recognized in the year 2013. Had a provision been made of the
amount receivable from Utopia Limited, the profit after taxation of year 2013 would have been
reduced by Rs. 70 million and loss after taxation of year 2014 would have been reduced by Rs.
70 million.
In our opinion, except for the effect on the financial statements of the matter referred to in the
SPOTLIGHT
preceding paragraph, the financial statements present fairly the financial position of Mars
Limited as at 30 September 2013 and the results of their operation for the year then ended.
You are the manager responsible for the audit of Health and Beauty Brands Limited (HBBL) for
the year ended 31 March 2014. HBBL has been selling its products through its own retail outlets
only. However, during the year under review, HBBL had entered into an agreement for sale of its
products at JDS, a chain of departmental stores.
Following information is available in respect of the above:
 According to the agreement, JDS would make payments within 30 days of the sale to
customers. Any unsold/expired products would be returned to HBBL.
 The stock sheets provided by JDS to HBBL revealed differences as compared to the
balances appearing in the HBBL’s inventory system. According to JDS these were due to
posting errors in the system of JDS, and have been subsequently corrected. HBBL’s
management is of the view that such differences are not material as compared to sales
made through JDS.
 There is a significant improvement in the operating results of HBBL. The management
considers that the agreement with JDS has played a major role in such improvement.
 The confirmation sent to JDS was not received. Alternatively, audit team had examined
partial payment amounting to 65% of the outstanding balance upto 31 May 2014.

Required:
Discuss with reasons, what course of action you would adopt in the above situation and the
possible impact thereof on the audit report.
Tutorial Notes:
Apart from normal steps, some other important steps like reconciliation of sales, receivables and
inventory related to JDS and possibility of scope limitation on account of inability to obtain
sufficient and appropriate audit evidence should not be missed.
 Solution:
Significant improvements in profits reflects the risk that the revenue and profit in the 2014
financial statements may be significantly overstated.
The following point are needed to be considered in relation to the given situation:
 HBBL’s arrangement with JDS is such that JDS facilitated sales to customers but does not
purchase the inventory itself and HBBL retains title to the product until it is sold to the
final customer.
 HBBL may have knowingly or erroneously, recognize the Sales Revenue on dispatch of
AT A GLANCE
goods to JDS.
 Subsequent recovery of 65% upto 31 May 2014, is also not sufficient appropriate audit
evidence of receivable balance from JDS, because as per the agreement JDS is required
to make the payments within 30 days of sale to customers.
 It is also indicative of the risk that sales/receivable balance is overstated.
 Although, the differences between stock sheets and balances were corrected
subsequently, but it is indicative of a risk that during the year there is a possibility of
wrong posting in the system of JDS, which consequently will result in overstatement/
understatement of sales and stock in trade
In response to the above we would need to carry out the following procedures:
i. Obtain an understanding of when the sales are recorded in the system.
SPOTLIGHT
ii. Enquire the reasons of 65% of subsequent recovery from JDS, and ask for confirmation
from JDS.
iii. Review global reconciliation of Sales, Receivable and stock at JDS.
iv. Assess what type of mistakes were made in the stock posting system at JDS and review
the reconciliations prepared before making the corrections.
Implications on the Audit Report:
 After performing the above procedures if the auditor finds any error in the recording of
sales or receivables, he should ask the client to make appropriate adjustments, failing
which the report may be modified i.e. qualified or adverse depending upon the
materiality of the amounts involved.
 If we are unable to obtain sufficient appropriate audit evidence, as regards the recording
of sales or in relation to receivable from JDS, it will be scope limitation and based on the
materiality and pervasiveness of the matter, the auditor may issue a qualified or
disclaimer of opinion.
Haali Limited has a policy to carry its buildings at revalued amounts. At the balance sheet date
i.e. 31 December 2012, the valuer had finalised the valuation reports of only 3 out of a total of 8
properties. According to these reports these properties were assigned a valuation of Rs. 50
million as against the carrying amount of Rs. 62 million.

Required:
a) Evaluate the above condition and discuss the impact on the audit report in each of the
following situations:
i. The impairment of Rs. 12 million is recorded in the financial statements.
ii. The impairment is not recorded.
b) During the year ended 31 December 2012 Chiragh Limited has changed its policy for
valuation of investment in a subsidiary from the ‘fair value’ to ‘cost’. Had the company
continued with its previous policy for valuation of investment at ‘fair value’, the subject
value would have been reduced by Rs. 50 million.
Required:
Discuss the matters which you should consider in respect of the above situation and the possible
impact thereof on the audit report.
Tutorial Notes:
a) Impact on the audit report if the impairment was recognized and also if the impairment
was not recognized would be an easier target in this question. However other points to
focus can be identifying that revaluing only 3 out 8 properties would not be in
AT A GLANCE
accordance with IAS and that inability to have all the properties revalued represents a
scope limitation.
b) Your answer should cover both aspects i.e. the auditor need to report whether he
concurs with the change or not.
 Solution:
a) As per IAS 16, if an item of property, plant and equipment is revalued, the entire class of
property, plant and equipment to which that asset belongs shall be revalued.
It is not appropriate to incorporate the revised value of only three properties out of eight
as the effect of revaluation of entire class of properties has not been incorporated in the
Impact on audit report
SPOTLIGHT
i. The auditor would need to mention that the recording of impairment restricted to
only 3 properties instead of entire class of assets is not in accordance with the IAS.
Moreover, since the valuation of the other properties has not been completed it
represents scope limitation and therefore the auditor would be required to give a
qualified opinion or a disclaimer, depending upon the materiality of the issue.
ii. The auditor will need to report that the value of three properties at the valuation
date is impaired and to report the amount of impairment. Moreover, since the
valuation of the other properties has not been completed it represents scope
limitation and therefore the auditor would be required to give a qualified opinion or
a disclaimer, depending upon the materiality of the issue.
b) Auditor will ask the management for justification for change in accounting policy from
fair value to cost method.
The auditor shall mention the exception to the consistent application of accounting
policy and a statement that whether they concur with the change in accounting policy or
not.
Moreover, the auditor would need to evaluate whether all the accounting treatment/
disclosures related to the change have been appropriately recorded in accordance with
IAS -8.
If the management is unable to provide reasonable justification for change in accounting
policy than the auditor will issue a qualified or adverse opinion, depending upon the
materiality and pervasiveness of the matter.


The following situations have arisen at different audit clients of your firm:
a) Zafar Technology Limited (ZTL), a listed company, is engaged in the manufacture of
compressors used in electrical appliances. During the conduct of the audit for the year
ended31 March 2012, a team member has discovered a letter dated 18 March 2012 from
Sartaj Electronics Limited (SEL) which states that SEL will not pay the current
outstanding invoices as according to it the compressors supplied by ZTL are of an
incorrect specification.
ZTL’s Technical Director believes that the problem arose due to changes in the design of
appliances produced by SEL and not because of faulty production by ZTL. However, both
the companies have agreed to refer the matter to arbitration.
Sales to SEL account for approximately 25% of the revenue of ZTL and the balance due
from SEL as at 31 March 2012 amounted to Rs. 3.12 million. The profit after taxation of
ZTL is Rs. 25 million with an asset base of Rs. 150 million.
b) IPL is a manufacturer of diversified products and has factories in seven major cities of
the country. The demand for some of its products has been falling and the company
wants to concentrate on its core products only. Consequently, it has decided to close
AT A GLANCE
three of its factories and has made a provision of Rs. 30 million in respect of
redundancies and restructuring. The directors’ report for the year ended 31 May 2012
comprehensively discusses the restructuring plan and states that the factories in Lahore
and Multan would be closed in the months of July and September 2012 respectively. The
third factory will be closed before December 2012 however, location of that factory will
be decided in November 2012.
The profit after taxation of IPL according to its draft financial statements for the year
ended31 May 2012 is Rs. 80 million.
Required:
Discuss the matters which the auditor should consider for each of the above situations
and the possible impact thereof on the respective audit reports.
SPOTLIGHT
Tutorial Notes:
a) Both risks should be highlighted i.e. risk of uncollectibility of the amount and the
possibility of creating a going concern or at least a liquidity issue on account of possible
loss of a major customer. Discussing modification of audit report without discussing the
materiality would not be appreciated. This is important to consider that the result of the
arbitration is not yet known.
b) The students are expected to identify the following aspects:
 The provision of Rs. 30 million is material.
 A constructive obligation existed in respect of the two factories which have been
identified but not for the third factory.
 The auditor would need to see whether the provision pertains to the two factories
for which the constructive obligation exists. If provision had also been made in
respect of the third factory, the related amount would have to be reversed.
 The fact that a third factory would be closed in due course would need to be
disclosed in the financial statements.
 In case of disagreement with the client, a qualified or adverse opinion would be
required.

 Solution:
a)
 Two significant uncertainties exist for ZTL i.e. recoverability of balance due from SEL
and whether the going concern assumption is appropriate in light of the possible
termination of the contract by SEL.
 The Accounts receivable balance is material to the financial statements as it is 12.48%
of profit after tax.
 The possible loss of contract from SEL is material to the financial statements as the
revenue from SEL contributes about 25% of total revenue.
 It appears that the uncertainty relating amount receivable balance and termination of
contract will not be resolved till the time of signing off the financial statements and audit
report.
 If uncertainties are adequately disclosed in the financial statements then an unqualified
opinion can be given, however an emphasis of matter paragraph is to be included in the
auditor’s report to draw user’s attention to the significant uncertainties. In case
appropriate disclosure is not given a qualified opinion or adverse opinion, as
appropriate, should be given.
AT A GLANCE
b)
 A provision of Rs. 30 million has been made in the financial statements and it represents
37.5% of the profit after tax and is material to the financial statements.
 A constructive obligation to restructure arises only when an entity has a detailed formal
plan for the restructuring identifying at least the principal locations affected.
 In this case it is unlikely that a constructive obligation exists in respect of third factory
because the factory which is to be closed is not identified.
 The auditor shall determine whether provision of Rs. 30 million pertains to two factories
which are identified or it pertains to three factories (including one which is not
identified).
 If the provision relates to three factories, auditor will ask the management to adjust the
SPOTLIGHT
amount of provision to reflect the provision for two factories Moreover, the plan for
closure of the third factory should be disclosed.
 If the management refuses to do so, a qualified or adverse opinion may be issued
depending upon the materiality and pervasiveness.
A regulatory body has recently revised certain requirements pertaining to the information to be
disclosed in the financial statements of one of your existing clients. These requirements may be
in conflict with the financial reporting framework being followed by the client.
You have informed the client that in view of the possible conflict, the audit report may require a
modification. However, the client has expressed its reservations over the issue and requested
you to avoid modifying the report.
Required:
Assuming that you decide to modify the audit report, on grounds as you consider appropriate,
draft the basis for modification paragraph to be included in that report.
Tutorial Notes:
The catch of this question is to provide an appropriate and practical example of a situation
whereby the local regulation may be in conflict with the accounting framework. This requires a
sound knowledge of the standard as well as happenings around you.

 Solution:
BASIS FOR MODIFICATION PARAGRAPH
In accordance with the requirement of the XYZ Act 2012, the company is required to disclose the
amount of all the Contingent Assets that existed at the balance sheet date. The Company has not
disclosed the amount of Contingent assets as required under clause XX of the XYZ Act, 2012,
because the inflow of economic benefits was not probable and hence such disclosure would not
be in compliance with the requirements of the International Financial Reporting Framework.
You are the manager responsible for the audit of Hafiz Limited (HL), a listed company, whose
fieldwork in respect of the statutory audit is in progress. You are reviewing the following issues
which were brought to your attention by the audit team:
 HL’s parent company is registered in a foreign country and has asked your firm to also
provide an audit report on a separate set of financial statements which have been
prepared under the accounting framework prevalent in that country.
Required:
Discuss how would you deal with each of the above issues and what may be the implications
AT A GLANCE
thereof on your audit report.

Tutorial Notes:
A common mistake could be not highlighting the need to determine whether the reporting
requirements of other framework are acceptable to the auditor in the prevailing circumstances.
Consequently, the student would also fail to specify that if the framework was acceptable, the
auditor would need to include an “other matter paragraph” in the audit report.
 Solution:
In this case of reporting on more than one set of financial statements, the auditor will need to
determine whether the reporting requirements of other framework are acceptable to the auditor
in the prevailing circumstances.
Impact on Audit Report
SPOTLIGHT
If the framework is acceptable then the auditor will include another matter paragraph in the
auditor’s report, which will include a reference that he has also issued an audit report on another
set of financial statement which has been prepared as per the reporting requirements of a
different accounting framework.
Ranjha Limited (RL), a listed company, is engaged in the manufacture of fast moving consumer
goods. The draft financial statements for the year ended March 31, 2011 show a profit before
taxation of Rs. 12million and total assets of Rs. 300 million.
As the audit manager, you are reviewing the following issues which were brought to your notice
by the audit team:
i. On June 1, 2010 RL acquired a plant at a cost of Rs. 50 million. The plant has a useful life
of 10years with no residual value. RL follows the policy to depreciate the plant on the
straight line method. On January 1, 2011 the plant suffered physical damage due to a fire
in the factory. The technician from the manufacturer has inspected the plant and
reported that the damage has affected its production capacity which has now been
reduced by 30%.
ii. During the year a petition has been filed against RL by one of its customers for recovery
of Rs. 20million, along with mark-up, damages and compensation, on the ground that
materials supplied by RL were defective. RL has filed a written statement in the Court
denying the allegations.

RL’s legal advisor is of the view that the final liability of the company may range from
0% to 50%. However, at this point of time, it is not possible to determine the amount
with reasonable degree of accuracy. No provision in this regard has been made in the
draft financial statements.
iii. In April 2007, RL acquired high-tech production management software for Rs. 10
million. The useful life of the software is 10 years. During the year it was discovered that
in the past the software was erroneously amortized assuming a useful life of 20 years.
The management has decided to adjust the amount short provided, over the remaining useful life
of the software.
Required:
Discuss the matters that may be of significance to you as an auditor in respect of each of the above
issues. Also explain their implication on the audit report.
Tutorial Notes:
i. Issue of impairment in the value of plant and the impact on audit report is to be focused.
ii. The impact of contingent liabilities, its disclosure and an emphasis of matter paragraph
can be the first thought. Onwards the possibility of a disagreement with the
AT A GLANCE
management, on the issue of disclosure, can also be discussed.
iii. A demarcation between change in policy and error as per IAS 08 is the key thing.
 Solution:
i. Significant matter
 In view of the decline in production capacity, it has become necessary to recalculate
the value in use and recoverable amount in order to assess the impairment in the
value of plant.
 The value of plant is material to the financial statements in terms of total assets as
well as profit before tax of the company.
 If the impairment test indicates a decline in the value of plant, the management
SPOTLIGHT
should be advised to make appropriate adjustments.
 In case of disagreement with the management, the auditor should give a qualified
opinion.
ii. Significant matter
 Amount claimed by the customer is material to the financial statements in terms of
total assets as well as profit before tax of the company.
 If management agrees to explain the issue in the note on contingent liabilities, the
report will not be qualified but in view of the material uncertainty an emphasis of
matter paragraph would have to be added to the auditor’s report to draw the user’s
attention to the note in the financial statements.
 In case of disagreement on making appropriate disclosure, the auditor should give
a qualified opinion.
iii. Significant matter
 It is a fundamental error within the meaning of IAS-8 and its effect should be taken
into account retrospectively. All comparatives figures should be restated
accordingly.
 The management’s decision to adjust the short amortization in the future years is in
contravention to the requirements of IAS-8.


 Since the error is material in terms of profit after tax, it should be discussed with the
management. They should be advised to make appropriate adjustment and
disclosure in accordance with the requirements of IAS-8.
 In case of disagreement, the auditor should give a qualified opinion.
The draft accounts of Kingfisher Pharmaceutical Limited (KPL) for the year ended September 30,
2010 show a profit before taxation of Rs. 115 million and total assets of Rs. 450 million.
Being the audit manager you are currently reviewing the following matters:
i. The basis of preparation of financial statements states that these have been prepared in
accordance with the International Financial Reporting Standards. However, the
accounting policy note for borrowing costs states that all borrowing costs are expensed
as incurred. Results of audit tests show that borrowing costs expensed during the year
include Rs. 15million which relate to qualifying assets.
ii. On October 17, 2010 the Income Tax Department issued amended assessment orders
for the tax years 2006 to 2009 in which an aggregate tax of Rs. 40 million has been
demanded. KPL has filed appeals against the orders before the Income Tax Appellate
AT A GLANCE
Tribunal. KPL’s tax consultant has advised that it is not possible at this stage to give a
reasonably accurate estimate of the amount of tax that the company may ultimately be
required to pay but it would range between Rs. 10-35 million. There is no reference of
this matter in the draft financial statements.
Required: In respect of each of the above matters:
a) State with reasons what action you would take; and
b) discuss the implications on the audit report, if any.
 Solution:
i. Action/reasons
 In order to comply with IAS 23, borrowing costs which meet its criteria should be
capitalized.
SPOTLIGHT
 The company’s policy of expensing out the borrowing costs in spite of meeting the
criteria for capitalization is not in accordance with IAS 23 and needs to be changed.
 Costs of Rs. 15 million are material to the income statement, as reducing the
expenses would increase profit by 13%.
 If management agrees to change the accounting policy, the firm should mention the
concurrence statement in audit report that accounting policies have been
consistently applied except for the changes as stated in the relevant notes with
which the auditor concurs.
 If management refuses to capitalize the borrowing costs or to change the accounting
policies, the firm should give a qualified opinion (except for). Reason for the
qualified opinion i.e material disagreement between management and auditors
regarding accounting for borrowing costs, will be explained in “Basis for Qualified
Opinion” paragraph placed before opinion paragraph.
ii. Action/reasons
 The amount involved is material as Rs. 35 million is 30% of profit before tax and 8%
of total assets.
 The firm should request the management to:
¯ provide an amount which is the best estimate of the tax liability.

¯ include a note describing the situation in the financial statements, as the

circumstances give rise to a significant uncertainty which could have an impact
on the financial statements.
 If the management agree to provide for the amount and to include a note explaining
the issue, the report will be modified, but unqualified. An emphasis of matter
paragraph should be added to the report after the opinion section drawing the
user’s attention to the note in the financial statements. There should be a specific
statement that the opinion is not qualified and a brief description of the
circumstances.
 If the management do not agree to make a provision and include a note explaining
the issue, the firm should give a qualified opinion (except for). Reason for the
qualified opinion i.e. material disagreement between management and auditors,
will be explained in “Basis for Qualified Opinion” paragraph placed before opinion
paragraph.
You are the senior responsible for the audit of Iqra Industries Limited (IIL). During the course of
AT A GLANCE
the audit you became aware that a legal action has been instituted against IIL by some of its
customers, on account of disputes related to performance of its products. In response to your
request for an opinion the company’s lawyer has simply stated that “We are totally unable to give
any estimate”.
No provision was made in the financial statements for the possible loss as a result of the claims
(which are considered to be material) or for the related legal expenses, although details of those
legal claims were fully disclosed in the notes.
Required:
Comment on the implication of the above matter on the auditors’ report and the financial
statements of IIL.
 Solution:
SPOTLIGHT
Significant uncertainty regarding litigation The ultimate outcome of the matter cannot presently
be determined and therefore there is a significant uncertainty the resolution of which is
dependent upon future events.
Since it is not possible to reliably estimate the amount of loss accounting treatment of not
recognizing the provision and giving of disclosure is correct.
The auditor should consider modifying the auditor’s report by adding an emphasis of matter
paragraph referring to the detailed note in the financial statements.
You are the senior in charge on the external audit of Brown Limited (BL), a company dealing in
consumer products. The draft financial statements for the year ended December31, 2008 show
profit before tax of Rs. 30.1 million and total assets of Rs. 242.4 million. The following issues have
been identified during the course of the audit:
i. During the year the company incurred costs of Rs. 1.1 million in respect of repairs and
maintenance of its machinery. These costs have been capitalized and included in the
carrying value of property, plant and equipment. The management has refused to make
any adjustments in the financial statement in respect of this matter.
ii. During the year, the company has commercially imported certain branded products
amounting to Rs. 200 million, which are subject to FTR at import stage. The final tax paid
at import stage amounted to Rs. 4 million and the entire amount has been recognized as
expense, in the current period. However, goods costing Rs. 50 million remained unsold
and are included in the stock-in-trade

Required:
Explain the possible effects of the situations described above, on BL’s financial statements for the
year ended December 31, 2008 and discuss the implications thereof, if any, on the audit report.
 Solution:
Effect on Financial Statement Effect on Audit Report
1 Repair and maintenance cost is a revenue  Although there is disagreement over the
expenditure and should be charged to the accounting treatment of the repairs and
profit and loss account. maintenance costs, the amount is not
material as it is only 3.6% of profit
before tax and 0.45% of total assets.
 There is no need to modify the audit
report as long as any unadjusted errors
in aggregate do not exceed the
materiality threshold.
 Matter should be reported in
Management letter.
AT A GLANCE
2 Any tax paid at import stage under FTR  Amount involved is 3.3% of profit
should be recognized as a tax expense in before tax and 0.4% of total assets and
the period in which the related goods are therefore is not material.
sold.  There is no need to modify the audit
Accordingly, the portion of the tax paid report as long as any unadjusted errors
that pertains to the unsold inventory in aggregate do not exceed the
should be carried forward in the balance materiality threshold.
sheet as prepaid tax, subject to the  Matter should be reported in
following conditions: Management Letter unless the error is
rectified
 It is probable that the sale of imported
goods would result in sufficient future
SPOTLIGHT
taxable profits;
 The carry forward of tax shall not
relate to the inventories written
down to net realizable value in
accordance with IAS 2 “Inventories”;
The tax to be carried forward as explained
above shall not constitute value of
inventories.

CHAPTER 12
SPECIAL AUDITS
AT A GLANCE
IN THIS CHAPTER: The International Standards on Auditing (ISAs) in the 100–700
series apply to an audit of complete set of financial
AT A GLANCE statements as per the requirements of a general purpose
financial reporting framework, and are to be adapted as
SPOTLIGHT necessary in the circumstances when applied to audits of other
historical financial information.
1. Special considerations—
audits of financial statements 800 series of the ISAs deals with special considerations where
AT A GLANCE
prepared in accordance with the framework or the financial statements are a bit different
special purpose frameworks from those included in an audit of financial statements as per
(ISA 800) the aforementioned series of 100-700.
ISA-800 deals with special considerations in the application of
2. Special considerations - those ISAs to an audit of financial statements prepared in
audits of single financial accordance with a special purpose framework
statements and specific
elements, accounts or items ISA-805 deals with special considerations in the application of
of a financial statements (ISA those ISAs to an audit of a single financial statement or of a
805) specific element, account or item of a financial statement. The
single financial statement or the specific element, account or
3. Engagements to report on item of a financial statement may be prepared in accordance
SPOTLIGHT
summary financial with a general or special purpose framework. If prepared in
statements (ISA 810) accordance with a special purpose framework, ISA 800 (also
applies to the audit
ISA-810 deals with the auditor’s responsibilities relating to an
engagement to report on summary financial statements derived
from financial statements audited in accordance with ISAs by
that same auditor
These ISAs (i.e. ISA 800, ISA 805, ISA 810) do not override the
requirements of the other ISAs; nor does they purport to deal
with all special considerations that may be relevant in the
circumstances of the engagement

CHAPTER 12: SPECIAL AUDITS CFAP 6: AARS
1. SPECIAL CONSIDERATIONS—AUDITS OF FINANCIAL STATEMENTS

PREPARED IN ACCORDANCE WITH SPECIAL PURPOSE FRAMEWORKS (ISA
800)
This ISA is written in context of a complete set of financial statements prepared in accordance with a special
purpose framework.
 Definition: Special purpose framework

Financial reporting framework designed to meet financial information needs of specific users.
Financial reporting framework may be fair presentation framework or compliance framework.
Examples of special purpose frameworks are:
 A tax basis of accounting for a set of financial statements that accompany an entity’s tax return.
 Cash receipts and disbursements basis of accounting for cash flow information that an entity may be
requested to prepare for creditors.
 Financial reporting provisions established by a regulator.
 Financial reporting provisions of a contract (e.g. a loan agreement).
AT A GLANCE
1.1 Considerations When Accepting the Engagement (Ref: 8, A5-A8)

Auditor shall obtain an understanding of the:
 Purpose for which the financial statements are prepared;
 Intended users; and
 Steps taken by management to determine that applicable financial reporting framework is acceptable in
the circumstances.
Acceptability of the Financial Reporting Framework

 Financial information needs of the intended users are a key factor to consider.
SPOTLIGHT
 Financial reporting standards established by an organization that is authorized or recognized to

promulgate standards for special purpose financial statements will be presumed acceptable.
 Reporting framework prescribed by law or regulation (that area) is also acceptable.
 In case of financial reporting provisions of a contract etc., acceptability of the financial reporting
framework is determined by considering whether the framework exhibits attributes, normally exhibited
by acceptable financial reporting frameworks i.e.:
¯ Relevance
¯ Completeness
¯ Reliability
¯ Neutrality
¯ Understandability
1.2 Considerations When Planning and Performing the Audit (Ref: 9-10 A9-A12)
Auditor shall determine whether application of the ISAs requires special consideration in the circumstances of
this engagement. Such considerations may be:
 Relevant ethical requirements (including those pertaining to independence)
 Considering all ISAs relevant to the audit. (unless entire ISA or a part of it is not relevant)
 Judgments about materiality (ISA 320) would be based on the consideration of financial information
needs of the intended users (not common financial information needs)

CFAP 6: AARS CHAPTER 12: SPECIAL AUDITS
 If financial information is prepared solely for management’s use, Communication with those charged
with governance (ISA 260 etc.) may not be relevant to this audit
In case of financial statements prepared in accordance with the provisions of a contract, auditor shall obtain an
understanding of any significant interpretations of the contract that management made in the preparation of
those financial statements.
1.3 Forming an Opinion and Reporting Considerations (Ref: 11-13, A13-A19)

 Auditor’s report shall also describe the purpose for which the financial statements are prepared and, if
necessary, intended users, or refer to a note in special purpose financial statements that contains so; and
 If management has a choice of financial reporting frameworks, the explanation of management’s
responsibility for the financial statements shall also make reference to its responsibility for determining
that applicable financial reporting framework is acceptable in circumstances.
If financial statements are prepared in accordance with provisions of a contract, auditor shall evaluate whether
financial statements adequately describe any significant interpretations of the contract on which financial
statements are based.
Note: See Appendix for illustrations of auditors’ reports on special purpose financial statements.
AT A GLANCE
Basit and Company, Chartered Accountants has been appointed as auditor of Toys Pakistan
Limited, a subsidiary of a listed company incorporated in China, for the year ended 30 September
2019.
Basit and Company is required to audit following two sets of financial statements:
i. Financial statements prepared to meet the statutory requirements of Pakistan. The audit
report is expected to be issued on 10 December 2019.
ii. Financial statements prepared to meet the requirements of consolidation in China.
These financial statements would only be used by the group management in China. The
framework that has been used for the preparation of these financial statements is a
special purpose framework. The audit report is expected to be issued on 20
December 2019.
SPOTLIGHT
Required:
Discuss the additional matters that Basit and Company may include in its audit report on the
financial statements prepared for consolidation purpose.
Tutorial Notes:
Please mention that other matter paragraph should be included in the audit report to refer the
fact that another set of financial statements has been prepared by the same entity in accordance
with general purpose framework and that the auditor has issued a report on those financial
statements.
 Solution:
The audit report may include the following additional matters:
i. The auditor will include an Other Matter paragraph in the auditor’s report, referring to
the facts that another set of financial statements has been prepared by the same entity
in accordance with general purpose framework and that the auditor has issued a report
on those financial statements.
ii. The auditor’s report on special purpose financial statements shall include an Emphasis
of Matter paragraph alerting users of the auditor’s report that:
 the financial statements are prepared in accordance with a special purpose
framework and that, as a result, the financial statements may not be suitable for
another purpose.

 the auditor’s report is intended solely for the intended users, and should not be
distributed to or used by other parties.
1.4 Alerting Readers that financial statements Are Prepared in Accordance with Special Purpose
Framework (Ref: 14, A20-A21)
Auditor’s report shall include an Emphasis of Matter paragraph (using an appropriate heading) alerting users
of the report that financial statements are prepared in accordance with a special purpose framework (and
that the financial statements may not be suitable for another purpose).
Additionally, auditor may consider it appropriate to indicate that auditor’s report is intended solely for the
specific users. Depending on the law or regulation of the particular jurisdiction, this may be achieved by
restricting distribution or use of the auditor’s report.
AT A GLANCE
SPOTLIGHT

2. SPECIAL CONSIDERATIONS - AUDITS OF SINGLE FINANCIAL STATEMENTS

AND SPECIFIC ELEMENTS, ACCOUNTS OR ITEMS OF A FINANCIAL
STATEMENTS (ISA 805)
This ISA deals with special considerations in the application of ISAs to an audit of a single financial
statement or of specific element, account or item of a financial statement.
Single Financial Statement means any one of the financial statements (e.g. Statement of Financial position).
Examples of Specific element, account or item of a financial statement
 A Schedule of net tangible assets
 Lease disbursement schedule
 Schedule of profit participation or employees’ bonuses
 Accounts receivable, allowance for doubtful accounts receivable, inventory etc.
2.1 Considerations When Accepting the Engagement (Ref: 7, A5-A6)

If the auditor is not also engaged to audit entity’s complete set of financial statements, auditor shall determine
whether audit of single financial statement or of a specific element of those financial statements in accordance
AT A GLANCE
with ISAs is practicable.
Compliance with other ISAs would be impracticable due to:
 Auditor (not being the auditor of complete financial statements) often does not have same
understanding of the entity, its environment and its internal control.
 Auditor also does not have audit evidence about general quality of the accounting records or other
accounting information.
 In the case of an audit of a specific element of a financial statement, complying certain ISAs (e.g. ISA 570)
may not be practicable because of the audit effort required.
If the auditor concludes that an audit of a single financial statement or of a specific element of a financial
statement in accordance with ISAs may not be practicable, the auditor may discuss with management whether
SPOTLIGHT
another type of engagement might be more practicable.
2.2 Acceptability of the Financial Reporting Framework (Ref: 8, A7)

This shall include whether application of financial reporting framework will result in a presentation that
provides adequate disclosures to enable intended users to understand the information conveyed in the financial
statement or the element, and the effect of material transactions and events on the information conveyed in
financial statement or the element.
2.3 Form of Opinion (Ref: 9, A8-A9)

Auditor shall consider whether expected form of opinion is appropriate in the circumstances.
Factors that may affect the auditor’s consideration as to whether to use the phrases “presents fairly, in all material
respects,” or “gives a true and fair view” in the auditor’s opinion include:
 Whether applicable financial reporting framework is explicitly or implicitly restricted to preparation of
a complete set of financial statements.
 Whether single financial statement or the specific element of a financial statement will:
¯ Comply fully with each of relevant requirement of the framework, and presentation of the financial
statement or the element includes the related notes.
¯ If necessary to achieve fair presentation, provide the disclosures beyond those specifically required
by framework or, in exceptional circumstances, depart from that.

2.4 Adopting all ISAs relevant to the audit (Ref: 10, A10-A15)
Auditor shall adapt all ISAs relevant to the audit as necessary in the circumstances of the engagement. Some
considerations are:
 Element could be misstated as a result of fraud (ISA 240), effect of the related party transactions (ISA
550), or incorrect application of the going concern assumption (ISA 570).
 Written representations from management about complete set of financial statements would be
replaced by written representations about the presentation of the financial statement or the element in
accordance with the applicable financial reporting framework.
 When auditing a single financial statement or a specific element of a financial statement in conjunction
with audit of entity’s complete set of financial statements, auditor may be able to use audit evidence
obtained (in complete audit).
 Auditor may not be able to consider the financial statement or the element in isolation. Consequently,
the auditor may need to perform procedures in relation to the interrelated items to meet the objective
of the audit.
 Materiality determined for a single financial statement or for a specific element of a financial statement
may be lower than the materiality determined for the complete financial statements.
Auditor shall apply the requirements in ISA 700 (forming opinion), adapted as necessary in the
AT A GLANCE
circumstances of the engagement.

Appendix 2 contains illustrations of auditors’ reports on a single financial statement and on a specific element
of a financial statement.
2.5 Reporting on both simultaneously
(Entity’s Complete financial statements and on a Single Financial Statement or on a Specific Element)
(Ref: 11-17, A16-A28)
 Auditor shall express a separate opinion for each engagement.
 Audited single financial statement or element may be published together with audited complete set of
SPOTLIGHT
¯ If auditor concludes that presentation of single financial statement or element does not
differentiate it sufficiently from complete set of financial statements, auditor shall ask management
to rectify the situation.
¯ Auditor shall also differentiate the opinion on single financial statement or element from the
opinion on complete set of financial statements.
¯ Auditor shall not issue auditor’s report containing the opinion on the single financial statement or
element until satisfied with the differentiation.
Modification (Opinion/Other) in the Auditor’s Report on Complete Set of financial statements

Auditor shall determine the effect that this may have on the auditor’s report on a single financial statement or on
a specific element of those financial statements.
If deemed appropriate, auditor shall accordingly add modification in the report of single financial statement or
element of a financial statement (If the auditor judges it to be relevant to the users’ understanding).
If auditor concludes that it is necessary to express adverse opinion or disclaim an opinion on complete set of
financial statements as a whole,
 ISA 705 does not permit the auditor to include in the same auditor’s report an unmodified opinion on a
single financial statement or element.
 If auditor considers it appropriate to express an unmodified opinion on any element, auditor shall only
do so if:

¯ The auditor is not prohibited by law or regulation from doing so;

¯ That opinion is expressed in an auditor’s report that is not published together with the auditor’s
report containing the adverse opinion or disclaimer of opinion; and
¯ That element does not constitute a major portion of the complete set of financial statements.
Auditor shall not express an unmodified opinion on single financial statement of a complete set of financial
statements if auditor has expressed an adverse opinion or disclaimed an opinion on the complete set of
financial statements as a whole. (Even if report on single financial statement is not published together with
complete one. This is because a single financial statement is deemed to constitute a major portion of those
financial statements).
Expression of a disclaimer of opinion regarding the results of operations and cash flows, where relevant and an
unmodified opinion regarding the financial position is permitted (ISA 705).
The statutory auditor of Mighty Limited (ML) has expressed an adverse opinion in the audit
report on the financial statements of ML for the year ended 30 June 2012. After the issuance of
the annual report, ML has approached the auditor for reporting on the trade debts of the
company as on 30 June 2012. This report is required for submission to the bank which has
provided financing facilities to ML. The audit working papers reveal that the trade debts have
AT A GLANCE
been reported correctly in the financial statements.
Required: Discuss what may be the auditor’s response in the above situation.
Tutorial Notes:
Key point to remember is that there is no bar on issuing an unmodified opinion on a specific
element of a financial statement even when an adverse opinion had been given on the same
financial statements, however you should mention all the conditions which the auditor would be
subject to while expressing such an opinion.
 Solution:
If the auditor is satisfied with the valuation of trade debts, he may issue an unmodified opinion
on the element, even if he has expressed an adverse opinion on the entity’s complete set of
SPOTLIGHT
financial statements as a whole.
However, an unmodified opinion is permitted, subject to the following conditions:
 The auditor is not prohibited by law or regulation from issuing separate opinion on
specific element of financial statements.
 The opinion expressed on specific element is not to be published with the auditor’s
report containing the adverse opinion.
 The trade debts balance does not constitute major portion of the entity’s complete set of
The auditor may refer to the adverse opinion on the complete set of financial statements in the
other matter paragraph in the audit report on trade receivables, when the auditor judges it to be
relevant to the users’ understanding of the audited element or the related audit report.
In the other matter paragraph, it is also to be stated that the report is intended solely for the
Bankers of ML and should not be distributed to parties other than bankers of ML.

3. ENGAGEMENTS TO REPORT ON SUMMARY FINANCIAL STATEMENTS (ISA

810)
Applied criteria: Criteria applied by management in the preparation of the summary financial
statements.
Summary financial statements: Historical financial information that is derived from financial
statements but that contains less detail than financial statements, while still providing a
structured representation consistent with that provided by the financial statements of
entity’s economic resources or obligations at a point in time or the changes therein for a period
of time. Different jurisdictions may use different terminology to describe such historical financial
information.
3.1 Conditions for Engagement Acceptance (Ref: 5-7, A1-A7)

Auditor shall accept an engagement to report on summary financial statements only when auditor has been
engaged to conduct an audit of the financial statements from which the summary financial statements are derived.
Before accepting an engagement to report on summary financial statements, auditor shall:
AT A GLANCE
 Determine whether the applied criteria are acceptable;

 Obtain agreement of management that it acknowledges and understands its responsibility:
¯ For preparation of summary financial statements in accordance with applied criteria;
¯ To make audited financial statements available to the intended users of summary financial
statements without undue difficulty (or, if prohibited by law or regulation so to do; describe that
law or regulation in the summary financial statements that also establishes the criteria); and
¯ To include auditor’s report on summary financial statements in any document that contains
summary financial statements and that indicates that the auditor has reported on them.
 Agree with management the form of opinion to be expressed on summary financial statements.
If above conditions are not present, auditor shall not accept engagement, unless required by law or
SPOTLIGHT
regulation to do so. Accordingly, auditor’s report on summary financial statements shall not indicate that
engagement was conducted in accordance with this ISA.
Acceptability of the Criteria

Factors that may affect auditor’s determination of acceptability of the applied criteria include:
 The nature of the entity;
 The purpose of the summary financial statements;
 The information needs of the intended users of the summary financial statements; and
 Whether the applied criteria will result in summary financial statements that are not misleading.
Criteria for preparation of summary financial statements may be established by an authorized or recognized
standards setting organization or by law or regulation. Auditor may presume that such criteria are acceptable.
Where any established criteria do not exist, criteria may be developed by management. It would be
acceptable if it will result in preparation of summary financial statements that:
 Adequately disclose their summarized nature and identify the audited financial statements;
(e.g. “Summary financial statements Prepared from Audited financial statements for the Year Ended
December 31, 20X1”)
 Clearly describe from whom or where the audited financial statements are available;

(If law or regulation provides that audited financial statements need not be made available to the
intended users and establishes the criteria for preparation of summary financial statements; that law or
regulation).
 Adequately disclose the applied criteria;
 Agree with or can be recalculated from the related information in the audited financial statements; and
 Contain the information necessary, and are at an appropriate level of aggregation, so as not to be
misleading in the circumstances.
You are the engagement partner of Ghalib Limited (GL) whose audit report for the year ended 31
December 2015 was issued on 20 February 2016. The management of GL has now approached
your firm to report on summary financial statements pertaining to the same period.
Required:
Discuss the nature of risks involved in carrying out/reporting on such assignment.
Tutorial Notes:
Some common mistakes while attempting this question by the students could be mentioning:
1 The assignment cannot be undertaken because of restrictions imposed by code of ethics,
AT A GLANCE
listing regulations, etc.
2 It involves conflict of interest.
3 It involves self-review threat.
Students are advised to refer to solution for proper guidance on this Question.
 Solution:
 Summary financial statements are prepared to criteria and there is a risk that criteria
applied may not be adequately disclosed or financial statements may not be prepared as
per the criteria.
 Because summary financial statements by their nature contain aggregated information
and limited disclosure, there is an increased risk that they may not contain the
information necessary so as not to be misleading in the circumstances.
SPOTLIGHT
 The summary financial statements may be used for purposes other than the stated
purpose.
 As the summary financial statements are dated later than the audited financial
statements there is a risk of non-inclusion of effects of events subsequent to the date of
auditor’s report on the audited financial statements.
 The unaudited supplementary information presented with summary financial
statements may not be clearly differentiated from the summary financial statements.
 Risk of inconsistency in other information presented in documents containing summary
 The risk that documents containing the summary financial statements may not contain
the auditor’s report on the summary financial statements.
Your firm has been approached by Agar Products Limited for audit of accounts receivable and
accounts payable reported in the financial statements. The financial statements were prepared
in accordance with the general purpose framework and is audited by another firm of chartered
accountants.
Required:
Discuss the matters you would consider before accepting the above assignment.
(Ignore the ethical considerations for the acceptance of the audit)

Tutorial Notes:
 It is important to note that it is mentioned in the requirement to ignore the ethical
considerations, so it should not be covered in the solution.
 Consider the fact that in the case of an audit of a specific element of a financial statement,
certain ISAs require audit work that may be disproportionate to the element being
audited.
 This is worth to mention that if it is concluded that an audit of a single financial
statement or of a specific element of a financial statement in accordance with ISAs may
not be practicable, then the auditor may discuss with management whether another type
of engagement might be more practicable.
 Solution:
Following matters will be considered before accepting the assignment:
i. If we are not engaged in the audit of entity’s complete set of financial statements, then
we shall determine whether the audit of a specific element of those financial statements
in accordance with ISAs is practicable because compliance with the requirements of ISAs
relevant to the audit of a single financial statement or of a specific element of a financial
statement may not be practicable.
AT A GLANCE
ii. We might not have the same understanding of the entity and its environment, including
its internal control, as an auditor who also audits the entity’s complete set of financial
statements.
iii. We do not have the audit evidence about the general quality of the accounting records
or other accounting information that would be acquired in an audit of the entity’s
complete set of financial statements. Accordingly, we may need further evidence to
corroborate audit evidence acquired from the accounting record.
iv. In the case of an audit of a specific element of a financial statement, certain ISAs require
audit work that may be disproportionate to the element being audited.
v. If we conclude that an audit of a single financial statement or of a specific element of a
financial statement in accordance with ISAs may not be practicable, then we may discuss
SPOTLIGHT
with management whether another type of engagement might be more practicable.
3.2 Nature of Procedures (Ref: 8, A8)

Auditor shall perform the following procedures, and any other procedures that the auditor may consider necessary,
as the basis for the auditor’s opinion on the summary financial statements:
 Evaluate whether summary financial statements
¯ Adequately disclose their summarized nature and identify the audited financial statements.
¯ Adequately disclose the applied criteria.
¯ Are prepared in accordance with the applied criteria.
¯ Contain information necessary, and are at an appropriate level of aggregation, so as not to be
misleading in the circumstances.
 Compare summary financial statements with related information in audited financial statements to
determine whether summary financial statements agree with or can be recalculated from related
information in audited financial statements.
 When summary financial statements are not accompanied by audited financial statements, evaluate
whether they describe clearly:
¯ From whom or where the audited financial statements are available; or
¯ Law or regulation that specifies that the audited financial statements need not be made available
to the intended users of the summary financial statements and establishes the criteria for
preparation of those.

Auditor should also evaluate whether the audited financial statements are available to intended users of the
summary financial statements without undue difficulty, unless law or regulation provides otherwise. Important
factors to be considered are whether:
 Summary financial statements describe clearly from whom or where the audited financial statements
are available;
 The audited financial statements are on public record; or
 Management has established a process by which the intended users of the summary financial statements
can obtain ready access to the audited financial statements.
3.3 Form of Opinion (Ref: 9-11, A9)

Auditor’s opinion shall, unless required by law or regulation, use one of the following phrases:
 Summary financial statements are consistent, in all material respects, with audited financial statements,
in accordance with [applied criteria]; or
 Summary financial statements are a fair summary of audited financial statements, in accordance with
[applied criteria].
(Selecting from above 2 depends upon generally accepted practice in that particular jurisdiction)
AT A GLANCE
If law or regulation prescribes a different wording, the auditor shall:
 Apply the regular as well as additional procedures to reach the prescribed opinion; and
 Evaluate whether users of summary financial statements might misunderstand auditor’s opinion
 Evaluate whether additional explanation in report can mitigate possible misunderstanding.
If auditor concludes that additional explanation cannot mitigate possible misunderstanding:
 Auditor shall not accept engagement, unless required by law or regulation to do so.
 Auditor’s report on summary financial statements shall not indicate that engagement was conducted in
accordance with this ISA.
Modified Opinion on the Summary financial statements
SPOTLIGHT
If summary financial statements are not consistent, in all material respects, with or are not a fair summary
of audited financial statements, in accordance with applied criteria, and management does not agree to make
the necessary changes, the auditor shall express an adverse opinion on the summary financial statements.
3.4 Timing of Work and Events Subsequent to the Date of Auditor’s Report on Audited financial
statements (Ref: 12-13, A10)
Auditor’s report on summary financial statements may be dated later than date of auditor’s report on audited
financial statements. If so, auditor’s report on summary financial statements shall state that summary financial
statements and audited financial statements do not reflect the effects of events that occurred subsequent to date of
auditor’s report on audited financial statements
Auditor may become aware of facts that existed at date of auditor’s report on audited financial statements
but of which the auditor previously was unaware. In such cases, auditor shall not issue auditor’s report on
summary financial statements until consideration of such facts in relation to audited financial statements in
accordance with ISA 560 has been completed.
On 25 March 2019, your firm issued the audit report on the financial statements of Noor Limited
(NL) for the year ended 31 December 2018. During the first week of June 2019, NL’s management
has requested you to issue the report on summarized financial statements for the year ended 31
December 2018 for the use of its potential investor after incorporating the effect of a material
litigation decided in favor of NL on 31 May 2019.

Required:
Discuss your firm’s responsibility in respect of gathering the audit evidence and issuing a report
on summarized financial statements.
Tutorial Notes:
It is important to note that this question in its core is not only about adjusting event or non-
adjusting event and how to amend the original financial statements, it’s mainly about the
requirements of ISA 810 in that specific case of subsequent event.
 Solution:
When the auditor reports on the summary financial statements after the completion of the audit
of the financial statements, the auditor is not required to obtain additional audit evidence on the
audited financial statements, or report on the effects of events that occurred subsequent to the
date of the auditor’s report on the audited financial statements since the summary financial
statements are derived from the audited financial statements and do not require updating.
The auditor’s report on the summary financial statements may be dated later than the date of the
auditor’s report on the audited financial statements. In such cases, the auditor’s report on the
summary financial statements shall state that the summary financial statements and audited
AT A GLANCE
financial statements do not reflect the effects of events that occurred subsequent to the date of
the auditor’s report on the audited financial statements that may require adjustment of, or
disclosure in, the audited financial statements.
3.5 Elements of Auditor’s Report on Summary financial statements (Ref: 16-20, A5-A23)
 A title clearly indicating it as the report of an independent auditor
 Appropriate addressee (may be different than those of Audit report on audited financial statements)
 An introductory paragraph that:
¯ Identifies the summary financial statements, including the title of each statement included in it
¯ (e.g. page numbers may be mentioned on which the summary financial statements are presented)
¯ Identifies the audited financial statements
SPOTLIGHT
¯ Refers to auditor’s report on audited financial statements, date of that report and the fact that an
unmodified opinion is expressed on the audited financial statements
¯ If date of the auditor’s report on summary financial statements is later than date of auditor’s report
on audited financial statements, states that summary financial statements and audited financial
statements do not reflect the effects of events that occurred subsequent to date of auditor’s report
on the audited financial statements; and
¯ A statement indicating that summary financial statements do not contain all the disclosures
required by the financial reporting framework applied in preparation of audited financial
statements, and that reading summary financial statements is not a substitute for reading the
audited financial statements.
 A description of management’s responsibility for preparation of the summary financial statements in
accordance with the applied criteria.
 A statement that auditor is responsible for expressing an opinion on summary financial statements
based on the procedures required by this ISA.
 A paragraph clearly expressing an opinion
 Auditor’s signature.
 Date of auditor’s report.
 Auditor’s address

The auditor shall date auditor’s report on summary financial statements no earlier than:
 Date on which auditor has obtained sufficient appropriate evidence, including evidence that summary
financial statements have been prepared and those with recognized authority have asserted that they
have taken responsibility for them; and
 Date of the auditor’s report on audited financial statements.
Restriction on Distribution or Use or Alerting Readers to the Basis of Accounting

When distribution or use of auditor’s report on audited financial statements is restricted, or auditor’s report
on audited financial statements alerts readers that these are prepared in accordance with a special purpose
framework, auditor shall include a similar restriction or alert in auditor’s report on summary financial statements.
3.6 Modifications in the Auditor’s Report on the Audited financial statements (Ref: 21-22, A23)
Qualified opinion, emphasis of matter para or other matter para

If auditor is satisfied that the summary financial statements requires unmodified opinion, auditor’s report on
summary financial statements shall also:
 State that auditor’s report on audited financial statements contains such a modification; and
AT A GLANCE
 Describe:
¯ The basis for such modification in the auditor’s report on the audited financial statements; and
¯ The effect thereof on summary financial statements (if any)
Adverse opinion or a disclaimer of opinion

Auditor’s report on summary financial statements shall also:
 State that auditor’s report on audited financial statements contains an adverse opinion or a disclaimer;
 Describe the basis for that adverse opinion or disclaimer of opinion; and
 State that, as a result of the adverse opinion or disclaimer of opinion, it is inappropriate to express an
opinion on the summary financial statements.
SPOTLIGHT
Ghulam Limited (GL) is a listed company. You have issued an audit report on GL’s financial
statements for the year ended 30 June 2011. In November 2011, the management of GL has
approached your firm to provide a report on their summary financial statements for the year
ended30 June 2011.
Following information is available:
i. The audit report on the annual financial statements had been qualified on account of
management’s failure to capitalize borrowing costs of Rs. 15 million, on the construction
of a building for GL’s own use. The building is in use of the company since January 2011.
ii. Under a local regulation which has recently been introduced, you are required to issue a
report on the summary financial statements. However, there are no established criteria
for the preparation of summary financial statements. The management has developed
the criteria but which is not acceptable to you.
iii. The summary financial statements include a note which explains the reasons for decline
in the profitability of the company. You concur with the reasons given in the note but it
did not form part of the annual audited financial statements.
Required
Evaluate each of the above situations considering them to be independent of each other and
discuss what measures would you take in each case.

 Solution:
i. If audit report on the audited financial statements contains a qualified opinion but the
summary financial statements are consistent with the audited financial statements, the
audit report on the summary financial statements shall:
 state that the audit report on the audited financial statements contains a qualified
opinion;
 describe the basis for the qualified opinion on the audited financial statements and
that qualified opinion.
 describe the effect of the qualification in the audited financial statements, on the
summary financial statements.
ii. Since it is necessary under the local regulation to report on the summary financial
statements, but the applied criteria are not acceptable, we would:
 Make appropriate reference of this fact in the terms of engagement.
 Indicate in the audit reports that the engagement was not conducted in accordance
with the International Standard on Auditing.
 Reconsider whether the firm may continue to accept the engagement to audit the
statutory financial statements.
AT A GLANCE
iii. We would ask the management to change the presentation of the note explaining the
reasons for decline in profitability, in such a way that it is clearly differentiated from the
If the management does not agree to change the presentation, the audit report on the
summary financial statements shall disclose the fact that the said information is not
covered by that report.
3.7 Comparatives (Ref: 23-24, A24-A25)

If audited financial statements contain comparatives, but summary financial statements do not, the auditor shall
determine whether such omission is reasonable (user may expect same comparatives in summary).
If summary financial statements contain comparatives that were reported on by another auditor, auditor’s report
SPOTLIGHT
on summary financial statements shall also contain the matters required by ISA 710.
3.8 Unaudited Supplementary Information Presented with Summary financial statements (Ref: 25, A26)
Auditor shall evaluate whether any unaudited supplementary information presented with summary financial
statements is clearly differentiated from summary financial statements.
 If that is not clearly differentiated from summary financial statements, auditor shall ask management to
change the presentation of unaudited supplementary information.
 If management refuses to do so, auditor shall explain in auditor’s report on summary financial
statements that such information is not covered by that report.
Other Information in Documents Containing Summary financial statements

Auditor shall read other information included in a document containing the summary financial statements and
related auditor’s report to identify material inconsistencies, if any
 If auditor identifies a material inconsistency, he shall determine whether the summary financial
statements or the other information needs to be revised.
 If auditor becomes aware of an apparent material misstatement of fact, the auditor shall discuss the
matter with management.

3.9 Auditor Association (Ref: 26-27, A27)

 If auditor becomes aware that entity plans to state that auditor has reported on summary financial
statements in a document containing summary financial statements, but does not plan to include
auditor’s report, auditor shall request management to include the auditor’s report in the document.
 If management does not do so, auditor shall determine and carry out other appropriate actions designed
to prevent management from inappropriately associating the auditor with the summary financial
statements in that document. These actions may include:
¯ Informing intended users and other known third-party users of the inappropriate reference to the
auditor.
¯ Considering legal advice.
 Auditor may be engaged to report on the financial statements of an entity, while not engaged to report
on summary financial statements. If, in this case, auditor becomes aware that entity plans to make a
statement in a document that refers to the auditor and the fact that summary financial statements are
derived from the financial statements audited by the auditor, auditor shall be satisfied that:
¯ Reference to auditor is made in the context of auditor’s report on the audited financial statements;
and
¯ Statement does not give the impression that auditor has reported on the summary financial
AT A GLANCE
statements.
 Alternatively, entity may engage the auditor to report on the summary financial statements and include
the related auditor’s report in the document.
 If none of the above conditions are satisfied, auditor shall determine and carry out other appropriate
actions (discussed above).
Saleem & Company, Chartered Accountants is the statutory auditor of Duo Limited (DL). The
management of DL has prepared summary financial statements, which have been derived from
DL’s statutory financial statements for the year ended 31 December 2020. The management
intends to make a statement that the summary financial statements have been derived from the
financial statements for which audit report was issued by Saleem & Company on 25 February
SPOTLIGHT
2021.
Required:
Discuss whether DL can include such a statement in the summary financial statements and the
course of action that the firm should take in this regard.
 Solution:
Yes, the client may make such a statement in the summary financial statements. But since the
auditor was not engaged to report on the summary financial statements, the auditor should be
satisfied that:
 the reference to the auditor is made in the context of the auditor’s report on the audited
financial statements; and
 the statement does not give the impression that the auditor has reported on the
If the above requirements are not met, the auditor shall ask the management to change the
statement to meet the requirement or not to refer the auditor in the document.
If the management does not take the requested action, the auditor may:
 consider informing the intended users and other known third parties about the in-
appropriate reference.
 consider seeking legal advice regarding the firm’s rights and obligations in this regard.

AT A GLANCE
SPOTLIGHT

CHAPTER 13
REVIEW ENGAGEMENTS
AT A GLANCE
IN THIS CHAPTER:
ISRE-2400 deals with practitioner’s responsibilities when
engaged to perform a review of historical financial statements,
AT A GLANCE
when the practitioner is not the auditor of the entity’s financial
statements.
SPOTLIGHT
This ISRE does not address a review of an entity’s financial
1. Engagements to Review Historical statements or interim financial information performed by a
Financial Statements (ISRE practitioner who is the independent auditor of the entity’s
AT A GLANCE
2400) financial statements.
A review engagement is an evidence-based engagement in
2. Review of Interim Financial
which the practitioner obtains limited assurance to support a
Information (ISRE 2410)
conclusion on the financial statements. When an audit of
financial statements is not required, a review engagement may
3. Due diligence engagements
be required by law or regulation or can be voluntarily
undertaken.
The auditor who is engaged to perform a review of interim
financial information should perform review in accordance with
ISRE-2410.
Objective of an engagement to review interim financial
SPOTLIGHT
information is to “enable the auditor to express a conclusion
whether, on the basis of the review, anything has come to the
auditor’s attention that causes the auditor to believe that the
interim financial information is not prepared, in all material
respects, in accordance with an applicable financial reporting
framework”.

CHAPTER 13: REVIEW ENGAGEMENTS CFAP 6: AARS
1. ENGAGEMENTS TO REVIEW HISTORICAL FINANCIAL STATEMENTS (ISRE

2400)
This ISRE deals with practitioner’s responsibilities when engaged to perform a review of historical financial
statements, when the practitioner is not the auditor of the entity’s financial statements.
This ISRE does not address a review of an entity’s financial statements or interim financial information
performed by a practitioner who is the independent auditor of the entity’s financial statements.
1.1 Conduct of a Review Engagement in Accordance with this ISRE (Ref: 18-20)
Practitioner shall:
 Have an understanding of the entire text of this ISRE, including its application and other explanatory
material, to understand its objectives and to apply requirements properly.
 Comply with each requirement of this ISRE, unless a requirement is not relevant to the review
engagement.
 Not represent compliance with this ISRE in practitioner’s report unless practitioner has complied with
all the requirements of this ISRE relevant to the review engagement.
AT A GLANCE
1.2 Ethical Requirements (Ref: 21)

Practitioner shall comply with relevant ethical requirements, including independence.
1.3 Professional Skepticism and Professional Judgment (Ref: 22-23)

Practitioner shall:
 Plan and perform the engagement with professional skepticism recognizing that circumstances may
exist that cause the financial statements to be materially misstated.
 Exercise professional judgment in conducting a review engagement.
1.4 Engagement Level Quality Control (Ref: 24-28)

SPOTLIGHT
Engagement partner shall possess competence in assurance skills and techniques and competence in financial
reporting, appropriate to the engagement circumstances.
Engagement partner shall take responsibility for:
 Overall quality of each review engagement to which that partner is assigned;
 Direction, supervision, planning and performance of review engagement in compliance with
professional standards and applicable legal and regulatory requirements;
 Practitioner’s report being appropriate in the circumstances; and
 Engagement being performed in accordance with firm’s quality control policies, including:
¯ Being satisfied that appropriate procedures regarding acceptance and continuance of client
relationships and engagements have been followed.
¯ Being satisfied that engagement team collectively has appropriate competence and capabilities,
including assurance skills and techniques and expertise in financial reporting.
¯ Taking responsibility for appropriate engagement documentation being maintained.
Engagement partner shall remain alert for evidence of non-compliance with relevant ethical
requirements by members of the engagement team. If matters come to the engagement partner’s attention
through firm’s system of quality control or otherwise indicating non-compliance, engagement partner shall
determine the appropriate action.

CFAP 6: AARS CHAPTER 13: REVIEW ENGAGEMENTS
Relevant Considerations after Engagement Acceptance

If engagement partner obtains information that would have caused the firm to decline the engagement had that
information been available earlier, engagement partner shall communicate that information promptly to firm
for necessary actions.
Monitoring
A process designed to provide firm with reasonable assurance that policies & procedures relating to system
of quality control are relevant, adequate and operate effectively. Engagement partner shall consider the
results of monitoring process, as evidenced in latest information circulated by firm and impact of deficiencies
noted in that information.
1.5 Acceptance and Continuance of Client and Review Engagements (Ref: 29-35)
Unless required by law or regulation, practitioner shall not accept a review engagement if:
 Practitioner is not satisfied that:
¯ There is a rational purpose for the engagement; or
¯ A review engagement would be appropriate in the circumstances;
AT A GLANCE
 Practitioner has reason to believe that relevant ethical requirements will not be satisfied;
 Practitioner’s preliminary understanding of engagement indicates that the information needed to
perform review engagement is likely to be unavailable or unreliable;
 Management’s integrity is in doubt, likely to affect proper performance of the review; or
 Management or those charged with governance impose a scope limitation in terms of proposed review
engagement that may result in the practitioner disclaiming a conclusion on the financial statements.
Preconditions for Accepting a Review Engagement

Determine whether financial reporting framework is acceptable including, in the case of special purpose
financial statements, obtaining an understanding of the purpose for which the financial statements are prepared
and of the intended users; and
SPOTLIGHT
Obtain agreement of management that it acknowledges and understands its responsibilities:
 For preparation and fair presentation of financial statements in accordance with applicable financial
 For necessary internal control to enable the preparation of financial statements; and
 To provide the practitioner with:
¯ Access to all information of which management is aware that is relevant to preparation of the
financial statements, such as records, documentation and other matters;
¯ Additional information that practitioner may request from management; and
¯ Unrestricted access to persons within entity from whom the practitioner determines it necessary to
obtain evidence.
If practitioner is not satisfied as to any precondition:
 He shall discuss the matter with management or those charged with governance.
 If they are unable to satisfy him, he shall not accept the proposed engagement unless required by law or
regulation.
 He shall then not include any reference of compliance with ISRE in his review report.
If it is discovered after acceptance of engagement that any of the precondition is not present, practitioner shall
discuss matter with management or those charged with governance and shall determine:

 Whether the matter can be resolved;

 Whether it is appropriate to continue with the engagement; and
 Whether and, if so, how to communicate the matter in the report.
Wording of Practitioner’s Report Is Prescribed by Law or Regulation

 Practitioner shall evaluate whether users might misunderstand assurance obtained from review and, if
so, whether additional explanation can mitigate possible misunderstanding.
 If additional explanation in report cannot mitigate possible misunderstanding, he shall not accept review
engagement unless required by law or regulation to do so.
 He shall then not include any reference of compliance with ISRE in his review report.
1.6 Terms of Engagement (Ref: 36-41)

Practitioner shall agree terms with management or those charged with governance prior to performing
engagement. Agreed terms shall be recorded in an engagement letter or other suitable form of written
agreement and shall include:
 Intended use and distribution of financial statements, and restrictions on use or distribution, if any;
AT A GLANCE
 Identification of applicable financial reporting framework;

 Objective and scope of the review engagement;
 Responsibilities of the practitioner;
 Responsibilities of management;
 A statement that it is not an audit and practitioner will not express an audit opinion; and
 Reference to expected form and content of the report to be issued and a statement that there may be
circumstances in which report may differ from expected form and content.
Recurring Engagements
Practitioner shall evaluate whether circumstances require the terms of engagement to be revised and
whether there is a need to remind management or those charged with governance of the existing terms.
SPOTLIGHT
Acceptance of a Change in the Terms of the Review Engagement

Practitioner shall not agree to a change in terms without any reasonable justification.
If before completion, practitioner is requested to change engagement to an engagement for which no assurance
is obtained, he shall ask for any reasonable justification.
If terms are changed during the engagement, practitioner and management or those charged with governance
shall agree on and record new terms in an engagement letter etc.
1.7 Communication with Management and those charged with governance (Ref: 42)
Practitioner shall communicate with management or those charged with governance on a timely basis during
the course of review, all matters concerning the engagement that are of sufficient importance to merit the
attention of management or those charged with governance.
1.8 Performing the Engagement (Ref: 43-49)
Materiality
Practitioner shall determine materiality for the financial statements as a whole, and apply this materiality in
designing the procedures and in evaluating the results obtained from those procedures.
Practitioner shall revise materiality for the financial statements as a whole in the event of becoming aware of any
information during the review that would cause him to decide a different amount.

Practitioner’s Understanding
Obtain an understanding of entity and its environment, and financial reporting framework, to identify areas
in financial statements where material misstatements are likely to arise. Understanding shall include
following:
 Relevant industry, regulatory and other external factors including the applicable financial reporting
framework;
 Nature of the entity, including:
¯ Its operations;
¯ Its ownership and governance structure;
¯ The types of investments that the entity is making and plans to make;
¯ The way that the entity is structured and how it is financed; and
¯ The entity’s objectives and strategies;
 Entity’s accounting systems and accounting records; and
 Entity’s selection and application of accounting policies.
Designing and Performing Procedures
AT A GLANCE
Practitioner shall design and perform inquiry and analytical procedures:
 To address all material items in the financial statements, including disclosures; and
 To focus on addressing areas in the financial statements where material misstatements are likely to
arise.
Practitioner’s inquiries of management and others within entity shall include the following:
 How management makes significant accounting estimates required under applicable financial reporting
framework;
 Identification of related parties and related party transactions, including their purpose;
 Whether there are significant, unusual or complex transactions, events or matters that have affected or
may affect the entity’s financial statements, including:
SPOTLIGHT
¯ Significant changes in entity’s business activities or operations;
¯ Significant changes to terms of contracts that materially affect entity’s financial statements,
including terms of finance and debt contracts or covenants;
¯ Significant journal entries or other adjustments to the financial statements;
¯ Significant transactions occurring or recognized near the end of the reporting period;
¯ Status of any uncorrected misstatements identified during previous engagements; and
¯ Effects or possible implications of transactions or relationships with related parties.
 The existence of any actual, suspected or alleged:
¯ Fraud or illegal acts affecting the entity; and
¯ Non-compliance with provisions of laws and regulations having a direct effect on the
determination of material amounts and disclosures in financial statements.
 Whether management has identified and addressed events occurring between date of financial
statements and date of practitioner’s report that require adjustment of or disclosure in the financial
statements;
 Basis for management’s assessment of the entity’s ability to continue as a going concern;
 Whether there are events or conditions that appear to cast doubt on going concern;

 Material commitments, contractual obligations or contingencies that have affected or may affect the
entity’s financial statements, including disclosures; and
 Material non-monetary transactions or transactions for no consideration in the financial reporting
period under consideration.
In designing analytical procedures, practitioner shall consider whether data from entity’s accounting system
& accounting records are adequate for performing these procedures.
1.9 Procedures to Address Specific Circumstances (Ref: 50-57)
Related parties
During review, practitioner shall remain alert for arrangements or information that may indicate existence of
related party relationships or transactions that management has not previously identified or disclosed to the
practitioner.
If practitioner identifies significant transactions outside the entity’s normal course of business, he shall inquire
of management about:
 Nature of those transactions;
 Whether related parties could be involved; and
AT A GLANCE
 The business rationale (or lack thereof) of those transactions.
Going concern
In considering management’s assessment of entity’s ability to continue as a going concern, practitioner shall
cover the same period as that used by management to make its assessment.
If, during review, practitioner becomes aware of events or conditions that may cast significant doubt about the
entity’s ability to continue as a going concern, practitioner shall:
 Inquire of management about plans for future actions and about the feasibility of those plans, and also
whether management believes the outcome will improve the situation;
 Evaluate results of those inquiries, to consider whether it provide a sufficient basis to:
¯ Continue to present the financial statements on going concern basis; or
SPOTLIGHT
¯ Conclude whether financial statements are materially misstated, or are otherwise misleading
regarding the entity’s ability to continue as a going concern; and
 Consider management’s responses in light of all relevant known information.
Reconciling the financial statements to the Underlying Accounting Records

Practitioner shall obtain evidence that the financial statements agree with or reconcile to these records.
Fraud and non-compliance with laws or regulations

When there is an indication that fraud or non-compliance with laws or regulations, or suspected fraud or
non-compliance, has occurred in the entity, the practitioner shall:
 Communicate that matter to appropriate level of senior management or those charged with governance;
 Request management’s assessment of the effect(s), if any, on the financial statements;
 Consider the effect, if any, on the practitioner’s conclusion and on the report; and
 Determine whether there is a responsibility to report the occurrence or suspicion of fraud or illegal acts
to a party outside the entity.
Use of work performed by others

If practitioner uses work performed by another practitioner or an expert, he shall take appropriate steps to be
satisfied that work performed is adequate for practitioner’s purposes.

Additional Procedures
If practitioner becomes aware of a matter(s) that causes the financial statements to be materially misstated,
practitioner shall design and perform additional procedures sufficient to enable him to decide whether the
matter(s) is or is not likely to cause the financial statements to be materially misstated
1.10 Subsequent Events (Ref: 58-60)

If practitioner becomes aware of any such events occurring between date of financial statements and date of
report, practitioner shall request management to correct those misstatements.
He has no obligation to perform any procedures after date of report.
If, after date of report but before date of issuance of financial statements, a fact becomes known to the
practitioner that, had it been known to the practitioner at date of report, may have caused the practitioner to
amend the report, the practitioner shall:
 Discuss the matter with management or those charged with governance, as appropriate;
 Determine whether the financial statements need amendment; and
 If so, inquire how management intends to address the matter in the financial statements.
If management does not amend the financial statements (where practitioner believes they need to be amended),
and report has already been provided to the entity, practitioner shall notify management and those charged with
AT A GLANCE
governance not to issue the financial statements to third parties before amendments
If financial statements are however subsequently issued without necessary amendments, practitioner shall take
appropriate action to seek to prevent reliance on his report.
1.11 Written Representations (61-65)

Practitioner shall request management to provide written representation that management has fulfilled its
responsibilities described in terms of engagement. it shall include that:
 Management has fulfilled its responsibility for the preparation and fair presentation of the financial
statements in accordance with the applicable and has provided the practitioner with all relevant
information and access to information; and
 All transactions have been recorded and are reflected in the financial statements.
SPOTLIGHT
 Practitioner shall also request written representations that management has disclosed:
 Identity of related parties and all known related party relationships and transactions;
 Significant facts relating to any frauds or suspected frauds known to management;
 Known actual or possible non-compliance with laws and regulations;
 All information relevant to use of the going concern assumption in the financial statements;
 That all events occurring subsequent to the date of the financial statements and for which the applicable
financial reporting framework requires adjustment or disclosure, have been adjusted or disclosed;
 Material commitments, contractual obligations or contingencies that have affected or may affect the
entity’s financial statements, including disclosures; and
 Material non-monetary (or for no consideration) transactions undertaken by the entity
If management does not provide 1 or more of written representations, practitioner shall:
 Discuss the matter with management and those charged with governance, as appropriate;
 Re-evaluate the integrity of management, and evaluate the effect that this may have on the reliability of
representations (oral or written) and evidence in general; and
 Take appropriate actions, including determining the possible effect on the conclusion in the
practitioner’s report in accordance with this ISRE.

Practitioner shall disclaim a conclusion, or withdraw from engagement if possible under applicable law or
regulation, as appropriate, if:
 Practitioner concludes that there is sufficient doubt about the integrity of management; or
 Management does not provide the required representations.
The date of written representations shall be as near as practicable to, but not after, the date of practitioner’s
report. It shall be for all financial statements and period(s) referred to in the report.
1.12 Evaluating Evidence Obtained from the Procedures Performed (Ref: 66-68)
Practitioner shall evaluate whether sufficient appropriate evidence has been obtained
If practitioner is not able to obtain sufficient appropriate evidence to form a conclusion, he shall discuss with
management and those charged with governance, the effects of such scope limitations on review
Practitioner shall evaluate the evidence to determine the effect on practitioner’s report.
1.13 Forming the Practitioner’s Conclusion on the financial statements (Ref: 69-71)
In forming the conclusion on the financial statements, the practitioner shall:
 Evaluate whether financial statements adequately refer to or describe the applicable financial reporting
AT A GLANCE
framework;
 Consider whether, in the context of requirements of financial reporting framework and the results of
procedures:
¯ Terminology used in financial statements, including the title of each financial statement, is
appropriate;
¯ financial statements adequately disclose the significant accounting policies selected and applied;
¯ Accounting policies selected and applied are consistent with financial reporting framework and are
appropriate;
¯ Accounting estimates made by management appear reasonable;
¯ Information in financial statements appears relevant, reliable, comparable, and understandable; and
SPOTLIGHT
¯ financial statements provide adequate disclosures to enable intended users to understand the
effects of material transactions and events on the information conveyed in the financial statements.
Practitioner shall consider the impact of:
 Uncorrected misstatements identified during review, and in previous year’s review; and
 Qualitative aspects of entity’s accounting practices, including indicators of possible bias in
management’s judgments.
In case of a fair presentation framework, practitioner’s consideration shall also include:
 Overall presentation, structure and content of the financial statements in accordance with financial
reporting framework; and
 Whether financial statements, including related notes, appear to represent the underlying transactions
and events in a manner that achieves fair presentation or gives a true and fair view
1.14 Form of the Conclusion (Ref: 72-85)
Unmodified Conclusion
Practitioner shall express an unmodified conclusion when the practitioner has obtained limited assurance to be able
to conclude that nothing has come to his attention that causes him to believe that the financial statements are not
prepared, in all material respects, in accordance with financial reporting framework. Practitioner shall, unless
otherwise required by law or regulation, use one of the following phrases, as appropriate:

 “Based on our review, nothing has come to our attention that causes us to believe that the financial
statements do not present fairly, in all material respects (or do not give a true and fair view), … in
accordance with the applicable financial reporting framework,” (fair presentation framework); or
 “Based on our review, nothing has come to our attention that causes us to believe that the financial
statements are not prepared, in all material respects, in accordance with the applicable financial
reporting framework,” (compliance framework).
Modified Conclusion
Practitioner shall express a modified conclusion when:
 financial statements are materially misstated; or
 Practitioner is unable to obtain sufficient appropriate evidence.
When the practitioner modifies the conclusion expressed on the financial statements, he shall:
 Use heading “Qualified Conclusion,” “Adverse Conclusion” or “Disclaimer of Conclusion,” as appropriate,
for the conclusion paragraph in the practitioner’s report; and
 Provide a description of the matter giving rise to the modification, under an appropriate heading in a
separate paragraph in report immediately before conclusion paragraph.
AT A GLANCE
Financial statements are materially misstated
If practitioner determines that financial statements are materially misstated, the practitioner shall express:
 A qualified conclusion, when effects of the matter(s) are material, but not pervasive; or
 An adverse conclusion, when effects of the matter(s) are both material and pervasive.
When practitioner expresses a qualified conclusion because of a material misstatement, he shall, unless
otherwise required by law or regulation, use one of the following phrases:
 “Based on our review, except for the effects of the matter(s) described in the Basis for Qualified
Conclusion paragraph, nothing has come to our attention that causes us to believe that the financial
SPOTLIGHT
accordance with the applicable financial reporting framework,” (fair presentation framework); or
 “Based on our review, except for the effects of the matter(s) described in the Basis for Qualified
When practitioner expresses an adverse conclusion, he shall, unless otherwise required by law or regulation, use
one of the following phrases, as appropriate:
 “Based on our review, due to the significance of the matter(s) described in the Basis for Adverse
Conclusion paragraph, the financial statements do not present fairly, in all material respects (or do not
give a true and fair view), … in accordance with the applicable financial reporting framework,” (fair
presentation framework); or
 “Based on our review, due to the significance of the matter(s) described in the Basis for Adverse
Conclusion paragraph, the financial statements are not prepared, in all material respects, in accordance
with the applicable financial reporting framework,” (compliance framework).
In basis for conclusion paragraph, in relation to material misstatements, practitioner shall:
 Describe and quantify financial effects of the misstatement if the material misstatement relates to
specific amounts in the financial statements (including quantitative disclosures), unless impracticable,
in which case the practitioner shall so state;

 Explain how disclosures are misstated if material misstatement relates to narrative disclosures; or
 Describe nature of omitted information if the material misstatement relates to the non-disclosure of
information required to be disclosed.
Inability to obtain sufficient appropriate evidence
If practitioner is unable to form a conclusion on the financial statements due to inability to obtain sufficient
appropriate evidence, he shall:
 Express a qualified conclusion if possible effects could be material but not pervasive; or
 Disclaim a conclusion if possible effects could be both material and pervasive.
Practitioner shall withdraw from the engagement if following conditions are present:
 Due to a limitation on scope of review imposed by management after the practitioner has accepted the
engagement, practitioner is unable to obtain sufficient appropriate evidence;
 Practitioner has determined that the possible effects on financial statements of undetected
misstatements are material and pervasive; and
 Withdrawal is possible under applicable law or regulation.
AT A GLANCE
When practitioner expresses a qualified conclusion due to inability to obtain sufficient appropriate evidence,
practitioner shall use one of the following phrases, as appropriate:
 “Based on our review, except for the possible effects of the matter(s) described in the Basis for Qualified
accordance with applicable financial reporting framework,” (fair presentation framework); or
 “Based on our review, except for the possible effects of the matter(s) described in the Basis for Qualified
SPOTLIGHT
When disclaiming a conclusion, the practitioner shall state in the conclusion paragraph that:
 Due to significance of the matter(s) described in Basis for Disclaimer paragraph, he is unable to obtain
sufficient appropriate evidence to form a conclusion on the financial statements; and
 Accordingly, the practitioner does not express a conclusion on the financial statements.
1.15 The Practitioner’s Report (Ref: 86-92)

Practitioner’s report shall be in writing, and shall contain the following elements:
 A title, clearly indicating that it is report of an independent practitioner for a review;
 Addressee(s), as required by the circumstances of the engagement;
 An introductory paragraph that:
¯ Identifies title of each of the statements contained in the set of financial statements and date and
period covered by each financial statement;
¯ Refers to the summary of significant accounting policies and other explanatory information; and
¯ States that the financial statements have been reviewed.
 A description of responsibility of management for the preparation of financial statements, including an
explanation that management is responsible for:

¯ Their preparation in accordance with applicable financial reporting framework including its fair
presentation;
¯ Such necessary internal control to enable preparation of financial statements.
 If the financial statements are special purpose financial statements:
¯ A description of the purpose for which financial statements are prepared and, if necessary, the
intended users, or reference to a note in special purpose financial statements that contains that
information; and
¯ If management has a choice of financial reporting frameworks in preparation of such financial
statements, a reference within the explanation of management’s responsibility for the same.
 A description of practitioner’s responsibility to express a conclusion on the financial statements
including reference to this ISRE and, where relevant, applicable law or regulation;
 A description of a review of financial statements and its limitations, and the following statements:
¯ A review engagement under this ISRE is a limited assurance engagement;
¯ He performs procedures, primarily consisting of making inquiries of management and others and
AT A GLANCE
applying analytical procedures, and evaluates evidence obtained; and
¯ Procedures performed in a review are substantially less than audit conducted in accordance with
ISAs, and, accordingly, practitioner does not express an audit opinion.
 A paragraph under the heading “Conclusion” that contains:
¯ Practitioner’s conclusion on the financial statements as a whole; and
¯ A reference to applicable financial reporting framework used to prepare financial statements.
 When the practitioner’s conclusion on the financial statements is modified:
¯ A paragraph under appropriate heading that contains modified conclusion; and
¯ A paragraph, under an appropriate heading, that provides a description of matter(s).
SPOTLIGHT
 A reference to his obligation under ISRE to comply with relevant ethical requirements;
 The date of the practitioner’s report;
 The practitioner’s signature; and
 The location in the jurisdiction where the practitioner practices.
Emphasis of Matter Paragraphs

Practitioner may consider it necessary to draw users’ attention to a matter presented or disclosed in the financial
statements that, in his judgment, is of such importance that it is fundamental to users’ understanding of the
Such paragraph shall refer only to information presented or disclosed in the financial statements.
Practitioner’s report on special purpose financial statements shall include Emphasis of Matter paragraph alerting
users that financial statements are prepared in accordance with special purpose framework.
Practitioner shall include an Emphasis of Matter paragraph immediately after paragraph that contains the
practitioner’s conclusion on the financial statements under the heading “Emphasis of Matter,” or other
appropriate heading.

Other Matter Paragraphs

If practitioner considers it necessary to communicate a matter other than those that are disclosed in the
financial statements that, in his judgment, is relevant to users’ understanding, practitioner’s responsibilities
or report and this is not prohibited by law or regulation, the practitioner shall do so in a paragraph with the
heading “Other Matter” or other appropriate heading.
Other Reporting Responsibilities

A practitioner may be requested to address other reporting responsibilities in report that are in addition to
practitioner’s responsibilities under this ISRE. Those responsibilities shall be addressed in a separate section
in report headed “Report on Other Legal and Regulatory Requirements,” or otherwise as appropriate, after the
section of “Report on the financial statements.”
Vulture Limited (VL) is planning to acquire 100% shares in Sparrow (Private) Limited (SPL)
which is a small company and is not required to have a statutory audit. In order to satisfy VL
about the company’s financial statements, the directors of SPL have appointed your firm, Pigeon
&Company, Chartered Accountants, to undertake a review engagement. According to the terms
of engagement, your firm is required to review SPL’s financial statements for the year ended
AT A GLANCE
September 30, 2010 and provide a report to the directors.

While performing the review you have observed that SPL has not carried out a physical inventory
count as at September 30, 2010. SPL’s inventory records were last updated on August 31, 2010.
The valuation of inventory was based on quantities determined by the store manager using the
goods receipt and dispatch notes that he had kept since the last count. However, he is not
confident that all goods receipt and dispatch notes have been recorded. Your firm has not been
able to verify the quantity of inventory through any other means. The carrying amount of
inventory is material to SPL’s financial statements.
Required:
Draft a review report on the financial statements, for submission to the directors of SPL.
Tutorial Notes:
SPOTLIGHT
Special care must be given while drafting the qualifications. Moreover, you are required to draft
complete report including all contents like title, date, place etc.
 Solution:
Review Report to the Directors
We have reviewed the accompanying balance sheet of Sparrow (Private) Limited at September
30, 2010 and the income statement, statement of changes in equity and cash flow statement for
the year then ended. These financial statements are the responsibility of the Company’s
management. Our responsibility is to issue a report on these financial statements based on our
review.
We conducted our review in accordance with the International Standard on Review
Engagements 2400. This standard requires that we plan and perform the review to obtain
moderate assurance as to whether the financial statements are free of material misstatement. A
review is limited primarily to inquiries of company personnel and analytical procedures applied
to financial data and thus provides less assurance than an audit. We have not performed an audit,
and, accordingly, we do not express an audit opinion.
The Management did not carry out a physical stock taking of inventories which are valued at Rs.
____ in the accompanying financial statements, as of September 30, 2010. We were unable to
satisfy ourselves regarding inventory quantities by means of other review procedures.

The financial statement of Parrot (Private) Limited for the year ended September 31, 2009 was
unaudited.
Based on our review, except for the financial effects of any adjustments that might have been
determined to be necessary had the management carried out physical stock taking as of
September 30, 2009 or applied appropriate alternate procedures to account for inventory value
in the financial statements , nothing has come to our attention that causes us to believe that the
accompanying financial statements are not presented fairly, in all material respects in
accordance with the International Financial Reporting Standards.
City
Date of Report
Pigeon & Co.
Chartered Accountants
1.16 Documentation (Ref: 93-96)

Practitioner shall document following aspects in a timely manner, sufficient to enable an experienced
AT A GLANCE
practitioner, having no previous connection with engagement, to understand:
 The nature, timing and extent of the procedures performed to comply with this ISRE and applicable legal
and regulatory requirements;
¯ Who performed the work and the date such work was completed; and
¯ Who reviewed the work performed and the date and extent of the review?
 Results obtained from procedures, and practitioner’s conclusions formed; and
 Significant matters arising during the engagement, the conclusions reached, and the significant
professional judgments made in reaching those conclusions.
Practitioner shall also document discussions with management, those charged with governance, and relevant
others of significant matters arising during the engagement, including the nature of those matters.
SPOTLIGHT
If information is identified that is inconsistent with the practitioner’s findings regarding significant matters affecting
the financial statements, the practitioner shall document how the inconsistency was addressed.

2. REVIEW OF INTERIM FINANCIAL INFORMATION (ISRE 2410)

2.1 Differences between ISRE 2400 & ISRE 2410
ISRE 2400 ISRE 2410

Words used for Reviewer Practitioner Auditor
Status of the Reviewer Practitioner is not the auditor of the Same Auditor who performed
entity’s financial statements audit of financial statements
Period of financial statements Full Year Interim
Note: If a practitioner is appointed to perform review of interim financial information and is not the auditor of
the entity, would perform the review in accordance with ISRE 2400.
2.2 Introduction, Objective and General Principles (Ref: 1-9)

The auditor who is engaged to perform a review of interim financial information should perform review in
accordance with this ISRE.
Objective of an engagement to review interim financial information is to “enable the auditor to express a
AT A GLANCE
conclusion whether, on the basis of the review, anything has come to the auditor’s attention that causes
the auditor to believe that the interim financial information is not prepared, in all material respects, in
accordance with an applicable financial reporting framework”.
GENERAL PRINCIPLES
 Should comply with the ethical requirements.
 Should implement quality control procedures.
 Plan & perform review with an attitude of professional scepticism.
2.3 Agreeing the Terms of the Engagement (Ref: 10-11)

 Objective of a review.
SPOTLIGHT
 Scope of the review.

 Management’s responsibility for interim financial information.
 Management’s responsibility for effective internal control.
 Management’s responsibility for making all financial records and related information available.
 Management’s agreement to provide written representations.
 Anticipated form, content and addressee of report to be issued.
 Management’s agreement that review report will be included in the document claiming that interim
financial information has been reviewed.
2.4 Procedures for a Review of Interim Financial Information (Ref: 12-29)

 Understanding Entity and Environment, Including Internal Control
 Reading documentation of related preceding year’s audit & reviews.
 Considering significant risks, including risk of management override of controls,
identified in latest audit.
 Considering materiality with reference to applicable financial reporting framework.
 Considering nature of any corrected material misstatements and any identified
uncorrected immaterial misstatements in prior year’s financial statements.
 Considering significant financial accounting and reporting matters.

 Considering results of any audit procedures performed this year.

 Considering results of any internal audit performed and subsequent actions taken by
management.
 Inquiring management about results of management’s risk assessment due to fraud.
 Inquiring management about effect of changes in business activities.
 Inquiring management about significant changes in internal control and potential effect
on preparation of interim financial information.
 Inquiring management of the process by which interim financial information has been
prepared and reliability of accounting records.
 Inquiries and Other Review Procedures
 Reading minutes of meetings of shareholders, those charged with governance, and other
appropriate committees and inquiring about matters dealt with at meetings for which
minutes are not available.
 Considering effect of matters giving rise to a modification of report identified in previous
audit or reviews.
 Communicating with other auditors performing review of entity’s significant
components.
AT A GLANCE
 Inquiring of members of management responsible for financial and accounting matters,
and others as appropriate about following:
¯ Whether interim financial information has been prepared and presented in
accordance with applicable financial reporting framework.
¯ Whether there have been any changes in accounting principles or in the methods of
applying them.
¯ Whether interim financial information contains any known uncorrected
misstatements.
¯ Unusual or complex situations e.g. a business combination.
¯ Whether related party transactions have been appropriately accounted for and
disclosed in interim financial information.
SPOTLIGHT
¯ Significant changes in commitments and contractual obligations.
¯ Significant changes in contingent liabilities including litigation.
¯ Compliance with debt covenants.
¯ Questionable Matters.
¯ Significant transactions occurring in last several days of interim period or the first
several days of the next interim period.
¯ Knowledge of any fraud or suspected fraud affecting entity involving Management,
Employees or any Others.
¯ Knowledge of any allegations of fraud, or suspected fraud, communicated by
employees, former employees, analysts, regulators, or others.
¯ Knowledge of any actual or possible noncompliance with laws.
¯ Significant assumptions relevant to fair value measurement or disclosures and
management’s intention and ability to carry out specific courses of action on behalf
of the entity.
 Analytical Procedures (Appendix 2)
 Comparing interim financial information with:
¯ Immediately preceding interim periods.
¯ Management expectation for current period.
¯ Most recent audited annual financial statements.

¯ Anticipated results, such as budgets or forecasts.

¯ Relevant non-financial information.
 Comparing recorded amounts, or ratios with auditor’s expectations
 Comparing ratios and indicators with entities in same industry.
 Performing horizontal ratio analysis.
 Comparing disaggregated data.
¯ By period.
¯ By product line or source of revenue.
¯ By location, for example, by component.
¯ By single or several attributes of the transaction.
¯ Auditor should obtain evidence that interim financial information agrees or
reconciles with underlying accounting records.
¯ Auditor should inquire whether management has identified all subsequent events.
It is not necessary for auditor to perform other procedures to identify events after
date of review report.
¯ Auditor should inquire whether management has changed its assessment of going
AT A GLANCE
concern.
¯ If there are significant doubt on going concern assumption, auditor should:
o Inquire management as to its plans for future actions, feasibility of these plans,
and whether they believe that the outcome of these plans will improve the
situation.
o Consider adequacy of disclosure about such matters.
2.5 Evaluation of Misstatements (Ref: 30-33)

Auditor should evaluate, individually and in aggregate, whether uncorrected misstatements that have come to
the auditor’s attention are material to the interim financial information.
SPOTLIGHT
2.6 Management Representations (Ref: 34-35)

 Acknowledges its responsibility for internal control;
 information is prepared and presented in accordance with applicable financial reporting framework;
 Believes that effect of uncorrected misstatements is immaterial;
 Disclosed to auditor all significant facts relating to frauds;
 Disclosed to auditor the results of its risk assessment;
 Disclosed to auditor all known actual or possible noncompliance with laws and regulations;
 Disclosed to auditor all subsequent events requiring adjustment.
2.7 Auditor’s Responsibility for Accompanying Information (Ref: 36-37)

Should read other information that accompanies interim financial information to consider materially
inconsistency (if any).
If materially inconsistency comes to auditor’s attention, auditor should discuss the matter with the entity’s
management.
2.8 Communication (Ref: 38-42)

 When auditor believes that it is necessary to make a material adjustment to interim financial
information, auditor should communicate this matter to appropriate level of management.
 When management does not respond appropriately within a reasonable period of time, auditor should
inform those charged with governance.

 If those charged with governance do not respond appropriately, auditor should consider:
¯ Whether to modify the report.
¯ Possibility of withdrawing from engagement.
¯ Possibility of resigning from appointment to audit.
 When auditor finds existence of fraud or noncompliance of laws, auditor should communicate to
appropriate level of management.
 Auditor should communicate relevant matters of governance interest arising from the review to those
2.9 Reporting the Nature, Extent and Results of the Review (Ref: 43-63)
Contents of Report:
 An Appropriate title.
 An Addressee, as required by circumstances of engagement.
 Identification of interim financial information reviewed, including title of each statement and date and
period covered.
 A statement that management is responsible for Preparation and (fair) presentation of interim financial
information in accordance with applicable financial reporting framework.
AT A GLANCE
 Auditor’s responsibility for expressing a conclusion.
 That review was conducted in accordance with ISRE 2410, and a statement that that review consists of
making inquiries and applying analytical and other review procedures.
 That a review is substantially less in scope than an audit and accordingly no audit opinion is expressed.
 A conclusion.
 Date of the report.
 Location in country or jurisdiction where the auditor practices.
Departure from the Applicable Financial Reporting Framework
SPOTLIGHT
Express a qualified or adverse conclusion.
Limitation on Scope
If auditor is unable to complete review, auditor should communicate to appropriate level of management and
those charged with governance.
By Management
Auditor does not accept such an engagement if his preliminary knowledge indicates that he would be unable to
complete review:
 If, after acceptance, management imposes such limitation, auditor requests removal of that limitation.
 If management refuses, auditor shall communicate to appropriate level of management and those
 Auditor also considers legal and regulatory responsibilities. If there is such a requirement, auditor shall
disclaim conclusion.
Other Limitations on Scope

 Issue Qualified Conclusion.
 If Audit report was Qualified; Auditor shall consider whether that limitation still exists and, if so,
implications for review.

Going Concern and Significant Uncertainties

 If adequate disclosure about going concern is made, auditor should add an emphasis of matter
paragraph.
 If material uncertainty is adequately disclosed, auditor modifies review report by adding an emphasis
of matter paragraph.
 If material uncertainty is not adequately disclosed, auditor should express a qualified or adverse
conclusion, as appropriate.
You are the audit manager of a listed company, Brace Limited (BL). During your discussion with
the audit team deputed on the review assignment of BL’s interim financial statements for the half
year ended 31 May 2019, the following matters are highlighted:
i. Auditor was not asked to attend the stock count at the end of the period. Consequently,
the audit team relied on the physical count sheets provided by the management.
ii. BL has significant accumulated losses and its current liabilities exceed the current assets.
iii. Provision for bad debts is in line with the prior period. However, age-analysis of debtors
has not been used.
AT A GLANCE
iv. Due to time constraints, the review of subsequent events has not been carried out by the
audit team.
Required:
Discuss how you would deal with the above matters and the possible implications of each of the
above matters on the review report.
Tutorial Notes:
 A wrong interpretation could be mentioning auditor’s inability to attend stock count and
not performing any procedures on subsequent event is a scope limitation and therefore
the review report should be qualified.
 Reporting implications are also asked and should be the part of answer.
SPOTLIGHT
 Solution:
i. Ordinarily an auditor is not required to perform the procedure of observation for
obtaining evidence in a review engagement. However, only relying on the count sheets
provided by management is not sufficient and we will have to perform analytical
procedure.
Considering this, there will be no implication on review report.
ii. Existence of accumulated losses and adverse ratio indicates that BL may not be a going
concern. Therefore, we will have to inquire management as to its plans for future actions,
feasibility of future plans and whether outcome of the plans would improve the
situation.
Consider the adequacy of the disclosures about such matters in the interim financial
information.
If it is assessed that going concern assumption is not valid and adequate disclosure is
made in the interim financial information, we would include an emphasis of matter
paragraph to highlight a material uncertainty to a condition that may cast significant
doubt on BL’s ability to continue as a going concern.
If adequate disclosure is not made in the interim financial information, we would express
a qualified or adverse opinion as appropriate.

If the auditor considers that going concern assumptions is not valid and the financial
statements are not prepared on other than going concern basis, then an adverse opinion
will be expressed.
iii. The auditor is required to use inquiry and analytical procedures in a review engagement
and if the auditor satisfactorily concludes that the bad debt provision is following the
historical trend then no further procedures are required and there will be no implication
on review report.
iv. In this case, the audit team should perform the following procedures:
 Inquired from management about the procedure it has followed to identify
subsequent adjusting event and whether all events up to the date of review report
that may require disclosure or adjustment have been identified.
 Obtain written representation that the management has disclosed to the auditor all
significant events that have occurred subsequent to the balance sheet date and
through to the date of the review report.
 Ensure that all relevant adjustments and disclosure have been made in the financial
statements.
There will be no implication on review report unless any material misstatement is identified in
the above procedures.
AT A GLANCE
You are the audit engagement partner of a listed company, Steel Limited (SL). The firm is
currently in the process of completing limited scope review of SL’s interim financial statements
for the half year ended December 31, 2007. The audit team has recently concluded their work
with following findings for your decision:
i. Inventory is a significant item of the balance sheet but the auditor was not asked to
attend the stock count at the end of the period. Consequently, the audit team relied on
the count communicated by the management.
ii. SL has executed many contracts with its customers for long term future deliveries at
different prices, amounting to Rs. 1,200 million. To avoid loss on account of price
fluctuation, short term futures had been bought in international market against future
SPOTLIGHT
deliveries valuing Rs. 300 million only. Such futures are carried-over on maturity.
Remaining deliveries have been left open.
iii. A set up of the company in Lahore having carrying value of Rs. 235 million has been sold
to an associated undertaking for Rs. 240 million. The minutes of the Board of Directors
show that the transaction was carried out at an arm’s length price. No explanatory note
has been given in the financial statements in this regard.
iv. As a percentage of total debts the provision for bad debts are in accordance with the
previous history of the company. However, due to time constraints the practice of using
age-analysis of debtors has not been used this time.
v. Due to time constraints the review of subsequent event was not carried out by the audit
team.
Required
Discuss the above issues and their implications on your report.
 Solution:
The implications of the various issues referred to in the question, on the auditor report, are
discussed hereunder:
i. Failure to observe stock count:
 Ordinarily the auditor is not required to perform the procedure of observation for
obtaining evidence in a review engagement.

 Analytical procedure will be sufficient in this case.

 There will be no implication on auditor’s review report.
ii. Exposure to significant exchange rate risk:
 Auditor is not supposed to give any assurance on the adequacy of the management’s
risk management activities.
 Auditor is responsible to assess whether the derivatives, as discussed, have been
accounted for and presented according to the requirement of the International
Financial Reporting Standards.
 However, if open position casts a significant threat to the viability of the company’s
business, the auditor may draw the attention of the reader of conclusion report by
adding an emphasis of matter paragraph in the report.
iii. Sale of one of the company’s set-up to an associated undertaking:
 The information about the sale of the business segment to a related party is
necessary for understanding the changes in financial position. Therefore, an
explanatory note should be included in the condensed financial statements.
 Ordinarily the auditor is not required to corroborate the evidence provided by the
management.
 In case management refuses to disclose this information, suitable modification will
AT A GLANCE
be considered.
iv. Discontinuation of the practice of using Age Analysis for bad debts estimation:
 Apparently, bad debt provision is following the historical trend. The auditor is
required to pursue inquiry and analytically review procedures in a review
engagement.
 If the results of such procedures are satisfactory, then no further procedures are
required. Accordingly, age analysis for estimating bad debts is not mandatory in this
situation.
 There will be no implication on audit report.
v. Failure to carry out review of subsequent events:
 In a review engagement auditor is not responsible to review subsequent events.
SPOTLIGHT
Management is inquired about the procedure it has followed to identify subsequent

adjusting event.
 There will be no implication on audit report.
Wood Limited (WL) is a listed company. SMSF Chartered Accountants have been the auditors of
the company for the last three years. In November 2007, with substantial change in shareholding
a new Board of Directors was elected. The new Board made significant changes in the senior
management within a week of taking charge.
On February 10, 2008, after completing the field work, the auditors sent the financial statements
along with initialed draft audit report, to WL’s board for its approval. On the same date, a senior
partner was assigned to carry out an engagement quality control review. During the review he
noted the following:
i. Management representation letter contains a paragraph that “We have taken charge
from the previous management on 28 November 2007 and after taking charge, we
commenced valuation exercise in respect of plant and machinery in various factories
owned by WL. To date, thirty percent of plant and machinery has been valued. The
exercise carried out so far shows that fair value of the assets is 20% less than the
carrying value, for which an impairment loss has been accounted for. In view of this
situation, we are not confident about the fair value of the plant and machinery as
presented in the financial statements.”

ii. The valuation is being carried out by the production manager who is a qualified
engineer. He had been responsible for year-end valuation review for many years. This is
the first time when he has reported impairment.
iii. The issue of impairment loss, which is of material amount, was a contentious matter
between a team member and the job in charge. On inquiry Mr. Manzoor Nazar, the
engagement partner, informed that he had accepted the job in charge’s view point.
iv. This matter was also reported to the stock exchanges on December 5, 2007 resulting in
a sharp decline in share prices of WL, which otherwise had a good price-growth history.
v. Subsequent to year end, WL has been awarded a very profitable long-term supply
contract by Timber Limited (TL), a reputable industrial undertaking. No direct
confirmation was obtained from TL.
vi. WL announced a 100% right issue in December 2007 at market price. Because of
discouraging response from the minority shareholders, the directors and their
associates purchased a large number of right letters from the open market.
vii. The firm’s record reveals that Mr. Manzoor had applied twice for a job in WL during last
one and half years. However, there is no current information about his intention.
Required
AT A GLANCE
Write a review report on behalf of the reviewer indicating the deficiencies noted in the audit as
well as the policies of the firm and submit your recommendations.
 Solution:
Quality Control Issues:
 While assigning the audit work to Mr. Manzoor Nazar, the firm ignored the threat which
existed due to his earlier intention to join WL as an employee.
 Mr. Manzoor also failed to update the firm about this matter, due to which firm could not
ascertain the self-interest threat to independence and objectivity of the engagement
partner.
 Engagement partner did not ensure the engagement reviewer had been appointed. As a
result, significant matters arising during the audit could not be discussed or resolved.
SPOTLIGHT
 No consultation was undertaken on impairment loss issue, which was contentious and
material.
 It appears that engagement partner resolved the difference of opinion between the team
member and the job in charge by imposing his decision without satisfying the team
member. No avenue was available to the team member to assert his opinion.
The following Risk Factors do not seem to have been considered:
 Change in Board of Directors and significant change in Management.
 Valuation of plant and machinery was being done by an employee who may have been
an expert but his independence was questionable.
 Sudden change of assessment in the valuation creates doubts on the reliability of the
work done.
 Informing stock exchanges about impairment loss, uncertainty on fair value of plant and
machinery, issue of right shares at declined market price and acquisition of right shares
by directors and their associates point to an apparent motive of the Board of directors
to accumulate WL’s shares at low price.
Deficiencies in Audit Approach:
 In view of the management’s perceived motive of presenting poor financial position to
affect the market price, the representation by the management as regards impairment
of plant and machinery is not a reliable evidence.

 Opinion of the internal expert seems to have been influenced by the directors and the
management. Thus, it should not have been considered as appropriate evidence.
 Due consideration was not given to the auditor’s previous knowledge and evidences that
were already available in previous year’s working paper files.
 Audit opinion on a significant matter was formed without corroborating other
evidences.
Recommendation:
An independent valuation expert be appointed to form an opinion on valuation of plant and
machinery.
If independent valuation supports the opinion of the internal expert,
 ascertain whether or not valuation done in previous year was erroneous.
 In case of error in previous years, comparative financial statements be amended after
completion of valuation exercise.
 In case valuation exercise cannot be completed, the audit report should contain an
emphasis of matter paragraph on significant uncertainty.
If independent valuation does not support the opinion of the internal expert, the auditor should
AT A GLANCE
 Re-assess the risk of fraudulent misstatement by management and those charged with
governance.
 Consider whether misstatement due to fraud involves higher management and those
charged with governance, in which case the firm may consider withdrawal from the
engagement.

Prepare review documentation that is sufficient and appropriate to provide a basis for auditor’s conclusion and
to provide evidence that review was performed in accordance with ISRE and applicable legal and regulatory
requirements.
SPOTLIGHT
2.12 Similarities between Audit and Review Standards
ISRE ISRE ISAs Containing Similar

Relevant Topic
2400 2410 Requirements
 Conduct of an Engagement in 18-23 ISA-200

Accordance with ISAE/ISRE A15-A25
 Complying with Relevant Requirements
 Ethical Requirements
 Professional Skepticism
 Professional Judgment
 Acceptance & Continuance of Client 29 ISA-210
Relationships & Engagements A34-A35
 Preconditions 30-35 ISA-210
 Additional Considerations When A39-A51,
Wording of Practitioner’s Report Is A142
Prescribed by Law or Regulation
 Agreeing the Terms of Engagement 36-37 10-11 ISA-210
A52-A53, A55


Relevant Topic
 Recurring Engagements 38-41 ISA-210

 Acceptance of a Change in the Terms of A57-A62
the Review Engagement
 Request to Change Nature of
Engagement
 Engagement Level Quality Control 24-28 ISA-220
A26-A33 ISQC-1
 Documentation 93-96, A145 64 ISA-230
 Fraud and non-compliance with laws or 52 ISA-240
regulations A92 ISA-250
 Communication with Management and 42 ISA-260
Those Charged with Governance A63-A69
AT A GLANCE
 The Practitioner’s Understanding 45-46 12-18 ISA-315
A75-A78
A87,A89
 Materiality 43-44 ISA-320
A70-A74
 Specific Procedures 47-49 19-24 ISA-330
A79-A91
 Reconciling financial statements to the 56 25 ISA 330
Underlying Accounting Records A94
SPOTLIGHT
 Evaluating Evidence Obtained from the 66-68 ISA-330
Procedures Performed A103-A105
 Evaluation of Misstatements 30-33 ISA-450
 Related parties 50-51 ISA-550
 Subsequent Events 58-60 26 ISA-560
 Going Concern 53-54 27-28 ISA-570
A93 55-60
 Written Representations 61-65 34-35 ISA-580
A100-A102
 Components of groups of entities A54 ISA-600
 Use of work performed by others 55 ISA-620
 Consideration of applicable financial 69 ISA-700
reporting framework in Relation to the A106-A110
 Qualitative Aspects of the Entity’s 70, 71 ISA-700
Accounting Practices A111-A112


Relevant Topic
 Form of the Conclusion 72 ISA-700

 Unmodified Conclusion 73-74 ISA-700
A113-A114
 The Practitioner’s Report 86 43 ISA-700
A118-A132
 Practitioner’s Report Prescribed by Law A142 44 ISA-700
or Regulation
 Practitioner’s Report for Reviews A143 ISA-700
Conducted in Accordance with Both
Relevant Standards of a Specific
Jurisdiction and ISRE
 Other Reporting Responsibilities 91, 92 ISA-700
 Date of the Practitioner’s Report A135-A137
AT A GLANCE
 Modified Conclusion 75-85 45-54 ISA-705

A117
 Emphasis of Matter Paragraphs 87, 89-90 ISA-706
 Other Matter Paragraphs
 Responsibilities for accompanying 36-37 ISA-720
information
 Alerting Readers 88 ISA-800
 Restriction on Distribution or Use A133, A134
SPOTLIGHT

3. DUE DILIGENCE ENGAGEMENTS

3.1 Due diligence engagements
One of the most common forms of audit-related review services is ‘due diligence’ work. This term refers to any
engagement where the practitioner is engaged to make inquiries into the accounts, organisation or activities of
an entity.
Due diligence is not governed by a specific standard and therefore can be interpreted in a number of ways. In
practice a due diligence engagement would be conducted in accordance with whichever standard best fits the
particular engagement being conducted e.g.
 As a review engagement in accordance with ISRE 2400
 As an assurance engagement in accordance with ISAE 3000
 As a related services engagement (e.g. agreed-upon procedures) in accordance with ISRS 4400.
Due diligence work is most commonly referred to in the context of mergers and takeovers. The work involves
obtaining information about the target company, prior to the takeover (or merger). The objective should be to
find out everything that may be relevant about the target company’s operations, financial performance, financial
position and future prospects. In addition, information should also be gathered about the business environment
in which the target company operates.
AT A GLANCE
The practitioner will also interview the senior management of the target company as well as other key employees
and possibly external third parties. Due diligence work does not involve tests of controls (unless the client
specifically asks for this), nor does it involve substantive testing. Due diligence work is not a form of audit work.
The main objective of due diligence is therefore often to provide information that will allow the client to:
 decide whether a takeover or merger is actually desirable, and
 if so, whether the proposed cost of the acquisition is reasonable.
An adverse or critical due diligence report may therefore result in:
 abandoning a proposed takeover or merger, or
 reducing the offer price for the acquisition.
SPOTLIGHT
Benefits of using an audit firm for due diligence
There is no reason why an accountancy firm should not be engaged to carry out due diligence. Management could
do some or all the work themselves. However, using an accountancy firm to do the work has two potential
benefits:
 Hiring an accountancy firm to do the work saves management time for the potential buyer. In addition,
the practitioners assigned to the due diligence work should have suitable experience in this type of work.
For large takeover, the amount of time and resources required to carry out proper due diligence can be
substantial.
 Using a professional firm to do due diligence may help to reassure shareholders in the potential buyer
(or investors who will be asked to provide loan finance for the takeover) that the acquisition has been
properly evaluated
Examples of due diligence engagements

Practical examples include:
 Financial due diligence
 Personnel due diligence
 Environmental due diligence
 Regulatory due diligence
 Operational and IT due diligence.

Items to investigate in a due diligence exercise

Financial performance and financial position. The practitioner will look at the available historical financial
information about the target company, such as its financial statements for the past few years. Ratio analysis will
often be used to make an assessment. The practitioner will also look at the target company’s management
accounts, budgets and profit/cash flow forecasts, and at any current business plan.
Operational issues. The practitioner should also look for any operational issues in the target company that may
raise questions about its value. For example, the target company might have important contracts with major
customers, and the practitioner should try to find out when these contracts reach their termination date and
what the probability that the contracts will be renewed is. Other operational problems may be discovered, such
as a high rate of labour turnover, or high costs incurred in meeting warranties or guarantees to customers.
Management representations. Management of the takeover target may have provided representations to the
potential buyer. For example, they might have given a written assurance that the target company is not subject
to any tax investigation or potential litigation. Due diligence work should seek to establish that these
representations appear to be correct.
Identification of assets. A takeover usually results in purchased goodwill in the consolidated accounts. However,
the takeover target may have several intangible assets that do not appear in its statement of financial position
(because they were internally-generated assets) but which should be recognised for the purpose of
AT A GLANCE
consolidation. Examples are internally-generated patent rights, customer lists and databases and brand names.
These should be identified and valued, for inclusion in the consolidated statement of financial position after the
acquisition. It is also useful for the management of the potential buyer to be aware of the nature and estimated
value of the intangible assets that they would be acquiring.
Benefits and costs of a takeover. Due diligence may also include an attempt to estimate the future benefits of the
takeover, such as cost savings from synergies such as economies of scale. Any ‘one off’ expenses such as
redundancy costs and reorganisation costs will have to be estimated.
You are employed as an audit manager in Bashir and Company, Chartered Accountants. One of
your clients, Davidsons Pharma Limited (DPL), is considering to acquire 60% shareholding in
Sehat Healthcare (Pvt.) Ltd. (SHPL) and has requested your firm to carry out a due diligence.
SPOTLIGHT
During the fieldwork of due diligence exercise, your team has brought the following matters to
your attention:
i. A major customer which accounts for 10% of SHPL’s annual sales has refused to place
further sale orders. On inquiry, it was revealed that competitor has offered significant
discount of 12% to increase its market share.
ii. DPL has central distribution model where single distributor has non-exclusive rights
countrywide with commission rate of 5%. All sales made to the distributor on 30 days’
credit. On the Other hand, SHPL has a regional distribution model where multiple
distributors are involved country wide with commission rates ranging from 2% to 4%.
Under this model, all sales are made on cash.
Required
Discuss how the above matters are to be investigated for due diligence review and also
recommend the additional procedures to be performed in this respect.
Tutorial Notes:
Important issues to consider are:
 How the matters are to be investigated for due diligence review.
 Verification procedures related to an audit engagement are not required.
 Correspondence to identify any renegotiation occurred on the terms of their
agreements.

 Analyzing the impact of aggressive competitive marketing strategy to offset the impact
of discount offered by competitor and the possibility of same by assessing profitability
analysis.
 Assessing if the goodwill of brand name may have any impact in offsetting impact of
discount.
 Reviewing subsequent sales trend.
 Effects of difference among the distribution model followed by both the companies.
 Solution:
Termination of Supply agreement:
Loss of a major customer may lead to a reduction in forecast revenue by as much as 10% per
year. It is vital to establish all potential revenue and cost implications due to loss of the customer
to ascertain the impact on the overall acquisition price.
The switching of major customer has wider implications if the competitor is directly targeting
the major customers of DPL. It is possible that other major customers may also switch to the
competitor, which would have further implications on future revenue and cost forecasts.
Additional procedures:
AT A GLANCE
 Analytically review the revenue earned from the customer to help determine an
appropriate estimate for the potential loss of future revenues and cash inflows.
 Identify other major customers and review any supply agreements in place to determine
their expiry.
 Obtain any correspondence to identify any renegotiation occurred on the terms of their
agreements.
 Analyze the impact of aggressive competitive marketing strategy to offset the impact of
discount offered by competitor.
 Review minutes of board of directors meeting which may give an insight about the
reasons of losing this customer.

SPOTLIGHT
Inquire the management about the possibility of offering discount by analyzing the
profitability analysis.
 Assess the Goodwill of brand name may have any impact in offsetting the impact of
discount.
 Review the subsequent sales trend to analyze the magnitude of loss of sales and
measures taken by management accordingly.
 Review the subsequent IMS/ third party sales report to assess the increase in market
share of competitor due to discount.
Distribution Model:
The existing central distributor model of DPL is nonexclusive so DPL can also change its model
by involving regional distributors considering the business rationale, commission rates, credit
period, product portfolio, distributor claims, etc.
DPL also needs to determine the distribution model to be adopted for SHPL by carrying out the
cost benefit analysis and considering the group synergies created by both models especially
when SHPL’s existing regional model yields saving in commission rates and have favorable credit
terms as compared to DPL central model.
Additional procedures:
 Review the existing distribution agreements of SHPL with regional distributors to
determine the terms of agreement are aligned with national distributor.

 Inquire from the management of DPL, whether the information management system in
DPL can cater multiple distributors.
 Perform the cost benefit analysis considering the product portfolio of SHPL for
difference in commission rates, payment terms, product expiry claims, product
availability, frequency of sale reporting and increase in administrative cost.
 Review the forecast prepared by management based on existing distribution model to
assess the impact of change in distribution model.
Your firm has been approached by Eagle Courier Limited (ECL) to provide due diligence review
on a potential acquisition. ECL is a leading courier service company having a network of offices
throughout the country. ECL has a vast fleet of delivery vans and motorcycles.
ECL intends to use its courier industry experience and expand into food delivery business by
using its current fleet of motorcycles. However, it would require bringing on board a vast number
of restaurants and build its own online food ordering website, of which they do not have any
expertise and experience.
For this purpose, ECL has identified an online food ordering business Foodi.com (FC) for
acquisition. FC is a partnership concern and was set up by three college friends in 2014. FC
AT A GLANCE
received the best ‘start-up business’ award in 2015. Founders of FC had borrowed funds from
two individual investors, which are to be repaid in 10 years.
IT, restaurant relation, customer support and administrative departments are led by the
partners. Being an online service business, the only major assets of FC are a fleet of motorcycles
obtained on an operating lease of 5 years and computers.
Apart from 500 riders, FC employs 30 staff, out of which 10 are related to IT department, 10
belong to customer support, 5 belong to restaurant liaison and the remaining 5 are responsible
for the accounts, HR and administration of the business.
Extracts from audited profit or loss statement for four years are as follows:
2017 2016 2015 2014

SPOTLIGHT
--------------Rs in million------------
Revenue 55,000 50,000 20,000 10,000
Operating expenses (34,650) (30,000) (16,000) (15,000)
Lease rentals (5,750) (4,600) (2,875) (1,150)
Operating profit/(loss) 14,600 15,400 1,125 (6,150)
Finance cost (3,075) (3,155) (1,615) (1,615)
Profit/(loss) for the year 11,525 12,245 (490) (7,765)
Required:
Identify and explain the matters you would focus on in your due diligence review. Also identify
any additional information / document you would require during the review.
Tutorial Notes:
It is important to understand that this is a scenario based question in which you are required to
discuss the matters which they would focus while performing a due diligence review under the
given scenario. Meanwhile, you are also supposed to identify any additional information which
you may require during the review.

A common mistake could be to pay more attention towards analytical procedures and failing to
cover other discussions about due diligence. Some important areas that might be overlooked by
students while answering are:
i. role of partners and in the absence of any experience of similar business,
ii. is there any key staff and would they continue,
iii. terms of employment of the existing delivery staff who would have to be relieved,
iv. are the financial statements audited, and
v. other off balance sheet items.
Some points that may be skipped from mind while answering could be:
 Why the finance cost remained constant in 2014 and 2015?
 Which assets have been leased and would the lease continue?
 Why there is no provision for taxation?
 What are the details of operating expenses?
 Solution:
(i) FC being a partnership business is not subject to regulation and oversight of corporate
AT A GLANCE
regulatory authorities and we would need to inquire about the financial reporting
framework used for the preparation of the financial statements and whether it is acceptable.
Documents/information required:
 Audited financial statements of four years
 Any regulatory returns filed by FC
(ii) It is crucial to identify the role of other 2 persons who have financed the business of FC. It is
important to determine whether the partners can sell their business without the consent of
the lenders.
 Copy of partnership deed
SPOTLIGHT
 Copy of agreement with the lenders
(iii) Evaluate why the finance cost remained the same and then increased when business became
profitable i.e. assess whether there is any profit sharing agreement with the lenders.
 Balance of the outstanding loan
 Terms of repayment of loan
 Copy of agreement with the lenders
(iv) Evaluate the reasons for significant improvement in revenue/profits in 2016.
Evaluate whether the levels of revenue/profits of 2016 and 2017 are sustainable.
 Forecast profit and loss account for next three years should be obtained
 Reasonableness of assumptions on which they are based should be evaluated
 Number of active customers registered with FC
 Contracts with restaurants
(v) Though the increase in expenses appears reasonable on an overall basis i.e. based on the
increased activities (revenue). However, to assess whether the change is reasonable we have
to obtain details/breakup of major expenses.

(vi) All partners are crucial to the success of FC, as the business relies heavily on them. We would
have to see whether ECL would be able to find adequate replacement for the expertise of
partners. Moreover, continuity of other key staff should also be ascertained for smooth
operation of business.
 Documents/information required:
 Names of the key staff
 Job description of the staff
 Offering letter / employment agreement
(vii) ECL plans to use their own delivery riders for the business. It therefore needs to be
ascertained whether the riders are employed on a fixed salary or commission plus fixed
salary and are they entitled to any redundancy payments. The same also needs to be
ascertained for other staff of FC who would not be retained.
 Contract with the employees/appointment letters.
(viii) FC fleet of delivery bikes have been acquired on a five-year lease. It seems that it is a finance
lease as the useful life of the bikes is also five years. ECL plans to use its own fleet for food
AT A GLANCE
delivery, so it needs to be ascertained that whether the lease agreement contains any clause
of early exit and its associated cost.
 Lease agreement
 Valuation of motor cycles and the lease liability
(ix) The valuation of the website should also be taken into consideration. Since ECL intends to
use the online system developed by FC, the systems should be tested for security and should
be considered in valuation of the website.
 Security certificates obtained by FC

SPOTLIGHT
Detail of amounts paid to developer for constructing the web site

 Any other certificates obtained by FC
(x) All off balance sheet items should also be taken into consideration along with the assessment
of it's probable outcome.
 Names and addresses of the legal advisors of FC
 Names and addresses of all banks of FC
 Details of any pending cases against FC
 Details of future contracts with suppliers
(xi) The applicability of the income tax and sales tax on the business of FC should also be
considered. It should also be ensured that the tax return have been filed appropriately and
would not result in any future claims by the tax authorities.
 Tax returns
(xii) It also needs to be ensured that whether the information systems of FC and ECL could be
integrated.
 System specification of both the companies

CHAPTER 14
ASSURANCE AND NON ASSURANCE

ENGAGEMENTS
AT A GLANCE
IN THIS CHAPTER:
Although the standards on audit, review and assurance provide
AT A GLANCE the guidance in the relevant dimensions, yet we can observe
some similarities of contents and structure across these
SPOTLIGHT standards by IAASB. The main reason behind these similarities
is a consistent thought process and an aim to standardize the
AT A GLANCE
1. Similarities between Audit, things as per some universal guidance.
Review and Assurance
In the very first unit, this chapter provides a tabular comparison
Standards
of ISAs and ISAE 3000 where the students can track the relevant
2. Map of Assurance Standards
requirements of different standards of auditing ad its
3. Assurance engagements
connection with the assurance engagements.
other than audits or reviews
of historical financial Chapter also aims to differentiate between different standards
information (ISAE 3000) of Assurance and provides the students with relevant
4. The Examination of information to be remembered along with an identification of
Prospective Financial the annexures that can support an open book exam.
Information (ISAE 3400)
ISAE-3000 deals with the assurance engagements other than
5. Audit Considerations
audits or reviews of historical financial information.
Relating to an Entity Using a
SPOTLIGHT
Service Organization (ISA Purpose of ISAE-3400 is to establish standards and provide
402) guidance on engagements to examine and report on prospective
6. Assurance Reports on financial information including examination procedures for
Controls at a Service best-estimate and hypothetical assumptions.
Organization (ISAE 3402)
ISAE-3402 deals with assurance engagements undertaken by a
7. Assurance Engagements on
practitioner to provide a report for use by user entities and their
Greenhouse Gas Statements
auditors on the controls at a service organization. It should be
(ISAE 3410)
read in conjunction with ISA 402.
8. Assurance Engagements to
Report on the Compilation of ISAE-3420 deals with assurance engagements undertaken by a
Pro FormaFinancial practitioner to report on the responsible party’s compilation of pro
Information Included in a forma financial information included in a prospectus.
Prospectus (ISAE 3420)
Purpose of ISRS-4400 is to establish standards and provide
9. Engagements to Perform
guidance on the auditor’s professional responsibilities when an
Agreed-Upon Procedures
engagement to perform agreed-upon procedures regarding
(ISRS 4400)
financial information is undertaken.
10. Compilation Engagements
(ISRS 4410) Purpose of ISRS-4410 is to establish standards and provide
guidance on the accountant’s professional responsibilities when
an engagement to compile financial information is undertaken.

CHAPTER 14: ASSURANCE AND NON-ASSURANCE ENGAGEMENTS CFAP 6: AARS
1. SIMILARITIES BETWEEN AUDIT AND ASSURANCE STANDARDS

ISAE ISAs Containing
Relevant Topic
3000 Similar Requirements
 Conduct of an Engagement in Accordance 14-20, 37, 38 ISA-200

with ISAE/ISRE A21-A34, A76-A85, A170
 Complying with Relevant Requirements
 Ethical Requirements
 Professional Skepticism
 Professional Judgment
 Acceptance & Continuance of Client 21-23 ISA-210
Relationships & Engagements A30-A34
 Preconditions 24-26, 30 ISA-210
 Additional Considerations When Wording of A35-A56
Practitioner’s Report Is Prescribed by Law or
AT A GLANCE
Regulation
 Agreeing the Terms of Engagement 27 ISA-210
A57-A58
 Recurring Engagements 28, 29 ISA-210
 Acceptance of a Change in the Terms of the
Review Engagement
 Request to Change Nature of Engagement
 Engagement Level Quality Control 31-36 ISA-220
A60-A75 ISQC-1
 Documentation 79-83 ISA-230
SPOTLIGHT
A193-A200
 Planning 40-43 ISA-300
A86-A91
 Materiality 44 ISA-320
A92-A100
 Evaluation of Misstatements 51 ISA-450
A118-A119
 Subsequent Events 61 ISA-560
A140-A141
 Written Representations 56-60 ISA-580
A136-A138
 Use of work performed by others 52-55, 70 ISA-620
A120-A135, A185-A187
 Consideration of applicable financial 63 ISA-700
reporting framework in Relation to the A143-A145

CFAP 6: AARS CHAPTER 14: ASSURANCE AND NON-ASSURANCE ENGAGEMENTS
ISAE ISAs Containing

Relevant Topic
3000 Similar Requirements
 Form of the Conclusion 64-65 ISA-700

A146-154
 The Practitioner’s Report 67-69 ISA-700
A158-A184
 Practitioner’s Report Prescribed by Law or 30 ISA-700
Regulation
 Modified Conclusion 66, 74-76 ISA-705
A155-A157, A188-A190
 Responsibilities for accompanying 62 ISA-720
information A142
AT A GLANCE
SPOTLIGHT

2. MAP OF ASSURANCE STANDARDS

2.1 Key Definitions (ISAE 3000)
 Assurance engagement
An engagement in which a practitioner aims to obtain sufficient appropriate evidence in order to
express a conclusion designed to enhance the degree of confidence of the intended users other
than the responsible party about the subject matter information (that is, the outcome of the
measurement or evaluation of an underlying subject matter against criteria).
Each assurance engagement is classified on two dimensions;
i. Either a reasonable assurance engagement or a limited assurance engagement:
Reasonable assurance engagement
An assurance engagement in which the practitioner reduces engagement risk to an acceptably low level
in the circumstances of the engagement as the basis for the practitioner’s conclusion. The practitioner’s
conclusion is expressed in a form that conveys the practitioner’s opinion on the outcome of the
measurement or evaluation of the underlying subject matter against criteria.
Limited assurance engagement
AT A GLANCE
An assurance engagement in which the practitioner reduces 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 expressing a conclusion in a form that conveys whether, based on the
procedures performed and evidence obtained, a matter(s) has come to the practitioner’s attention to
cause the practitioner to believe the subject matter information is materially misstated. The nature,
timing, and extent of procedures performed in a limited assurance engagement is limited compared with
that necessary in a reasonable assurance engagement but is planned to obtain a level of assurance that
is, in the practitioner’s professional judgment, meaningful.
To be meaningful, the level of assurance obtained by the practitioner is likely to enhance the intended
users’ confidence about the subject matter information to a degree that is clearly more than
inconsequential.
SPOTLIGHT
ii. Either an attestation engagement or a direct engagement:

Attestation engagement
An assurance engagement in which a party other than the practitioner measures or evaluates the
underlying subject matter against the criteria. A party other than the practitioner also often presents the
resulting subject matter information in a report or statement. In some cases, however, the subject matter
information may be presented by the practitioner in the assurance report. In an attestation engagement,
the practitioner’s conclusion addresses whether the subject matter information is free from material
misstatement. The practitioner’s conclusion may be phrased in terms of:
i. The underlying subject matter and the applicable criteria;
ii. The subject matter information and the applicable criteria; or
iii. A statement made by the appropriate party.
Direct engagement
An assurance engagement in which the practitioner measures or evaluates the underlying subject matter
against the applicable criteria and the practitioner presents the resulting subject matter information as
part of, or accompanying, the assurance report. In a direct engagement, the practitioner’s conclusion
addresses the reported outcome of the measurement or evaluation of the underlying subject matter
against the criteria.


a) You are a partner in a firm of chartered accountants, looking after the audit and advisory
services department. One of your clients has approached you for services in relation to
certification of compliance with a specific control framework, with regard to their
production process. Required: What are the different types of reports that you can offer
to the client, clearly specifying the key characteristics of each form of report.
b) Your manager has identified that the client should prepare a statement of compliance
with the said control framework and your firm can only issue a report on that statement.
Required: Identify the type of assurance engagement to which the manager is referring
to and the key characteristics of such engagement.
Tutorial Notes:
This question requires good conceptual understanding of the various types of assurance
engagements. One of the confusions can be between report under assurance engagement and
report under Agreed Upon Procedures. It is important to note that in the assurance engagement,
the auditor may either issue a Reasonable Assurance Report or a Limited Assurance Report.
 Solution:
a) The services may be provided either as an Agreed Upon Procedures Engagement or as
AT A GLANCE
an Assurance Engagement other than Audit of Historical Financial Information.
In case of Agreed Upon In case of assurance engagement, the report

Procedures, the report will contain may take two different forms
the procedures performed and the
i.e. a reasonable assurance report or a limited
results of such procedures in the
assurance report.
form of factual findings.
In a reasonable assurance report the auditor

will provide a positive assurance on the
compliance of the entity with the framework.
SPOTLIGHT
In the limited assurance report the auditor will
provide negative assurance on the compliance
of entity with the framework
b) The manager is referring to assertion based engagement, in which:

 the evaluation or measurement of the subject matter is performed by the
responsible party; and
 the subject matter information is in the form of an assertion by the responsible party
that is made available to the intended users.
2.2 Elements of an assurance engagement (A recap)
Definition: Assurance engagement

An engagement in which a practitioner aims to obtain sufficient appropriate evidence in order to express a
conclusion designed to enhance the degree of confidence of the intended users other than the responsible party
about the subject matter information (that is, the outcome of the measurement or evaluation of an underlying
subject matter against criteria).
Source: Handbook of International Quality Control, Auditing, Review, Other Assurance, and Related
Pronouncements, 2016-2017 Edition
An assurance engagement performed by a practitioner will consist of the following five elements:

 A three party relationship:

¯ Practitioner - the individual providing professional services that will review the subject matter and
provide the assurance. E.g. the audit firm in a statutory audit
¯ Responsible party - the person(s) responsible for the subject matter. E.g. the Directors are
responsible for preparing the financial statements to be audited
¯ Intended users - the person(s) or class of persons for whom the practitioner prepares the
assurance report. E.g. the shareholders in a statutory audit
 Subject matter: This is the data such as the financial statements that have been prepared by the
responsible party for the practitioner to evaluate. Another example might be a cash flow forecast to be
reviewed by the practitioner.
 Suitable criteria: This can be thought of as ‘the rules’ against which the subject matter is evaluated in
order to reach an opinion. In a statutory audit this would be the applicable reporting framework (e.g.
IFRS and company law).
 Evidence: Information used by the practitioner in arriving at the conclusion on which their opinion is
based. This must be sufficient (enough) and appropriate (relevant).
 Assurance Report: The report (normally written) containing the practitioner’s opinion. This is issued
AT A GLANCE
to the intended user following the collection of evidence.
2.3 Key Considerations regarding different ISAEs
Title Key Considerations Annexures

ISAE- 3400 Examination of  Difference between Forecast &  No Annexure
Prospective Financial Projection  Report Pattern given in
Information  2 Fold opinion (negative and Para 28 & 29
positive)
ISAE-3402 Controls at Service  Difference between ISAE 3402  Service Organization
Organization and ISA 402 Statements
SPOTLIGHT
 Service entity, User entity and  Assurance reports

auditors  Modified Assurance
 Type 1 & Type 2 Report Reports
 Concept of Subservice Entity
ISAE-3410 Greenhouse Gas  - Purpose of Greenhouse Gas  Description of different
Statement Statement scope emissions
 - Different type of Emissions  Assurance Reports
ISAE-3420 Compilation of Pro  Concept of Pro Forma Financial  Report with
Forma Financial Information unmodified opinion
Information included  Local example in Pakistan
in a Prospectus
 (Subsidiary as per 1st Schedule
– Securities Act 2015)

3. ASSURANCE ENGAGEMENTS OTHER THAN AUDITS OR REVIEWS OF

HISTORICAL FINANCIAL INFORMATION (ISAE 3000)
3.1 Conduct of an Assurance Engagement in Accordance with ISAE (Para 14-19)
The practitioner shall comply with this ISAE and any subject matter-specific ISAE relevant to the engagement.
The practitioner shall not represent compliance with this or any other ISAE unless the practitioner has complied
with the requirements of this ISAE and any other ISAE relevant to the engagement.
Complying with Relevant Requirements

Practitioner shall comply with each requirement of this ISAE and of any relevant subject matter-specific ISAE
unless, in the circumstances of the engagement the requirement is not relevant because it is conditional and the
condition does not exist.
In exceptional circumstances, the practitioner may judge it necessary to depart from a relevant requirement in
an ISAE. In such circumstances, the practitioner shall perform alternative procedures to achieve the aim of that
requirement. This is normally required where the requirement is for a specific procedure to be performed and,
in the specific circumstances of the engagement, that procedure would be ineffective in achieving its aim.
AT A GLANCE
3.2 Ethical Requirements (Para 20)
The practitioner shall comply with relevant Parts of the IESBA Code related to assurance engagements or other
professional requirements or requirements imposed by law or regulation, that are at least as demanding.
3.3 Acceptance and Continuance (Para 21-30)

The practitioner shall accept or continue an assurance engagement only when:
 The practitioner has no reason to believe that relevant ethical requirements, including independence,
will not be satisfied;
 The practitioner is satisfied that those persons who are to perform the engagement collectively have the
appropriate competence and capabilities; and
SPOTLIGHT
 The basis upon which the engagement is to be performed has been agreed, through:
¯ Establishing that the preconditions for an assurance engagement are present; and
¯ Confirming that there is a common understanding between the practitioner and the engaging party
of the terms of the engagement, including the practitioner’s reporting responsibilities.
If the engagement partner obtains information that would have caused the firm to decline the engagement had
that information been available earlier, the engagement partner shall communicate that information promptly
to the firm, so that the firm and the engagement partner can take the necessary action.
Preconditions for the Assurance Engagement

Practitioner shall, on the basis of a preliminary knowledge of the engagement circumstances and discussion with
the appropriate party(ies), determine whether:
a) The roles and responsibilities of the appropriate parties are suitable in the circumstances; and
b) The engagement exhibits all of the following characteristics:
 The underlying subject matter is appropriate;
 The criteria that the practitioner expects to be applied in the preparation of the subject matter
information are suitable for the engagement circumstances, including that they exhibit the following
characteristics:
¯ Relevance.

¯ Completeness.
¯ Reliability.
¯ Neutrality.
¯ Understandability.
 The criteria that the practitioner expects to be applied in the preparation of the subject matter
information will be available to the intended users;
 The practitioner expects to be able to obtain the evidence needed to support the practitioner’s
conclusion;
 The practitioner’s conclusion, in the form appropriate to either a reasonable assurance engagement or
a limited assurance engagement, is to be contained in a written report; and
 A rational purpose including, in the case of a limited assurance engagement, that the practitioner expects
to be able to obtain a meaningful level of assurance.
If the preconditions for an assurance engagement are not present, the practitioner shall discuss the matter with
the engaging party. If changes cannot be made to meet the preconditions, the practitioner shall not accept the
engagement as an assurance engagement unless required by law or regulation to do so. Practitioner shall not
include any reference within the assurance report to the engagement having been conducted in accordance with
AT A GLANCE
this ISAE or any other ISAE(s).
Limitation on Scope Prior to Acceptance of the Engagement

If the engaging party imposes a limitation on the scope of the practitioner’s work in the terms of a proposed
assurance engagement such that the practitioner believes the limitation will result in the practitioner disclaiming
a conclusion on the subject matter information, the practitioner shall not accept such an engagement as an
assurance engagement, unless required by law or regulation to do so.
Agreeing on the Terms of the Engagement

The practitioner shall agree the terms of the engagement with the engaging party. The agreed terms of the
engagement shall be specified in sufficient detail in an engagement letter or other suitable form of written
SPOTLIGHT
agreement, written confirmation, or in law or regulation.

On recurring engagements, the practitioner shall assess whether circumstances require the terms of the
engagement to be revised and whether there is a need to remind the engaging party of the existing terms of the
engagement.
Acceptance of a Change in the Terms of the Engagement

The practitioner shall not agree to a change in the terms of the engagement where there is no reasonable
justification for doing so. If such a change is made, the practitioner shall not disregard evidence that was obtained
prior to the change.
Assurance Report Prescribed by Law or Regulation

In some cases, law or regulation of the relevant jurisdiction prescribes the layout or wording of the assurance
report. In these circumstances, the practitioner shall evaluate:
 Whether intended users might misunderstand the assurance conclusion; and
 If so, whether additional explanation in the assurance report can mitigate possible misunderstanding.
If the practitioner concludes that additional explanation in the assurance report cannot mitigate possible
misunderstanding, the practitioner shall not accept the engagement, unless required by law or regulation to do
so. Practitioner shall not include any reference within the assurance report to the engagement having been
conducted in accordance with this ISAE or any other ISAE.

3.4 Quality Control (Para 31-36)
Characteristics of the Engagement Partner

 Be a member of a firm that applies ISQC 1, or other professional requirements, or requirements in law
or regulation, that are at least as demanding as ISQC 1;
 Have competence in assurance skills and techniques developed through extensive training and practical
application; and
 Have sufficient competence in the underlying subject matter and its measurement or evaluation to
accept responsibility for the assurance conclusion
Assignment of the Team

 Be satisfied that those persons who are to perform the engagement collectively have the appropriate
competence and capabilities to:
¯ Perform the engagement in accordance with relevant standards and applicable legal and regulatory
AT A GLANCE
requirements; and
¯ Enable an assurance report that is appropriate in the circumstances to be issued.
 Be satisfied that the practitioner will be able to be involved in the work of:
¯ A practitioner’s expert where the work of that expert is to be used; and
¯ Another practitioner, not part of the engagement team, where the assurance work of that
practitioner is to be used,
to an extent that is sufficient to accept responsibility for the assurance conclusion on the subject matter
information.
Responsibilities of the Engagement Partner
SPOTLIGHT
Engagement partner shall take responsibility for overall quality on engagement including responsibility for:
 Appropriate procedures being performed regarding the acceptance and continuance of client
relationships and engagements;
 The engagement being planned and performed (including appropriate direction and supervision) to
comply with professional standards and applicable legal and regulatory requirements;
 Reviews being performed in accordance with the firm’s review policies and procedures, and reviewing
the engagement documentation on or before the date of the assurance report;
 Appropriate engagement documentation being maintained to provide evidence of achievement of the
practitioner’s objectives, and that the engagement was performed in accordance with relevant ISAEs
and relevant legal and regulatory requirements; and
 Appropriate consultation being undertaken by the engagement team on difficult or contentious matters.
Throughout the engagement, the engagement partner shall remain alert, through observation and making
inquiries as necessary, for evidence of non-compliance with relevant ethical requirements by members of the
engagement team. If any non-compliance come to engagement partner’s attention, the engagement partner, in
consultation with others in the firm, shall determine the appropriate action.
The engagement partner shall consider the results of the firm’s monitoring process as evidenced in the latest
information circulated by the firm and, if applicable, other network firms and whether deficiencies noted in that
information may affect the assurance engagement.

Engagement Quality Control Review

For those engagements, if any, for which a quality control review is required by law or regulation or for which
the firm has determined that an engagement quality control review is required:
 The engagement partner shall take responsibility for discussing significant matters arising during the
engagement with the engagement quality control reviewer, and not date the assurance report until
completion of that review; and
 The engagement quality control reviewer shall perform an objective evaluation of the significant
judgments made by the engagement team, and the conclusions reached in formulating the assurance
report. This evaluation shall involve:
¯ Discussion of significant matters with the engagement partner;
¯ Review of the subject matter information and the proposed assurance report;
¯ Review of selected engagement documentation relating to the significant judgments the
engagement team made and the conclusions it reached; and
¯ Evaluation of the conclusions reached in formulating the assurance report and consideration of
whether the proposed assurance report is appropriate.
AT A GLANCE
3.5 Professional Skepticism, Professional Judgment, and Assurance Skills and Techniques (Para 36-39)
The practitioner shall plan and perform an engagement with professional skepticism, recognizing that
circumstances may exist that cause the subject matter information to be materiality misstated.
The practitioner shall exercise professional judgment in planning and performing an assurance engagement,
including determining the nature, timing and extent of procedures.
3.6 Planning and Performing the Engagement (Para 40-47)
Planning
The practitioner shall plan the engagement so that it will be performed in an effective manner
The practitioner shall determine whether the criteria are suitable for the engagement circumstances
SPOTLIGHT
If it is discovered after engagement acceptance that one or more preconditions for an assurance engagement is
not present, the practitioner shall discuss the matter with the appropriate party(ies), and shall determine:
 Whether the matter can be resolved to the practitioner’s satisfaction;
 Whether it is appropriate to continue with the engagement; and
 Whether and, if so, how to communicate the matter in the assurance report.
If it is discovered after the engagement has been accepted that some or all of the applicable criteria are unsuitable
or some or all of the underlying subject matter is not appropriate for an assurance engagement, the practitioner
shall consider withdrawing from the engagement, if withdrawal is possible under applicable law or regulation.
If the practitioner continues with the engagement, the practitioner shall express a qualified or adverse
conclusion, or disclaimer of conclusion, as appropriate in the circumstances.
Materiality
The practitioner shall consider materiality when:
 Planning and performing the assurance engagement, including when determining the nature, timing and
extent of procedures; and
 Evaluating whether the subject matter information is free from material misstatement.

Understanding the Underlying Subject Matter and Other Engagement Circumstances

The practitioner shall make inquiries of the appropriate party(ies) regarding:
 Whether they have knowledge of any actual, suspected or alleged intentional misstatement or non-
compliance with laws and regulations affecting the subject matter information;
 Whether the responsible party has an internal audit function and, if so, make further inquiries to obtain
an understanding of the activities and main findings of the internal audit function with respect to the
subject matter information; and
 Whether the responsible party has used any experts in the preparation of the subject matter
information.
3.7 Obtaining Evidence (Para 48-60)
Risk Consideration and Responses to Risks
Limited Assurance Reasonable Assurance

Based on the practitioner’s understanding, the Based on the practitioner’s understanding the
practitioner shall: practitioner shall:
AT A GLANCE
a) Identify areas where a material misstatement of (a) Identify and assess the risks of material
the subject matter information is likely to arise; misstatement in the subject matter
and information; and
b) Design and perform procedures to address those (b) Design and perform procedures to respond to
areas and to obtain limited assurance to support the assessed risks and to obtain reasonable
the practitioner’s conclusion. assurance to support the practitioner’s
If the practitioner becomes aware of a matter(s) that conclusion. In addition to any other procedures
causes the practitioner to believe that the subject on the subject matter information that are
matter information may be materially misstated, the appropriate in the engagement circumstances,
practitioner shall design and perform additional the practitioner’s procedures shall include
procedures to obtain further evidence until the obtaining sufficient appropriate evidence as
practitioner is able to: to the operating effectiveness of relevant
SPOTLIGHT
controls over the subject matter information
a) Conclude that the matter is not likely to cause
when:
the subject matter information to be materially
misstated; or (i) The practitioner’s assessment of the risks
of material misstatement includes an
b) Determine that the matter(s) causes the subject
expectation that controls are operating
matter information to be materially misstated.
effectively, or
(ii) Procedures other than testing of controls
cannot alone provide sufficient
appropriate evidence.
When designing and performing procedures, the practitioner shall consider the relevance and reliability of the
information to be used as evidence. If:
 Evidence obtained from one source is inconsistent with that obtained from another; or
 The practitioner has doubts about the reliability of information to be used as evidence,
The practitioner shall determine what changes or additions to procedures are necessary to resolve the matter,
and shall consider the effect of the matter, if any, on other aspects of the engagement.
The practitioner shall accumulate uncorrected misstatements identified during the engagement other than those
that are clearly trivial.

Work Performed by a Practitioner’s Expert

When the work of a practitioner’s expert is to be used, the practitioner shall also:
 Evaluate whether the practitioner’s expert has the necessary competence, capabilities and objectivity
for the practitioner’s purposes. In the case of a practitioner’s external expert, the evaluation of
objectivity shall include inquiry regarding interests and relationships that may create a threat to that
expert’s objectivity;
 Obtain a sufficient understanding of the field of expertise of the practitioner’s expert;
 Agree with the practitioner’s expert on the nature, scope and objectives of that expert’s work; and
 Evaluate the adequacy of the practitioner’s expert’s work for the practitioner’s purposes.
Work Performed by Another Practitioner, a Responsible Party’s or Measurer’s or Evaluator’s Expert, or

an Internal Auditor
When the work of another practitioner is to be used, the practitioner shall evaluate whether that work is
adequate for the practitioner’s purposes.
If information to be used as evidence has been prepared using the work of a responsible party’s or a measurer’s
or evaluator’s expert, the practitioner shall, to the extent necessary having regard to the significance of that
AT A GLANCE
expert’s work for the practitioner’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 evidence.
If the practitioner plans to use the work of internal audit function, practitioner shall evaluate the following:
 The extent to which the internal audit function’s organizational status and relevant policies and
procedures support the objectivity of the internal auditors;
 The level of competence of the internal audit function;
 Whether the internal audit function applies a systematic and disciplined approach, including quality
control; and
SPOTLIGHT
 Whether the work of the internal audit function is adequate for the purposes of the engagement.
The practitioner shall request from the appropriate party(ies) a written representation:
 That it has provided the practitioner with all information of which the appropriate party(ies) is aware
that is relevant to the engagement.
 Confirming the measurement or evaluation of the underlying subject matter against the applicable
criteria, including that all relevant matters are reflected in the subject matter information.
If, in addition to required representations, the practitioner determines that it is necessary to obtain one or more
written representations to support other evidence relevant to the subject matter information, the practitioner
shall request such other written representations.
When written representations relate to matters that are material to the subject matter information, the
practitioner shall:
 Evaluate their reasonableness and consistency with other evidence obtained, including other
representations (oral or written); and
 Consider whether those making the representations can be expected to be well-informed on the
particular matters.
The date of the written representations shall be as near as practicable to, but not after, the date of the assurance
report.

Requested Written Representations Not Provided or Not Reliable

If one or more of the requested written representations are not provided or the practitioner concludes that there
is sufficient doubt about the competence, integrity, ethical values, or diligence of those providing the written
representations, or that the written representations are otherwise not reliable, the practitioner shall:
 Discuss the matter with the appropriate party(ies);
 Reevaluate the integrity of those from whom the representations were requested or received and
evaluate the effect that this may have on the reliability of representations (oral or written) and evidence
in general; and
 Take appropriate actions, including determining the possible effect on the conclusion in the assurance
report.
3.8 Subsequent Events (Para 61)

When relevant to the engagement, the practitioner shall consider the effect on the subject matter information
and on the assurance report of events up to the date of the assurance report, and shall respond appropriately to
facts that become known to the practitioner after the date of the assurance report, that, had they been known to
the practitioner at that date, may have caused the practitioner to amend the assurance report.
AT A GLANCE
3.9 Other Information (Para 62)
When documents containing the subject matter information and the assurance report thereon include other
information, the practitioner shall read that other information to identify material inconsistencies, if any, with
the subject matter information or the assurance report and, if on reading that other information, the practitioner:
 Identifies a material inconsistency between that other information and the subject matter information
or the assurance report; or
 Becomes aware of a material misstatement of fact in that other information that is unrelated to matters
appearing in the subject matter information or the assurance report,
the practitioner shall discuss the matter with the appropriate party(ies) and take further action as appropriate.
3.10 Description of Applicable Criteria (Para 63)
SPOTLIGHT
The practitioner shall evaluate whether the subject matter information adequately refers to or describes the
applicable criteria.
3.11 Forming the Assurance Conclusion (Para 62-66)

The practitioner shall evaluate the sufficiency and appropriateness of the evidence obtained in the context of the
engagement and, if necessary in the circumstances, attempt to obtain further evidence.
The practitioner shall form a conclusion about whether the subject matter information is free from material
misstatement. In forming that conclusion, the practitioner shall consider the practitioner’s conclusion regarding
the sufficiency and appropriateness of evidence obtained and an evaluation of whether uncorrected
misstatements are material, individually or in the aggregate.
If the practitioner is unable to obtain sufficient appropriate evidence, a scope limitation exists and the
practitioner shall express a qualified conclusion, disclaim a conclusion, or withdraw from the engagement, where
withdrawal is possible under applicable law or regulation, as appropriate.
3.12 Preparing the Assurance Report (Para 67-71)

The assurance report shall be in writing and shall contain a clear expression of the practitioner’s conclusion
about the subject matter information.
Practitioner’s conclusion shall be clearly separated from information or explanations that are not intended to
affect practitioner’s conclusion, including any Emphasis of Matter, Other Matter, findings related to particular
aspects of the engagements, recommendations or additional information included in the assurance report.

Assurance Report Content

The assurance report shall include, at a minimum, the following basic elements:
 A title that clearly indicates the report is an independent assurance report.
 An addressee.
 An identification or description of the level of assurance obtained by the practitioner, the subject matter
information and, when appropriate, the underlying subject matter. When the practitioner’s conclusion
is phrased in terms of a statement made by the appropriate party(ies), that statement shall accompany
the assurance report, be reproduced in the assurance report or be referenced therein to a source that is
available to the intended users.
 Identification of the applicable criteria.
 Where appropriate, a description of any significant inherent limitations associated with the
measurement or evaluation of the underlying subject matter against the applicable criteria.
 When the applicable criteria are designed for a specific purpose, a statement alerting readers to this fact
and that, as a result, the subject matter information may not be suitable for another purpose.
 A statement to identify the responsible party and the measurer or evaluator if different, and to describe
their responsibilities and the practitioner’s responsibilities.

AT A GLANCE
A statement that the engagement was performed in accordance with this ISAE or, where there is a
subject-matter specific ISAE, that ISAE.
 A statement that the firm of which the practitioner is a member applies ISQC 1, or other professional
requirements, or requirements in law or regulation, that are at least as demanding as ISQC 1. If the
practitioner is not a professional accountant, the statement shall identify the professional requirements,
or requirements in law or regulation, applied that are at least as demanding as ISQC 1.
 A statement that the practitioner complies with the independence and other ethical requirements of the
IESBA Code, or other professional requirements, or requirements imposed by law or regulation, that are
at least as demanding as the IESBA Code related to assurance engagements.
 An informative summary of the work performed as the basis for the practitioner’s conclusion. In the case
of a limited assurance engagement, an appreciation of the nature, timing and extent of procedures
performed is essential to understanding the practitioner’s conclusion. In a limited assurance
SPOTLIGHT
engagement, the summary of the work performed shall state that:

¯ The procedures performed in a limited assurance engagement vary in nature and timing from, and
are less in extent than for, a reasonable assurance engagement; and
¯ Consequently, the level of assurance obtained in a limited assurance engagement is substantially
lower than the assurance that would have been obtained had a reasonable assurance engagement
been performed.
¯ The practitioner’s conclusion: When appropriate, the conclusion shall inform the intended users of
the context in which the practitioner’s conclusion is to be read.
¯ In a reasonable assurance engagement, the conclusion shall be expressed in a positive form.
¯ In a limited assurance engagement, the conclusion shall be expressed in a form that conveys
whether, based on the procedures performed and evidence obtained, a matter(s) has come to the
practitioner’s attention to cause the practitioner to believe that the subject matter information is
materially misstated.
¯ The conclusion shall be phrased using appropriate words for the underlying subject matter and
applicable criteria given the engagement circumstances and shall be phrased in terms of:
a) The underlying subject matter and the applicable criteria;
b) The subject matter information and the applicable criteria; or
c) A statement made by the appropriate party(ies).
¯ When the practitioner expresses a modified conclusion, the assurance report shall contain:
a) A section that provides a description of the matter(s) giving rise to the modification; and

b) A section that contains the practitioner’s modified conclusion.

 The practitioner’s signature.
 The date of the assurance report. Shall be dated no earlier than the date on which the practitioner has
obtained the evidence on which the practitioner’s conclusion is based, including evidence that those with
the recognized authority have asserted that they have taken responsibility for subject matter
information.
Reference to the Practitioner’s Expert in the Assurance Report

If the practitioner refers to the work of a practitioner’s expert in the assurance report, the wording of that report
shall not imply that the practitioner’s responsibility for the conclusion expressed in that report is reduced
because of the involvement of that expert.
Assurance Report Prescribed by Law or Regulation

If the practitioner is required by law or regulation to use a specific layout or wording of the assurance report, the
assurance report shall refer to this or other ISAEs only if the assurance report includes, at a minimum, each of
the elements identified in above unit.
AT A GLANCE
3.13 Unmodified and Modified Conclusions (Para 72-77)
The practitioner shall express an unmodified conclusion when the practitioner concludes:
 In the case of a reasonable assurance engagement, that the subject matter information is prepared, in all
material respects, in accordance with the applicable criteria; or
 In the case of a limited assurance engagement, that, based on the procedures performed and evidence
obtained, no matter(s) has come to the attention of the practitioner that causes the practitioner to
believe that the subject matter information is not prepared, in all material respects, in accordance with
the applicable criteria.
If the practitioner considers it necessary to:
 Draw intended users’ attention to a matter presented or disclosed in the subject matter information that,
SPOTLIGHT
in the practitioner’s judgment, is of such importance that it is fundamental to intended users’
understanding of the subject matter information (an Emphasis of Matter paragraph); or
 Communicate a matter other than those that are presented or disclosed in the subject matter
information that, in the practitioner’s judgment, is relevant to intended users’ understanding of the
engagement, the practitioner’s responsibilities or the assurance report (an Other Matter paragraph),
If this is not prohibited by law or regulation, the practitioner shall do so in a paragraph in the assurance report,
with an appropriate heading, that clearly indicates the practitioner’s conclusion is not modified in respect of the
matter.
The practitioner shall express a modified conclusion in the following circumstances:
 When, in practitioner’s professional judgment, a scope limitation exists and the effect of the matter could
be material. In such cases, practitioner shall express a qualified conclusion or a disclaimer of
conclusion.
 When, in the practitioner’s professional judgment, the subject matter information is materially
misstated. In such cases, the practitioner shall express a qualified conclusion or adverse conclusion.
When the statement made by the appropriate party(ies) has identified and properly described that the subject
matter information is materially misstated, the practitioner shall either:
 Express a qualified conclusion or adverse conclusion, phrased in terms of the underlying subject matter
and the applicable criteria; or

 If specifically required by the terms of the engagement to phrase the conclusion in terms of a statement
made by the appropriate party(ies), express an unqualified conclusion but include an Emphasis of
Matter paragraph in the assurance report referring to the statement made by the appropriate party(ies)
that identifies and properly describes that the subject matter information is materially misstated.
3.14 Other Communication Responsibilities (Para 78)

The practitioner shall consider whether, pursuant to the terms of the engagement and other engagement
circumstances, any matter has come to the attention of the practitioner that is to be communicated with the
responsible party, the measurer or evaluator, the engaging party, those charged with governance or others.
3.15 Documentation (Para 79-83)

The practitioner shall prepare on a timely basis engagement documentation that provides a record of the basis
for the assurance report that is sufficient and appropriate to enable an experienced practitioner, having no
previous connection with the engagement, to understand:
 The nature, timing and extent of the procedures performed to comply with relevant ISAE and applicable
legal and regulatory requirements;
 The results of the procedures performed, and the evidence obtained; and
AT A GLANCE
 Significant matters arising during the engagement, the conclusions reached thereon, and significant
Practitioner shall assemble the engagement documentation in an engagement file and complete administrative
process of assembling the final engagement file on a timely basis after the date of the assurance report.
After the assembly of the final engagement file has been completed, the practitioner shall not delete or discard
engagement documentation of any nature before the end of its retention period.
If the practitioner finds it necessary to amend existing engagement documentation or add new engagement
documentation after the assembly of the final engagement file has been completed the practitioner shall,
regardless of the nature of the amendments or additions, document:
 The specific reasons for making the amendments or additions; and
SPOTLIGHT
 When, and by whom, they were made and reviewed.

Aster Textile Limited (ATL) manufactures industrial grade safety garments. It uses certain
chemicals whose waste needs to be disposed of in a certain manner to prevent any harm to the
environment.
The government has prescribed the safety standards which are required to be adhered to, with
regard to disposal of these chemicals. ATL has its own internally developed standards which have
been approved by some of its international customers. These customers require that ATL as well
as all its suppliers should comply with these standards. However, the standards set by the
government are far more comprehensive and stringent as compared to ATL’s internally
developed standards.
ATL has approached your firm to report on compliance with its internally developed standards.
ATL has informed you that the report would be submitted to the concerned international
customers.
Required:
In the light of the relevant international standards on assurance engagements:
a) Discuss what steps would you take before deciding to accept the above assignment.
b) Assuming that you have accepted the engagement, what matters would you like to
include in your report to ensure that it is not misleading for the intended users.

Tutorial Notes:
The key issue is that the government had also issued its own safety standards which were more
comprehensive and stringent. Two types of errors to be avoided while answering the question
are:
 Failing to offer any comments regarding the use of internally developed standards in the
presence of more comprehensive standards issued by the government.
 Not mentioning how the auditor should assess that the standards to be applied are
suitable
 Solution
a) Our firm shall only accept the engagement if we are satisfied that relevant ethical
requirements including those related to independence have been met. We need to
ensure that the basis upon which the engagement is to be performed has been agreed
i.e. there is a common understanding between our firm and ATL of the terms of
engagement. We would also need to ensure that our team have the appropriate
competence and capabilities.
One of the precondition for accepting an engagement is that the standard that will be
applied to evaluate the disposal of waste should be suitable for the engagement
AT A GLANCE
circumstances i.e. it should exhibit the following characteristics.
(i) Relevance
(ii) Completeness
(iii) Reliability
(iv) Neutrality
(v) Understandability
Although the standards have been developed internally, it exhibits the characteristics of
relevance, completeness and neutrality since these are agreed by all the intended users.
The reliability of the criteria would have to be assessed by considering whether the
criteria is such that it would lead to a reasonably consistent measurement or evaluation
of the underlying subject matter when used in similar circumstances by different
SPOTLIGHT
practitioners. The understandability criteria would be considered to have been met if it
results in information that can be understood by the intended users.
Whether the criteria meet the requirement of reliability and understandability is a
matter of professional judgment and we would need to assess it accordingly.
It may be noted that the relevant auditing standard allow the use of internally developed
criteria for the purpose of preparing the subject matter information in the particular
circumstances of the engagement despite the existence of a different criteria embodied
in the law or regulation. However, we should seek acknowledgement from all the
intended users that the said criteria are suitable for their purpose.
b) Though all the intended users agree on the use of internally developed standards, the
existence of more comprehensive standards issued by the government requires that our
assurance report:
(i) States that the criteria are not embodied in law or regulation, or issued by
authorized or recognized bodies of experts.
(ii) Alerts readers that the subject matter information is prepared in accordance with
special purpose criteria and as a result, the subject matter information may not be
suitable for other purposes; and
(iii) Indicates that the assurance report is intended solely for specific users and is not
to be distributed to any other parties other than the engaging parties.


Your firm has been hired by Sensitive Products Limited (SPL), for an assurance engagement
regarding compliance with regulatory requirements. SPL is engaged in the production of highly
sensitive products and is required to comply with strict regulatory requirements. In this regard
a report is submitted by SPL to the regulatory authority which contains certain information.
Required:
Draft a limited assurance report to be issued to the regulatory authority regarding the
information provided to the authority by SPL. The report should contain a qualification and
mention atleast three procedures performed by your firm. (You may assume necessary details,
however any annexures to the report are not required).
Tutorial Notes:
Drafting of the report is usually considered easy at this level especially with Open book exam.
However, non-availability of proper format at end of ISAE 3000 supported by the utter lack of
knowledge, on part of student, may result in poor performance. Students are advised to seek
guidance in respect of this question from the solution given below. Also you can use this solution
for any general purpose assurance engagement covering under ISAE 3000 (not specifically under
the scope of ISAE 3400, ISAE 3402, ISAE 3410, ISAE 3410 and ISAE 3400).
AT A GLANCE
 Solution:
Independent Limited Assurance Report
To the Director Compliance of Nuclear Drug Control Authority:
We have been engaged by Sensitive Products Limited (SPL) to perform a limited assurance
engagement in respect of the following information (said information) presented in the 2016
Report to the Director Compliance, Nuclear Drug Control Authority, for the year ended December
31, 2016:
 The type and number of nuclear medicines produced during the year;
 The details of machinery and equipment used to manufacture nuclear medicines;
 Details of safety and quality control measures adopted by SPL during the year.
SPOTLIGHT
Inherent Limitations
Non- financial information, such as that included in the SPL’s report to the Nuclear Drug Control
Authority, is subject to more inherent limitations than financial information, given the more
qualitative characteristics of the said information and the methods used for determining said
information.
Management’s Responsibilities:
Preparation and fair presentation of the said information in accordance with the specified
regulations is the responsibility of the SPL’s management. Management is also responsible for
such internal control as management determines is necessary to enable the preparation of the
said information such that it is free from material misstatement.
Practitioner’s Responsibility:
We are responsible for:
 Planning and performing the engagement to obtain limited assurance about whether the
said information is free from material misstatement, whether due to fraud or error;
 Forming an independent conclusion, based on the procedure we have performed and
the evidence we have obtained; and
 Reporting our conclusion to the Director Compliance, Nuclear Drug Control Authority.

Professional Standards applied and level of assurance:

We conducted our limited assurance engagement in accordance with the International Standard
on Assurance Engagements 3000 (ISAE 3000), “Assurance Engagements other than Audits or
Reviews of Historical Financial Information” published by the International Federation of
Accountants. A limited assurance engagement is substantially less in scope than a reasonable
assurance engagement in relation to both the risk assessment procedures, including an
understanding of internal control, and the procedures performed in response to the assessed
risks.
Independence, quality control and competency statement:
We have complied with the Code of Ethics for Professional Accountants issued by the
International Ethics Standards Board for Accountants, which includes independence and other
requirements founded on fundamental principles of integrity, objectivity, professional
competence and due care, confidentiality and professional behavior. In accordance with
International Standard on Quality Control 1, we maintain a comprehensive system of quality
control including documented policies and procedures regarding compliance with ethical
requirements, professional standards and applicable legal and regulatory requirements.
Work Done
We are required to plan and perform our work to obtain limited assurance about whether the
AT A GLANCE
said information is free from material misstatements, in doing so we:
 Make enquiries of SPL’s management.
 Evaluate the design of the key structures, systems, processes and controls for managing,
recording and reporting the said information.
 Perform limited substantive testing on a selected basis and access the records and
discussion with the relevant staff to check that data had been appropriately measures,
recorded, collated and reported; and
 Evaluate the disclosure and presentation of the said information.
Basis for qualified opinion
As per Nuclear Drug Control Regulations, SPL is required to get approval of the updated list of
SPOTLIGHT
suppliers from NDCA on yearly basis, however during the year no such approval was obtained
and we observed that the raw materials were purchased from suppliers who were not in the list
of suppliers of last year. Therefore, we are unable to determine whether the raw material
procured by SPL comply with the minimum safety requirements as specified by NDCA.
Qualified opinion
Based on our limited assurance procedures performed, as described above and the evidence we
have obtained, except for the possible effects of the matter described in the basis for qualified
opinion paragraph, nothing has come to our attention that causes us to believe that the selected
information for the 2015 reporting year has not been prepared, in all material respects, in
accordance with the Nuclear Drug Control Regulations.
Other Matters
Our report has been prepared solely for the purposes of SPL’s compliance with the reporting
requirements relating to Sections XXX of the NDCR and is not intended to be and should not be
used for any other purpose. Our duties in relation to this report are owed solely to NDCA, and
accordingly, we do not accept any responsibility for loss occasioned to any other party acting or
refraining from acting based on this report.
XYZ Chartered Accountants

Engagement partner: ABC
Dated: 08 December 2016
Karachi


To ensure the continuity in supply of cement required for development projects in far flung areas,
the Provincial Government sought application from cement producers for a three years supply
contract. Cement Limited (CL), a relatively new cement producer, was also interested in filing the
said application, as it could bring provincial government as a secured and committed customer.
CL also has a similar contract with Local Government for last two years.
One of the requirements of the Provincial Government is that CL should submit a report by their
independent auditors on CL’s compliance with certain covenants of their agreement with the
Local Government i.e. those related to capital adequacy, price computation, minimum level of
inventory and any other matter directly related to financial reporting. SSZ Chartered
Accountants have been the statutory auditors of CL for the last three years. They were appointed
to carry out the engagement at a fee of Rs. 100,000. Mr. Sharif, engagement partner of the last
annual audit, discussed the scope of work with the management. The discussion revealed the
following matters:
i. The report is supposed to cover the period November 03, 2004 to December 31,2007.
ii. The agreement (Referred to as XYZ/2004 dated November 03, 2004) consisted of
voluminous annexures and attachments; and contained references to a number of rules
and regulations contained in various legislations.
AT A GLANCE
iii. Certain disputes have erupted over the period, some of which still remain unsettled.
iv. Mr. Sharif assessed that the assignment would take around twenty working days. The
management felt the estimate unreasonable, as the said agreement had already been
reviewed by the auditors during the annual audits.
The firm accepted the offer and Mr. Sharif performed the engagement in fifteen working days. He
is now preparing the required compliance report with the following information in hand:
i. Two significant disputes were raised by the Local Government relating to capital
adequacy and price computation of ‘Quick-set Cement’. Both were resolved through
negotiations as confirmed by the officials of the Local Government verbally; however, a
written confirmation was refused. The records show that CL convinced the Local
Government authorities by producing the opinion of a legal expert, based on Regulation
SPOTLIGHT
JKL of 1961.
ii. The management is confident that this compliance report will also support their
viewpoint in their dealing with the Local Government, although the engagement letter
does not contain such an understanding.
iii. Minimum level of inventory was actually kept by three distributors of CL under binding
contracts clearly citing the purpose of the arrangement. The management is of the view
that this practice is in conformity with the interpretation given in Regulation referred to
above
iv. CL was also required to provide a performance guarantee of Rs. 24 million issued by a
scheduled bank. However, this facility was not renewed after the first year. As a result,
CL is exposed to a general penalty as provided in the agreement.
Required:
Based on International Standards on Auditing and ICAP’s Code of Conduct:
a) Explain how the above issues should be dealt with in the compliance report.
b) Draft a Report on Compliance with the Agreement.
c) Explain your view point in response to the management’s comments regarding
assignment completion time.
d) Comment on the firm’s decision to appoint Mr. Sharif, for carrying out this engagement.

 Solution:
(a)
 Verbal confirmation from Local Government as regards the resolution of dispute on capital
adequacy and price computation of cement, will not be considered as appropriate/sufficient
audit evidence.
 Refusal of written confirmation is a scope limitation and unless other appropriate evidence
is available the report will need to be modified.
 Management’s intention to use the auditor’s report for the purpose of dealing with the local
government is beyond the scope of the engagement. Therefore, the auditor’s report should
specify the agreed intended use thereof.
 Interpretations given in Regulation JKL, 1961 were used to form the opinion on compliance
relating to minimum inventory level and price computation. Therefore, the Regulation
should also be referred to in the report for better understanding of the assurance.
 Not renewing performance guarantee is a clear non-compliance which needs to be reported
as qualification.
 Decision to keep the inventory with distributors could not be considered as a non-
compliance because these are covered under binding contracts and the purpose of the
arrangement is also mentioned in the contract.
AT A GLANCE
(b)
We have audited Cement Limited’s compliance with certain covenants of cement supply
agreement No. XYZ/2004 dated November 03, 2004 read with Local Regulation JKL 1961,
executed between the company and the Local Government. The purpose of the report is to fulfill
the condition attached to an application to be filed with the Provincial Government to obtain a
cement supply contract.
We conducted our audit in accordance with International Standards on Auditing-800 “The
Independent Auditor’s Report on Special Purpose Audit Engagement” applicable to compliance
auditing.
The Standard requires that we plan and perform the audit to obtain reasonable assurance as to
whether Cement Limited has complied with the agreement referred to in preceding paragraph.
SPOTLIGHT
An audit includes examining appropriate evidence on a test basis. We believe that our audit
provides a reasonable basis for our opinion. We report that:
(a) We could not directly confirm, from the Local Government, the status of non-compliance of
capital adequacy and price computation of ‘quick-set cement’.
(b) The company failed to maintain a performance guarantee with a scheduled bank, which is a
violation of the agreement.
In our opinion, except for the effect on the overall compliance, if any, as might have been
determined, had we been able to obtain the confirmation from the Local Government in
respect of capital adequacy and price computation of quick-set cement and the non-
compliance stated in paragraph (b) above, as of December 31, 2007, the Company was, in all
material respects, in compliance with the covenants of price computation, minimum
inventory level and other matters related to financial reporting of the agreement referred to
in the preceding paragraphs.
AUDITOR
Date
Address

(c) Views of the management on job time:

It is true that auditors have already reviewed the subject agreement during the audit of the
financial statements. However, the review was different in nature as discussed below:
Materiality was set on the basis of certain Materiality was set on the basis of
values of financial statements. principles agreed at the time of
engagement.
During the audit only those clauses of the In the given engagement the auditors
agreement would have been studied which were required to obtain assurance about
could impact the revenue and exspenditure the management’s claim of compliance
and risk of loss. with all the clauses which may or may not
have significant financial impact on the
company.
The agreement was among one of the very Since only this agreement was the subject
large number of documents that could have of the auditor’s report, it required far
required auditors’ attention. Hence only a extensive examination.
general review of the same was required.
AT A GLANCE
Due to these differences the nature and extent of examination of agreement was much larger
in this engagement than in audit. Accordingly, considerable time was required to complete
the engagement.
(d) Appointment of Mr. Sharif since
Mr. Sharif was also the engagement partner on the audit of Cement Ltd., his appointment for
this assignment may result in self review threat.
SPOTLIGHT

4. EXAMINATION OF PROSPECTIVE FINANCIAL INFORMATION (ISAE 3400)

4.1 Introduction (Para 1-7)
In an engagement to examine prospective financial information, the auditor should obtain sufficient appropriate
evidence as to whether:
 Management’s best-estimate assumptions on which the prospective financial information is based are
not unreasonable and, in the case of hypothetical assumptions, such assumptions are consistent with
the purpose of the information;
 The prospective financial information is properly prepared on the basis of the assumptions;
 The prospective financial information is properly presented and all material assumptions are
adequately disclosed, including a clear indication as to whether they are best-estimate assumptions or
hypothetical assumptions; and
 The prospective financial information is prepared on a consistent basis with historical financial
statements, using appropriate accounting principles.
 “Prospective financial information” means financial information based on assumptions about events that
may occur in the future and possible actions by an entity. It is highly subjective in nature and its preparation
requires the exercise of considerable judgment. Prospective financial information can be in the form of a
AT A GLANCE
forecast, a projection or a combination of both, for example, a one year forecast plus a five-year projection.
 A “forecast” means 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).
 A “projection” means prospective financial information prepared on the basis of:
a) Hypothetical assumptions about future events and management actions which are not
necessarily expected to take place, such as when some entities are in a start-up phase or
are considering a major change in the nature of operations; or
b) A mixture of best-estimate and hypothetical assumptions.
Such information illustrates the possible consequences as of the date the information is prepared
if the events and actions were to occur (a “what-if” scenario)
SPOTLIGHT
Prospective financial information can include financial statements or one or more elements of financial
statements and may be prepared:
 As an internal management tool, for example, to assist in evaluating a possible capital investment; or
 For distribution to third parties in, for example:
¯ A prospectus to provide potential investors with information about future expectations.
¯ An annual report to provide information to shareholders, regulatory bodies and other interested
parties.
¯ A document for the information of lenders which may include, for example, cash flow forecasts.
Management is responsible for the preparation and presentation of the prospective financial information,
including the identification and disclosure of the assumptions on which it is based. The auditor may be asked to
examine and report on the prospective financial information to enhance its credibility whether it is intended for
use by third parties or for internal purposes.
4.2 The Auditor’s Assurance Regarding Prospective Financial Information (Para 8-9)
Prospective financial information relates to events and actions that have not yet occurred and may not occur.
While evidence may be available to support the assumptions on which the prospective financial information is
based, such evidence is itself generally future oriented and, therefore, speculative in nature, as distinct from the
evidence ordinarily available in the audit of historical financial information. The auditor is, therefore, not in a
position to express an opinion as to whether the results shown in the prospective financial information will be
achieved.

4.3 Acceptance of Engagement (Para 10-12)

Before accepting an engagement, the auditor would consider, amongst other things:
 The intended use of the information;
 Whether the information will be for general or limited distribution;
 The nature of the assumptions, that is, whether they are best-estimate or hypothetical assumptions;
 The elements to be included in the information; and
 The period covered by the information.
Auditor should not accept, or should withdraw from, engagement when the assumptions are clearly unrealistic
or when auditor believes that the prospective financial information will be inappropriate for its intended use.
Auditor and client should agree on the terms of the engagement. It is in the interests of both entity and auditor
that the auditor sends an engagement letter to help in avoiding misunderstandings regarding the engagement.
4.4 Knowledge of the Business (Para 13-15)

The auditor would also need to become familiar with the entity’s process for preparing prospective financial
information, for example, by considering the following:
AT A GLANCE
 The internal controls over the system used to prepare prospective financial information and the
expertise and experience of those persons preparing the prospective financial information.
 The nature of the documentation prepared by the entity supporting management’s assumptions.
 The extent to which statistical, mathematical and computer-assisted techniques are used.
 The methods used to develop and apply assumptions.
 The accuracy of prospective financial information prepared in prior periods and the reasons for
significant variances.
The auditor should consider the extent to which reliance on the entity’s historical financial information is
justified. The auditor requires a knowledge of the entity’s historical financial information to assess whether the
prospective financial information has been prepared on a basis consistent with the historical financial
information and to provide a historical yardstick for considering management’s assumptions.
SPOTLIGHT
4.5 Period Covered (Para 16)

Auditor should consider the period of time covered by the prospective financial information.
Since assumptions become more speculative as the length of the period covered increases, as that period
lengthens, the ability of management to make best-estimate assumptions decreases. The period would not extend
beyond the time for which management has a reasonable basis for the assumptions.
The following are some of the factors that are relevant to the auditor’s consideration of the period of time covered
by the prospective financial information:
 Operating cycle, for example, in the case of a major construction project the time required to complete
the project may dictate the period covered.
 The degree of reliability of assumptions, for example, if the entity is introducing a new product the
prospective period covered could be short and broken into small segments, such as weeks or months.
 The needs of users, for example, prospective financial information may be prepared in connection with
an application for a loan for the period of time required to generate sufficient funds for repayment.
4.6 Examination Procedures (Para 17-25)

When determining nature, timing and extent of procedures, auditor’s considerations should include:
 The likelihood of material misstatement;
 The knowledge obtained during any previous engagements;

 Management’s competence regarding the preparation of prospective financial information;

 The extent to which the prospective financial information is affected by the management’s judgment;
and
 The adequacy and reliability of the underlying data.
The auditor would assess the source and reliability of the evidence supporting management’s best-estimate
assumptions.
The auditor would consider whether, when hypothetical assumptions are used, all significant implications of
such assumptions have been taken into consideration.
Although evidence supporting hypothetical assumptions need not be obtained, the auditor would need to be
satisfied that they are consistent with the purpose of the prospective financial information and that there is no
reason to believe they are clearly unrealistic.
The auditor will need to be satisfied that the prospective financial information is properly prepared from
management’s assumptions by, for example, making clerical checks such as re-computation and reviewing
internal consistency.
When engaged to examine one or more elements of prospective financial information, such as an individual
financial statement, it is important that the auditor consider the interrelationship of other components as well.
AT A GLANCE
When any elapsed portion of the current period is included in the prospective financial information, the auditor
would consider the extent to which procedures need to be applied to the historical information.
The auditor should obtain written representations from management regarding the intended use of the
prospective financial information, the completeness of significant management assumptions and management’s
acceptance of its responsibility for the prospective financial information.
4.7 Presentation and Disclosure (Para 26)

When assessing the presentation and disclosure, auditor will need to consider whether:
 The presentation of prospective financial information is informative and not misleading;
 The accounting policies are clearly disclosed in the notes to the prospective financial information;
SPOTLIGHT
 The assumptions are adequately disclosed in the notes to the prospective financial information;
 The date as of which the prospective financial information was prepared is disclosed.;
 The basis of establishing points in a range is clearly indicated and the range is not selected in a biased
or misleading manner when results shown in the prospective financial information are expressed in
terms of a range; and
 Any change in accounting policy since the most recent historical financial statements is disclosed, along
with the reason for the change and its effect on the prospective financial information.
4.8 Report on Examination of Prospective Financial Information (Para 27-32)

The report by an auditor on an examination of prospective financial information should contain the following:
 Title;
 Addressee;
 Identification of the prospective financial information;
 A reference to the ISAE or relevant national standards or practices applicable to the examination of
prospective financial information;
 A statement that management is responsible for the prospective financial information including the
assumptions on which it is based;
 When applicable, a reference to the purpose and/or restricted distribution of the prospective financial
information;

 A statement of negative assurance as to whether the assumptions provide a reasonable basis for the
prospective financial information;
 An opinion as to whether the prospective financial information is properly prepared on the basis of the
assumptions and is presented in accordance with the relevant financial reporting framework;
 Appropriate caveats concerning the achievability of the results indicated by the prospective financial
information;
 Date of the report which should be the date procedures have been completed;
 Auditor’s address; and
 Signature.
 Such a report would:
¯ State whether, based on the examination of the evidence supporting the assumptions, anything has
come to the auditor’s attention which causes the auditor to believe that the assumptions do not
provide a reasonable basis for the prospective financial information.
¯ Express an opinion as to whether prospective financial information is properly prepared on the
basis of the assumptions and is presented in accordance with the relevant financial reporting
framework.
AT A GLANCE
¯ State that:
○ Actual results are likely to be different from the prospective financial information; and
○ In case of a projection, prospective financial information has been prepared for (state purpose),
using a set of assumptions that include hypothetical assumptions.
 The following is an example of an extract from an unmodified report on a forecast:
We have examined the forecast1 in accordance with the International Standard on Assurance
Engagements applicable to the examination of prospective financial information. Management is
responsible for the forecast including the assumptions set out in Note X on which it is based.
Based on our examination of the evidence supporting the assumptions, nothing has come to our
attention which causes us to believe that these assumptions do not provide a reasonable basis
SPOTLIGHT
for the forecast. Further, in our opinion the forecast is properly prepared on the basis of the
assumptions and is presented in accordance with
Actual results are likely to be different from the forecast since anticipated events frequently do
not occur as expected and the variation may be material.
The following is an example of an extract from an unmodified report on a projection:
We have examined the projection in accordance with the International Standard on Assurance
Engagements applicable to the examination of prospective financial information. Management is
responsible for the projection including the assumptions set out in Note X on which it is based.
This projection has been prepared for (describe purpose). As the entity is in a start-up phase the
projection has been prepared using a set of assumptions that include hypothetical assumptions
about future events and management’s actions that are not necessarily expected to occur.
Consequently, readers are cautioned that this projection may not be appropriate for purposes
other than that described above.
Based on our examination of the evidence supporting the assumptions, nothing has come to our
attention which causes us to believe that these assumptions do not provide a reasonable basis
for the projection, assuming that (state or refer to the hypothetical assumptions). Further, in our
opinion the projection is properly prepared on the basis of the assumptions and is presented in
accordance with

Even if the events anticipated under the hypothetical assumptions described above occur, actual
results are still likely to be different from the projection since other anticipated events frequently
do not occur as expected and the variation may be material.
When the auditor believes that the presentation and disclosure of the prospective financial
information is not adequate, the auditor should express a qualified or adverse opinion in the
report on the prospective financial information, or withdraw from the engagement as
appropriate. An example would be where financial information fails to disclose adequately the
consequences of any assumptions which are highly sensitive.
When the auditor believes that one or more significant assumptions do not provide a reasonable
basis for the prospective financial information prepared on the basis of best-estimate
assumptions or that one or more significant assumptions do not provide a reasonable basis for
the prospective financial information given the hypothetical assumptions, the auditor should
either express an adverse opinion in the report on the prospective financial information, or
withdraw from the engagement.
When the examination is affected by conditions that preclude application of one or more
procedures considered necessary in the circumstances, the auditor should either withdraw from
the engagement or disclaim the opinion and describe the scope limitation in the report on the
prospective financial information.
AT A GLANCE
Gama Pakistan Limited (GPL) is planning to expand its business by manufacturing
telecommunication accessories. For this purpose, GPL intends to obtain financing from a bank
for the planned expansion. To meet the bank’s requirement, GPL has prepared a five years’ cash
flow forecast based on management’s estimates. GPL has requested your firm to review the
forecast and furnish a report thereon.
Following information is available to you in respect of the forecast:
i. GPL has secured agreement with two mobile phone manufacturers under which it would
be able to sell 30% of its production capacity. The mobile phone manufacturers would
pay to GPL after selling the accessories to the wholesalers.
SPOTLIGHT
ii. The telecommunication accessories would be sold to mobile phone manufacturers with
one-year warranty.
iii. During the first year, the supplies to the customers would be made through delivery
trucks; however, in order to reduce the delivery, cost to other cities, cargo train would
be used from second year of production. Negotiations with railway authorities are
underway.
iv. Royalty would be paid to a foreign company for acquiring the right to manufacture
certain accessories.
v. A significant reduction in the cash outflows on account of income tax has been forecasted
in the years 3, 4 and 5. The management has placed a comment in support of this
reduction that the taxation authorities have principally agreed to reduce tax rates for
companies manufacturing ‘telecommunication equipment and related accessories’ and
the announcement of the reduction in tax rates will be made in the next budget.
Required:
Discuss the key examination procedures that your firm would perform in respect of the above
information. Also discuss the reporting implication(s), if any.
 Solution:
Sale to mobile phone manufactures:
i. Review the agreement made with the two customers and evaluate the payment terms.

ii. Review the agreement to assess that whether they have agreed to purchase any specific
quantity and compare it with the forecast.
iii. Inquire from the management about any report which provides current sales cycle of
prospective customers.
iv. Inquire from the management about how they have assessed the sale for subsequent
years and their assumptions.
Warranty costs:
i. Inquire from the management that whether GPL is required to repair the faulty products
under warranty or to replace them. In case of replacement, discuss how the related costs
has been determined.
ii. Inquire from the management that since no previous history is available, then how they
have arrived at the warranty payments.
iii. Inquire from the management that whether they have made any correspondence with
the foreign company regarding any estimated warranty claims.
iv. Ensure that the percentage of warranty payments are consistent with the
increase/decrease in sale each year.
Transportation costs:
AT A GLANCE
i. Obtain the correspondence with the railway authorities to assess whether it would be
available for use from the second year of production.
ii. Obtain any agreement with the transporter to verify the freight rates and payments
terms charged by truck operators.
iii. Verify the railway freight rates from the website and the correspondence with the
railway authorities.
Royalty payments:
i. Obtain the royalty agreement from the management and check the basis on which
royalty is charged.
ii. Verify that percentage applied is consistent with sales amount appearing in the cash flow
SPOTLIGHT
forecast and that correct foreign exchange rate has been applied.
Taxation:
i. Ask the management regarding any confirmation from the Federal Board of
Revenue/Business Association relating to the reduced tax rates.
Reporting implication:
The assumptions related to cash flows are very hypothetical especially those related to tax relief.
If the auditor is unable to obtain sufficient appropriate audit evidence and conclude that the
assumptions used by the management do not provide a reasonable basis for the prospective
financial information, the auditor will then either express an adverse opinion or withdraw from
the engagement.
Masala (Pvt.) Limited (MPL) produces a range of packed spices for last many years. Currently,
MPL sells its products in Karachi and Lahore only. MPL is now planning to expand its business to
all major cities of Pakistan and United Arab Emirates. For this purpose, it intends to seek a
financing of Rs. 2 billion from a local bank. MPL’s CFO has prepared a five-year cash flow forecast
and has presented it to your firm for review.
The following further information is available:
i. MPL signed a three-year contract with a distributor, Asif Brothers (AB) under which AB
was given exclusive right of distribution in Karachi and Lahore. The contract is about to

expire in June 2020. AB makes payment to MPL within 45 days from the date of sales.
The contract specifies AB’s rights to bonus on achieving the sales target.
ii. MPL is in negotiation with many distributors in Islamabad, Peshawar, Quetta, Multan
and Dubai for distribution of its packed spices. The directors wish to sign a five-year
contract with a credit period of 30 days. It is expected that contract will be finalised by
February 2020.
iii. In order to meet the additional demand to be raised through expansion, MPL is planning
to set up additional manufacturing facility in Karachi.
Required:
Discuss the key examination procedures that your firm would perform in respect of the
information from (i) to (iii).
Tutorial Notes:
Common mistakes could be:
 Producing verification procedures related to an audit engagement instead of directing
towards the cash flow forecast.
 Mentioning general procedures despite of mentioning in the requirement of the question
AT A GLANCE
that examination procedures are required related to specific three information.
 Omitting the examination procedures related to bonus payments to distributors, the
translation of foreign currency receipts and examination procedure for setting up the
new manufacturing facility.
 Solution:
i. Contract with AB
 Examine the contract with AB to confirm the specified volume and the profit
forecast.
 A bonus payable to AB should be included in the cash flow forecast at the end of the
contract only if the specified volume of spices is forecasted to be sold by AB.
 Ensure that cash flows of 45-day credit period have been appropriately accounted
SPOTLIGHT
for in the cash flow forecast.
 Discuss with the management about the renewal of the contract with AB.
- If the contract is not renewed, then how the final settlement would be worked
out and check that it is appropriately reflected in the forecast.
- If the contract is renewed, then what would be new terms and check that it is
appropriately reflected in the forecast.
ii. Contract for distribution ship in other cities within Pakistan and UAE
 Examine the status of new distribution ship contract for other cities of Pakistan and
Dubai and confirm the forecast volume from the agreement.
 Inquire from the management regarding likelihood of obtaining five-year contracts
with new distributors at a credit term of 30 days.
 Review that receipts from new distributor(s) should commence after February
2020 with a credit period of 30 days.
 Supply of stock to other distributors should be reconciled with the existing capacity
as well as revised capacity (i.e. after new plant). In any point of time, it should not
exceed the maximum capacity.
 For sales transacted in foreign currencies, discuss with the management regarding
the assumptions used for the exchange rates.

 Check whether the new distributors have the capacity to hold the forecast inventory
levels in their warehouses.
iii. Set up of new manufacturing facility
 Obtain the quote obtained by MPL to assess the cost of the plant to be set up in
Karachi.
 Check the time by when the plant would be set up and when will it be available for
production.
 Obtain the payment plan for the installation of additional manufacturing facility and
ensure that it is appropriately reflected in the financial statements.
Dildar Textile Limited (DTL) has a factory situated in Faisalabad. DTL has been facing acute
shortage of power supply, due to which it has not been able to fulfil its orders within the
committed time. Directors of DTL have decided to install gas driven power plant, to resolve the
issue of power breakdown and has approached its bank for a loan of Rs. 500 million to finance
the required expenditure.
To meet the bank’s requirement, DTL has prepared a forecast cash flow for the next three years.
The following further information is available:
AT A GLANCE
i. DTL intends to supply the surplus electricity produced to the national grid. Directors
expect an increase in the cash flow due to the proceeds of sale of electricity.
ii. DTL plans to procure a vacant plot next to its facility for installation of the plant.
iii. The installation of plant is expected to be completed by 30 June 2019.
iv. Currently, 40% of the production is exported and the rest is sold locally. DTL is expecting
a rise in export as well as local orders by 30% and 20% respectively.
v. Other major outflows pertain to raw material, payroll cost and marketing costs.
Required:
DTL has asked your firm of chartered accountants to provide a report on the forecast. State the
key examination procedures to be used in respect of the cash flow forecast.
SPOTLIGHT
Tutorial Notes:
This is a simple question requiring steps to verify cash flow forecast. The common mistake can
be that student copy exact wording from the standard and do not structure their answers
according to the scenario. Some specific steps might be overlooked, while answering, such as
those related to draft loan agreement, vendor quotations for machinery, cost and time frame for
installation of generators, foreign exchange rates and bids received for construction of building
for installation of generators etc.
 Solution:
i. Confirm expected timeframe for the import and installation of machinery by referring to
vendor quotations/communication.
ii. Obtain the pro forma invoice / quotation for the procurement and installation of the
generators.
iii. Confirm the cost purchase of land with agreement made with the seller.
iv. Obtain the bids received from the contractors for estimating the amount of expenditure
required for the construction of the building in which the generator would be installed.
v. Inquire from management whether necessary approvals have been obtained from the
government for the installation of power plant.
vi. Assess the amount of gas available by reviewing the communication with the
government, and whether it corroborates with management’s expectations.

vii. Review the payment terms with the government for the supply of extra electricity.
viii. Inquire management about basis of increases in export and local sales.
ix. Review the foreign exchange rates used for translating the exports sales.
x. Purchase of raw material, staff cost and marketing expense corroborates with expected
increase in sales.
xi. Inquire with the marketing department whether any new campaigns would be required
to meet the expected rise in sales and its estimated cost.
xii. Consider whether fuel costs have been revised in line with the specifications provided
by the generator supplier.
xiii. Inquire about the interest rates and the repayment terms of the loan and ensure that
they have been appropriately incorporated in the cash flow.
xiv. Assess management competence regarding the preparation of the cash flow forecast.
Delicacy Foods Limited (DFL) produces and sells ice cream and juices. It’s ice cream plant is quite
old and the management is planning to invest in an advanced technology for manufacturing ice
cream, which would result in lowering the costs and would also enable the company to launch a
new range of premium flavours. DFL has sufficient cash to fund 50% of the necessary capital
AT A GLANCE
expenditure and has approached its bank for a loan of Rs. 400 million to finance the remaining
amount.
To meet the banks requirement DFL has prepared a forecast comprising of statement of
comprehensive income for the next three years. It has asked your firm to provide a report on the
forecast.
The following information is available to you in respect of the above:
i. The machinery is expected to be available for commercial production from 1 January
2018.
ii. DFL is expecting a decrease in production cost by 20% and plans to sell the new
premium flavours at 30% above the price of regular flavours.
iii. Operating expenses mainly include staff cost, depreciation, repairs and maintenance.
SPOTLIGHT
Required:
State the examination procedures to be used in respect of the above forecast.
Tutorial Notes:
Common expected errors are:
i. Steps relating to audit of historical financial statements may be included by the student
along with steps related to report on the forecast.
ii. Important points may be missed such as obtaining understanding of the business,
review of market research report to assess projected sales, tax working and
management representation.
 Solution:
Examination procedures should include the following:
 Obtain an understanding of the business of DFL.
 Discuss how the management has developed the significant assumptions and assess the
reasonableness thereof.
 Inquire about the process of making the prospective information and the internal
controls over the system used to prepare prospective financial information.
 Inquiry about the expertise and experience of those preparing the information.
 Inquire about accuracy of previous prospective information made by the management
and the estimates and basis used.

 Ensure that accounting policies used in preparing the prospective financial information
are consistent with those used in historical financial information and comply with the
applicable financial reporting framework.
 Confirm expected timeframe for the import and installation of machinery by referring to
vendor quotations/communication.
 Confirm that the sales of new flavours have been assumed from the date the machine is
ready for commercial production.
 Verify the production capacity of the new plant to corroborate the projected revenue.
 Review market research documents to assess the reasonableness of projected sales
quantities and review prices charged by competitors for the premium flavors.
 Assess the reasonableness of staff cost through average employee turnover rate and the
salary growth rates.
 Discuss the expected decrease in production costs with the management and review the
information on which the projection is based.
 Obtain information from management about major ingredients and wastage
percentages etc. to review the projected cost of raw material.
 Review how cost of repairs and maintenance has been projected and whether the fact
AT A GLANCE
that it is a new plant has been considered.

 Verify the cost of the new plant from supplier’s quote and bills related to import and
installation costs to calculate the depreciation expense.
 Check how the management has accounted for the gain/loss on disposal of the old plant
and equipment.
 Check whether projections related to juices segment are based on past trends and
discuss any major changes in the market, processes, etc. and the effect thereof on the
projections.
 Recalculate the finance cost.
 Review the tax workings.
 Carry out analytical review.
SPOTLIGHT
 Obtain written representations from the management regarding the assumptions used
intended use of prospective financial information and management’s acceptance of its
responsibility for the prospective comprehensive income.
Fawad Limited (FL) is a manufacturer of personal care products. FL intends to diversify its
operations by entering into the packaged food business. For this purpose, it intends to seek a
financing of Rs. 2 billion from Ameen Commercial Bank Limited (ACBL). The company’s CFO has
prepared a five-year cash flow forecast and has presented it to the bank. ACBL has requested
your firm to review the forecast in consultation with FL and furnish a report thereon. On
reviewing the cash flow projections, you have noted the following:
i. Cash sales constitute 80% of the total sales of the new business. Debtors turnover days
related to current business are projected to be reduced from 75 days to 30 days.
ii. In the forecast, 24% of the income is under the head “Income from an associate”, which
is the management’s estimate of the company’s share of the associate income. The
associated company has confirmed the amounts which are incorporated in the forecast;
however, no other details are available with FL to support this assumption.
Required:
a) Comment on the above situations and briefly discuss the steps that you would take in
the given circumstances.

b) Assuming that your firm decides to modify the report on prospective financial
information, draft the basis for modification paragraph and opinion paragraph to be
included in the report. (You may assume necessary details and choose to base the
modification either on para (i) or para (ii) above).
Tutorial Notes:
a) It is important to explain why the assumptions seemed unreasonable and how the
auditors should satisfy themselves in this regard. Moreover, what could be the effect on
the audit opinion in case the basis of the assumptions was not appropriate.
In case of income from associates, along with stating that the confirmation did not
provide sufficient audit evidence in support of the prospective income from associate,
you should also focus on the fact that a scope limitation could arise if evidence was not
available to support this assumption.
Being prospective financial information issues related to ‘related party’ would not be
relevant in this case.
b) A common mistake can be drafting modification for each of the issue. Moreover, the
language and presentation of modification is also important to consider.
 Solution:
AT A GLANCE
a)
i. It is a best estimate assumption and the auditor is required to obtain sufficient
appropriate evidence from internal and external sources that best estimate assumptions
on which prospective financial information is based are not unreasonable. The following
steps may be carried out in this regard:
 Discuss and evaluate how the management plans to reduce the credit period from
75 days to 30 days.
 Consider the market norms and practices, related to credit period prevailing in
personal care to assess the reasonableness of assumptions.
 Consider whether food packaging business can expect to achieve 80% cash sales.
For this purpose, the general practice prevailing in companies which are in the same
line of business may be considered.
SPOTLIGHT
 The auditor will need to ask the management to explain basis on which they have
made the assumptions specially as regards the assumptions which appear to be un-
reasonable in comparison with market practices and norms.
 If the management is unable to provide the basis on which any of the assumption is
based; or the basis provided by the management are not appropriate to conclude
that the assumptions are reasonable, then the auditor will conclude that the
assumption relating to debtors’ turnover days or cash sales does not provide a
reasonable basis for the prospective financial information and will either express an
adverse opinion or withdraw from engagement.
ii. It is a best estimate assumption and the auditor is required to obtain sufficient
appropriate evidence from internal and external sources that best estimate assumptions
on which prospective financial information is based are not unreasonable. The following
steps may be carried out in this regard:
 The confirmation provided by the associate company cannot be taken as sufficient
appropriate audit evidence in support of company’s income from the associated
company.
 The auditor should check the dividend history of the associate to ascertain the
reasonableness of the forecasted receipts.
 The auditor should communicate with management to prepare an investee
company income forecast to support the assumptions.

 If the forecast is prepared, the auditor would need to assess the assumptions on
which it is based and to evaluate the overall reasonableness of the forecast.
 If the forecast is not provided or the auditor is unable to obtain evidence in relation
to reasonableness of assumption, then it will constitute a scope limitation.
 If the investee company do not provide forecast, then the auditor should either
withdraw from the engagement or disclaim the opinion and describe the scope
limitation in the report on the prospective financial information.
b) As discussed under the caption “Debtors” in the summary of significant forecast
assumptions, the debtor’s turnover days are forecasted to be 30 days as compared to
present debtors’ turnover days of 75 days. The debtors’ turnover days forecasted are not
consistent with the prevailing market practices. Further, the company has not
committed any resources or taken any steps to reduce the debtors’ turnover days that
provide the basis for reducing debtors’ turnover days.
The accompanying forecast is not presented fairly in accordance with the International
Standard on Assurance Engagements applicable to the examination of prospective
financial information because management assumption, as discussed in the preceding
paragraph, do not provide a reasonable basis for management’s forecast
AT A GLANCE
a) XYZ Company Limited intends to seek a financing of Rs. 250 million from their bankers
in order to implement board’s latest expansion proposal. The company’s CFO has
prepared a five years ‘cash flow forecast’ based on management’s estimates for
presentation to the bankers’ company has requested your firm to review the forecast
and furnish a report thereon.
Required
Explain the matters which your firm would consider before accepting the above
engagement.
b) Assuming that your firm has accepted the above engagement and during the course of
the review, a significant reduction in the cash outflows on account of income tax has
SPOTLIGHT
been noted in the years 3, 4 and 5. The management has informed that the taxation
authorities have principally agreed to reduce tax rates for companies operating in the
‘industrial zone’ in which the company is situated and the announcement of the
reduction in tax rates will be made in the next budget. However, the management has
not provided any evidence to support their claim. The impact of this assumption is Rs. 5
million for each year.
The management has justified its stance by stressing that the assumption related to the
tax rates has been clearly disclosed in the prospective financial information.
Required:
Evaluate above situation and briefly discuss the steps that your firm should take.
Tutorial Notes:
a) This is a straightforward question based on ISAE 3400.
b) It is expected that the students would discuss some measures that the auditor can adopt
in such situations like, studying the related correspondence with FBR, discussions with
management of other companies in the same zone and correspondence with relevant
trade associations etc. Moreover, student is also expected to have a grip on the possible
types of modification, in case the evidence was considered to be insufficient.

 Solution:
a) Before accepting the engagement, I would consider the following matters:
 Period covered by the information: The business plan covers the five year.
Assumptions normally become more speculative as the length of period covered
increases. The final conclusion in this regard would however depend on the nature
of business and other conditions affecting the business.
 Reliability of the information: This will depend on management’s expertise and
integrity. Past experience with the company may help in assessing this aspect.
Otherwise the reputation of the company in the market and business risks may have
to be considered.
 Access to Information and personnel: I would seek assurance from the client that
all relevant information and personnel would be accessible during the audit. This
matter may be clarified in the engagement letter, in order to avoid any
misunderstanding at a later stage.
 Nature of assumptions: I would ensure that the assumptions are realistic and
assess whether I would be able to obtain a sufficient level of knowledge of XYZ’s
business to evaluate all significant assumptions.
AT A GLANCE
 The assumptions involved in projections of revenue on account of expansion could
be difficult as compared to assumptions related to normal business operations.
 Similarly, the I may consider hiring the services of an expert to assess the
assumptions pertaining to the costs of expansion (i.e. new plant, building etc.)
 General or Limited Distribution: I would consider the extent of my responsibility
as an auditor towards the intended users.
 Elements to be included in the Prospective Financial Information (PFI) and
their appropriateness for the intended use: I would determine through review
of the elements included in the PFI that whether an opinion can be formed and
issued on the PFI’s and whether these are appropriate for the intended use. Too
SPOTLIGHT
much detailed analysis of each item would increase the risk and consequently the
auditor’s responsibility.
b)
 It is a best estimate assumption and the auditor is required to obtain sufficient
appropriate evidence from internal and external sources.
 Preferably the management should provide the correspondence/ confirmation from
the Federal Board of Revenue relating to the reduced tax rates.
 If the correspondence/ confirmation from FBR is not available, the auditor may
discuss the matter with the management of other companies in the same Industrial
Zone or their representative association to assess the validity of XYZ’z claim.
 If the auditor is unable to obtain sufficient appropriate audit evidence, the auditor
will conclude that the assumption related to the taxation rates does not provide a
reasonable basis for the prospective financial information and will either express an
adverse opinion or withdraw from the engagement.


Sigma Pakistan (Pvt.) Limited (SPPL) manufactures telecommunication accessories. The
management of SPPL is negotiating with one of its competitors to acquire a factory, at an
estimated purchase price of Rs. 350 million. SPPL intends to obtain financing from a venture
capital company (VCC) for the proposed acquisition.
Your firm, Gamma & Co., has been approached by SPPL to provide a report on the following cash
flow forecast, which would be provided to VCC:
Quarter Ending (Rupees in Million)

June. Sep. 2010 Dec. 2010 Mar. 2010
2010
Cash inflows
Cash sales i 188 203 210 251
Receipts from credit sales ii 870 900 938 1,249
1,058 1,103 1,148 1,500
AT A GLANCE
Cash outflows
Operating
Payments to vendors iii 600 635 655 803
Salaries 140 140 140 140
Factory overheads iv 263 263 263 263
Others - - - -
Purchase of fixed assets - - 4 5
5 4
Dividend - 120 - -
SPOTLIGHT
Royalty v - - - 5
3
Advance income tax 18 18 2 2
0 9
Purchase of factory - - 350 -
1,021 1,176 1,473 1,342
Cash flow for the quarter 37 -73 -325 158
Opening cash balance 150 187 114 -211
Closing cash balance 187 114 -211 -
53
The following information is available:

i. Cash customers are allowed discount @ 3% when they purchase goods worth Rs.
100,000 or more.
ii. 60% of the amount billed is collected within one month, 25% by the end of the second
month and 13% by the end of the third month. Bad debts are estimated at 2%.
iii. Payment against purchase of raw material is made within 30 days, in order to avail cash
discount @ 5%. Payments for other materials are made within 45 days.

iv. Factory overheads include property rentals, utility bills, insurance premium and general
office expenses.
v. Royalty is paid to a foreign company, for availing the right to manufacture certain
accessories.
Required:
a) Outline the key procedures that your firm should undertake in order to provide a report
on the cash flow forecast.
b) Draft an unmodified report for submission to the Board of Directors.
 Solution:
a) Cash receipts:
i. Assess whether the assumption related to total sales and its bifurcation between cash
and credit sales is reasonable by considering whether it is in line with the known norms
of the business. Historical data of the company may also provide some useful
information.
ii. Assess the reasonableness of the pattern of receipts from credit customers by applying
the credit terms allowed to different categories of customers.
AT A GLANCE
iii. Review the latest age analysis of the receivables to assess the reasonableness of the
pattern of payment by credit customers.
iv. Check whether the 3% discount on sales allowed to cash customers is in accordance with
the market norms.
v. Check whether the increase in sales in 3rd quarter is in accordance with the production
capacity of the new factory.
Payment to vendors
i. Review norms of business and historical data to assess the reasonableness of the pattern
of payments forecasted.
ii. Check whether the 5% discount on raw material purchases is in accordance with terms
and conditions prevailing in the market.
SPOTLIGHT
Other operating cash outflows:
i. Discuss with the management why operating expenses and salaries are not increasing
in line with sales.
ii. Compare forecasted outflows on account of salary with latest available payroll.
iii. Obtain a breakdown of the outflow on account of overheads and ensure that:
 All expense categories have been included.
Non-cash items such as depreciation, amortization, provisions, etc. have been
excluded.
iv. For cash flows in respect of each main component of the overheads, review existing
actual documentation such as invoices and utility bills etc. to ascertain the
reasonableness of the pattern of payments included in the forecast.
Non-recurring cash flows:
i. Review the capital budget to assess requirement related to capital expenditure.
ii. Review the pattern of dividend payment and obtain representation letter if necessary.
iii. Check amount of royalty and payment schedule as per agreement.
iv. Check calculation of advance tax with profit forecast, working submitted by the client
and relevant tax laws.

v. Review the documents relating to purchase of factory and ensure that cash outflow given
in the forecast is reasonable.
General:
i. Enquire as to the competence and experience of the preparer of the forecast.
ii. Ascertain why financial cost is not included.
iii. Are there any other costs to be incurred in relation to the new factory in the period of
cash flow forecast? e.g. recruitment costs of new staff, any additional working capital
requirements, installation of plant and fixtures to the new factory etc.
iv. Ensure that timing of outflows for purchase of factory is correct by carrying out
discussion with management and review of minutes of Board of Directors etc.
v. Compare the forecast with actual cash flows of prior period and investigate unusual
variations, if any
vi. Compare assumptions made with general industry data and trends and investigate any
unusual variations.
b) AUDITOR’S REPORT TO THE BOARD OF DIRECTORS
We have examined the quarterly cash flow forecast of Sigma Pakistan (Pvt.) Limited for
AT A GLANCE
the year ending March 31, 2011 in accordance with the International Standards on
Assurance Engagements applicable to the examination of prospective financial
information. Management is responsible for the forecast including the assumptions set
out in Note A on which it is based.
Based on our examination of the evidence supporting the assumptions, nothing has
come to our attention which causes us to believe that these assumptions do not provide
a reasonable basis for the forecast. Further, in our opinion the forecast is properly
prepared on the basis of the assumptions and is presented in accordance with IFRS /
applicable financial reporting framework.
Actual results are likely to be different from the forecast since anticipated events
frequently do not occur as expected and the variation may be material.
SPOTLIGHT
Gamma & Co. Chartered Accountants

Karachi
June 11, 2010
In 2005 the management of Fiber Limited presented before the Board of Directors, the plan of a
new business segment, quite different from existing business of FL. The approval was granted in
the same year.
In December 2007, even after over two years of operation, the bottom line of cash flow was
negative. Some of the Board members are convinced with the management’s explanation that the
initial projections were correct, nevertheless, the periodic pattern of cash flows is not according
to the expectations. Others, who are in majority, feel that the initial projections were materially
misstated. The Board has therefore directed the management to submit prospective financial
statements relating to the segment for next five years. The management submitted the projection
with the following assumptions:
i. The company will be able to sell a large piece of land in the heart of the city, in 2008, to
set up a factory in a different city on hired premises.
ii. The factory will attain 70% capacity within six months of its establishment. Whole
production will conveniently be sold in that city and FL will not have to incur any
transportation cost.

iii. The transportation cost, which is one of the main contributors of negative cash flow, will
be reduced substantially by using cargo train in place of trucks. Negotiations with
railway authorities are in final stage.
iv. Administrative expenses will grow at 5% per annum.
After examination by an independent auditor, the board intends to publish the abridged form of
such financial statements in the newsletter of the company which is circulated to shareholders
each month.
ABUK Chartered Accountants have been contacted by the Board to examine the prospective
financial statements and submit their report within ten days.
Mr. Umer is a partner in the firm and has expertise in such assignments. When asked by the firm
to take up the offer as engagement partner, he informed that his wife is the daughter of the Chief
Financial Officer of FL and also holds 75,000 shares of the company.
Required:
a) Discuss the points which the firm should consider while accepting the engagement and
assigning the job to Mr. Umer.
b) Assuming that the engagement is accepted, draft an appropriate audit report.
AT A GLANCE
c) Explain how the historical financial statements can be used by the auditor in performing
the engagement.
 Solution:
a) The matters which should be considered while accepting the assignment and assigning
the job to Mr. Umer are as follows:
Acceptance of engagement:
 Client acceptance consideration, such as, integrity of management, expertise
available in firm etc will be given.
 Whether the assumptions being used are clearly realistic.
 Whether the time limit prescribed by the Board of Directors is sufficient.
SPOTLIGHT
 Whether the projected financial statements and auditor’s report will be appropriate
for the intended use.
 Although the firm is legally allowed to accept the assignment, adequate safeguards
should be considered in view of the fact that one of the partner’s wife had financial
interest in the entity and close family relations with the CFO of the company.
 There should be an agreement with the management that abridged projections must
contain a caution for shareholders that for better understanding complete set of
prospective financial statements be referred.
 Firm should also consider whether it will be able to carry out the engagement with
due professional competence even if Mr. Umer is unable to be the engagement
partner.
Assigning the job to Mr. Umer:
Since the wife of Mr. Umer has financial interest in the company as a shareholder, Mr.
Umer is not expected to carry out the assignment with the level of objectivity required
for the engagement. Therefore, he should not be appointed as engagement partner.
b) We have examined the projection of XYZ Business Segment of Fiber Limited in
accordance with the International Standard on Assurance Engagements applicable to
the examination of prospective financial information. Management is responsible for the
projections including the assumptions set out in Note X on which it is based.

This projection has been prepared for assuring the viability of the segment referred to in
preceding paragraph. As the segment is in development phase the projection has been
prepared using a set of assumptions that include hypothetical assumptions about future
events and management’s action that are not necessarily expected to occur.
Consequently, the users are cautioned that the projection may not be appropriate for
purposes other than those described above.
Based on our examination of the evidence supporting the assumptions, nothing has come
to our attention which causes us to believe that these assumptions do not provide a
reasonable basis for the projection. Further, in our opinion the projection is properly
prepared on the basis of the assumptions and is presented in accordance with the
International Financial Reporting Standards.
Even if the events anticipated under the hypothetical assumptions described above
occur, actual results are still likely to be different from the projection since other
anticipated events frequently do not occur as expected and the variation may be
material.
c) The historical financial statements provide the auditors with
 the knowledge of company’s business and trends and relation that would exist
among the elements of financial statements; and
AT A GLANCE
 a yardstick for considering management’s assumptions.

The auditors also use historical financial statements to assess whether the prospective financial
statements have been prepared on the basis consistent with them.
SPOTLIGHT

5. AUDIT CONSIDERATIONS RELATING TO AN ENTITY USING A SERVICE

ORGANIZATION (ISA 402)
Report on description and design of controls at a service organization (Type 1 report)
A report that comprises:
i. A description, prepared by management of service organization, of service
organization’s system, control objectives and related controls that have been designed
& implemented as at a specified date; and
ii. A report by service auditor with objective of conveying reasonable assurance that
includes service auditor’s opinion on description of service organization’s system,
control objectives and related controls and suitability of the design of the controls to
achieve the specified control objectives.
Report on description, design, and operating effectiveness of controls at service
organization (Type 2 report)
A report that comprises:
AT A GLANCE
i. A description, prepared by management of service organization, of service
organization’s system, control objectives and related controls, their design and
implementation as at a specified date or throughout a specified period and, in some
cases, their operating effectiveness throughout a specified period; and
ii. A report by service auditor with objective of conveying reasonable assurance that
includes:
a) Service auditor’s opinion on description of service organization’s system, control
objectives and related controls, suitability of the design of the controls to
achieve the specified control objectives, and the operating effectiveness of the
controls; and
b) A description of service auditor’s tests of the controls and results thereof.
SPOTLIGHT
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 auditor - An auditor who, at the request of the service organization, provides an
assurance report on the controls of a service organization.
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.
User entity - An entity that uses a service organization and whose financial statements are
being audited.
User auditor - An auditor who audits and reports on the financial statements of a user entity.
5.1 Obtaining Understanding of Services Provided by Service Organization (Ref: 9, A1-A11)

Information on nature of services provided by a service organization may be available from:
 User manuals.
 System overviews.
 Technical manuals.
 The contract or service level agreement between the user entity and the service organization.

 Reports by service organizations, internal audit function or regulatory authorities

 Reports by the service auditor, including management letters, if available.
When obtaining understanding of user entity, user auditor shall obtain understanding of how user entity uses
services of a service organization in user entity’s operations, including:
 Nature of services provided by service organization and the significance of those services to user entity,
including effect thereof on user entity’s internal control;
Examples of service organization services that are relevant to the audit include:
 Maintenance of the user entity’s accounting records.
 Management of assets.
 Initiating, recording or processing transactions as agent of the user entity.
 Nature and materiality of transactions processed or accounts or financial reporting processes affected
by the service organization;
 Degree of interaction between activities of service organization and those of user entity;
¯ If high degree of interaction exists (e.g. user entity authorises transactions and service organisation
processes those), it may be practicable for user entity to implement effective controls
AT A GLANCE
¯ If lower degree of interaction exists (e.g. service organization initiates or initially records,
processes, and does accounting for user entity’s transactions), user entity may be unable to
implement effective controls and may rely on controls at service organisation
 Nature of relationship between user entity and service organization, including relevant contractual
terms for the activities undertaken by the service organization.
¯ Information to be provided to user entity and responsibilities for initiating transactions relating to
the activities undertaken by the service organization;
¯ Application of requirements of regulatory bodies concerning the form of records to be maintained,
or access to them;
¯ Indemnification, if any, to be provided to user entity in event of a performance failure;
SPOTLIGHT
¯ Whether service organization will provide a report on its controls

¯ Whether such report would be a type 1 or type 2 report;
¯ Whether user auditor has rights of access to records of user entity maintained by service
organization and other information necessary for conduct of audit; and
¯ Whether agreement allows for direct communication between user auditor and service auditor
¯ A user auditor may use a service auditor to perform procedures on user auditor’s behalf, e.g.:
¯ Tests of controls at the service organization; or
¯ Substantive procedures on user entity’s financial statements transactions and balances maintained
by a service organization.
5.2 Understanding the Controls Relating to Services Provided by the Service Organization (Ref: 10-12,
A12-A20)
User auditor shall evaluate design and implementation of relevant controls at user entity, including those that
are applied to the transactions processed by service organization.
These controls may include:
 Comparing the data submitted to service organization with reports of information received from service
organization after data has been processed.

 Re-computing a sample of payroll amounts for clerical accuracy and reviewing total amount of the
payroll for reasonableness.
If user auditor is unable to obtain a sufficient understanding from user entity, the user auditor shall obtain that
understanding from one or more of the following procedures:
 Obtaining a type 1 or type 2 report, if available (as per ISAE 3402);
 Contacting service organization, through user entity, to obtain specific information;
 Visiting service organization and performing procedures providing necessary information about the
relevant controls at the service organization; or
 Using another auditor to perform procedures that will provide the necessary information about the
relevant controls at the service organization.
User auditor’s decision as to selection of procedure(s) may be influenced by such matters as:
 Size of both user entity and service organization;
 Complexity of transactions at user entity and complexity of services provided by service organization;
 Location of service organization;
 Nature of the relationship between user entity and the service organization.
AT A GLANCE
A user entity may use a service organization that in turn uses a subservice organization to provide some of the
services provided to a user entity that are part of user entity’s information system relevant to financial reporting.
 Subservice organization may be separate from service organization or may be related.
 A user auditor may need to consider controls at subservice organization.
5.3 Using Type 1 or Type 2 Report to Support Understanding of the Service Organization (Ref: 13-14, A21-
A23)
User auditor shall be satisfied as to:
 Service auditor’s professional competence;
 Service auditor’s independence from service organization; and
SPOTLIGHT
 Adequacy of standards under which type 1 or type 2 report was issued.
User auditor shall:
 Evaluate whether description and design of controls at service organization is at a date or for a period
that is appropriate for the user auditor’s purposes;
 Evaluate sufficiency and appropriateness of evidence provided by report; and
 Determine whether complementary user entity controls identified by service organization are relevant
and, if so, whether user entity has designed and implemented such controls.
Type 1 or type 2 report, along with information about user entity, may assist user auditor in obtaining an
understanding of:
 Aspects of controls at service organization that may affect processing of user entity’s transactions,
including the use of subservice organizations;
 Flow of significant transactions through service organization to determine the points in the transaction
flow where material misstatements in user entity’s financial statements could occur;
 Control objectives at the service organization relevant to the entity’s financial statements assertions;
and
 Whether controls at service organization are suitably designed and implemented to prevent or detect
and correct processing errors that could result in material misstatements in the user entity’s financial
statements.

5.4 Responding to the Assessed Risks of Material Misstatement (Ref: 15-17, A24-A39)
User auditor shall:
 Determine whether sufficient appropriate audit evidence concerning relevant financial statements
assertions is available from records held at user entity; and, if not,
 Perform further audit procedures to obtain sufficient appropriate audit evidence or use another auditor
to perform those procedures at service organization on his behalf.
When service organization maintains material elements of accounting records of user entity, direct access to
those records may be necessary. Such access may involve either physical inspection of records at the service
organization’s premises or interrogation of records maintained electronically from the user entity or another
location, or both.
In determining audit evidence to be obtained for assets held or transactions undertaken by a service
organization on behalf of user entity, following procedures may be considered:
 Inspecting records and documents held by the user entity.
 Inspecting records and documents held by service organization.
(This access may be defined in contract between user entity and service organization).
 May also use another auditor to gain access to such records at service organisation
AT A GLANCE
(Prime responsibility to obtain sufficient appropriate evidence rests with user auditor)
 Obtaining confirmations of balances and transactions from service organization
(Where user entity maintains independent records of balances and transactions)
 Performing analytical procedures on records maintained by user entity or on the reports received from
the service organization:
Tests of Controls
When user expects that controls at service organization are operating effectively, he shall obtain audit evidence
about operating effectiveness of controls by following procedure(s):
 Obtaining a type 2 report, if available;
SPOTLIGHT
 Performing appropriate tests of controls at the service organization; or

 Using another auditor to perform tests of controls at service organization on his behalf.
If type 2 report is not available, user auditor may contact service organization, through user entity, to request
that a service auditor be engaged to provide a type 2 report.
Using a Type 2 Report as Audit Evidence

User auditor shall determine whether type 2 report provides sufficient appropriate audit evidence about
effectiveness of the controls to support user auditor’s risk assessment by:
 Evaluating whether description, design and operating effectiveness of controls at service organization
is at a date or for a period that is appropriate for the user auditor’s purposes;
 Determining whether complementary user entity controls identified by service organization are
relevant to user entity and, if so testing their operating effectiveness;
 Evaluating adequacy of the time period covered by tests of controls; and
 Evaluating whether tests of controls performed by service auditor and the results thereof, as described
in the service auditor’s report, are relevant to the assertions in the user entity’s financial statements and
provide sufficient appropriate audit evidence to support the user auditor’s risk assessment.
Additional audit evidence may be obtained (e.g. by extending tests of controls over remaining period or testing
user entity’s monitoring of controls).

If service auditor’s testing period is completely outside user entity’s financial reporting period, user auditor will
be unable to rely on such tests, unless other procedures are performed.
Exceptions noted by service auditor or a modified opinion in type 2 report are considered in assessment of
test of controls performed by service auditor. User auditor may discuss such matters with service auditor.
Communication of deficiencies in internal control identified during the audit

User auditor is required to communicate in writing significant deficiencies identified during audit to both
management and those charged with governance of user entity on a timely basis. Matters that user auditor
may identify during audit and may communicate include:
 Any monitoring of controls that could be implemented by user entity;
 Instances where complementary user entity controls are noted in type 1 or type 2 report and are not
implemented at user entity; and
 Controls needed at service organization that do not appear to have been implemented.
5.5 Type 1 & Type 2 Reports that Exclude Services of Subservice Organization (Ref: 18, A40)
Service auditor’s report may either include (inclusive method) or exclude (crave-out method) the subservice
organization’s relevant control objectives and related controls.
AT A GLANCE
If those services are relevant to audit of user entity, user auditor shall apply requirements of this ISA with
respect to the services provided by the subservice organization.
5.6 Fraud, Non-Compliance with Laws and Regulations, and Uncorrected Misstatements in Relation to
Activities at the Service Organization (Ref: 19, A41)
User auditor shall inquire management of user entity whether the service organization has reported, or
whether user entity is otherwise aware of, any fraud, non-compliance with laws and regulations or
uncorrected misstatements affecting the financial statements of user entity.
User auditor shall evaluate how such matters affect nature, timing and extent of further audit procedures,
including effect on user auditor’s conclusions and report.
SPOTLIGHT
In certain circumstances, user auditor may require additional information, and may request the user entity to
contact the service organization to obtain necessary information.
5.7 Reporting by User Auditor (Ref: 20-22, A42-A44)

User auditor shall modify opinion (ISA 705) if user auditor is unable to obtain sufficient appropriate audit
evidence regarding services provided by service organization.
This may be the case when:
 User auditor is unable to obtain a sufficient understanding of services provided by service organization
and does not have a basis for identification and assessment of risks of material misstatement;
 User auditor’s risk assessment includes an expectation that controls at service organization are
operating effectively and user auditor is unable to obtain sufficient appropriate audit evidence about
operating effectiveness of these controls; or
 Sufficient appropriate audit evidence is only available from records held at the service organization, and
the user auditor is unable to obtain direct access to these records.
Reference to the Work of a Service Auditor

 User auditor shall not refer to work of service auditor in report containing an unmodified opinion unless
required by law or regulation to do so.
 If such reference is required by law or regulation, user auditor’s report shall indicate that reference does
not diminish the user auditor’s responsibility for audit opinion.

 If reference to work of a service auditor is relevant to an understanding of a modification to opinion,

user auditor’s report shall indicate that such reference does not diminish the user auditor’s
responsibility for that opinion.
 In such circumstances, user auditor may need the consent of the service auditor before making such a
reference.
Your firm Gul Khan and Company, Chartered Accountants (GK) is the auditor of Yameen
Corporation Limited (YCL), a listed company which has three subsidiaries. In the planning
meeting, the Chief Financial Officer of YCL informed you about the following developments which
took place during the year ending 31 December 2018:
There was a major reshuffle in one of the business segments of YCL which resulted in several
employees being laid off. The reshuffling was carried out when several ghost employees were
identified by the internal audit department. Consequently, the management of YCL decided to
outsource its payroll processing department along with few other activities related to the finance
department to another company.
Required:
In light of the above mentioned information what considerations should be taken into account
AT A GLANCE
while devising the over-all audit strategy.

Note: Audit procedures are not required
Tutorial Notes:
Considerations like requirement of any specialized knowledge especially the expertise needed
for calculating or estimating the agreed milestones to ensure correct revenue recognition should
be properly discussed. As an add on, actions like less reliance on internal controls and increasing
the extent of substantive testing along with need to exercise professional skepticism can also be
mentioned.
 Solution:
Consideration related to fraud risk:
SPOTLIGHT
i. The reliance placed on internal control and increasing the extent of substantive testing.
ii. Identification of fraud by the payroll department indicates that there might be other
instances of fraud even though there is a functioning internal audit department,
therefore team members need to maintain a questioning mind and to exercise
professional skepticism in gathering and evaluating audit evidence.
iii. Even though an internal audit department exist, but due to the emergence of fraudulent
activity we need to consider the management commitment to design, implementation
and maintenance of sound internal control.
iv. The selection of the engagement team and the assignment of audit work in light of fraud
risk and the complexity of the group and its operations.
Consideration related to service organisation:
i. YCL’s use of service organizations and how the audit team will obtain evidence
concerning the design or operation of controls performed by them, i.e. will the type 2
reports be available.
ii. Significance of those services to YCL and materiality of the transactions processed or
accounts or financial reporting processes affected by the service organization.
The nature of the relationship between the user entity and the service organization, including
the relevant contractual terms for the activities undertaken by the service organization.

Identification of high risk areas:

i. Identify areas of higher risk of material misstatement such as, staff lay-off, recognition
of revenue from project management services, related party transactions and business
combination along with the appropriate audit approach.
Your audit client Mars Pakistan Limited (MPL), is a multinational company. At the group level, a
decision has been taken whereby the payroll function of all group companies has been
outsourced to a payroll processing firm PayPro situated in London.
According to the terms of the contract, after processing, the payroll is sent to MPL for
authorisation. PayPro shares type 1 report with all of its clients on an annual basis. Due to
resource constraints for this engagement, it might not be possible for you to visit PayPro for
testing their controls.
Required:
Evaluate the above situation and explain how would you test the operating effectiveness of
controls over payroll applied by PayPro?
Tutorial Notes:
AT A GLANCE
The question can be proved to be hardest in this area given the weak knowledge base of majority
students. Common errors to be avoided are:
1. Controls as mentioned in the question should not be stated again, rather the procedures to
assess the effectiveness of the controls are required.
2. Wrongly suggesting a scope limitation and that the assignment should not be accepted.
3. Writing general statements about when a control would be considered to be operating
effectively
 Solution:
 As the payroll is sent to MPL for authorization, therefore it implies that a high degree of
SPOTLIGHT
interaction exists between PayPro and MPL.
 In these circumstances MPL can easily implement effective controls over those
transactions.
 Accordingly, there is no limitation of scope because of our inability to visit PayPro.
 We would test controls implemented by MPL for the authorization of payroll and related
data.
 However, there is still a need to evaluate the controls applied by PayPro.
 A type 1 report will not be helpful in evaluation of controls at PayPro. Though, it includes
the service auditor’s opinion on the description of the service organisation’s system,
control objectives and related controls and the suitability of the design of the controls to
achieve the specified control objectives, it does not provide any evidence of the
operating effectiveness of the relevant controls.
 Since PayPro only provides type 1 report therefore, we may contact PayPro, through
MPL, to request that type 2 report should also be provided. Further, we may also decide
not to rely on the auditor giving the type 2 report. In that case, we may appoint another
auditor to perform procedures at PayPro i.e. to test the operating effectiveness of those
controls.


The following situations have arisen at different audit clients of your firm. The year -end in
each case is 30 September 2015.
Certain management functions of the audit client had been outsourced. Most of the
outsourced functions are performed at the service organizations’ premises.
Required:
Evaluate the above situations and briefly explain the steps that the auditor would be required
to carry out in each of the above situations. (Impact on audit report is not required).
Tutorial Notes:
The candidates who had good grasp over the concept of service organization is able to give a
structured and precise answer, given an open book exam.
 Solution:
Since the client uses the services of a service organization, in such a situation, the auditor would
perform the following steps:
1. Obtain an understanding of the nature and significance of the services provided by the
AT A GLANCE
service organization and their effect on the client’s internal controls relevant to the audit,
which would provide the basis of identification and assessment of risks of material
misstatement; and
2. Obtaining knowledge relating to competencies, capabilities and qualifications possessed by
personnel in Service organizations.
3. In case the auditor is unable to obtain understanding from the client, the auditor shall obtain
that understanding from one or more of the following procedures:
 Obtain a type 1 or type 2 report, if available;
 Contact the service organization, through the client, to obtain specific information;
 Visit the service organization and perform procedures that will provide the necessary
SPOTLIGHT
information about the relevant controls at the service organization; or

 Using another auditor to perform procedures that will provide the necessary
information about the relevant controls at the service organization.

6. ASSURANCE REPORTS ON CONTROLS AT A SERVICE ORGANIZATION (ISAE

3402)
6.1 ISAE 3000 (Revised) (Para 10)
The service auditor shall not represent compliance with this ISAE unless the service auditor has complied with
the requirements of this ISAE and ISAE 3000 (Revised).
6.2 Ethical Requirements (Para 11)

The service auditor shall comply with IESBA Code relating to assurance engagements or other professional
requirements, or requirements imposed by law or regulation, that are at least as demanding.
6.3 Management and Those Charged with Governance (Para 12)

Service auditor shall determine the appropriate person(s) within the service organization’s management or
governance structure with whom to interact. This shall include consideration of which person(s) have the
appropriate responsibilities for and knowledge of the matters concerned.
6.4 Acceptance and Continuance (Para 13-14)
AT A GLANCE
Before agreeing to accept, or continue, an engagement the service auditor shall:
 Determine whether:
¯ The service auditor has the capabilities and competence to perform the engagement;
¯ The criteria the practitioner expects to be applied by the service organization to prepare the
description of its system are suitable and will be available to user entities and their auditors; and
¯ The scope of the engagement and the service organization’s description of its system will not be so
limited that they are unlikely to be useful to user entities and their auditors.
 Obtain the agreement of the service organization that it acknowledges and understands its
responsibility:
SPOTLIGHT
¯ For preparation of the description of its system, and accompanying service organization’s
statement, including the completeness, accuracy and method of presentation of that description and
statement;
¯ To have a reasonable basis for the service organization’s statement accompanying the description
of its system;
¯ For stating in the service organization’s statement the criteria it used to prepare the description;
 For stating in the description of its system:
a) The control objectives; and
b) Where they are specified by law or regulation, or another party, the party who specified
them;
 For identifying the risks that threaten achievement of the control objectives stated in the description of
its system, and designing and implementing controls to provide reasonable assurance that those risks
will not prevent achievement of the control objectives stated in the description of its system, and
therefore that the stated control objectives will be achieved; and
 To provide the service auditor with:

a) Access to all information, such as records, documentation and other matters, including
service level agreements, of which the service organization is aware that is relevant to
the description of the service organization’s system and the accompanying service
organization’s statement;

b) Additional information that the service auditor may request from the service
organization for the purpose of the assurance engagement; and
c) Unrestricted access to persons within the service organization from whom the service
auditor determines it necessary to obtain evidence.
Acceptance of a Change in the Terms of the Engagement

If the service organization requests a change in the scope of the engagement before the completion of the
engagement, the service auditor shall be satisfied that there is a reasonable justification for the change.
6.5 Assessing the Suitability of the Criteria (Para 15-18)

In determining the suitability of the criteria to evaluate the service organization’s description of its system, the
service auditor shall determine if the criteria encompass, at a minimum:
 Whether the description presents how the service organization’s system was designed and
implemented, including, as appropriate:
 The types of services provided, including, as appropriate, classes of transactions processed;
¯ The procedures, within both information technology and manual systems, by which services are
provided, including, as appropriate, procedures by which transactions are initiated, recorded,
AT A GLANCE
processed, corrected as necessary, and transferred to the reports and other information prepared
for user entities;
¯ The related records and supporting information, including, as appropriate, accounting records,
supporting information and specific accounts that are used to initiate, record, process and report
transactions; this includes the correction of incorrect information and how information is
transferred to the reports and other information prepared for user entities;
¯ How the service organization’s system deals with significant events and conditions, other than
transactions;
¯ The process used to prepare reports and other information for user entities;
¯ The specified control objectives and controls designed to achieve those objectives;
¯ Complementary user entity controls contemplated in the design of the controls; and
SPOTLIGHT
¯ Other aspects of the service organization’s control environment, risk assessment process,
information system (including the related business processes) and communication, control
activities and monitoring controls that are relevant to the services provided.
 In the case of a type 2 report, whether the description includes relevant details of changes to the service
organization’s system during the period covered by the description.
In determining the suitability of the criteria to evaluate the design of controls, the service auditor shall determine
if the criteria encompass, at a minimum, whether:
 The service organization has identified the risks that threaten achievement of the control objectives
stated in the description of its system; and
 The controls identified in that description would, if operated as described, provide reasonable assurance
that those risks do not prevent the stated control objectives from being achieved.
6.6 Materiality (Para 19)

When planning and performing the engagement, the service auditor shall consider materiality with respect to
the fair presentation of the description, the suitability of the design of controls and, in the case of a type 2 report,
the operating effectiveness of controls.
6.7 Obtaining an Understanding of the Service Organization’s System (Para 20)

The service auditor shall obtain an understanding of the service organization’s system, including controls that
are included in the scope of the engagement.

6.8 Obtaining Evidence Regarding the Description (Para 21-22)

The service auditor shall obtain and read the service organization’s description of its system, and shall evaluate
whether those aspects of the description included in the scope of the engagement are fairly presented, including
whether:
 Control objectives stated in the service organization’s description of its system are reasonable in the
circumstances;
 Controls identified in that description were implemented;
 Complementary user entity controls, if any, are adequately described; and
 Services performed by a subservice organization, if any, are adequately described, including whether
the inclusive method or the carve-out method has been used in relation to them.
6.9 Obtaining Evidence Regarding Design of Controls (Para 23)
The service auditor shall determine which of the controls at the service organization are necessary to achieve
the control objectives stated in the service organization’s description of its system, and shall assess whether
those controls were suitably designed. This determination shall include:
 Identifying the risks that threaten the achievement of the control objectives stated in the service
organization’s description of its system; and
AT A GLANCE
 Evaluating the linkage of controls identified in the service organization’s description of its system with
those risks.
6.10 Obtaining Evidence Regarding Operating Effectiveness of Controls (Para 24-29)
When designing and performing tests of controls, the service auditor shall:
 Perform other procedures in combination with inquiry to obtain evidence about:
¯ How the control was applied;
¯ The consistency with which the control was applied; and
¯ By whom or by what means the control was applied;
 Determine whether controls to be tested depend upon other controls (indirect controls) and, if so,
whether it is necessary to obtain evidence supporting the operating effectiveness of those indirect
SPOTLIGHT
controls; and
 Determine means of selecting items for testing that are effective in meeting the objectives of the
procedure.
Sampling
When the service auditor uses sampling, the service auditor shall:
 Consider the purpose of the procedure and the characteristics of the population from which the sample
will be drawn when designing the sample;
 Determine a sample size sufficient to reduce sampling risk to an appropriately low level;
 Select items for sample in such a way that each sampling unit in the population has a chance of selection;
 If a designed procedure is not applicable to a selected item, perform procedure on a replacement item;
and
 If unable to apply the designed procedures, or suitable alternative procedures, to a selected item, treat
that item as a deviation.
Nature and Cause of Deviations

Service auditor shall investigate the nature and cause of any deviations identified and shall determine whether:
 Identified deviations are within the expected rate of deviation and are acceptable; therefore, the testing
that has been performed provides an appropriate basis for concluding that the control is operating
effectively throughout the specified period;

 Additional testing of the control or of other controls is necessary to reach a conclusion on whether the
controls relative to a particular control objective are operating effectively throughout specified period;
or
 The testing that has been performed provides an appropriate basis for concluding that the control did
not operate effectively throughout the specified period.
In extremely rare circumstances when the service auditor considers a deviation discovered in a sample to be an
anomaly and no other controls have been identified that allow to conclude that the relevant control objective is
operating effectively throughout the specified period, the service auditor shall obtain a high degree of certainty
that such deviation is not representative of the population.
6.11 The Work of an Internal Audit Function (Para 30-37)
Obtaining an Understanding of the Internal Audit Function

If the service organization has an internal audit function, the service auditor shall obtain an understanding of the
nature of the responsibilities of the internal audit function and of the activities performed in order to determine
whether the internal audit function is likely to be relevant to the engagement.
Determining Whether and to What Extent to Use the Work of the Internal Auditors
AT A GLANCE
The service auditor shall determine:

 Whether the work of the internal auditors is likely to be adequate for purposes of the engagement; and
 If so, the planned effect of the work of the internal auditors on the nature, timing or extent of the service
auditor’s procedures.
In determining whether the work of the internal auditors is likely to be adequate for purposes of the engagement,
the service auditor shall evaluate:
 The objectivity of the internal audit function;
 The technical competence of the internal auditors;
 Whether the work of the internal auditors is likely to be carried out with due professional care; and
 Whether there is likely to be effective communication between the internal auditors and the service
SPOTLIGHT
auditor.
In determining the planned effect of the work of the internal auditors on the nature, timing or extent of the service
auditor’s procedures, the service auditor shall consider:
 The nature and scope of specific work performed, or to be performed, by the internal auditors;
 The significance of that work to the service auditor’s conclusions; and
 The degree of subjectivity involved in the evaluation of the evidence gathered in support of those
conclusions.
Using the Work of the Internal Audit Function

In order for the service auditor to use specific work of the internal auditors, the service auditor shall evaluate
and perform procedures on that work to determine its adequacy for the service auditor’s purposes.
To determine the adequacy of specific work performed by the internal auditors for the service auditor’s
purposes, the service auditor shall evaluate whether:
 The work was performed by internal auditors having adequate technical training and proficiency;
 The work was properly supervised, reviewed and documented;
 Adequate evidence has been obtained to enable the internal auditors to draw reasonable conclusions;
 Conclusions reached are appropriate in the circumstances and any reports prepared by the internal
auditors are consistent with the results of the work performed; and
 Exceptions relevant to the engagement or unusual matters disclosed by the internal auditors are
properly resolved.

6.12 Written Representations (Para 38-40)

The service auditor shall request the service organization to provide written representations:
 That reaffirm the statement accompanying the description of the system;
 That it has provided the service auditor with all relevant information and access agreed to; and
 That it has disclosed to the service auditor any of the following of which it is aware:
¯ Non-compliance with law and regulations, fraud, or uncorrected deviations attributable to the
service organization that may affect one or more user entities;
¯ Design deficiencies in controls;
¯ Instances where controls have not operated as described; and
¯ Any events subsequent to the period covered by the service organization’s description of its system
up to the date of the service auditor’s assurance report that could have a significant effect on the
service auditor’s assurance report.
The written representations shall be in the form of a representation letter addressed to the service auditor. The
date of the written representations shall be as near as practicable to, but not after, the date of the service auditor’s
assurance report.
AT A GLANCE
6.13 Other Information (Para 41-42)
Service auditor shall read other information, if any, included in a document containing service organization’s
description of its system and service auditor’s assurance report, to identify material inconsistencies, if any, with
that description. While reading other information for the purpose of identifying material inconsistencies, the
service auditor may become aware of an apparent misstatement of fact in that other information.
6.14 Subsequent Events (Para 43-44)

The service auditor shall inquire whether the service organization is aware of any events subsequent to the
period covered by the service organization’s description of its system up to the date of the service auditor’s
assurance report that may have caused the service auditor to amend the assurance report. If the service auditor
is aware of such an event, and information about that event is not disclosed by the service organization, the
service auditor shall disclose it in the service auditor’s assurance report.
SPOTLIGHT
The service auditor shall prepare on a timely basis engagement documentation that provides a record of the
basis for the assurance report that is sufficient and appropriate to enable an experienced service auditor, having
no previous connection with the engagement, to understand:
 The nature, timing and extent of the procedures performed to comply with this ISAE and applicable legal
and regulatory requirements;
 The results of the procedures performed, and the evidence obtained; and
 Significant matters arising during the engagement, and the conclusions reached thereon and significant
In documenting the nature, timing and extent of procedures performed, the service auditor shall record:
 The identifying characteristics of the specific items or matters being tested;
 Who performed the work and the date such work was completed? and
 Who reviewed the work performed and the date and extent of such review?
If service auditor finds it necessary to modify existing engagement documentation or add new documentation
after the assembly of the final engagement file has been completed and that documentation does not affect the
service auditor’s report, service auditor shall, regardless of the nature of modifications or additions, document:
 The specific reasons for making them; and
 When and by whom they were made and reviewed.

6.16 Preparing the Service Auditor’s Assurance Report (Para 53-55)
Content of the Service Auditor’s Assurance Report

 The service auditor’s assurance report shall include, at a minimum, the following basic elements:
 A title that clearly indicates the report is an independent service auditor’s assurance report.
 An addressee.
 Identification of:
 Service organization’s description of its system, and the service organization’s statement.
¯ Those parts of the service organization’s description of its system, if any, that are not covered by
the service auditor’s opinion.
¯ If the description refers to the need for complementary user entity controls, a statement that the
service auditor has not evaluated the suitability of design or operating effectiveness of
complementary user entity controls, and that the control objectives stated in the service
organization’s description of its system can be achieved only if complementary user entity controls
are suitably designed or operating effectively, along with the controls at the service organization.
¯ If services are performed by a subservice organization, the nature of activities performed by the
AT A GLANCE
subservice organization as described in the service organization’s description of its system and
whether the inclusive method or the carve-out method has been used in relation to them. Where
the carve-out method has been used, a statement that the service organization’s description of its
system excludes the control objectives and related controls at relevant subservice organizations,
and that the service auditor’s procedures do not extend to controls at the subservice organization.
Where the inclusive method has been used, a statement that the service organization’s description
of its system includes control objectives and related controls at the subservice organization, and
that the service auditor’s procedures extended to controls at the subservice organization.
 Identification of the applicable criteria and the party specifying the control objectives.
 A statement that the report and, in the case of a type 2 report, the description of tests of controls are
intended only for user entities and their auditors, who have a sufficient understanding to consider it,
along with other information including information about controls operated by user entities themselves,
SPOTLIGHT
when assessing the risks of material misstatements of user entities’ financial statements.
 A statement that the service organization is responsible for:
¯ Preparing the description of its system, and the accompanying statement, including the
completeness, accuracy and method of presentation of that description and that statement;
¯ Providing the services covered by the service organization’s description of its system;
¯ Stating the control objectives (where not identified by law or regulation, or another party, for
example, a user group or a professional body); and
¯ Designing and implementing controls to achieve the control objectives stated in the service
organization’s description of its system.
 A statement that the service auditor’s responsibility is to express an opinion on the service
organization’s description, on the design of controls related to the control objectives stated in that
description and, in case of a type 2 report, on the operating effectiveness of those controls, based on
service auditor’s procedures.
or requirements in law or regulation, applied that are at least as demanding as ISQC 1.

at least demanding as IESBA Code related to assurance engagements.
 A statement that the engagement was performed in accordance with ISAE 3402
 A summary of the service auditor’s procedures to obtain reasonable assurance and a statement of the
service auditor’s belief that the evidence obtained is sufficient and appropriate to provide a basis for the
service auditor’s opinion, and, in case of a type 1 report, a statement that service auditor has not
performed any procedures regarding operating effectiveness of controls and therefore no opinion is
expressed.
 A statement of the limitations of controls and, in the case of a type 2 report, of the risk of projecting to
future periods any evaluation of the operating effectiveness of controls.
 Service auditor’s opinion, expressed in positive form, on whether, in all material respects, based on
suitable criteria:
¯ In the case of a type 2 report:
a. The description fairly presents the service organization’s system that had been designed and
implemented throughout the specified period;
b. The controls related to the control objectives stated in the service organization’s description
AT A GLANCE
of its system were suitably designed throughout the specified period; and
c. The controls tested, which were those necessary to provide reasonable assurance that the
control objectives stated in description were achieved, operated effectively throughout
specified period.
¯ In the case of a type 1 report:
a. The description fairly presents the service organization’s system that had been designed and
implemented as at the specified date; and
b. The controls related to the control objectives stated in the service organization’s description
of its system were suitably designed as at the specified date.
 The date of the service auditor’s assurance report, which shall be no earlier than the date on which the
service auditor has obtained the evidence on which the service auditor’s opinion is based.
SPOTLIGHT
 The name of the service auditor, and the location in the jurisdiction where the service auditor practices.
Modified Opinions
If the service auditor concludes that:
 The service organization’s description does not fairly present, in all material respects, the system as
designed and implemented;
 The controls related to the control objectives stated in the description were not suitably designed, in all
material respects;
 In the case of a type 2 report, the controls tested, which were those necessary to provide reasonable
assurance that the control objectives stated in the service organization’s description of its system were
achieved, did not operate effectively, in all material respects; or
 The service auditor is unable to obtain sufficient appropriate evidence, the service auditor’s opinion
shall be modified, and the service auditor’s assurance report shall include a section with a clear
description of all the reasons for the modification.
6.17 Other Communication Responsibilities (Para 56)

If the service auditor becomes aware of non-compliance with laws and regulations, fraud, or uncorrected errors
attributable to the service organization that are not clearly trivial and may affect one or more user entities, the
service auditor shall determine whether the matter has been communicated appropriately to affected user
entities. If the matter has not been so communicated and the service organization is unwilling to do so, the service
auditor shall take appropriate action.


Explain the difference between:
i. Type 1 report and type 2 report.
ii. Scope of assurance engagement under the ‘Inclusive Method’ and under the ‘Carve out
Method’
Tutorial Notes:
A student who has not prepared for ISAE 3402 (and related ISA 402) will not be able to attempt
the question.
 Solution:
(i)
Type 1 report Type 2 report
(i) It gives reasonable assurance about the It gives reasonable assurance about the
suitability of design and implementation suitability of design and implementation of
of controls. controls and their operating effectiveness.
AT A GLANCE
(ii) Type 1 report is at a specified date. Type 2 report is for a specified period.
(iii) In type 1 report, service auditor mentions Type 2 report, includes the following:
that the he has not performed any  a summary of the service auditor’s
procedures regarding the operating procedures to obtain reasonable
effectiveness of controls and therefore no assurance.
opinion is expressed thereon.  A statement, that the evidence obtained
is sufficient and appropriate to provide a
basis for the service auditor’s opinion
 a separate section after the opinion, or an
attachment, that describes the tests of
controls that were performed and the
results of those tests.
SPOTLIGHT
(ii)
Inclusive method Carve-out method
(i) Service organization’s description of its Service organization’s description of its
system includes the control objectives and system excludes the control objectives and
related controls at the sub-service related controls at the sub-service
organization. organization.
(ii) Scope of the service auditor includes the Scope of the service auditor excludes the
subservice organization’s relevant control subservice organization’s relevant control
objectives and related controls. objectives and related controls.
(iii) Service auditor mention’s in his report Service auditor mention’s in his report that
that his procedures extend to controls at his procedures do not extend to controls at
the subservice organization. the subservice organization.
(iv) In the description of system, detailed In the description of system, there is no
processing or controls at the subservice need to describe detailed processing or
organization shall be described. controls at the subservice organization.

7. ASSURANCE ENGAGEMENTS ON GREENHOUSE GAS STATEMENTS (ISAE

3410)
The practitioner shall not represent compliance with this ISAE unless the practitioner has complied with the
requirements of both this ISAE and ISAE 3000 (Revised).
7.2 Acceptance and Continuance of the Engagement (Para 16-18)

 Have competence in assurance skills and techniques developed through extensive training and practical
application, and sufficient competence in the quantification and reporting of emissions, to accept
responsibility for the assurance conclusion; and
 Be satisfied that those persons who are to perform the engagement collectively have the appropriate
competence and capabilities, including in the quantification and reporting of emissions and in assurance,
to perform the assurance engagement in accordance with this ISAE.
Preconditions for the Engagement
AT A GLANCE
 The engagement partner shall determine that both the GHG statement and the engagement have
sufficient scope to be useful to intended users, considering, in particular:
¯ If the GHG statement is to exclude significant emissions that have been, or could readily be,
quantified, whether such exclusions are reasonable in the circumstances;
¯ If the engagement is to exclude assurance with respect to significant emissions that are reported
by the entity, whether such exclusions are reasonable in the circumstances; and
¯ If the engagement is to include assurance with respect to emissions deductions, whether the nature
of the assurance the practitioner will obtain with respect to the deductions and the intended
content of the assurance report with respect to them are clear, reasonable in the circumstances,
and understood by the engaging party.
 When determining the suitability of the applicable criteria, as required by ISAE 3000 (Revised), the
SPOTLIGHT
practitioner shall determine whether the criteria encompass at a minimum:
¯ The method for determining the entity’s organizational boundary;
¯ The GHGs to be accounted for;
¯ Acceptable quantification methods, including methods for making adjustments to the base year (if
applicable); and
¯ Adequate disclosures such that intended users can understand the significant judgments made in
preparing the GHG statement.
 Practitioner shall obtain the agreement of entity that it acknowledges and understands its responsibility:
¯ For designing, implementing and maintaining such internal control as the entity determines is
necessary to enable the preparation of a GHG statement that is free from material misstatement,
whether due to fraud or error;
¯ For the preparation of its GHG statement in accordance with the applicable criteria; and
¯ For referring to or describing in its GHG statement the applicable criteria it has used and, when it
is not readily apparent from the engagement circumstances, who developed them.
The terms of the engagement required to be agreed by ISAE 3000 (Revised) shall include:
 The objective and scope of the engagement;
 The responsibilities of the practitioner;
 The responsibilities of the entity;

 Identification of the applicable criteria for the preparation of the GHG statement;
 Reference to the expected form and content of any reports to be issued by the practitioner and a
statement that there may be circumstances in which a report may differ from its expected form and
content; and
 An acknowledgement that entity agrees to provide written representations at conclusion of engagement.
7.3 Planning (Para 19)

Practitioner shall:
 Identify the characteristics of the engagement that define its scope;
 Ascertain the reporting objectives of the engagement to plan the timing of the engagement and the
nature of the communications required;
 Consider the factors that, in the practitioner’s professional judgment, are significant in directing the
engagement team’s efforts;
 Consider the results of engagement acceptance or continuance procedures and, where applicable,
whether knowledge gained on other engagements performed by the engagement partner for the entity
is relevant;
AT A GLANCE
 Ascertain the nature, timing and extent of resources necessary to perform the engagement, including the
involvement of experts and of other practitioners; and
 Determine the impact of the entity’s internal audit function, if any, on the engagement.
7.4 Materiality in Planning and Performing the Engagement (Para 20-22)

When establishing the overall engagement strategy, the practitioner shall determine materiality for the GHG
statement.
The practitioner shall determine performance materiality for purposes of assessing the risks of material
misstatement and determining the nature, timing and extent of further procedures.
The practitioner shall revise materiality for the GHG statement in the event of becoming aware of information
during the engagement that would have caused the practitioner to have determined a different amount initially.
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7.5 Understanding the Entity and Its Environment, Including the Entity’s Internal Control, and
Identifying and Assessing Risks of Material Misstatement (Para 23-34)
Obtaining an Understanding of the Entity and Its Environment

The practitioner shall obtain an understanding of the following:
 Relevant industry, regulatory, and other external factors including the applicable criteria.
 The nature of the entity, including:
¯ The nature of the operations included in the entity’s organizational boundary, including:
a. The sources and completeness of emissions and, if any, sinks and emissions deductions;
b. The contribution of each to the entity’s overall emissions; and
c. The uncertainties associated with the quantities reported in the GHG statement.
¯ Changes from the prior period in the nature or extent of operations; and
¯ The frequency and nature of interruptions to operations.
 The entity’s selection and application of quantification methods and reporting policies, including the
reasons for changes thereto and the potential for double-counting of emissions in the GHG statement.
 The requirements of the applicable criteria relevant to estimates, including related disclosures.
 The entity’s climate change objective and strategy, if any, and associated economic, regulatory, physical
and reputational risks.

 The oversight of, and responsibility for, emissions information within the entity.
 Whether the entity has an internal audit function and, if so, its activities and main findings on emissions.
Procedures to Obtain an Understanding and to Identify and Assess Risks of Material Misstatement
The procedures to obtain an understanding of the entity and its environment and to identify and assess risks of
material misstatement shall include the following:
 Inquiries of those within the entity who, in the practitioner’s judgment, have information that is likely
to assist in identifying and assessing risks of material misstatement due to fraud or error.
 Analytical procedures.
 Observation and inspection.
Obtaining an Understanding of the Entity’s Internal Control
(a) The control environment; (a) The control environment;

(b) The information system, including the (b) The information system, including the related
AT A GLANCE
related business processes, and business processes, and communication of
communication of emissions reporting emissions reporting roles and responsibilities and
roles and responsibilities and significant significant matters relating to emissions reporting;
matters relating to emissions reporting;
(c) The entity’s risk assessment process;
and
(d) Control activities relevant to the engagement; and
(c) The results of the entity’s risk assessment
process. (e) Monitoring of controls.
Other Procedures for Understanding and to Identify and Assess 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 and assessing risks of material misstatement.
SPOTLIGHT
The practitioner shall make inquiries of management, and others within the entity as appropriate, to determine
whether they have knowledge of any actual, suspected or alleged fraud or non-compliance with law or regulation
affecting the GHG statement.
The practitioner shall evaluate whether the entity’s quantification methods and reporting policies, including the
determination of the entity’s organizational boundary, are appropriate for its operations, and are consistent with
applicable criteria and quantification and reporting policies used in relevant industry and in prior periods.
Internal Audit
Where the entity has an internal audit function that is relevant to the engagement, the practitioner shall:
 Determine whether, and to what extent, to use specific work of the internal audit function; and
 If using the specific work of the internal audit function, determine whether that work is adequate for the
purposes of the engagement.
Identifying and Assessing Risks of Material Misstatement
The practitioner shall identify and assess risks of The practitioner shall identify and assess risks of
material misstatement: material misstatement:


(a) At the GHG statement level; and (a) At the GHG statement level; and
(b) For material types of emissions and disclosures, (b) At the assertion level for material types of emissions
as the basis for designing and performing and disclosures, as the basis for designing and
procedures whose nature, timing and extent: performing procedures whose nature, timing and
extent:
(c) Are responsive to assessed risks of material
misstatement; and (c) Are responsive to assessed risks of material
misstatement; and
(d) Allow the practitioner to obtain limited assurance
about whether the GHG statement is prepared, in (d) Allow the practitioner to obtain reasonable
all material respects, in accordance with the assurance about whether the GHG statement is
applicable criteria. prepared, in all material respects, in accordance
with the applicable criteria.
Causes of Risks of Material Misstatement

When performing the procedures, the practitioner shall consider at least the following factors:
AT A GLANCE
 The likelihood of intentional misstatement in the GHG statement;

 The likelihood of non-compliance with the provisions of those laws and regulations generally recognized
to have a direct effect on the content of the GHG statement;
 The likelihood of omission of a potentially significant emission;
 Significant economic or regulatory changes;
 The nature of operations;
 The nature of quantification methods;
 The degree of complexity in determining the organizational boundary and whether related parties are
involved;
 Whether there are significant emissions that are outside the normal course of business for the entity, or
that otherwise appear to be unusual;
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 The degree of subjectivity in the quantification of emissions;

 Whether Scope 3 emissions are included in the GHG statement; and
 How the entity makes significant estimates and the data on which they are based.
7.6 Overall Responses to Assessed Risks of Material Misstatement and Further Procedures (Para 35-56)

The practitioner shall: The practitioner shall:
(a) Consider the reasons for the assessment (a) Consider the reasons for the assessment given to the risks of
given to the risks of material material misstatement at the assertion level for material
misstatement for material types of types of emissions and disclosures, including:
emissions and disclosures; and (i) The likelihood of material misstatement due to the
(b) Obtain more persuasive evidence the particular characteristics of the relevant type of
higher the practitioner’s assessment of emission or disclosure (that is, the inherent risk); and
risk. (ii) Whether the practitioner intends to rely on the
operating effectiveness of controls in determining the
nature, timing and extent of other procedures; and
(b) Obtain more persuasive evidence the higher the
practitioner’s assessment of risk.


Tests of Controls
The practitioner shall design and perform tests of controls if:
(a) The practitioner intends to rely on the operating
effectiveness of controls in determining the nature, timing
and extent of other procedures; or
(b) Procedures other than tests of controls cannot alone provide
sufficient appropriate evidence at assertion level.
Procedures Other than Tests of Controls
Irrespective of the assessed risks of material misstatement, the
practitioner shall design and perform tests of details or
analytical procedures in addition to tests of controls, if any, for
each material type of emission and disclosure.
The practitioner shall consider whether external confirmation
procedures are to be performed.
Analytical Procedures Analytical Procedures
AT A GLANCE
The practitioner shall: The practitioner shall:
(a) Determine the suitability of particular (a) Determine the suitability of particular analytical procedures
analytical procedures, taking account of for given assertions, taking account of the assessed risks of
the assessed risks of material material misstatement and tests of details, if any, for these
misstatement and tests of details, if any; assertions;
(b) Evaluate the reliability of data from (b) Evaluate the reliability of data from which the practitioner’s
which the practitioner’s expectation of expectation of recorded quantities or ratios is developed,
recorded quantities or ratios is taking account of the source, comparability, and nature and
developed, taking account of the source, relevance of information available, and controls over
comparability, and nature and preparation; and
relevance of information available, and (c) Develop an expectation of recorded quantities or ratios
controls over preparation; and which is sufficiently precise to identify possible material
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(c) Develop an expectation with misstatements.
respect to recorded quantities or ratios.
Procedures Regarding Estimates Procedures Regarding Estimates
(a) Evaluate whether: Evaluate whether:
(i) The entity has appropriately applied the (a) The entity has appropriately applied the requirements of the
requirements of the applicable criteria applicable criteria relevant to estimates; and
relevant to estimates; and (b) The methods for making estimates are appropriate and have
(ii) The methods for making estimates are been applied consistently, and whether changes, if any, in
appropriate and have been applied reported estimates or in the method for making them from
consistently, and whether changes, if prior period are appropriate in circumstances.
any, in reported estimates or in the The practitioner shall undertake one or more of the following,
method for making them from the prior taking account of the nature of estimates:
period are appropriate in the
(a) Test how entity made the estimate and the data on which it
circumstances; and
is based. In doing so, practitioner shall evaluate whether:
(b) Consider whether other procedures are
(i) The method of quantification used is appropriate in the
necessary in the circumstances.
circumstances; and
(ii) The assumptions used by the entity are reasonable.
(b) Test the operating effectiveness of the controls over how the
entity made estimate, together with other procedures.


(c) Develop a point estimate or a range to evaluate the entity’s
estimate.
Other Procedures Other Procedures
(a) Agreeing or reconciling GHG statement (a) Agreeing or reconciling the GHG statement with the
with the underlying records; and underlying records; and
(b) Obtaining, through inquiry of the entity, (b) Examining material adjustments made during the course of
understanding of material adjustments preparing the GHG statement.
made during the course of preparing
GHG statement and considering
whether other procedures are
necessary in the circumstances.
Accumulation and communication of Identified Misstatements

The practitioner shall accumulate misstatements identified during the engagement, other than those that are
clearly trivial.
AT A GLANCE
The practitioner shall determine whether the overall engagement strategy and engagement plan need to be
revised if:
 The nature of identified misstatements and the circumstances of their occurrence indicate that other
misstatements may exist that, when aggregated with misstatements accumulated during the
engagement, could be material; or
 The aggregate of misstatements accumulated during the engagement approaches materiality.
The practitioner shall communicate on a timely basis all misstatements accumulated during the engagement with
the appropriate level within the entity and shall request the entity to correct those misstatements.
If the entity refuses to correct some or all of the misstatements communicated by the practitioner, the
practitioner shall obtain an understanding of the entity’s reasons for not making the corrections and shall take
that understanding into account when forming the practitioner’s conclusion.
SPOTLIGHT
7.7 Using the Work of Another Practitioner (Para 57)

When the practitioner intends to use the work of another practitioner, the practitioner shall:
 Communicate clearly with the other practitioners about the scope and timing of the work and findings
of the other practitioner; and
 Evaluate the sufficiency and appropriateness of evidence obtained and the process for including related
information in the GHG statement.
7.8 Written Representations (Para 58-60)

The practitioner shall request written representations from a person(s) within the entity with appropriate
responsibilities for, and knowledge of, the matters concerned:
 That they have fulfilled their responsibility for the preparation of the GHG statement, including
comparative information where appropriate, in accordance with the applicable criteria, as set out in the
terms of the engagement;
 That they have provided the practitioner with all relevant information and access as agreed in the terms
of the engagement and reflected all relevant matters in the GHG statement;
 Whether they believe the effects of uncorrected misstatements are immaterial, individually and in the
aggregate, to the GHG statement. A summary of such items shall be included in, or attached to, the
written representation;
 Whether they believe that significant assumptions used in making estimates are reasonable;

 That they have communicated to the practitioner all deficiencies in internal control relevant to the
engagement that are not clearly trivial of which they are aware; and
 Whether they have disclosed to the practitioner their knowledge of actual, suspected or alleged fraud or
non-compliance with law or regulation where the fraud or non-compliance could have a material effect
on the GHG statement.
The date of the written representations shall be as near as practicable to, but not after, the date of the assurance
report.
The practitioner shall disclaim a conclusion on the GHG statement or withdraw from the engagement, where
withdrawal is possible under applicable law or regulation, if:
 The practitioner concludes that there is sufficient doubt about the integrity of the person(s) providing
the written representations; or
 The entity does not provide the first 2 essential written representations
7.9 Subsequent Events (Para 61)

The practitioner shall:
 Consider whether events occurring between the date of the GHG statement and the date of the assurance
report require adjustment of, or disclosure in, the GHG statement, and evaluate the sufficiency and
AT A GLANCE
appropriateness of evidence obtained about whether such events are appropriately reflected in that
GHG statement in accordance with the applicable criteria; and
 Respond appropriately to facts that become known to the practitioner after the date of the assurance
report, that, had they been known to the practitioner at that date, may have caused the practitioner to
amend the assurance report.
7.10 Comparative Information (Para 62-63)

When comparative information is presented with the current emissions information and some or all of that
comparative information is covered by the practitioner’s conclusion, the practitioner’s procedures with respect
to the comparative information shall include evaluating whether:
 The comparative information agrees with the amounts and other disclosures presented in the prior
period or, when appropriate, has been properly restated and that restatement has been adequately
SPOTLIGHT
disclosed; and (Ref Para. A121)
 The quantification policies reflected in the comparative information are consistent with those applied
in the current period or, if there have been changes, whether they have been properly applied and
adequately disclosed.
If practitioner becomes aware that there may be a material misstatement in comparative information he shall:
 Discuss the matter with those person(s) within the entity with appropriate responsibilities for, and
knowledge of, the matters concerned and perform procedures appropriate in the circumstances; and
 Consider the effect on the assurance report. If the comparative information presented contains a
material misstatement, and the comparative information has not been restated:
¯ Where the practitioner’s conclusion covers the comparative information, the practitioner shall
express a qualified conclusion or an adverse conclusion in the assurance report; or
¯ Where the practitioner’s conclusion does not cover the comparative information, the practitioner
shall include an Other Matter paragraph in the assurance report describing the circumstances
affecting the comparative information.
7.11 Other Information (Para 64)

The practitioner shall read other information included in documents containing the GHG statement and the
assurance report thereon to identify material inconsistencies, if any, with the GHG statement or the assurance
report and, if on reading that other information, the practitioner:

 Identifies a material inconsistency between that other information and the GHG statement or the
assurance report; or
 Becomes aware of a material misstatement of fact in that other information that is unrelated to matters
appearing in the GHG statement or the assurance report, the practitioner shall discuss the matter with
the entity and take further action as appropriate.

In documenting the nature, timing and extent of procedures performed, the practitioner shall record:
 The identifying characteristics of the specific items or matters tested;
 Who performed the engagement work and the date such work was completed; and
 Who reviewed the engagement work performed and the date and extent of such review?
The practitioner shall document discussions of significant matters with the entity and others, including the
nature of the significant matters discussed, and when and with whom the discussions took place.
Quality Control
The practitioner shall include in the engagement documentation:
 Issues identified with respect to compliance with relevant ethical requirements and how they were
AT A GLANCE
resolved;
 Conclusions on compliance with independence requirements that apply to the engagement, and any
relevant discussions with the firm that support these conclusions;
 Conclusions reached regarding the acceptance and continuance of client relationships and assurance
engagements; and
 The nature and scope of, and conclusions resulting from, consultations undertaken during the course of
the engagement.
Matters Arising after the Date of the Assurance Report

If, in exceptional circumstances, the practitioner performs new or additional procedures or draws new
conclusions after the date of the assurance report, the practitioner shall document:
SPOTLIGHT
 The circumstances encountered;

 The new or additional procedures performed, evidence obtained, and conclusions reached, and their
effect on the assurance report; and
 When and by whom the resulting changes to engagement documentation were made and reviewed.
Assembly of the Final Engagement File

The practitioner shall assemble the engagement documentation and complete the administrative process of
assembling the final engagement file on a timely basis after the date of the assurance report. After the assembly,
practitioner shall not discard any engagement documentation before end of retention period.
Where the practitioner finds it necessary to modify existing engagement documentation or add new engagement
documentation after the assembly of the final engagement file has been completed, the practitioner shall,
regardless of the nature of the modifications or additions, document:
 The specific reasons for making them; and
 When and by whom they were made and reviewed.
7.13 Engagement Quality Control Review (Para 71)

For those engagements, if any, for which a quality control review is required, the engagement quality control
reviewer shall perform an objective evaluation of the significant judgments made by the engagement team, and
the conclusions reached in formulating the assurance report. This evaluation shall involve:

 Discussion of significant matters with the engagement partner, including the engagement team’s
professional competencies with respect to the quantification and reporting of emissions and assurance;
 Review of the GHG statement and the proposed assurance report;
 Review of selected engagement documentation relating to the significant judgments the engagement
team made and the conclusions it reached; and
 Evaluation of the conclusions reached in formulating the assurance report and consideration of whether
the proposed assurance report is appropriate.
7.14 Forming the Assurance Conclusion (Para 72-75)
Whether anything has come to the practitioner’s Whether the GHG statement is prepared, in all material
attention that causes the practitioner to believe that respects, in accordance with the applicable criteria.
the GHG statement is not prepared, in all material
respects, in accordance with applicable criteria.
This evaluation shall include consideration of the qualitative aspects of the entity’s quantification methods and
AT A GLANCE
reporting practices, including indicators of possible bias in judgments and decisions in the making of estimates
and in preparing the GHG statement, and whether, in view of the applicable criteria:
 The quantification methods and reporting policies selected and applied are consistent with the
applicable criteria and are appropriate;
 Estimates made in preparing the GHG statement are reasonable;
 Information presented in GHG statement is relevant, reliable, complete, comparable and
understandable;
 The GHG statement provides adequate disclosure of the applicable criteria, and other matters, including
uncertainties, such that intended users can understand significant judgments made in its preparation;
and
 The terminology used in the GHG statement is appropriate.
SPOTLIGHT
This evaluation shall also include consideration of:
 The overall presentation, structure and content of the GHG statement; and
 When appropriate in the context of the criteria, the wording of the assurance conclusion, or other
engagement circumstances, whether the GHG statement represents the underlying emissions in a
manner that achieves fair presentation.
7.15 Assurance Report Content (Para 76-77)

The assurance report shall include, at a minimum, the following basic elements:
 A title that clearly indicates the report is an independent assurance report.
 An addressee.
 An identification or description of the level of assurance, either reasonable or limited, obtained by the
practitioner.
 Identification of the GHG statement, including the period(s) it covers
 A description of the entity’s responsibilities.
 A statement that GHG quantification is subject to inherent uncertainty.
 If GHG statement includes emissions deductions covered by practitioner’s conclusion, identification of
those emissions deductions, and a statement of the practitioner’s responsibility with respect to them.
 Identification of the applicable criteria;
¯ Identification of how those criteria can be accessed;

¯ If those criteria are available only to specific intended users, or are relevant only to a specific
purpose, a statement alerting readers to this fact and that, as a result, the GHG statement may not
be suitable for another purpose.; and
¯ If established criteria need to be supplemented by disclosures in the explanatory notes to the GHG
statement for those criteria to be suitable, identification of the relevant note(s).
or requirements in law or regulation, applied that are as least as demanding as ISQC 1.
at least as demanding as IESBA Code related to assurance engagements.
 A description of the practitioner’s responsibility, including:
¯ A statement that the engagement was performed in accordance with ISAE 3410, Assurance
Engagements on Greenhouse Gas Statements; and
¯ An informative summary of the work performed. In the case of a limited assurance engagement, an
appreciation of the nature, timing and extent of procedures performed is essential to understanding
the practitioner’s conclusion. In that case, the summary of the work performed shall state that:
AT A GLANCE
o The procedures in a limited assurance engagement vary in nature and timing from, and are
less in extent than for, a reasonable assurance engagement; and
o Consequently, the level of assurance obtained in a limited assurance engagement is
substantially lower than the assurance that would have been obtained in reasonable assurance
engagement.
 The practitioner’s conclusion:
o In a reasonable assurance engagement, the conclusion shall be expressed in a positive form; or
o In a limited assurance engagement, the conclusion shall be expressed in a form that conveys
whether, based on the procedures performed and evidence obtained, a matter(s) has come to the
practitioner’s attention to cause the practitioner to believe that the GHG statement is not prepared,
in all material respects, in accordance with the applicable criteria.
o When the practitioner expresses a modified conclusion, the assurance report shall contain:
SPOTLIGHT
a. A section that provides a description of the matter(s) giving rise to the modification; and
b. A section that contains the practitioner’s modified conclusion.
 The practitioner’s signature.
 The date of the assurance report. Shall be dated no earlier than the date on which the practitioner has
obtained the evidence on which the practitioner’s conclusion is based, including evidence that those with
the recognized authority have asserted that they have taken responsibility for the GHG statement.
Emphasis of Matter Paragraphs and Other Matter Paragraphs

If the practitioner considers it necessary to:
 Draw intended users’ attention to a matter presented or disclosed in the GHG statement that, in the
practitioner’s judgment, is of such importance that it is fundamental to intended users’ understanding
of the GHG statement (an Emphasis of Matter paragraph); or
 Communicate a matter other than those that are presented or disclosed in the GHG statement that, in
the practitioner’s judgment, is relevant to intended users’ understanding of the engagement, the
practitioner’s responsibilities or the assurance report (an Other Matter paragraph), and this is not
prohibited by law or regulation, the practitioner shall do so in a paragraph in the assurance report, with
an appropriate heading, that clearly indicates the practitioner’s conclusion is not modified in respect of
the matter.

7.16 Other Communication Requirements (Para 78)

The practitioner shall communicate, unless prohibited by law or regulation, with those person(s) with oversight
responsibilities for the GHG statement the following matters that come to the practitioner’s attention during the
course of the engagement, and shall determine whether there is a responsibility to report them to another party
within or outside the entity:
 Deficiencies in internal control that, in the practitioner’s professional judgment, are of sufficient
importance to merit attention;
 Identified or suspected fraud; and
 Matters involving identified or suspected non-compliance with laws and regulations, other than when
the matters are clearly trivial.
Dawood Limited (DL), a listed company, has approached your firm to provide a limited assurance
on sustainability report of the company and presently you are verifying the following statement
related to carbon emissions:
“Carbon emissions were within the limits allowed by the regulator.”
Required:
AT A GLANCE
Determine how you would verify the above claim.
Tutorial Notes:
Instead of over emphasizing the typical procedures on appointment and evaluation of the expert
from ISA 620, students are required to have understanding of the relevant assurance standard to
answer the question more accurately.
 Solution:
Steps for verification of the claim “Carbon emissions were within the limits allowed by the
regulator” are as follows:
 Inspection of relevant guidelines and benchmarks related to carbon emissions, as may
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be allowed/ specified by the regulator.
 Review the company’s processes for collecting, analyzing and aggregating data on the
carbon emissions.
 Assess the use of work of an expert with reference to compliance with environmental
regulations and standards.
 Interview management and employees of relevant departments.
 Compare the weekly/monthly / yearly carbon emission report and analyze and discuss
the reason for major variations, if any.

8. ASSURANCE ENGAGEMENTS TO REPORT ON THE COMPILATION OF PRO

FORMA FINANCIAL INFORMATION INCLUDED IN A PROSPECTUS (ISAE
3420)
The practitioner shall not represent compliance with this ISAE unless the practitioner has complied with the
requirements of both this ISAE and ISAE 3000 (Revised).
8.2 Engagement Acceptance (Para 13)

The practitioner shall:
 Determine that those persons who are to perform the engagement collectively have the appropriate
competence and capabilities;
 Determine that the criteria that the practitioner expects to be applied are suitable and that it is unlikely
that the pro forma financial information will be misleading;
 Evaluate the wording of the opinion prescribed by the relevant law or regulation, if any;
 If the entity’s historical financial information has never been audited or reviewed, consider whether the
AT A GLANCE
practitioner can obtain a sufficient understanding of the entity and its accounting and financial reporting
practices to perform the engagement;
 If the event or transaction includes an acquisition and the acquiree’s historical financial information has
never been audited or reviewed, consider whether the practitioner can obtain a sufficient understanding
of the acquiree and its accounting and financial reporting practices to perform the engagement; and
 Obtain the agreement of the responsible party that it acknowledges and understands its responsibility
for:
¯ Adequately disclosing and describing the applicable criteria to the intended users if these are not
publicly available;
¯ Compiling the pro forma financial information on the basis of the applicable criteria; and
¯ Providing the practitioner with:
SPOTLIGHT
a. Access to all information relevant to evaluating whether the pro forma financial information has
been compiled, in all material respects, on the basis of the applicable criteria;
b. Additional information that the practitioner may request from the responsible party;
c. Access to those within the entity and the entity’s advisors from whom the practitioner
determines it necessary to obtain evidence; and
d. When needed for purposes of the engagement, access to appropriate individuals within the
acquiree(s) in a business combination.
8.3 Planning and Performing the Engagement (Para 14-27)

Determining the Suitability of the Applicable Criteria
Practitioner shall determine whether the applicable criteria are suitable, and in particular shall determine that
they include, at a minimum, that:
 The unadjusted financial information be extracted from an appropriate source;
 The pro forma adjustments be:
¯ Directly attributable to the event or transaction;
¯ Factually supportable; and
¯ Consistent with the entity’s applicable financial reporting framework and its accounting policies
under that framework; and
 Appropriate presentation be made and disclosures be provided to enable the intended users to
understand.

In addition, the practitioner shall assess whether the applicable criteria are:
 Consistent, and do not conflict, with relevant law or regulation; and
 Unlikely to result in pro forma financial information that is misleading.
Obtaining an Understanding and evidences of How the Responsible Party Has Compiled the Pro Forma
Financial Information and Other Engagement Circumstances
The practitioner shall obtain an understanding of:
 The event or transaction in respect of which the pro forma financial information is being compiled;
 How the responsible party has compiled the pro forma financial information;
 The nature of the entity and any acquiree or divestee, including:
¯ Their operations;
¯ Their assets and liabilities; and
¯ The way they are structured and how they are financed;
 Relevant industry, legal and regulatory and other external factors pertaining to the entity and any
acquiree or divestee; and
AT A GLANCE
 The applicable financial reporting framework and the accounting and financial reporting practices of the
entity and of any acquiree or divestee, including their selection and application of accounting policies.
The practitioner shall determine whether the responsible party has extracted the unadjusted financial
information from an appropriate source.
If there is no audit or review report on the source from which the unadjusted financial information has been
extracted, the practitioner shall perform procedures to be satisfied that the source is appropriate.
In determining whether the pro forma adjustments are in accordance with the applicable criteria, the
practitioner shall determine whether they are:
 Directly attributable to the event or transaction;
 Factually supportable; If acquiree or divestee financial information is included in the pro forma
adjustments and there is no audit or review report on the source from which such financial information
SPOTLIGHT
has been extracted; and
 Consistent with the entity’s applicable financial reporting framework and its accounting policies.
A modified audit opinion or review conclusion may have been expressed with respect to either the source
from which the unadjusted financial information has been extracted or the source from which the acquiree or
divestee financial information has been extracted, or a report containing an Emphasis of Matter paragraph may
have been issued with respect to such source. In such circumstances, if the relevant law or regulation does not
prohibit the use of such a source, the practitioner shall evaluate:
 The potential consequence on whether the pro forma financial information has been compiled, in all
material respects, on the basis of the applicable criteria;
 What further appropriate action to take; and
 Whether there is any effect on the practitioner’s ability to report in accordance with the terms of the
engagement, including any effect on the practitioner’s report.
If, on the basis of the procedures performed, the practitioner identifies that the responsible party has:
 Used an inappropriate source from which to extract the unadjusted financial information; or
 Omitted a pro forma adjustment that should be included, applied a pro forma adjustment that is not in
accordance with the applicable criteria or otherwise inappropriately applied a pro forma adjustment,
the practitioner shall discuss the matter with the responsible party. If the practitioner is unable to agree
with the responsible party as to how the matter should be resolved, the practitioner shall evaluate what
further action to take.

Evaluating the Presentation of the Pro Forma Financial Information

This shall include consideration of:
 The overall presentation and structure of the pro forma financial information, including whether it is
clearly labeled to distinguish it from historical or other financial information;
 Whether the pro forma financial information and related explanatory notes illustrate the impact of the
event or transaction in a manner that is not misleading;
 Whether appropriate disclosures are provided with the pro forma financial information to enable the
intended users to understand the information conveyed; and
 Whether the practitioner has become aware of any significant events subsequent to the date of the
source from which the unadjusted financial information has been extracted that may require reference
to, or disclosure in, the pro forma financial information.
The practitioner shall read the other information included in the prospectus containing the pro forma financial
information to identify material inconsistencies, if any, with the pro forma financial information or the assurance
report.
8.4 Written Representations (Para 28)

AT A GLANCE
The practitioner shall request written representations from the responsible party that:
 In compiling the pro forma financial information, the responsible party has identified all appropriate pro
forma adjustments necessary to illustrate the impact of the event or transaction at the date or for the
period of the illustration; and
 The pro forma financial information has been compiled, in all material respects, on the basis of the
applicable criteria.
8.5 Forming the Opinion (Para 29-30)

The practitioner shall form an opinion on whether the pro forma financial information has been compiled, in all
material respects, by the responsible party on the basis of the applicable criteria.
8.6 Form of Opinion (Para 31-34)

SPOTLIGHT
Unmodified Opinion
Express an unmodified opinion when the practitioner concludes that the pro forma financial information has
been compiled, in all material respects, by the responsible party on the basis of the applicable criteria.
Modified Opinion
In many jurisdictions, the relevant law or regulation precludes publication of a prospectus that contains a
modified opinion with regard to whether the pro forma financial information has been compiled, in all material
respects, on the basis of the applicable criteria. In that case, the practitioner shall discuss the matter with the
responsible party. If the responsible party does not agree to make the necessary changes, the practitioner shall:
 Withhold the report;
 Withdraw from the engagement; or
 Consider seeking legal advice.
Emphasis of Matter Paragraph

In some circumstances, the practitioner may consider it necessary to draw users’ attention to a matter presented
or disclosed in the pro forma financial information or the accompanying explanatory notes. This would be the
case when, in the practitioner’s opinion, the matter is of such importance that it is fundamental to users’
understanding of whether the pro forma financial information has been compiled, in all material respects, on the
basis of the applicable criteria.

In such circumstances, the practitioner shall include an Emphasis of Matter paragraph in the practitioner’s report
provided that the practitioner has obtained sufficient appropriate evidence that the matter does not affect
whether the pro forma financial information has been compiled, in all material respects, on the basis of the
applicable criteria. Such a paragraph shall refer only to information presented or disclosed in the pro forma
financial information or the accompanying explanatory notes.
8.7 Preparing the Assurance Report (Para 35)

The practitioner’s report shall include, at a minimum, the following basic elements:
 A title that clearly indicates that the report is an independent assurance report;
 An addressee(s), as agreed in the terms of engagement;
 Introductory paragraphs that identify:
¯ The pro forma financial information;
¯ The source from which the unadjusted financial information has been extracted, and whether or not
an audit or review report on such a source has been published;
¯ The period covered by, or the date of, the pro forma financial information; and
¯ A reference to the applicable criteria on the basis of which the responsible party has performed the
compilation of the pro forma financial information, and the source of the criteria;
AT A GLANCE
 A statement that the responsible party is responsible for compiling the pro forma financial information
on the basis of the applicable criteria;
 A description of the practitioner’s responsibilities, including statements that:
¯ Practitioner’s responsibility is to express an opinion about whether pro forma financial information
has been compiled, in all material respects, by the responsible party on the basis of applicable
criteria;
¯ For purposes of this engagement, the practitioner is not responsible for updating or reissuing any
reports or opinions on any historical financial information used in compiling the pro forma financial
information, nor has the practitioner, in the course of this engagement, performed an audit or
review of the financial information used in compiling the pro forma financial information; and
¯ The purpose of pro forma financial information included in a prospectus is solely to illustrate the
SPOTLIGHT
impact of a significant event or transaction on unadjusted financial information of the entity as if the
event had occurred or the transaction had been undertaken at an earlier date selected for purposes
of the illustration. Accordingly, the practitioner does not provide any assurance that the actual
outcome of the event or transaction at that date would have been as presented;
 A statement that the engagement was performed in accordance with ISAE 3420;
or requirements in law or regulation, applied that are at least as demanding as ISQC 1;
IESBA Code, or other professional requirements, or requirements imposed by law and regulation;
 Statements that:
¯ A reasonable assurance engagement to report on whether the pro forma financial information has
been compiled, in all material respects, on the basis of the applicable criteria involves performing
procedures to assess whether the applicable criteria used by the responsible party in the
compilation of pro forma financial information provide a reasonable basis for presenting significant
effects directly attributable to event or transaction, and to obtain sufficient appropriate evidence
about whether:
o The related pro forma adjustments give appropriate effect to those criteria; and
o The pro forma financial information reflects the proper application of those adjustments to the
unadjusted financial information;

¯ The procedures selected depend on the practitioner’s judgment, having regard to the practitioner’s
understanding of the nature of the entity, the event or transaction in respect of which the pro forma
financial information has been compiled, and other relevant engagement circumstances; and
¯ Engagement also involves evaluating the overall presentation of the pro forma financial
information;
 Unless otherwise required by law or regulation, practitioner’s opinion using one of the following
phrases:
¯ The pro forma financial information has been compiled, in all material respects, on the basis of the
[applicable criteria]; or
¯ The pro forma financial information has been properly compiled on the basis stated;
 The practitioner’s signature;
 The date of the report; and
AT A GLANCE
SPOTLIGHT

9. ENGAGEMENTS TO PERFORM AGREED-UPON PROCEDURES (ISRS 4400)

An engagement to perform agreed-upon procedures may involve the auditor in performing certain procedures
concerning individual items of financial data (e.g., accounts payable, accounts receivable, profits of a segment of
an entity), a financial statement (for example, a balance sheet) or even a complete set of financial statements.
Auditor normally carries out procedures of an audit nature to which auditor and the entity and any appropriate
third parties have agreed and to report on factual findings.
 No assurance is expressed.
 Users of the report assess for themselves the procedures and findings reported by the auditor and draw
their own conclusions from auditor’s work.
 Report is restricted to those parties that have agreed to the procedures to be performed.
9.1 General Principles of an Agreed-Upon Procedures Engagement (Ref: 7-8)

 Auditor should comply with Code of Ethics for Professional Accountants issued by the International
Ethics Standards Board for Accountants (IESBA Code).
 Ethical principles for this type of engagement are:
¯ Integrity;
AT A GLANCE
¯ Objectivity;
¯ Professional competence and due care;
¯ Confidentiality;
¯ Professional behavior; and
¯ Technical standards.
 Independence is not a requirement for agreed-upon procedures engagements:
¯ Terms or objectives of an engagement or national standards may require the auditor to comply with
the independence requirements of the IESBA Code.
¯ Where auditor is not independent, a statement to that effect would be made in report.
SPOTLIGHT
9.2 Defining the Terms of the Engagement (Ref: 9-12)
Auditor should ensure with representatives of entity and other specified addressee of report, that there is clear
understanding regarding agreed procedures and conditions of engagement.
Matters to be agreed include the following:
 Nature of 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 financial information to which 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.
 Limitations on distribution of the report of factual findings.
(If limitation is in conflict with legal requirements, auditor would not accept engagement)
An engagement letter confirms the auditor’s acceptance of the appointment and helps avoid misunderstanding
regarding matters such as scope of engagement, extent of auditor’s responsibilities and form of reports to be
issued.
Matters that would be included in the engagement letter include the following:
 A listing of the procedures to be performed as agreed upon between the parties.
 A statement that the distribution of the report of factual findings would be restricted to the specified
parties who have agreed to the procedures to be performed.

 Appendix 1 - Engagement Letter for an Agreed-Upon Procedures Engagement

To Board of Directors or other appropriate representatives of the client who engaged auditor:
This letter is to confirm our understanding of the terms and objectives of our engagement and
the nature and limitations of the services that we will provide. Our engagement will be conducted
in accordance with the ISRS (or refer to relevant national standards or practices) applicable to
agreed-upon procedures engagements and we will indicate so in our report.
We have agreed to perform the following procedures and report to you the factual findings
resulting from our work:
(Describe the nature, timing and extent of the procedures to be performed, including specific
reference, where applicable, to the identity of documents and records to be read, individuals to
be contacted and parties from whom confirmations will be obtained.)
The procedures that we will perform are solely to assist you in (state purpose). Our report is not
to be used for any other purpose and is solely for your information.
The procedures that we will perform will not constitute an audit or a review made in accordance
with ISA or ISRE (or refer to relevant national standards or practices) and, consequently, no
assurance will be expressed.
We look forward to full cooperation with your staff and we trust that they will make available to
AT A GLANCE
us whatever records, documentation and other information requested in connection with our
engagement.
Our fees, which will be billed as work progresses, are based on the time required by the
individuals assigned to engagement plus out-of-pocket expenses. Individual hourly rates vary
according to the degree of responsibility involved and the experience and skill required.
Please sign and return the attached copy of this letter to indicate that it is in accordance with
your understanding of the terms of the engagement including the specific procedures which we
have agreed will be performed.
Acknowledged on behalf of ABC Company by XYZ & Co

(signed)
SPOTLIGHT
Name and Title

Date
9.3 Planning (Ref: 13)

Auditor should plan the work so that an effective engagement will be performed.

Auditor should document matters which are important in providing evidence to support the report of factual
findings and evidence that engagement was carried out in accordance with this ISRS and the terms of the
engagement.
9.5 Procedures and Evidence (Ref: 15-16)

Auditor should carry out the procedures agreed upon and use the evidence obtained as the basis for the report
of factual findings. Such procedures include the following:
 Inquiry and analysis.
 Re computation, comparison and other clerical accuracy checks.
 Observation.
 Inspection.
 Obtaining confirmations.

9.6 Reporting (Ref: 17-18)

Report of factual findings should contain:
 Title;
 Addressee (ordinarily client who engaged the auditor);
 Identification of specific financial or non-financial information to which the agreed-upon procedures
have been applied;
 A statement that the procedures performed were those agreed upon with the recipient;
 A statement that the engagement was performed in accordance with ISRS applicable to agreed-upon
procedures engagements, or with relevant national standards or practices;
 When relevant a statement that the auditor is not independent of the entity;
 Identification of the purpose for which the agreed-upon procedures were performed;
 A listing of the specific procedures performed;
 A description of auditor’s factual findings including 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;
 A statement that had the auditor performed additional procedures, an audit or a review, other matters
AT A GLANCE
might have come to light that would have been reported;
 A statement that report is restricted to those parties that have agreed to the procedures;
 A statement (when applicable) that report relates only to the elements, accounts, items or financial and
non-financial information specified and that it does not extend to financial statements taken as a whole;
 Date of the report;
 Auditor’s address; and
 Appendix 2 - Illustration of a Report of Factual Findings in Connection with Accounts Payable
REPORT OF FACTUAL FINDINGS
SPOTLIGHT
To (those who engaged the auditor)
We have performed the procedures agreed with you and enumerated below with respect to the
accounts payable of ABC Company as at (date), set forth in the accompanying schedules (not
shown in this example). Our engagement was undertaken in accordance with the ISRS (or refer
to relevant national standards or practices) applicable to agreed-upon procedures engagements.
The procedures were performed solely to assist you in evaluating the validity of the accounts
payable and are summarized as follows:
1. We obtained and checked the addition of the trial balance of accounts payable as at (date)
prepared by ABC Company, and we compared the total to the balance in the related general
ledger account.
2. We compared the attached list (not shown in this example) of major suppliers and the
amounts owing at (date) to the related names and amounts in the trial balance.
3. We obtained suppliers’ statements or requested suppliers to confirm balances owing at
(date).
4. We compared such statements or confirmations to the amounts referred to in 2. For amounts
which did not agree, we obtained reconciliations from ABC Company. For reconciliations
obtained, we identified and listed outstanding invoices, credit notes and outstanding checks,
each of which was greater than xx1. We located and examined such invoices and credit notes
subsequently received and checks subsequently paid and we ascertained that they should in
fact have been listed as outstanding on the reconciliations.

We report our findings below:

a) With respect to item 1 we found the addition to be correct and the total amount to be in
agreement.
b) With respect to item 2 we found the amounts compared to be in agreement.
c) With respect to item 3 we found there were suppliers’ statements for all such suppliers.
d) With respect to item 4 we found the amounts agreed, or with respect to amounts which did
not agree, we found ABC Company had prepared reconciliations and that the credit notes,
invoices and outstanding checks over xxx were appropriately listed as reconciling items with
the following exceptions:
(Detail the exceptions)
Because the above procedures do not constitute either an audit or a review made in accordance
with International Standards on Auditing or International Standards on Review Engagements (or
relevant national standards or practices), we do not express any assurance on the accounts
payable as of (date).
Had we performed additional procedures or had we performed an audit or review of the financial
statements in accordance with ISA or ISRE (or relevant national standards or practices), other
matters might have come to our attention that would have been reported to you.
AT A GLANCE
Our report is solely for the purpose set forth in the first paragraph of this report and for your
information and is not to be used for any other purpose or to be distributed to any other parties.
This report relates only to the accounts and items specified above and does not extend to any
financial statements of ABC Company, taken as a whole.
AUDITOR
Date
Address
You have recently completed the audit of Rubi Limited (RL), a multinational company, for the
SPOTLIGHT
year ended December 31, 2008. The Chief Financial Officer (CFO) of the company has now
approached you for a report on book value per share, as of December 31, 2008 for submission to
the regulatory authorities.
Following is an extract from the audited balance sheet of RL as at December 31, 2008:
Rupees
Issued, subscribed and paid-up share capital 4,000,000
(400,000 ordinary shares of Rs.10 each)
Accumulated profits 2,000,000
Unrealized gain on revaluation of investments 500,000
Surplus on revaluation of fixed assets–net of tax 600,000
The auditor’s opinion on the financial statements for the year ended December 31, 2008was
qualified as deferred tax asset amounting to Rs. 5 million was not recognized in the financial
statements.
Required
Draft a report for submission to the client. Show necessary calculations related to the figures
disclosed in the report.

 Solution:
The Board of Directors 08 March 2009
RL Limited (the Company)
Karachi
Dear Sirs
BOOK VALUE PER SHARE BASED ON THE AUDITED BALANCE SHEET AS AT 31 DECEMBER
2008
We have examined the annexed Statement of Book Value Per Share (the Statement) of the
company as at 31 December 2008 duly initialed by us for identification purposes. The book value
per share has been determined on the basis of audited balance sheet of the company as at
December 31, 2008 in accordance with the directives of the Institute of Chartered Accountants
of Pakistan contained in Technical Release 22 “Book Value Per Share” (TR-22) and we report that
The Statement is the responsibility of the Management of the Company. Our responsibility is to
examine the Statement and report thereon.
In our opinion, the Statement is presented fairly in all material respects in accordance with TR-
22 of the Institute of Chartered Accountants of Pakistan.
AT A GLANCE
The book value per share of the face value of Rs. 10 each, taking into consideration, surplus on
revaluation of fixed assets, works out to Rs. 30.25 per share.
The book value per share of the face value of Rs. 10 each without taking into consideration
surplus on revaluation of fixed assets works out to Rs. 28.75 per share.
This report is being issued at the specific request of the company to meet the regulatory
requirements and it should not be used for any other purpose or circulated to anyone else
without our prior written consent.
Yours faithfully
SPOTLIGHT
ALTERNATE REPORT BASED ON AGREED UPON PROCEDURES ENGAGEMENT
REPORT OF FACTUAL FINDINGS

The Board of Directors
RL limited (the Company)
Karachi
Dear Sirs
book value per share as of December 31, 2008, as set forth in the accompanying statement. Our
engagement was undertaken in accordance with the International Standard on Related Services
applicable to agreed-upon procedures engagements. The procedures were performed solely to
assist you in evaluating the validity of the book value per share and its submission to regulatory
authorities and are summarized as follows:
1. We obtained the statement of book value per share as prepared by management and
compared the information with the audited financial statements as at December 31, 2008.
2. We checked that the calculation of the book value per share is in accordance with the
directives of the Institute of Chartered Accountants of Pakistan contained in Technical
Release 22 “Book Value Per Share.


a) The book value per share of the face value of Rs. 10 each, taking into consideration, surplus
on revaluation of fixed assets, works out to Rs. 30.25 per share.
b) The book value per share of the face value of Rs. 10 each without taking into consideration
relevant national standards or practices), we do not express any assurance on the book value per
share as of December 31, 2008.
Had we performed additional procedures in accordance with International Standards on
Auditing or International Standards on Review Engagements (or relevant national standards or
practices), other matters might have come to our attention that would have been reported to you.
This report relates only to the item specified above and does not extend to any financial
statements of RL Limited (the Company), taken as a whole.
AUDITOR
AT A GLANCE
Date
Address
RUBY LIMITED
BOOK VALUE PER SHARE
(With and without surplus on revaluation of fixed assets)
As at December 31, 2008
With surplus Without surplus
SPOTLIGHT
Rupees
Issued, subscribed and paid-up capital 4,000,000 4,000,000
Accumulated profit 2,000,000 2,000,000
Unrealized gain on revaluation of investments 500,000 500,000
Surplus on revaluation of fixed assets 600,000 -
*Deferred tax asset (not recognized in the financial 5,000,000 5,000,000
statements)
12,100,000 11,500,000
Number of ordinary shares of Rs. 10 each, issued for 400,000 400,000

cash
Book value per ordinary share of Rs. 10 each 30.25 28.75
(*Included in the computation because the audit report was qualified on this issue and the
qualification was quantified)


TFL has recently applied for listing on a Stock Exchange in Pakistan. Following information has
been extracted from TFL’s financial statements for the year ended 30 June 2012.
Rs. in 000
Issued, subscribed and paid up capital-Ordinary shares 4,000,000
Issued, subscribed and paid up capital-Nonredeemable preference shares 600,000
Share deposit money- Nonredeemable preference shares 3,000

Un-appropriated profit 30,000
Unrealized gain on re-measurement of available for sale investments (net 500,000
of tax)
Surplus on revaluation of fixed assets 120,000
Unpaid dividend on preference shares 75,000
The face value of both types of shares is Rs. 10 each. Preference shares are convertible into
AT A GLANCE
ordinary shares at any time after listing of ordinary shares. The conversion price shall be Rs.
10per ordinary share. For the purpose of conversion, unpaid dividend on preference shares,
accumulated up to the date of announcement of conversion by the company, shall also be taken
into account for determining the number of ordinary shares to be issued upon conversion.
Required: On behalf of the auditors of the company, draft a report on factual findings on break-
up value of shares for submission to the client.
Tutorial Notes:
Common errors to be avoided are as follows:
 Not providing book values of ordinary and preference shares separately.
 Not reproducing the correct version of the report.
SPOTLIGHT
 Not providing break-up values inclusive of surplus on revaluation.
 Apportioning the unappropriated profit, surplus on revaluation of fixed assets and
unrealized gain on available for sale investments, to ordinary as well as preference
shares.
 Solution:
REPORT ON FACTUAL FINDINGS
The Board of Directors,
TFL (the Company),
Karachi.
Dear Sirs,
book value per share as of 30 June 2012, as set forth in the accompanying statement. Our
engagement was undertaken in accordance with the International Standard on Related Services
applicable to agreed-upon procedures engagements. The procedures were performed solely to
assist you in evaluating the validity of the book value per share and its submission to regulatory
Stock Exchange and are summarized as follows:

1. We obtained the statement of book value per share as prepared by management and
compared the information with the audited financial statements as at 30 June 2012.
2. We checked that the calculation of the book value per share is in accordance with the
directives of the Institute of Chartered Accountants of Pakistan contained in Technical
Release 22 “Book Value Per Share.”
a) The book value per share of the face value of Rs. 10 each, taking into consideration, surplus
on revaluation of fixed assets, works out to Rs. 11.41 per share.
b) The book value per share of the face value of Rs. 10 each without taking into consideration
relevant national standards or practices), we do not express any assurance on the book value per
share as of 30 June 2012
Had we performed additional procedures in accordance with International Standards on
Auditing or International Standards on Review Engagements, other matters might have come to
our attention that would have been reported to you.
AT A GLANCE
This report relates only to the item specified above and does not extend to any financial
statements of the Company, taken as a whole.
AUDITOR
Date Address
TFL-BOOK VALUE PER SHARE

SPOTLIGHT
(With and without surplus on revaluation of fixed assets) - As at 30 June 2012
Breakup value per share

Shares
Ordinary preference
(Ordinary &
shares shares
Preference)
Rupees in Thousands
Equity
Issued subscribed and paid up capital 4,000,000 600,000 4,600,000
Share deposit money( Preference shares - 3,000 3,000
related)
Unappropriated profit 30,000 - 30,000
Unrealized gain on revaluation of available 500,000 500,000
for sale investment net
Surplus on revaluation of fixed assets 120,000 120,000
Total equity (with Surplus on revaluation of 4,650,000 603,000 5,253,000
fixed assets)
equity (without Surplus on revaluation of 4,530,000 603,000 5,133,000
fixed assets)

Breakup value per share

Shares
Ordinary preference
(Ordinary &
shares shares
Preference)
Rupees in Thousands
Number of ordinary shares is issue 400,000,000 400,000,000
Number of convertible preference share in - 60,000,000 60,000,000
issue
Number of convertible preference shares to 300,000 300,000
be issued in respect of share deposit money
received
400,000,000 60,300,000 460,300,000
Break-up value per share (with surplus on 11.63 10.00 11.41

revaluation of fixed assets)
Break-up value per share (without surplus on 11.33 10.00 11.15
AT A GLANCE
revaluation of fixed assets)
Preference Shares are non-redeemable but convertible into Ordinary Share at face value at any
time after the issuance of Ordinary shares. The conversion price shall be Rs. 10 per Ordinary
Share and dividend not paid to the preference shareholders, if any, accumulated up to the date
of announcement of conversion by the Company, shall be taken into account for determining the
number of the Ordinary Shares to be issued upon conversion and therefore the number of
Ordinary Shares to be issued to the preference shareholders shall be in the ratio 1:1, plus unpaid
accumulated preferential dividends, if any. Such unpaid preferential dividend aggregated Rs. 75
million as at 30 June 2012.
Spectrum Limited has patented a manufacturing process for the production of Product X. It has
SPOTLIGHT
allowed Lava Company Limited (LCL) to produce and market product X against a royalty of 4%
of the sales value. LCL is a large manufacturing concern and sells a number of products. It issues
serially numbered invoices and each invoice contains a number of products. Different prices are
charged from different categories of customers, according to price lists duly approved at the start
of the year.
Spectrum Limited has engaged your firm to carry out agreed upon procedures relating to
verification of the amount of royalty.
Required:
Draft a report of factual findings in accordance with the relevant standard. The report should
contain at least three procedures and three findings. You may assume necessary details
wherever required.
Tutorial Notes:
Common errors could be:
1. Mentioning incorrect procedures such as obtaining confirmation from selected customers,
ensuring that credit notes have been issued in case of sales returns, procedures to ensure
that sales were not overstated, etc. An extreme can be to mention about obtaining
confirmation from Spectrum Limited who had appointed them.
2. Reporting unrelated findings i.e. which did not arise from the procedures which had been
carried out.

 Solution:
Report of Factual Findings
Board of Directors,
Spectrum Limited,
Karachi.
Dear Sirs,
verification of royalty. Our engagement was undertaken in accordance with the International
Standards on Related Services applicable to agreed-upon procedures engagements. The
procedures were carried out solely to assist you in verification of the royalty.
The procedures are summarised as follows:
i. We obtained the list of all invoices issued by the company and agreed the total with the
total sales reported in the financial statements.
ii. We selected every 10th invoice and traced the sales (if any) of product X, from the invoice
AT A GLANCE
onto the list of transactions and checked the price charged with the rate list applicable
to different customers.
iii. For every selected invoice of product X, we checked that the royalty had been recorded
as per the agreed rates.
Findings
i. With respect to item (i) we found that the total list of all invoices was in agreement with
the total sales reported in the financial statements.
ii. With respect to item (ii) we found that price charged was in agreement with the rate list.
iii. With respect to item (iii) we found that royalty had been recorded as per the agreed
SPOTLIGHT
rates.
Because the above procedures do not constitute an audit or a review in accordance with
International Standards on Auditing or International Standards on Review Engagements, we do
not express any assurance on the royalty.
Had we performed additional procedures or had we performed an audit or review of financial
statements in accordance with International Standards on Auditing or International Standards
on Review Engagements, other matters may have come to our attention that would have been
reported to you.
This report relates only to the accounts and items specified above and do not extend to financial
statements of LCL, taken as a whole.
AUDITOR
NAME
ADDRESS


Your firm has received a Request for Proposal from a regulator to investigate the affairs of
Ghalib Limited (GL), a listed company. The investigation has been initiated on complaint of
fraud from a shareholder. The annual reports of the company contain the following information:
2015 2014 2013
------------- Rs. in ‘000 -------------
Sales 923,215 875,471 863,215
Cost of sales (757,388) (608,950) (533,476)
Gross profit 165,827 266,521 329,739
Selling and administration expenses (585,194) (436,582) (242,455)
Profit/(loss) before tax (419,367) (170,061) 87,284
80% of raw material is purchased from a related party.

The audit reports of 2014 and 2015 contain emphasis of matter paragraphs discussing the going
concern issues.
The Board consists of 5 members from the parent company and 2 executive directors, excluding
AT A GLANCE
the chief executive officer.
The Company Secretary (CS) and Internal Auditor (IA) resigned in March 2015. The
replacements of CS and IA were appointed in August 2015 and approved by the CEO and the
Board of Directors respectively.
Required:
Prepare paragraph(s) for inclusion in the proposal, describing the scope of work.
Tutorial Notes:
It can be an underscoring question if the students are unable to understand the requirement and
try to produce the standard wording of an agreed upon procedures’ engagement letter, whereas
the requirement is to write only the scope of the investigation assignment/proposal and that too
SPOTLIGHT
with relevance to the given situation.
 Solution:
Areas of focus from investigation perspective:
(i) Cost of sales/ Gross profit:
 Checking the pricing mechanism agreed with the related party;
 Checking whether increase in cost or decline in profitability is in line with the industry
trends.
 Investigating any other reasons for increase in cost or decline in profit.
(ii) Selling and administration expenses: Verifying major expenses with specific emphasis on
assessing whether all expenditure incurred are for the Company’s business and not
otherwise;
(iii) Resignation of key management personnel:
Inquiring the reasons for resignation and delayed replacement of the Company’s Secretary
and Internal Auditor and interviewing them if required. The probability that they resigned
because of differences on ethical issues would be assessed;
(iv) Compliance with laws and regulations:
Obtaining an understanding of laws and regulations and where relevant checking
compliance with them.


Bluebell Foundation (BF) is a non-profit organisation. It is in the process of receiving a grant from
the federal government. To receive such grant BF has to submit a report of factual findings on
the projects being run by BF. The trustees approached your firm and on their request you
provided a specimen of the report that may be issued in the given situation.
Subsequently, you have received a letter from the trustees in which they have requested to
remove the statement from the report, “this report is not to be distributed to any other parties
other than the federal government”, as BF also intends to distribute the report to its current
corporate donors.
Required:
Discuss how the firm should deal with the request of the trustees.
 Solution:
 The report is restricted to those parties that have agreed to the procedures to be
performed.
 The reason for restricting the AUP report in this manner is to prevent readers who are
unaware of the context for the AUP from misinterpreting the results of those procedures.
AT A GLANCE
 However, if BF intends to share the report with persons other than the federal
government, BF should agree with the firm, the specific donors to whom the report
would be available and such parties should be disclosed in the engagement letter.
 Furthermore, BF should ensure that the said donors are aware and understand the
procedures which will be performed by the firm.
 If disclosure to the other parties is agreed as discussed above, the report would still
include a statement to the effect that the AUP report is restricted to the specified users
and is not to be used for any other purpose.
SPOTLIGHT

10. COMPILATION ENGAGEMENTS (ISRS 4410)

10.1 The Compilation Engagement (Ref: 5-10)
Management may request a professional accountant in public practice to assist with the preparation and
presentation of financial information of an entity. Practitioner apply his professional expertise in accounting and
financial reporting and compliance with professional standards, including relevant ethical requirements
Scope of compilation engagement will vary depending on circumstances of engagement. In every case it will
involve assisting management in preparation and presentation of entity’s financial information in accordance
with financial reporting framework, based on information provided by management
Since it is not an assurance engagement, it does not require practitioner to verify the accuracy or completeness
of information provided by management for compilation. Management retains responsibility for financial
information and basis on which it is prepared & presented.
Different financial reporting framework can be used to prepare and present financial information, ranging from
a simple entity-specific basis of accounting to established financial reporting standards.
Applicable financial reporting framework (applicable financial reporting framework)
AT A GLANCE
The financial reporting framework adopted by management and, where appropriate, those
charged with governance in the preparation of financial information that is acceptable in view of
the nature of the entity and the objective of the financial information, or that is required by law
or regulation.
Compilation engagement
An engagement in which a practitioner applies accounting and financial reporting expertise to
assist management in the preparation and presentation of financial information of an entity in
accordance with an applicable financial reporting framework, and reports as required by this
ISRS.
Throughout this ISRS, the words “compile”, “compiling” and “compiled” are used in this context.
Practitioner
A professional accountant in public practice who conducts the compilation engagement. The
SPOTLIGHT
term includes the engagement partner or other members of the engagement team, or, as
applicable, the firm. Where this ISRS expressly intends that a requirement or responsibility be
fulfilled by the engagement partner, the term “engagement partner” rather than “practitioner” is
used. “Engagement partner” and “firm” are to be read as referring to their public sector
equivalents where relevant.
10.2 Conduct of a Compilation Engagement in Accordance with this ISRS (Ref: 18-20)
Practitioner shall:
 Have an understanding of entire text of this ISRS, including its application and other explanatory
material, to understand its objectives and to apply its requirements.
 Comply with each requirement of this ISRS unless a particular requirement is not relevant to the
compilation engagement.
 Not represent compliance with this ISRS unless the practitioner has complied with all requirements of
this ISRS relevant to the compilation engagement.
10.3 Ethical Requirements (Ref: 21, A19-A21)

The practitioner shall comply with relevant ethical requirements.
The fundamental principles of professional ethics are:
 Integrity;
 Objectivity;

 Professional competence and due care;

 Confidentiality; and
 Professional behavior.
Under IESBA Code, in applying principle of integrity, a professional accountant is required to not knowingly be
associated with reports, returns, communications or other information where the professional accountant
believes that the information:
 Contains a materially false or misleading statement;
 Contains statements or information furnished recklessly; or
 Omits or obscures information required to be included where such omission or obscurity would be
misleading.
Independence requirements normally do not apply to compilation engagements; National ethical codes or
laws/regulations may specify requirements or disclosure rules regarding that
10.4 Professional Judgment (Ref: 22, A22)

The practitioner shall exercise professional judgment in conducting a compilation engagement
Professional judgment is essential to proper conduct of a compilation engagement. This is because interpretation
AT A GLANCE
of relevant ethical requirements and requirements of this ISRS, and the need for informed decisions throughout
performance of a compilation engagement, require the application of relevant knowledge and experience to the
facts and circumstances of the engagement. Professional judgment is necessary, in particular, when engagement
involves assisting management regarding decisions about:
 Acceptability of financial reporting framework that is to be used to prepare and present the financial
information, in view of the intended use of the financial information and the intended users thereof.
 The application of the applicable financial reporting framework.
10.5 Engagement Level Quality Control (Ref: 23)

The engagement partner shall take responsibility for:
SPOTLIGHT
 The overall quality of each compilation engagement to which that partner is assigned; and
 The engagement being performed in accordance with firm’s quality control policies and procedures, by:
¯ Following appropriate procedures regarding acceptance and continuance of client relationships and
engagements;
¯ Being satisfied that engagement team collectively has the appropriate competence and capabilities
to perform the compilation engagement;
¯ Being alert for indications of non-compliance by members of the engagement team with relevant
ethical requirements, and determining appropriate action if matters come to engagement partner’s
attention indicating that members of the engagement team have not complied with relevant ethical
requirements;
¯ Directing, supervising and performing the engagement in compliance with professional standards
and applicable legal and regulatory requirements; and
¯ Taking responsibility for appropriate engagement documentation being maintained.
10.6 Engagement Acceptance and Continuance (Ref: 24-26, A31, A37, A40)
The practitioner shall not accept the engagement unless the practitioner has agreed the terms of engagement
with management, and the engaging party if different, including:
 The intended use and distribution of the financial information, and any restrictions on either its use or
its distribution where applicable;
 Identification of the applicable financial reporting framework; Acceptability may depend on:

¯ Nature of the entity, and whether it is a regulated form of entity

¯ Intended use of financial information and intended users.
¯ Whether applicable financial reporting framework is prescribed or specified, either in applicable law
or regulation, or in a contract or other form of agreement with a third party etc.
¯ Nature and form of financial information that is to be prepared and presented.
 Objective and scope of the compilation engagement;
 Responsibilities of practitioner, including ethical requirements;
 The responsibilities of management for:
¯ The financial information, and for preparation and presentation in accordance with a financial
reporting framework that is acceptable in view of intended use of information and the intended
users;
¯ The accuracy and completeness of the records, documents, explanations and other information
provided by management for the compilation engagement;
¯ Judgments needed in preparation and presentation of financial information, including those for
which practitioner may provide assistance; and
 The expected form and content of the practitioner’s report.
AT A GLANCE
Engagement Letter or Other Form of Written Agreement
Practitioner shall record the agreed terms of engagement in an engagement letter or other written agreement,
prior to performing the engagement. An engagement letter confirms the practitioner’s acceptance of the
engagement and confirms such matters as:
 The objectives and scope of the engagement, including the understanding of the parties to the
engagement that the engagement is not an assurance engagement.
 The intended use and distribution of the financial information, and any restrictions on its use or
distribution (where applicable).
 The responsibilities of management in relation to the compilation engagement.
 The extent of the practitioner’s responsibilities, including that the practitioner will not express an audit
SPOTLIGHT
opinion or a review conclusion on the financial information.
 The form and content of the report to be issued by the practitioner for the engagement.
Recurring Engagements
On recurring compilation engagements, practitioner shall evaluate whether circumstances, including changes in
engagement acceptance considerations, require the terms of engagement to be revised and whether there is need
to remind management of existing terms.
Practitioner may decide not to send a new engagement letter or other written agreement each period. However,
following factors may indicate that it is appropriate to revise the terms of the compilation engagement, or to
remind management or engaging party of existing terms:
 Any indication that management or engaging party misunderstands objective and scope of the
engagement.
 Any revised or special terms of the engagement.
 A recent change of senior management of the entity.
 A significant change in ownership of the entity.
 A significant change in nature or size of the entity’s business.
 A change in legal or regulatory requirements affecting the entity.
 A change in the applicable financial reporting framework.

10.7 Communication with Management and Those Charged with Governance (Ref: 27, A41)
Practitioner shall communicate with management or those charged with governance on a timely basis during the
course of the compilation engagement, all matters concerning the compilation engagement that, in the
practitioner’s professional judgment, are of sufficient importance to merit the attention of management or those
charged with governance, as appropriate.
Relevant circumstances include the significance and nature of the matter and any action expected to be taken by
management or those charged with governance. E.g. it may be appropriate to communicate a significant difficulty
encountered during engagement as soon as practicable if management or those charged with governance are
able to assist the practitioner to overcome the difficulty.
10.8 Performing the Engagement
The Practitioner’s Understanding (Ref: 28, A42-A44)

Practitioner shall obtain an understanding of following matters:
 Entity’s business & operations, including accounting system and accounting records; and
(It is an ongoing process that occurs throughout the compilation engagement)
 The applicable financial reporting framework including its application in the entity’s industry.
AT A GLANCE
Examples of matters the practitioner may consider in obtaining such understanding include:
 Size and complexity of the entity and its operations.
 Complexity of the financial reporting framework.
 Entity’s financial reporting obligations or requirements (under applicable laws, under provisions of
contract or other form of 3rd party agreement).
 Level of development of entity’s management and governance structure.
 Level of development and complexity of entity’s financial accounting and reporting systems and related
controls.
 Nature of the entity’s assets, liabilities, revenues and expenses.
SPOTLIGHT
Compiling the Financial Information (Ref: 29, 30, 37, A45)

Practitioner shall compile financial information using the records, documents, explanations and other
information, including significant judgments, provided by management.
Practitioner shall discuss with management, or those charged with governance, those significant judgments, for
which the practitioner has provided assistance in the course of compiling the financial information. (e.g. in
relation to a required accounting estimate or helping management with its consideration of appropriate
accounting policies).
Practitioner shall obtain an acknowledgement from management or those charged with governance that they
have taken responsibility for the final version of the compiled financial information.
Reading the Financial Information (Ref: 31, 32, 37, A46)

Prior to completion of compilation engagement, practitioner shall read the compiled financial information in
light of his understanding of entity’s business and operations, and of the applicable financial reporting
framework.
It would assist the practitioner in fulfilling the ethical obligations relevant to the engagement.
If, in the course of compilation engagement, practitioner becomes aware that the records, documents,
explanations or other information, including significant judgments, provided by management for compilation
engagement are incomplete, inaccurate or otherwise unsatisfactory, practitioner shall bring that to the attention
of management and request the additional or corrected information.

Proposing Amendments to the Financial Information (Ref: 34, A47-A51)

The practitioner shall propose the appropriate amendments to management, if practitioner becomes aware
during the course of the engagement that:
 The compiled financial information does not adequately refer to or describe applicable financial
 Amendments to compiled financial information are required for the financial information not to be
materially misstated; or
 The compiled financial information is otherwise misleading.
It is reasonable for the practitioner to assume, in context of materiality, that users:
 Have a reasonable knowledge of business and economic activities and accounting, and a willingness to
study the financial information with reasonable diligence;
 Understand that financial information is prepared and presented to levels of materiality;
 Recognize the uncertainties inherent in the measurement of amounts based on the use of estimates,
judgment and the consideration of future events; and
 Make reasonable economic decisions on the basis of information in financial information.
AT A GLANCE
10.9 Conditions Requiring Practitioner to Withdraw from Engagement (Ref: 33-36, A52)
 Practitioner shall withdraw from the engagement and inform management and those charged with
governance of the reasons for withdrawing where:
¯ If practitioner is unable to complete the compilation engagement because management has failed
to provide records, documents, explanations or other information, including significant judgments;
or
¯ If the management declines, or does not permit practitioner to make proposed amendments to
compiled financial information.
 Such communication provides an opportunity to explain practitioner’s ethical obligations.
 If withdrawal from engagement is not possible, practitioner shall determine professional and legal
responsibilities applicable in the circumstances.
SPOTLIGHT
Practitioner shall include in the engagement documentation:
 Significant matters arising during the engagement and how those were addressed;
 A record of how compiled financial information reconciles with the underlying records, documents,
explanations and other information, provided by management; and
 A copy of the final version of compiled financial information for which management or those charged
with governance has acknowledged their responsibility, and the practitioner’s report.
Practitioner may consider also including a copy of trial balance, summary of significant accounting records or
other information that practitioner used to perform compilation.
10.11 The Practitioner’s Report (Ref: 39-41, A56-A62)

Practitioner’s report is not a vehicle to express an opinion or conclusion on financial information. The
practitioner’s report shall be in writing, and shall include following elements:
 The report title;
 The addressee (normally party who engaged practitioner, ordinarily the management);
 A statement that practitioner has compiled the financial information based on the information provided
by management;

 A description of the responsibilities of management or TWG, in relation to compilation engagement and

the financial information;
 Identification of applicable financial reporting framework and, if a special purpose financial reporting
framework is used, a description or reference to the description of that special purpose financial
reporting framework in the financial information;
 Identification of the financial information, including title of each element of the financial information,
and the date of financial information or the period to which it relates;
 A description of practitioner’s responsibilities in compiling the financial information, including that
engagement was in complaint with this ISRS and ethical requirements;
 A description of what a compilation engagement entails in accordance with this ISRS;
 Explanations that:
¯ Since a compilation engagement is not an assurance engagement, practitioner is not required to
verify the accuracy or completeness of information provided by management for the compilation;
and
¯ Accordingly, practitioner does not express an audit opinion or a review conclusion on whether
financial information is prepared in accordance with applicable financial reporting framework.
 If financial information is prepared using special purpose financial reporting framework, explanatory
AT A GLANCE
paragraph:
¯ That describes the purpose for which financial information is prepared and, if necessary, intended
users, or contains a reference to a note in the financial information that discloses this information;
and
¯ That draws the attention of readers of report to the fact that the financial information is prepared in
accordance with a special purpose framework and that, as a result, the information may not be
suitable for other purposes;
 The date of the practitioner’s report on which compilation engagement was completed;
 The practitioner’s signature; and
 The practitioner’s address.
Practitioner may consider it appropriate to indicate that the practitioner’s report is intended solely for the
SPOTLIGHT
specified intended users of the financial information. In case of Special Purpose Framework, such indication
would be beneficial in alerting the readers of the report.
 Appendix 1
Illustrative Engagement Letter for a Compilation Engagement
This engagement letter illustrates the following circumstances (Assumptions):
 financial statements are to be compiled for sole use by management of a company (ABC
Company), and use of the financial statements will be restricted to management. Use and
distribution of practitioner’s report is also restricted to management.
 Compiled financial statements will comprise only the balance sheet of the company as at
December 31, 20X1 and the income statement for the year then ended, without notes.
 Management has determined that the financial statements be prepared on an accrual
basis as described.
To the Management1 of ABC Company:
[The objective and scope of the compilation engagement]
You have requested that we provide the following services:
On the basis of information that you will provide, we will assist you in the preparation and
presentation of the following financial statements for ABC Company: the balance sheet of ABC
Company as at December 31, 20X1 and the income statement for the year then ended, on the

historical cost basis, reflecting all cash transactions with the addition of trade accounts payable,
trade accounts receivable less an allowance for doubtful accounts, inventory accounted for on an
average cost basis, current income taxes payable as at the reporting date, and capitalization of
significant long-lived assets at historical cost amortized over their estimated useful lives on the
straight-line basis. These financial statements will not include explanatory notes, other than a
note describing the basis of accounting as set out in this engagement letter.
The purpose for which the financial statements will be used is to provide full-year financial
information showing the entity’s financial position at the financial reporting date of December
31, 20X1 and financial performance for the year then ended. The financial statements will be
solely for your use, and will not be distributed to other parties.
Our Responsibilities
A compilation engagement involves applying expertise in accounting and financial reporting to
assist you in the preparation and presentation of financial information. Since a compilation
engagement is not an assurance engagement, we are not required to verify the accuracy or
completeness of the information you provide to us for the compilation engagement, or otherwise
to gather evidence to express an audit opinion or a review conclusion. Accordingly, we will not
express an audit opinion or are view conclusion on whether the financial statements are
prepared in accordance with the basis of accounting you have specified, as described above.
AT A GLANCE
We will perform the compilation engagement in accordance with the International Standard on
Related Services (ISRS) 4410(Revised), Compilation Engagements. ISRS 4410(Revised) requires
that, in undertaking this engagement, we comply with relevant ethical requirements, including
principles of integrity, objectivity, professional competence and due care. For that purpose, we
are required to comply with the International Ethics Standards Board for Professional
Accountants’ Code of Ethics for Professional Accountants (IESBA Code).
Your Responsibilities
The compilation engagement to be performed is conducted on the basis that you acknowledge
and understand that our role is to assist you in the preparation and presentation of the financial
statements in accordance with the financial reporting framework you have adopted for the
financial statements. Accordingly, you have the following overall responsibilities that are
SPOTLIGHT
fundamental to our undertaking the compilation engagement in accordance with ISRS
4410(Revised):
a) Responsibility for the financial statements and the preparation and presentation thereof
in accordance with a financial reporting framework that is acceptable in view of the
intended use of the financial statements and the intended users.
b) Responsibility for the accuracy and completeness of the records, documents,
explanations and other information you provide to us for the purpose of compiling the
c) Responsibility for the judgments needed in the preparation and presentation of the
financial statements, including those for which we may provide assistance in the course
of the compilation engagement.
Our Compilation Report
As part of our engagement, we will issue our report attached to the financial statements compiled
by us, which will describe the financial statements, and the work we performed for this
compilation engagement [see attached]. The report will also note that the use of the financial
statements is restricted to the purpose set out in this engagement letter, and that use and
distribution of our report provided for the compilation engagement is restricted to you, as the
management of ABC Company.

Please sign and return the attached copy of this letter to indicate your acknowledgement of, and
agreement with, the arrangements for our engagement to compile the financial statements
described herein, and our respective responsibilities.
[Other relevant information]
[Insert other information, such as fee arrangements, billings and other specific terms, as
appropriate.]
XYZ & Co.

Acknowledged and agreed on behalf of the management of ABC Company by
(Signed)
Name and Title
Date
AT A GLANCE
 Illustration 1
Practitioner’s report for an engagement to compile financial statements using a general purpose
General purpose financial statements required under applicable law that specifies that entity’s
financial statements are to be prepared applying IFRS for Small- and Medium sized Entities (IFRS
for SMEs).
PRACTITIONER’S COMPILATION REPORT
[To Management of ABC Company]
We have compiled the accompanying financial statements of ABC Company based on information
you have provided. These financial statements comprise the statement of financial position of
SPOTLIGHT
ABC Company as at December 31, 20X1, the statement of comprehensive income, statement of
changes in equity and statement of cash flows for the year then ended and a summary of
significant accounting policies and other explanatory information.
We performed this compilation engagement in accordance with International Standard on
Related Services 4410(Revised), Compilation Engagements.
We have applied our expertise in accounting and financial reporting to assist you in the
preparation and presentation of these financial statements in accordance with International
Financial Reporting Standards for Small- and Medium-sized Entities (IFRS for SMEs). We have
complied with relevant ethical requirements, including principles of integrity, objectivity,
professional competence and due care.
These financial statements and the accuracy and completeness of the information used to
compile them are your responsibility.
Since a compilation engagement is not an assurance engagement, we are not required to verify
the accuracy or completeness of the information you provided to us to compile these financial
statements. Accordingly, we do not express an audit opinion or a review conclusion on whether
these financial statements are prepared in accordance with IFRS for SMEs.
[Practitioner’s signature]
[Date of practitioner’s report]
[Practitioner’s address]

 Illustration 3
Practitioner’s report for an engagement to compile financial statements using the basis of
accounting specified in a contract.
 Financial statements prepared to comply with provisions of a contract, applying basis of
accounting specified in contract.
 Practitioner is engaged by a party other than management or those charged with
governance of the entity.
 The financial statements are intended for use only by the parties specified in the
contract.
 Distribution and use of practitioner’s report is restricted to the intended users specified
in the contract.

[To the Engaging Party]
We have compiled the accompanying financial statements of ABC Company (“the Company”)
AT A GLANCE
based on information provided by the management of the Company(“management”). These
financial statements comprise [name all the elements of the financial statements prepared under
the basis of accounting specified in the Contract and the period/date to which they relate].
We performed this compilation engagement in accordance with International Standard on
Related Services 4410(Revised), Compilation Engagements. We have applied our expertise in
accounting and financial reporting to assist management in the preparation and presentation of
these financial statements on the basis of accounting described in Note X to the financial
statements.
We have complied with relevant ethical requirements, including principles of integrity,
objectivity, professional competence and due care.
These financial statements and the accuracy and completeness of the information used to
compile them are management’s responsibility.
SPOTLIGHT
the accuracy or completeness of the information provided to us by management to compile these
financial statements. Accordingly, we do not express an audit opinion or a review conclusion on
whether these financial statements are prepared in accordance with the basis of accounting
described in Note X.
As stated in Note X, the financial statements are prepared and presented on the basis described
in Clause Z of the provisions of the Company’s contract with XYZ Limited dated [insert date of
the relevant contract/agreement] (“the Contract”) and for the purpose described in Note Y to the
financial statements. Accordingly, these financial statements are intended for use only by the
parties specified in the Contract, and may not be suitable for other purposes.
Our compilation report is intended solely for the parties specified in the Contract and should not
be distributed to other parties.
[Date of practitioner’s report]

 Illustration 5
Practitioner’s report for an engagement to compile financial information that is an element,
account or item, being [insert appropriate reference to information required for a regulatory
compliance purpose].
 Financial information prepared for a special purpose, i.e., to comply with financial
reporting framework established by a regulator, in accordance with provisions
established by the regulator prescribing the form and content of the financial
information.
 The applicable financial reporting framework is a compliance framework.
 The financial information is intended to meet the needs of particular users, and use of
the financial information is restricted to those users.
 Distribution of the practitioner’s report is restricted to the intended users.

[To the Management of ABC Company]
AT A GLANCE
We have compiled the accompanying schedule of [identify the compiled financial information]
of ABC Company as at December 31, 20X1(“the Schedule”) based on information you have
provided.
We performed this compilation engagement in accordance with ISRS 4410(Revised).
We have applied our expertise in accounting and financial reporting to assist you in the
preparation and presentation of the Schedule as prescribed by [insert name of or reference to
the relevant regulation]. We have complied with relevant ethical requirements, including
principles of integrity, objectivity, professional competence and due care.
This Schedule and the accuracy and completeness of the information used to compile it are your
responsibility.
SPOTLIGHT
the accuracy or completeness of the information you provided to us to compile the Schedule.
Accordingly, we do not express an audit opinion or a review conclusion on whether the Schedule
is prepared in accordance with [insert name of or reference to applicable financial reporting
framework as specified in the relevant regulation].
As stated in Note X, the Schedule is prepared and presented on the basis prescribed by [insert
name of or reference to the applicable financial reporting framework as specified in the relevant
regulation], for the purpose of ABC Company’s compliance with [insert name of or reference to
the relevant regulation] Accordingly, the Schedule is for use only in connection with that purpose
and may not be suitable for any other purpose.
Our compilation report is intended solely for the use of ABC Company and Regulator F, and
should not be distributed to parties other than ABC Company or Regulator F.
[Date of the practitioner’s report]


You are employed as audit manager in Saleem and Company, Chartered Accountants, who have
been appointed by Indigo Private Limited to prepare certain financial information. The
management has informed that the information would be submitted to prospective private
investors in a foreign country and the fact that the information has been prepared by your firm
shall also be disclosed therein.
While preparing the financial information you identified that current maturity of a long term loan
amounting to Rs. 100 million has been shown as a long term liability, in the books of account. The
management disagrees with your observations and believes that the amount should be disclosed
as a long term liability. To support their point of view they have informed you that their
negotiations with the lenders are at the advanced stages and the agreement for restructuring will
be signed soon after the date on which the information is due for submission.
Required
Draft a suitable report to address the above situation.
 Solution:
COMPILATION REPORT TO BOARD OF DIRECTOR
On the basis of information provided by management we have compiled, in accordance with the
AT A GLANCE
International Standard on Related Services applicable to compilation engagements, the balance
sheet of Indigo (Private) Limited as of December 31, 2008 and statements of income and cash
flows for the year then ended in accordance with the approved accounting standards as
applicable in Pakistan.
Management is responsible for these financial statements. We have not audited or reviewed
these financial statements and accordingly express no assurance thereon.
We draw attention to Note X to the financial statements because the management has disclosed
the current maturity of loan amounting to Rs. 100 million as a long term liability which is a
departure from the requirement of international accounting standard.
ACCOUNTANT
SPOTLIGHT
Date
Address
Your firm has been hired by Pedro Limited to assist the management in preparation of certain
financial information. You are in disagreement with some of the adjustments made by the
management in the financial information and consider these to be inaccurate.
Required:
Discuss how you would resolve the disagreement along with the implication, if any, on the report.
 Solution:
Since the assignment involves assisting the management in preparation of financial information,
it should be considered as ‘compilation engagement’. In such an engagement, no opinion can be
formed.
Considering the scenario, if your firm becomes aware that compiled financial information is
misleading, appropriate amendments in this regard should be proposed to the management.
However, if the management declines, or does not permit your firm to make the amendments to
the compiled financial information, your firm shall withdraw from the engagement and inform
management and those charged with governance.
If withdrawal from the engagement is not possible, your firm shall determine the professional
and legal responsibilities applicable in the circumstances.

AT A GLANCE
SPOTLIGHT

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CFAP - 6

AUDIT, ASSURANCE AND

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN i

© The Institute of Chartered Accountants of Pakistan, January 2022

ii THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN

GUIDANCE FOR OPEN BOOK EXAM 1

Chapter 1 CONCEPT AND NEED FOR ASSURANCE 5

Chapter 2 THE REGULATORY ENVIRONMENT 13

Chapter 3 PROFESSIONAL ETHICS 35

Chapter 4 APPOINTMENT OF AN AUDITOR AND THE PLANNING PHASE 111

Chapter 5 PROFESSIONAL RESPONSIBILITY AND LIABILITY 157

Chapter 6 THE AUDIT APPROACH 189

Chapter 7 UNDERSTANDING THE ENTITY AND THE RISK ASSESSMENT 263

Chapter 8 USING THE WORK OF OTHERS 371

Chapter 9 AUDIT EVIDENCE 419

Chapter 10 AUDIT FINALISATION AND REPORTING 461

Chapter 11 MODIFICATION IN THE AUDIT REPORT 495

Chapter 12 SPECIAL AUDITS 563

Chapter 13 REVIEW ENGAGEMENTS 579

Chapter 14 ASSURANCE AND NON ASSURANCE ENGAGEMENTS 609

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THE INSTITUTE OF CHARTERED ACCOUNTANTS OF PAKISTAN 1

1. APPROACH FOR OPEN BOOK EXAM

Pillars of the Approach

 Understanding the concepts

1.1 Understanding the concepts

1.2 Mind Mapping of the contents

1.3 Skimming of the Standards

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1.4 Highlighting and Marking (Building affiliations with the standards)

1.5 Basic Self-Assessment

1.6 Advanced Self-Assessment

1.7 Final Mock for practice from multiple areas

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CONCEPT AND NEED

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1. THE MEANING OF AUDIT

 Notes to the Financial Statements

1.2 Concepts of accountability, stewardship and agency

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The key features of the audit report are as follows:

Independence of the auditor

True and fair view (fair presentation)

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1.4 The statutory requirement for audit

1.5 Responsibility of management and those charged with governance

¯ Access to information relevant to the preparation of the financial statements

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2. THE MEANING OF ASSURANCE

Assurance provided by audit

Assurance provided by review

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2.3 Elements of an assurance engagement

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3. ADVANTAGES AND LIMITATIONS OF STATUTORY AUDITS

3.2 Limitations of statutory audits

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THE REGULATORY ENVIRONMENT

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1. THE NEED FOR REGULATION OF AUDIT AND ASSURANCE SERVICES

1.2 Ethical regulation