Chapter 2

Auditing: Bangladesh Perspective

2.1. Audit in Bangladesh: The Companies Act 1994 makes it compulsory for every company to have its accounts audited by qualified auditors. The desirability of this provision can be based on the fact that shareholders who contribute the capital of the company leave its management and control in the hands of directors. Auditors are there to safeguard the interest of shareholders. The qualified chartered accountants from the Institute of Chartered Accountants of Bangladesh (ICAB) are eligible for auditing practices after getting sufficient experience in this field through a firm established through the approval of ICAB. Chronological incidents of Company Audit (ICAB, 1999) reveal the following sequential incidents towards auditing standards and practice in Bangladesh over the years: 1850: Indian Joint Stock Companies Act (enacted in UK as the 1844 Act) All incorporated companies required to have their annual financial statements audited. The Act did not require that the auditor be independent or be a professional accountant. The audit report was to state whether the balance sheet gave a full and fair view of its state of affairs. 1859: Nichols Case: The judgment stated that it was part of the auditors duty to discover fraudulent misrepresentation. This was the start of fraud and error detection as the main audit objective for the next 80 years or so. 1896: Re. Kingston Cotton Mill: The judge remarked that the auditor was a watchdog not a bloodhound, and that what was required of him was the

exercise of what was regarded at the time as reasonable skill and care in the circumstances. 1913: Companies Act (India): Every company required to have its accounting books and records audited. A report had to be made on the balance sheet and profit and loss account. Auditors had to be professionally qualified. 1932: Auditors Certificate Rule: A comprehensive set of rules governing the regulation and training for the auditors. 1936: Amendments to 1913 Act: Increasing awareness took place about the importance of financial information to investors. 1947: Partition adopted by Pakistan. 1950: Auditors Certificate Rules 1950: These replaced the 1932 rules. Under these rules persons who fulfilled specified conditions in relation to practical and theoretical training could have their names entered in the register and use the designation Registered Accountant. Only a registered accountant could be appointed auditor of a public limited company. 1961: Institute of Chartered Accountants of Pakistan (ICAP): ICAP was formed from registered accountants. Government created department of accountancy. 1973: Formation of ICAB: Bangladesh liberated in 1971 creating a major problem because of the lack of an institute. In 1972 Institute of Chartered Accountants of Bangladesh formed under Bangladesh Chartered Accountants Order 1973 (P.O. No. 2 of 1973). 1973: Onwards: Bangladesh had been participating in the creation of International Accounting and Auditing Standards. Increasing awareness of the role of accounting and auditing was been going on.

2.2 Control, Corporate Governance and Audit: The term control is used at a wide range of levels. At one extreme it means effects to achieve organizational goals and objectives; at another extreme the concern of control is to see if there are two approved signatures on a disbursement check; and in between there are all sorts of resources and operational activities, which must be dealt with (Chowdhury, 2004). Otley and Bery (1980) view that the study of organization and the study of control are interrelated. According to McMahon and Ivancevich (1976), an organization implies control. The above view has support from Tannenbaum (1968) when he claims that an organization without some form of control is impossible. He states that an organization can be seen as the relationship of human beings, the exercise of power, use of resources, and the distribution of resources. All these organizational issues need to be planned, carefully designed, directed, motivated, and controlled. There are control mechanisms internal and external to the organization. The external control mechanisms include market competition, government regulations, the market for takeovers, and corporate governance and monitoring by shareholders, auditors, and independent outside experts (Chowdhury, 2004). Committee on Corporate Governance (September 1999) suggests that external auditors shall perform fair audits independently from the corporation concerned, its management and controlling shareholders, so that shareholders and other users may maintain confidence in the corporations accounting information. Sir Adrin Cadbury perfectly said, Corporate governance is considered withholding balance between economic and social goals and between individual and community goals. The aim is to align as nearly as possible the interests of individuals, corporations and society (Cadbury, 2003). Corporate governance has become a top priority for the regulatory bodies
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with the objective of providing better and effective protection to all stakeholders and also to make the market confident as research reveals a positive correlation between corporate governance and share prices (Ahmad, 2004). Various elements of corporate governance discussion includes the legal framework, ownership structure, shareholding and protection of minority shareholders, board of directors, and the role of capital markets and Securities and Exchange Commission (SEC) in corporate governance, accounting and auditing standards, independent auditors report(Ahmed, 2005). Corporate Governance Committee (1997) stated remarkably, An audit committee is to be created within the board of directors. All the members of the committee are to be non-executive directors. Its function will be to audit the quality of compliance achievements, as well as the appropriateness of risk management of management. Auditors should audit beyond the normal inspection of compliance by management, and at the very least should make due judgments on the strategic decisions made by the board of directors. The quality of corporate auditing has to be upgraded by designating more than one independent auditor and by a more systematized auditing (Corporate Governance Committee, 1997). 2.3 Economic significance of the audit: Economic significance of the audit of the financial statements of the company emphasizes the great importance of the audit. ICAB well stated: In Bangladesh as in most other developed and developing societies, the owners of resources place them in the custody or stewardship of others. Examples of this process are the shareholders (owners) of a company committing the resources of the company to the stewardship of the directors; the public at large committing publicly owned resources to the stewardship of elected
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representatives. The owners hold the stewards accountable. Under the stewardship system of financial reporting, the shareholders, who defector represent the ownership of corporate entity, are distinct separate from the board of directors, who defector represent the management of the company. The share holders appoint the directors in the company annual general meeting to manage the entity in the best interest of the ownership. The shareholders need an honest, unbiased, objective, independent expert, professional opinion, and evaluation of the performance of responsibilities entrusted upon the directors. The management is unlikely to render that opinion and appraisal with any degree of objectivity. Hence the auditor acts as a bridge helping to make management accountable to shareholder, through his audit report on the companys financial information. The concept of audit independence also enumerates from the application of this system of stewardship reporting of financial reporting. The accountability is frequently in the form of annual reports incorporating financial statements. The typical example is the annual report and accounts of limited companies produced by the directors in accounting for their stewardship to the shareholders. Before these financial statements can be accepted by the owners, they need to be examined by audit (ICAB, 1999).

Thus the role of the audit is essentially linked with the role of accounting information, and may be summarized (ICAB, 1 999)

The owners of resources (investors) must make decisions on the employment of these resources; Such decisions are linked with the expected returns from investments;

In the absence of forecast information the investors look at historical data as a guide to the future;

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Such data is provided by the stewards of the resources (e.g. the company management);

Since their interest may conflict with the investors, the audit serves the function of lending credibility to the financial statements. We have seen that the need for an external audit arises primarily when the ownership and management of an enterprise are separated. There are, however, certain inherent advantages in having financial statements audited even where no statutory requirement exists for such an audit: Disputes between management may be more easily settled. For instance, a partnership which has complicated profit-sharing arrangements may require an independent examination of the accounts to ensure as far as possible an accurate assessment and division of those profits; Major changes in ownership may be facilitated if past accounts contain an unqualified audit report. For instance, where two sole traders merge their business to form a new partnership; Applications to third parties for finance may be enhanced by audited accounts. However, do remember that a bank, for instance, is likely to be far more concerned about the future of the business and available security than the past historical cost accounts, audited or otherwise; An auditor may well discover major errors and fraud during his audit, even though such a discovery is not the primary objective of the audit; The audit is likely to involve an in-depth examination of the business and so may enable the auditor to give more constructive advice to management on improving the efficiency of the business (ICAB, 1999).

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2.4 Auditing standards: These prescribed basic principles and practices which members are expected to follow in the conduct of an audit. Apparent failures by members to observe these standards may be enquired into by appropriate committees of the accountancy bodies and may lead to disciplinary action. Major accountancy bodies of the world have issued auditing standards to be followed by their respective members. The major accounting bodies of the United Kingdom and Eire formed themselves into a body known as the Consultative Committee of Accountancy Bodies. This body through its subcommittee known as Auditing Practices Committee (APC) is issuing auditing standards and guidelines (ASC). The initial major standards issued by the APC encompassed: The auditors operational standard The audit report Qualification in audit reports. There is more detailed guidance on how the auditing standards may be applied in practice. Since it would be impossible to establish a code of rules sufficiently elaborate to cater for all situations these guidelines are not mandatory. However, they do represent a code of current best practice and an auditor would be unwise to ignore them unless he had good grounds for doing so. In a court of law for instance, the court would be likely to use auditing standards and guidelines as indicative of best practice and would be likely to judge the auditors work against the advice laid down in the guidelines or standards.

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2.4.1 International Standards on Auditing (ISAs) ISA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing ISA 210, Agreeing the Terms of Audit Engagements ISA 220, Quality Control for an Audit of Financial Statements ISA 230, Audit Documentation ISA 240, The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements ISA 250, Consideration of Laws and Regulations in an Audit of Financial Statements ISA 260, Communication with Those Charged with Governance ISA 265, Communicating Deficiencies in Internal Control to Those Charged with Governance and Management ISA 300, Planning an Audit of Financial Statements ISA 315, Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment ISA 320, Materiality in Planning and Performing an Audit ISA 330, The Auditor's Responses to Assessed Risks ISA 402, Audit Considerations Relating to an Entity Using a Service Organization ISA 450, Evaluation of Misstatements Identified during the Audit ISA 500, Audit Evidence ISA 501, Audit Evidence-Specific Considerations for Selected Items ISA 505, External Confirmations ISA 510, Initial Audit Engagements-Opening Balances ISA 520, Analytical Procedures
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ISA 530, Audit Sampling ISA 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures ISA 550, Related Parties ISA 560, Subsequent Events ISA 570, Going Concern ISA 580, Written Representations ISA 600, Special Considerations-Audits of Group Financial Statements (Including the Work of Component Auditors) ISA 610, Using the Work of Internal Auditors ISA 620, Using the Work of an Auditor's Expert ISA 700, Forming an Opinion and Reporting on Financial Statements ISA 705, Modifications to the Opinion in the Independent Auditor's Report ISA 706, Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor's Report ISA 710, Comparative Information-Corresponding Figures and Comparative Financial Statements ISA 720, The Auditor's Responsibilities Relating to Other Information in Documents Containing Audited Financial Statements ISA 800, Special Considerations-Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks ISA 805, Special Considerations-Audits of Single Financial Statements and Specific Elements, Accounts or Items of a Financial Statement ISA 810, Engagements to Report on Summary Financial Statements

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2.4.2 Bangladesh Standards on Auditing (BSAs) BSA 200: Objective and General Principles Governing and Audit of Financial Statements BSA 210: Terms of Audit Engagements BSA 220: Quality Control for Audits of Historical Finance Information BSA 230: Audit Documentation BSA 240: The Auditor's Responsibility to Consider Fraud in an Audit of Financial Statements BSA 250: Consideration of Laws and Regulations in an Audit of Financial Statements BSA 260: Communications of Audit Matters with Those Charged with Governance BSA 300: Planning an Audit of Financial Statements BSA 315: Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement BSA 320: Audit materiality BSA 330: The Auditor's Procedures in Response to Assessed Risks BSA 402: Audit Considerations Relating to Entities Using Service Organization BSA 500: Audit Evidence BSA 501: Audit Evidence-Additional Considerations for Specific items BSA 505: External Confirmations BSA 510: Initial Engagements-Opening Balances BSA 520: Analytical Procedures BSA 530: Audit Sampling and Other Means of Testing BSA 540: Audit of Accounting Estimates

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BSA 545: Auditing Fair Value Measurements and Disclosures BSA 550: Related Parties BSA 560: Subsequent Events BSA 570: Going Concern BSA 580: Management Representations BSA 600: Using the Work of another Auditor BSA 610: Considering the Work of Internal Auditing BSA 620: Using the Work of an Expert BSA 700: The Independent Auditor's Report on Complete Set of General Purpose Financial Statements BSA 710: Comparatives BSA 720: Other Information in Documents Containing Audited Financial Statements BSA 800: The Auditor's Report on Special Purpose Audit Engagements BSA 1000: Inter-Bank Confirmation Procedures BSA 1004: The Relationship between Bank Supervisions and Banks' External Auditors BSA 1005: The Special Considerations in the Audit of Small Entities BSA 1014: Reporting by Auditors on Compliance with International Financial Reporting Standards

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2.5 Auditing statements: In addition to the auditing standards and guidelines, some accounting bodies also issue auditing statements on the general principles of auditing. International Federation of Accountants: The International Federation of Accountants (IFAC) came into existence on 7 October 1977 with the board objective of the development and enhancement of a co-coordinated worldwide accountancy profession with harmonized standards. In working toward this objective, the Council of IFAC has established International Auditing Practices Committee (IAPC) to develop and issue, on behalf of the Council guidelines on generally accepted auditing practices and on the form and content of audit reports (ICAB, 1999). The Institute of Chartered Accountants of Bangladesh (ICAB): The Institute of Chartered Accountants of Bangladesh (ICAB), being the only institute in Bangladesh for providing CA education, combines a high value qualification with a reputation as the countrys best institution for training and supports the chartered accountants. ICAB pursues the following objectives: Regulate the accountancy profession and matters connected therewith in the country. Ensure sound professional ethics and code of conduct by its members

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 Provide specialized training and professional expertise in accounting, auditing, taxation, corporate laws, management consultancy, information technology and related subjects. Impart mandatory continuing professional education (CPE) to its members. Foster acceptance and observe of International Financial Reporting Standards (IFRSs) and International Standards on Auditing (ISA) and adopt IFRSs and ISA in Bangladesh as Bangladesh Financial Reporting Standards (BFRSs) and Bangladesh Standards of Auditing (BSA) respectively. Keep abreast of latest development in accounting techniques, audit methodology, information technology, management consultancy and related fields. Liaise with international and regional organizations to influence the development of efficient capital market and international trade in services. 2.6. General principles of an Audit: The Auditor should comply with the Code of Ethics for Professional Accountants issued by the Council of the Institute of Chartered Accountants of Bangladesh. Ethical principles governing the auditors professional responsibilities (ICAB, 2004) are: Independence; Integrity; Objectivity; Professional competence and due care;

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 Confidentiality; Professional behavior; and Technical Standards The auditor should conduct an audit in accordance with BSAs or ISAs as adopted in Bangladesh. These contain basic principles and essential procedures together with related guidance in the form of explanatory and other material. The auditor should plan and perform an audit with an attitude of professional skepticism recognizing that circumstance may exist that cause the financial statements to be materially misstated. An attitude of professional skepticism means the auditor makes a critical assessment, with a questioning mind, of the validity of audit evidence obtained and is alert to audit evidence that contradicts or brings into question the reliability of documents or management representations. For example, an attitude of professional skepticism is necessary throughout the audit process for the auditor to reduce the risk of overlooking suspicious circumstances, of over generalizing when drawing conclusions from audit observations, and of using faulty assumptions in determining the nature, timing and extent of the audit procedures and evaluating the results thereof. In planning and performing an audit, the auditor neither assumes that management is dishonest nor assumes unquestioned honesty. Accordingly, representations from management are not a substitute for obtaining sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion. 2.7. Scope of an audit:

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The term scope of an audit refers to the audit procedures deemed necessary in the circumstances to achieve the objective of the audit. The procedures required to conduct an audit in accordance with BSAs should be determined by the auditor having regard to the requirements of BSAs, relevant professional bodies, legislation, regulations and, where appropriate, the terms of the audit engagement and reporting requirements. 2.8. Reasonable assurance: An audit in accordance with BSAs is designed to provide reasonable assurance that the financial statements taken as a whole are free from material misstatement. Reasonable assurance is a concept relating to the accumulation of the audit evidence necessary for the auditor to conclude that there are no material misstatements in the financial statements taken as a whole. Reasonable assurance relates to the whole audit process. An auditor cannot obtain absolute assurance because there are inherent limitations in an audit that affect the auditors ability to detect material misstatements. These limitations result from factors such as: The use of testing. The inherent limitations of any accounting and internal control system (for example, the possibility of management override or collusion). The fact that most audit evidence is persuasive rather than conclusive. Also, the work undertaken by the auditor to form an opinion is permeated by judgment, in particular regarding: The gathering of audit evidence, for example, in deciding the nature, timing and extent of audit procedures; and

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The drawing of conclusions based on the audit evidence gathered, for example, assessing the reasonableness of the estimates made by management in preparing the financial statement

Further, other limitations may affect the persuasiveness of audit evidence available to draw conclusions on particular financial statement assertions (for example, transactions between related parties). In these cases certain BSAs identify specified audit procedures which will, because of the nature of the particular assertions, provide sufficient appropriate audit evidence in the absence of: Unusual circumstances which increase the risk of material misstatement beyond that which would ordinarily be expected; or Any indication that a material misstatement has occurred. Accordingly, because of the factors described above, an audit is not a guarantee that the financial statements are free of material misstatement (ICAB, 2004).

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