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Module- 1
Audit Framework and Regulation
Audit Engagement is an arrangement that an auditor has with a client to perform an audit of the
client’s accounting records. An audit engagement is an agreement between a client and an
independentthird-partyauditortoperformanauditof some elementof the client’sbusiness,suchas
accounting records, financial statements, internal controls, regulatory compliance, information
systems,operational processes,etc.More informationonwhatauditorsdoandthe differenttypesof
audit engagements can be found in a previous post.
Why to have third party Auditor to Audit?
The purpose of engaging a third-party auditor is to obtain an unbiased and independent opinion on
the organization’s ability to achieve the specified audit criteria. Your auditor should be a subject
matterexpertwhoprovidesvalue indeliveringconclusionsonthe effectivenessof businessprocesses
and controls, while alerting the company of any risks identified.
Assurance Engagement: Means an engagement in which a practitioner expresses a conclusion
designedtoenhance the degree of confidence of the intendedusersotherthanthe responsible party
about the outcome of the evaluation or measurement of a subject matter against criteria.
Who appoints the Auditor?
Auditorisappointedbythe Boardof Directorsappointedbythe shareholdersti expressopinioninthe
form of a report over recognition, measurement, presentation and disclosure i.e., if the financial
statements prepared is in accordance with IFRS or any other reporting standard as prescribed.
Assurance Engagement Risk: It is the Risk that the practitioner expresses on inappropriate
conclusion when the subject matter information is materially misstated.
Types of Assurance Engagement:
1. Reasonable Assurance: Inthisengagementthe practitionergatherssufficientevidencetobe
able to draw reasonable conclusions and concludes that subject matter conforms in all
material respectswithidentifiedsuitablecriteria.He concludingbygivingapositivelyworded
assurance opinion.
2. Limited assurance: In this engagement after gathering sufficient evidence the practitioner
the concludes that the risk is greater than that for reasonable assurance while expressing
negative conclusion.
Elements of Assurance Engagement
There are five elements to assurance engagement
1) There are three parties involved
a) The practioner(i.e., the reviewer of the information called Auditor)
b) The intended users of the information (stakeholders)
c) The responsible parties who prepare the information i.e., Management
2) The subject matter under Scrutiny
3) Suitable criteria against which to judge the realiability and accuracy of the subject matter
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4) Sufficient appropriate evidence to substantiate an opinion
5) A written report in an appropriate form
Assurance Practitioner
Assurance isbroader than auditoras in the regularcase while performinghistorical financial audit.If
the subject matter requires specialized skills and knowledge beyond those ordinarily possessed. In
suchcasesthe assurance practitionercanuse the servicesof otherprofessionaldisciplinesreferredas
experts.
Responsible party is the one who is responsible for the subject matter information. It is the
management which prepares the subject matter which is to be audited.
IntendedUsers:Are the personsorclassof personsforwhomthe assurancepractitionerpreparesthe
assurance report. The responsible party can be one of the intended users but only one.
Subject Matter: The subject matter and subject matter information can take many forms such as:
Financial performanceorconditionsforwhichthe subjectmatterinformationmaybe the
recognition, measurement, presentation and disclosure representation in a financial
report.
Non-Financial Performance or conditions for which the subject matter informationmay
be key indicators of efficiency and effectiveness.
Physical characteristics for which subject matter information may be a specifications
documents.
Systemsandprocessesforwhichthe subjectmatterinformationmaybe assertionabout
effectiveness.
Behavior for which subject matter information may be statement of compliance or a
statement of effectiveness.
Appropriate subject matter must have following features
i. It shouldidentifiable andcapable of consistentevaluationormeasuredagainstidentified
criteria.
ii. Information when subjected to procedure for gathering sufficient appropriate evidence
to support a reasonable assurance or limited assurance conclusion as appropriate.
iii. Criteria are the benchmarks used to evaluate or measure the subject including where,
relevant,benchmarksforpresentationanddisclosure.Criteriacanformal like IAS,IFRSetc
Characteristics of Suitable Criteria
1. Relevance: Relevant criteria contribute to conclusions that assist decision tended users.
2. Completeness: Criteria are sufficiently complete when relevant factors that could affect the
conclusions in the context of the assurance engagement circumstances are not omitted.
Complete criteria include, where relevant, benchmarks for presentation and
3. Reliability: Reliable criteria allow reasonably consistent evaluation or me subject matter
including, where relevant, presentation and disclosure, when used in similar Circumstances
by similarly qualified assurance practitioners.
4. Neutrality: Neutral criteria contribute to conclusions that are free from bias
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5. Understandability:Understandable criteriacontributetoconclusionscomprehensiveandnot
subject to significantly different interpretations.
The Criteria are to made available to the intended users in one or more of the following ways:
1. Publicly
2. Through inclusion in a clear manner in the presentation of the subject matter information
3. Through inclusion in a clear manner in the assurance report.
4. By general understanding,
General Characteristics of the reliability of evidence are as follows:
1. Evidence ismore reliablewhenit isobtainedfrom independent sources outside the entity.
2. Evidence thatisgeneratedinternallyismore reliable whenthe relatedcontrolsare effective.
3. Evidence obtained directly by the assurance practitioner is more reliable than evidence
obtained indirectly or by inference.
4. Evidence is more reliable, when it existsin documentary form, whether paper, electronic or
other media.
5. Evidence provided by original documents is more reliable than evidence provided by
photocopies or facsimiles.
Assurance Report
The assurance practitioner provides a written report containing the conclusion that conveys the
assurance obtainedaboutthe subjectmatterinformation.AUASBStandardsestablishbasicelements
for assurance reports. In addition, the assurance practitioner considers other reporting
responsibilities,includingcommunicatingwiththose chargedwithgovernance whenitisappropriate
to do so.
Importance of Assurance engagement
1. Potential bias in providing information.
2. Remoteness between a user and the organization.
3. Complexity of the transactions, information or processing systems.
4. Investorsneedtomanage theirriskand therebyminimize financial surprisesasconsequence
to investors and others, of relying on inaccurate information can be quite significant.
Limitation of Assurance Engagement
a. Use of selective testing.
b. Use of judgment.
c. Inherent Limitations of internal control.
d. Persuasive evidence rather than conclusive evidence.
Definition of Concepts of Accountability
Accountability is the acknowledgement and assumption of responsibility for actions, products,
decisions and policies including the administration, governance and implementation within the
scope of the role or employment position and encompassing the
How does Accountability help organisation?
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a. More authority will ensure greater responsibility for decision-making.
b. Can improve delivery of the organisations aims and objectives.
c. Can improve management of human and financial resources.
Characteristics of Accountability
a. Accountability is personal: Authority can only be delegated to one person.
b. Accountabilityisvertical:Fromtopto bottom, responsibilitiesandauthorityisdelegate from
supervisor to subordinate.
c. Accountabilityis neutral: It is neither a positive nor a negative concept.Excellent results are
recognized, but failure may involve sanctions, including the withdrawal or modifications of
working systems.
Principles of Accountability
a. The person receiving authority must be informed of the program results and resourcesthat
are available in terms of finance and human resource. How these are to be monitored and
assessed. What are his limits of his authority? Organisational values, policies, rules and
regulation and behavioural standards.
b. He should be provided with guidance and support on a regular basis. Along with regular
training and support from senior managers.
c. Responsibility and authority needs to be monitored and assessed against target.
d. Also decide on appropriate action to be taken in case of Unsatisfactory execution of
responsibility.
Perspectives of Accountability
a. The Traditional Perspective: Each official is technically accountable, through the
hierarchical structure of the bureaucracy, to electedpoliticians and to the citizens. All other
perspectives, honesty, integrity, impartialityand objectivity form the code the behaviour of
officers as they administer rules decided by the politicians.
b. The Democratic Perspective: This is closely related to the traditional perspective but
incorporatesthe notionof the publicbeingpassiveconsumersof publicservicesandthatthe
traditional channelsof accountabilityhavebeendowngradedinfavourof managerial notions.
This perspective highlights both representative and participatory forms of democracy as
channels for holding public administration to account.
c. The Professional Perspective: Professionalismrepresentedtranscendentsetsof rulesand
knowledge which guaranteed the neutrality of state intervention.
d. The Managerial Perspective: Recognizes that accountability operates at two levels-the
strategic level for which politicians are responsible and the operational level,which is the
sphere of managers.
e. The Governance Perspective: Accountability, in terms of governance, is equated with
answerability, blameworthiness, liability, and the expectation of account-giving.
f. Regulatory Prespective: It emphasizes the use of authority, rules and standard setting.
particularly displacing an earlier emphasis on public ownership,public subsidiesand directly
provided services. Consequently, accountability is no longer ensured through line
managementrelationswithinclearhierarchical structuresbutthroughincreasedsurveillance
and audit and hands off regulation.
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g. The Rational Choice Perspective: It is based on rational choice theory, which explains social
phenomenafromthe beliefsandgoalsof individuals.Thus,the rational choiceperspective on
accountability emphasizespsychological and behavioral factors in public administrators that
resultinindividualsbyhighlightingthepotentialforpublicadministratorstoevadetraditional,
democratic and other channels of accountability.
Principles of Effective Accountability
a. Clear roles and responsibilities: The roles and responsibilities of the parties in the
accountability relationship should be well understood and agreed upon. Such an
understandingprovidesthe contextwithinwhichbothpartieswill respond and perform
b. Clear performance expectations: The objectives being pursued, the accomplishments
expected. Without a clearly spelt out expected outcomes, it would be impossible to
determine whether these outcomes have been realized
c. Balanced expectationsand capacities: The performance expectationsneedtobe clearly
linkedtoandinbalance withthe capacity,thatis,authorities,skillsandresourcesof each
party to deliver.
d. Credible reporting: Effective accountability requires reporting what has been
accomplished to bodies to whom the parties are responsible and to the other parties in
the accountability. relationship. For the report to be useful, it must be seen as credible
andmust be timely.Itmustdescribe resultsaccomplished,resourcesandactionstakenin
light of the agreed expectations.
e. Reasonable reviewandadjustment: A credible review andfeedbackonthe performance
achieved should be carried out by the accountable parties. Where achievements are
below agreed levels,the causes of the underperformance are recognized and necessary
corrective actionsare taken and possible adjustmentstothe accountabilityarrangement
made and lessons-learned noted
Theories of Accountability
Stewardship Theory
Stewardship theories argue that managers executives of company are stewards of the owners both
groups common goals. Therefore, the board should not be too controlling. The board should play a
supportingrole byempoweringexecutivesandinturnincrease the potential forhigherperformance.
Stewardship theories argues that relationship between board and executives involve training,
mentoring and shared decision making. It is based on relationship model between principal and
steward.
Factors for Stewardship Theory:
1. Theory suggests outcome is achieved both employment relationship select behave as
stewards.the heartof stewardshiptheorythe assumptionthatprincipal-stewardrelationship
is based on a choice.
2. The choice of stewardshipbehaviourisimpactedbybothpsychologicalandsituational factors.
Psychological factorssuchas intrinsicmotivation,highidentificationandpersonal powercan
steer the behavioral choice to stewardship. Intrinsic motivationexists within individuals and
provides satisfaction in and of itself it is a psychological attribute of stewardship theory
because steward managers are motivated by intangible, higher order rewards
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3. Individuals who have high levels of identification with their organization are more likely to
choose stewardshipbecausetheyfeel astrongsense of membershipwiththeirorganization.
4. Situational factors depict the organizational structure and include the management
philosophy and culture
5. The underlying assumption of stewardshiptheory is basedon the humanistic model of man
due to its foundation in sociology and psychology. This model assumes that individuals are
motivated by higher order needs fulfilment.
Agency Theory
Agency theory is about the relationship between two parties, the principal (owner) and the agent.
More specifically,itexaminesthisrelationshipfromabehavioral andastructural perspective.Theory
suggests that given the chance, agents will behave in a self-interested manner. behaviour that may
conflictwiththe principal'sinterest.Assuch,principalswill enactstructural mechanismsthatmonitor
the agent in order to curb the opportunistic behaviour and better align the parties' interests.
1. Firmperformance bywayof costminimizationandgreaterefficienciesisthe desiredoutcome
of the agency theory perspective. When the ownership and management of a firm are
separated, theory suggests that agency problems are created and agency costs are incurred
to alleviate these problems.
2. Anagencyproblemiscreatedwhentheinterestof the principal andagentare misalignedand
the principal lacks the information to accurately assess the behavior of the agent
3. Theory suggests the principal has two options for reducing agency problems
a. The first is to create a governance structure
b. Assess the actual behaviour of the agent.
4. The underlying assumption of agency theory is based on the economic model of man. The
model assumes that individuals will seek to optimize their own utility.
Compliance Audit
Compliance Audit: Compliance audits generally begin with determining the applicable compliance
requirementsagainstwhichthe operationswill be assessed.Thistendstoinclude federalregulations,
state regulations, permits and local ordinances/codes.
Responsibilities of Directors
a. To take appropriate stepsto provide reasonable assurance thatthe entitycomplieswithlaw
and regulations applicable to its activities.
b. To establish arrangements for preventing any non-compliance with law or regulations and
detecting any that occur.
c. To prepare financial statements that gives a true and fair view of the state of affairs of an
entity or group and of its profit or loss for the financial year.
How doesthe DirectorDischarge hisresponsibilitiesof preventionanddetectionof non-compliance?
a. Maintaining an up-to-date register of significant laws and regulations with which the entity
has to comply within its particular industry.
b. Monitoring legal requirements and any changes therein and ensuring that operating
procedures are designed to meet these requirements.
c. Instituting and operating appropriate systems of internal control.
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d. Developingacode of conduct,ensuringemployeesare properlytrainedinandunderstandits
provisions,maintainingcompliance andtakingappropriate actionincasesofnomcompliance.
e. Engaging legal advisers to assist in monitoring legal requirements
f. Maintaining a record of complaints
g. Procedures when possible non-compliance is discovered.
REASONS FOR THE REGULATION OF AUDITORS
a. To protect public interest: The primary reason for the regulation of auditors is to public
interests Auditors undertakes various types of engagements those affect public interest
particularlystatutoryauditinwhichtheyprovide ahighlevelof assurance aboutthe financial
statements.The shareholdersincludinga wide range of stake holdersdecisionsbasedonthe
auditedfinancial statementsandthe auditorsopinioninthe auditsalthoughauditor'sreport
inastatutoryauditisaddressedtothe membersof the companyisnotsurprisingthatauditors
will not collude with directors of a company and give a opinion in the audit report as a
consequence the publicinterestswill be impairedandevenwill bring an economic disaster.
b. To Maintaindignity of the Profession: Accountancyand auditingprofessionhaseve through
the past centuries and now it is one of the important and credible professions o society. If
there is no regulationsandaccountabilitymechanismforauditorsthe professionwill loseits
dignity and credibility.
c. To ensure independence and professional competence: To perform a statutory audit and
other assurance engagements and other engagements by a professional accountant it is
importantto ensure that theypossesssufficientcompetence andalsotheyare the company
they are auditing since independence is an important concept in auditing.
Mechanisms: The mechanism for the regulation of auditors
i. Code of ethics issued by the accountancy body such as ACCA that an auditor must
comply with.
ii. Disciplinary system by the accountancy body.
iii. National law such as The Companies Act that necessitates certain qualification to act as
auditor
iv. Auditing standards.
v. Pearreviewisanexaminationandreviewof the systemsandproceduresadoptedbymember
of the professional bodytoensure the qualityof services complying with techno standards.
Objectives of Auditor as per article ISA 250
i. To obtainsufficientappropriate auditevidenceregardingcompliancewiththe provisionthose
lawsand regulationsthathave a directeffectonthe determinationof material amountsand
disclosures in the financial statements.
ii. To perform specified audit procedure to help identity non-compliance with other laws
and regulations that may have a material effect on the financial statements.
iii. To respond appropriately to non-compliance or suspected non-compliance identified
during the audit.
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Functions of Auditor
Cooperation and collaboration: Laws, regulations or other arrangements provide
framework for cooperation and collaboration with relevant domestic authorities and
for supervisors.
Supervisoryapproach: Aneffective systemof bankingsupervisionrequiresthe supervisor
developandmaintainaforward-lookingassessmentof the riskprofile of individualbanks
Audit Framework.
Supervisory Reporting: As supervisor he collects reviews and analyses prudential
reports and statistical returns from banks on both a solo and consolidated basis.
Internal control and Audit: as a supervisor he has to determine companies adequate
internal control framework and maintain it properly.
Financial reportingandexternal audit:The supervisordeterminesthatbanksandbanking
groups maintain adequate and reliable records, prepare financial statements in
accordance with accounting policies and practices that are widely accepted
internationally and annually publish information that fairly reflects their financial
condition and performance and bears an independent external auditor's opinion.
Disclosure and transparency: The supervisordeterminesthathanks and bankinggroups
regularlypublishinformationonaconsolidatedand,whereappropriate,solobaasthatis
easily accessible and fairlyreflects their financial condition, performance, riskexposures
risk
Abuse of financial Services: As supervisor he has to see to it that adequate policies
and processes and due diligence rules are followed and prevent any intentional or
unintentionally criminal activities.
Types of Auditors
External auditor/ Statutory audit is an independent firm engaged by the client subject to the audit,
to express an opinion on whether the company's financial statements are free of material
misstatements, whether due to fraud or For publicly traded companies external auditor may be
requiredtoexpressan opinion over the effectiveness of internal controls over financial reporting.
Internal Auditor: are employedbythe organisation theyaudit.Theyhave internationallyrecognized
standing body of profession i.e.,Institute of Internal Auditors. Internal auditing is an independent
objective assurance and consulting activity designed to add value and improve organizations
operations.Itbringsin systematicdisciplinedapproachtoevaluate andimprove effectivenessof risk
management.
Planning of Audit
The auditor should properly plan the audit of internal control over financial reporting properly supervise
the engagement team members.When planning an integrated audit, the site should evaluate whetherthe
following mattersare important to the company's financial statementsand internal control over financial
reporting and, if so, bow they will affect the auditor's procedures:
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Knowledge of the company's internal control over financial reporting obtained during other
engagements performed by the auditor
Matters effecting the industry in which the company operates, such as financial reporting
practices, economic conditions, laws and regulations and technological changes.
Matters relating to the company's business, including its organization, operating
characteristics and capital structure.
The extentof recentchanges,if any,inthe company,itsoperationsoritsinternal controlover
financial reporting.
The auditor's preliminary judgments about materiality, risk and other factors relating to the
determination of material weaknesses.
Control deficiencies previously communicated to the audit committee.
Legal or regulatory matters of which the company should be aware of
The type and extent of available evidence related to the effectiveness of the company's
internal control over financial reporting.
Preliminaryjudgmentsabout the effectiveness of internal control over financial reporting.
Publicinformationaboutthe companyrelevanttothe evaluationof the likelihoodof material
financial statement misstatements and the effectiveness of the company's internal control
over financial reporting.
Addressing the Risk of Fraud
I. Control over significant transactions that are outside the normal course of business for the
company or that otherwise appear to be unusual due to their timing, size or nature,
particularly those that result in late and unusual journal entries.
II. Controls over journal entries and adjustments made in the period-end financial of financial
reporting process
III. Controls over related party transactions
IV. Controls related to significant management estimates.
V. Controls that mitigate incentives for and pressures on, management to falsify or
inappropriately manage financial results.
. Entity-level controls include:
a. Controls related to the control environment.
b. Controls over management override.
c. The company's risk assessment process.
d. Centralized processing and controls, including shared service environments.
e. Controls to monitor results of operations.
f. Controlstomonitorothercontrols,includingactivitiesof the internal auditfunction,theaudit
committee and self-assessment programs.
g. Controls over the period-end financial reporting process.
h. Policies that address significant business control and risk management practices.
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APPOINTMENT OF FIRST AUDITOR
As persection139(6) the firstauditorof the companyshall be appointedby the Boardwithin30 days
of Incorporation.Incase of Board's failure,anEGM shall be calledwithin90 days to appointthe first
auditor. The law is silent regarding from when this time limit of be reckoned, it is better to take a
stricter view and interpret that the 90 days’ limit starts from Incorporation rather than expiry of 30
days from it.
Tenure: Till conclusionof 1st
annual general meeting.Remuneration:Asper provision tosection 142
(1) remuneration of the first auditor decided by the Board
Procedure of Appointment
1. Intimate the proposed auditor regarding the intention of appointing him as auditor and ask
whether it is eligible and not disqualified to be appointed as auditor of the company.
2. Obtain consent and certificate from auditor
3. Call Board meeting
4. Approve the appointment of auditor at board meeting
5. Intimate the auditor and file with ROC form ADT-1 within 15 days.
Tenure subject to ratification: The tenure of 5 consecutive years is subject to ratification by
shareholders at every AGM
Remuneration; Aspersection142-(1) remunerationof the auditorof a companyshall be fixedinits
general meeting or in such manner as may be determined therein,
Manner and Procedure for selection to be governed through rules
1. Consideration of the appointment: The Board of the Audit Committee (where it is required
to be constituted)shallconsiderthe qualifications,experience of the auditorandwhetherthe
aforesaid attributes are commensurate with the size and requirements of the company.
2. Recommendationofname: The procedure dependsuponwhetherauditcommittee required
to be constituted or not.
3. Constitutionof auditcommittee required:Inthiscase the committee shallrecommendname
of the auditortothe Boardwhichif agreeswiththe recommendation,will furtherrecommend
it to the members.
Reappointment of auditor
After the completion of tenure of 5 consecutive years the auditor may be reappointed by
complying with the provison of section 139(9). He is reappointed under following conditions
1. He is not disqualified for reappointment
2. He has not given company a notive in writing of his unwillingness
3. A special resolution has not been passed at that meeting appointment
Casual Vacancy
Any casual vacancy shall be filled by the board within 30 days. Such vacancy shall be filled
within 30 months after approval from companies general meeting. Reasons for vacancy are
Death, end of tenure, Resignation, Disqualification and failure of ratification at AGM
Procedure
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Intimate the proposedauditor(s) regardingthe intentionof appointinghim/itasauditor and
ask whetherhe/itiseligible andnotdisqualifiedtobe appointed as auditor of the company
Obtain consent and certificate from auditor.
If Audit Committee required to be constituted under section 177, then obtain
recommendation (Section 139(119)
Call Board meeting.
Approve the appointment of auditor in casual vacancy at the Board meeting.
Intimate the Auditor and file with ROC form ADT-1(to be attached in form GNL-2 45 MCA
circular 09/2014 dated 25th April, 2014) within 15 days. Procedure: Where casual vacancy
arises due to resignation of existing auditor:
Rights of Auditor
1. Rightto accessbooksof accounts:Everyauditorhasa rightto accessat all timestothe books
of accountsand vouchersof the companywhetherkeptatthe head office of the companyor
else where
2. Right to obtain information and explanation: He has right to obtain from the directors and
officers of the company information and explanation as he thinks necessary for the
performance of his duties as an auditor.
3. Rightto correct any wrong statement:The auditorisrequiredto make a to make a reportto
the membersof the company on the accounts examinedbyhimand on everyBalance Sheet
Profit and Less Account and on every other document declared by this Act to be part of
annexedtothe Balance Sheetor Profitand Loss Account whichare laidbefore the company
inGeneral Meeting during his tensure of office. The Directors have a duty to prepare them
4. Rightto visitbranches:the auditorhasa rightto accessat all time to the books,accountsand
vouchers of the company.
5. Right to signature on audit report: only person appointed as auditor or where a firm is
appointed, onlya partner in the firm practicing is India may sign the auditor’s report or sign
or authenticate any other document.
6. Right to receive: Notice and other communication relat
7. ing to General Meeting and attend them.
8. Right of beingindemnified:hasthe right to be indemnifiedoutof the assetsof the company
against any liability incurred by him defending himself against any civil and criminal
proceedings by the company
9. Right to have legal and technical advice: He has right to seek the opinion of the experts as
necessary to give an opinion in the report.
Duties of an auditor
1. To certifythe statutoryreport:Itisthe dutyof the auditorthathe shouldcertifythatstatutory
report is correct regarding the shares allotted cash receivedand receipts and payment on
capital account of the company.
2. To certifythe performance of the company:Whenacompanyisalreadycarryingthe business
it issuesthe prospectusand statementsof profitand loss.Dividendpaidduringthe previous
years is included also in the prospectus. Such statements and clear position about the
dividends paid verified by the auditor
3. Submission of report: The auditor of the company has to examine the accounts of the
company. He has to report to the shareholders on the accounts. In the general meeting he
submitshisreportregardingthe accountsexaminedbyhimandeverybalance sheetandprofit
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and loss account including notesor statements. His report can be inspected by any member
of the company. If auditor is not satisfied, he may report to the shareholders.
4. Assistance to advocate general: In connection withthe prosecution of the director’sauditor
of the company is bound to provide assistance in investigation to advocate general if his
services are required.
5. Duty in case of voluntarywinding:Inthe voluntarywindingup,the auditorhas to certifythe
profit and loss account. The Balance sheet, assets and liabilities statements to show that
company is in a position to pay the liabilities or not
6. Signature's duty: It is also duty of the auditor that he should sign on the report which is
submitted in the annual general meeting of the shareholders.
7. Helpsinspectors:The Govt, can appointinspectorsto collectthe informationaboutmatters.
It is the legal duty of the auditor that he should help the inspectors and provide true
information's.
8. Performance of job: The auditor is bound to perform all jobs according the terms and
conditions of employment. The duties mentioned in agreement cannot change.
9. Verify securities: It is the duty of the auditor that he should verify the securities of the
company and also check that these are in safe custody.
10. Verifyassets Itisthe dutyof the auditorthat he shouldverifythe assetsof the company and
also check that these are in safe custody.
11. Verify the payments: It is the duty of the auditor that payments made by the company are
according the article of association or not.
12. Honesty: It is the duty of the auditor that he should work honestly.
Removal of Auditor
1. Removal of auditor before the expiry of his term is to be done only by passing a special
resolution by a company after obtaining previous approval from central government.
2. He should be given reasonable opportunity to be heard before taking action.
3. Application to government shall be filed within 30 days from the date resolution
4. CompanyneedtoholdGeneralmeetingwithin60daysof the approvalof central government.
Form ADT require following information:
a. Details of the application clearly indicating the grounds for seeking removal of auditor.
b. Whether the accounts have been qualified during last three years.
c. Details of opportunity given to auditor concerned for being heard
d. Whether any civil or criminal proceedings are pending between the company and the
concerned officers.
e. Whether any special notice has been received for removal of auditors.
f. Whether all due audit fee has been paid to the concerned auditors.
g. Pendency of audit.
h. Whether there is any dispute with regard to Books of Accounts.
Limitation of External Audit:
a. Use of estimation and judgement: numerous values reported in financial statements are
based on estimation such as depreciation, doubtful debts etc.
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b. Historic nature of reporting: Audit is based on historic information
c. Use of sampling:Basistoextractconclusionregardingpopulationof largesizesthatcannotbe
examined 100% by the auditor
d. Humans: Since it is prepared humans they are prone to errors.
e. Nature of evidence: Most times it is persuasive rather than conclusive.
f. Nature of audit:Auditprovidesassurancesregardingaccuracyof assertionstogive true state
of affairsof the entity. Auditorsopinioninnowayhelpusersto derive conclusionsregarding
managerial effectiveness.
g. Riskof Fraud:Fraudsare intendedtoconcealedbythe perpetrators andthereforepose avery
high risk of remaining undetected by the auditors in spite of sound audit methodology.
h. Scope: Audit procedure are designed to detect material misstatement in the financial
statements. Non-financial matters are not considered unless they have relevance to the
financial statements.
i. Time constraints:
Corporate Governance
Corporate Governance isthe frameworkof rulesandpracticesbywhicha board of directorsensures,
accountability, fairness and transparency in a company’s relationship with all its stakeholders.
Corporate Governance referstothe wayacorporationisgoverned.Itisaboutbalancingindividual and
societal goals, as well as economic and social goals.
Corporate governance is the system by which organisations are directed and controlled. It
encompassesthe relationshipbetweenthe boardof directors,shareholdersandotherstakeholders,
and the effectsoncorporate strategyand performance.Corporate governance isimportantbecause
itlooksat howthese decisionmakersact,how theycanor shouldbe monitored,andhow theycanbe
held to account for their decisions and actions.
The Corporate Governance Framework
1. Explicit and implicit contracts between the company and the stakeholders for distribution of
responsibilities, rights and rewards.
2. Procedures for reconciling interests of stakeholders in accordance with their duties, privileges
and roles.
3. Proceduresforproper supervision control and information- flows to serve as a system of checks
and balances.
Regulatory framework on corporate governance
The Indian statutory framework has, by and large, been in consonance with the international best
practices of corporate governance. Broadly speaking, the corporate governance mechanism for
companies in India is enumerated in the following enactments/ regulations/ guidelines/ listing
agreement:
1. The Companies Act, 2013 inter alia contains provisions relating to board constitution, board
meetings, board processes,independent directors, general meetings, audit committees, related
party transactions, disclosure requirements in financial statements, etc.
2. Securities and Exchange Board of India (SEBI) Guidelines: SEBI is a regulatory authority
having jurisdiction over listed companies and which issues regulations, rules and guidelines to
companies to ensure protection of investors.
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3. Standard Listing Agreement of Stock Exchanges: For companies whose shares are listed on
the stock exchanges.
4. Accounting Standards issued by the Institute of Chartered Accountants of India (ICAI): ICAI
is anautonomous body, which issues accounting standardsproviding guidelines for disclosures
of financial information. Section 129 of the New Companies Act inter alia provides that the
financial statements shall give a true and fair view of the state of affairs of the company or
companies, comply with the accounting standards notified under s 133 of the New Companies
Act. It is further provided that items contained in such financial statements shall be in
accordance with the accounting standards.
5. Secretarial Standards issued by the Institute of Company Secretaries of India (ICSI): ICSI is
an autonomous body, which issues secretarial standards in terms of the provisions of the New
Companies Act. So far, the ICSI has issued SecretarialStandard on "Meetings of the Board of
Directors" (SS-1) and Secretarial Standards on "General Meetings" (SS-2). These Secretarial
Standards have come into force w.e.f. July 1, 2015. Section 118(10) of the New Companies
Act provide that every company (other than one person company) shall observe Secretarial
Standards specified as such by the ICSI with respect to general and board meetings.
Principles of Corporate Governance Principles:
1. Leadership: Every Company should be headed by an effective board which is collectively
responsible forthe long term successofthe company and should lead and control the company’s
operation. Non-executive directors should constructively challenge and help develop proposals
on strategy. The board should include a balance of executive and non-executive directors such
that no individual or small group of individuals can dominate the board’s decision taking.
2. Effectiveness: The board and its committees should have the appropriate balance of skills,
experience, independence and knowledge of the company to enable them to discharge their
respective duties and responsibilities effectively.
There should be a formal, rigorous and transparent procedure for the appointment of new
directors to the board. All directors should receive induction on joining the board and should
regularly update and refresh their skills and knowledge.
3. Accountability: The board should present a balanced and understandable assessment of the
company’s position and prospects. The board should maintain sound risk management and
internal control systems. The board should establish formal and transparent arrangements for
considering how they should apply the corporate reporting and risk management and internal
control principles and for maintaining an appropriate relationship with the company’s auditor.
4. Remuneration: Levels of remuneration should be sufficient to attract, retain and motivate
directors of the quality required to run the company successfully, but a company should avoid
paying more than is necessary for this purpose. A significant proportion of executive directors’
remuneration should be structured so as to link rewards to corporate and individua l
performance.
5. Relations with Shareholders: There should be a dialogue with shareholders basedon the mutual
understanding of objectives. The board as a whole has responsibility for ensuring that a
satisfactory dialogue with shareholders takes place. The board should use the Annual General
Meeting to communicate with investors and to encourage their participation.
Directors Responsibilities:
The CompaniesActclearlystatesthat the directorshave the lion’sshare of the responsibilitieswhen
it comes to the preparation of the financial statements. They are as follows:
1. ACompanies Act requires directors to prepare and present financial statementsabout their
companies, which show a realistic position of the company as at year end. Financial
statements tend to consist of the Income Statement and Balance Sheet, Notes to the
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accounts, Auditors' report and accompanying schedules. Other variations and additional
financial components may be required depending on the accounting financial framework
being applied and the country in question.
2. The directors responsibilities does not stop here. Directors are also responsible for the
contents of the financial statements. The financial statementsshouldbe prepared in such a
way as to show continuity (the technical term being Going Concern Basis) unless there are
events which suggests otherwise.
3. The policies applied in generating the financial statements are also subject to a number of
judgement calls and estimates. All of these are the responsibility of the directors.
4. The most importantresponsibilitiesof the directors are to implementcontrolswhichdeters
and detectsfraudand errors.All of these responsibilitiesultimatelyhelpdirectorssafeguard
a company's assets.
Characteristics features of Corporate Governance
1. Discipline: Corporate discipline is a commitment by a company’s senior management to
adhere tobehaviourthatisuniversallyrecognizedandacceptedtobe correctandproper.This
encompasses a company’s awareness of, and commitment to, the underlying principles of
good governance, particularly at senior management level.
2. Transparency: Transparencyisthe ease withwhichanoutsiderisable tomake meaningful
analysis of a company’s actions, its economic fundamentals and the non-financial aspects
pertinenttothatbusiness.Thisisameasure of how goodmanagementisatmakingnecessary
information available in a candid, accurate and timely manner – not only the audit data but
also general reports and press releases. It reflects whether or not investors obtain a true
picture of what is happening inside the company.
3. Independence: Independence is the extent to which mechanisms have been put in place to
minimizeoravoidpotential conflictsof interestthatmayexist,suchasdominance byastrong
chief executive or large share owner. These mechanisms range from the composition of the
board,toappointmentstocommitteesof theboard,andexternalpartiessuchasthe auditors.
The decisionsmade,andinternalprocessesestablished,should be objectiveandnotallowfor
undue influences
4. Accountability: Individualsorgroupsin a company,who make decisionsandtake actions on
specificissues,needtobe accountable fortheirdecisionsandactions.Mechanismsmustexist
and be effectivetoallowforaccountability.These provide investorswiththe meanstoquery
and assess the actions of the board and its committees.
5. Responsibility:Withregard to management,responsibilitypertainsto behaviourthatallows
for corrective action and for penalizing mismanagement. Responsible management would,
whennecessary,putinplace what it wouldtake to setthe companyon the right path.While
the board is accountable to the company, it must act responsively to and with responsibility
towards all stakeholders of the company.
Audit Committee:
An auditcommittee isone of the majoroperatingcommitteesof a company'sboardof directorsthat
is in charge of overseeing financial reporting and disclosure. All publicly traded companies must
maintain a qualified audit committee in order to be listed on stock exchange. Committee members
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mustbe made up of independentoutside directorsincludingaminimumof one personwhoqualifies
as financial expert.
Responsibilities of Audit Committee:
1. Overseeing the financial reporting and disclosure process.
2. Monitoring choice of accounting policies and principles.
3. Overseeing hiring, performance and independence of the external auditors.
4. Oversight of regulatory compliance, ethics, and whistle-blower hotlines.
5. Monitoring the internal control process.
6. Overseeing the performance of the internal audit function.
7. Discussing risk management policies and practices with management.
Role in overseeing the financial reporting and accounting:
Auditcommitteestypicallyreviewfinancialstatementsquarterlyandannuallyinpubliccompanies.In
addition, members will often discuss complex accounting estimates and judgments made by
managementandthe implementationof new accountingprinciplesor regulations.Auditcommittees
interact regularly with senior financial management such as the CFO and Controller and are in a
position to comment on the capabilities of these managers. Should significant problems with
accountingpracticesor personnel be identifiedoralleged,aspecial investigationmaybe directedby
the audit committee, using outside consulting resources as deemed necessary.
External auditors are also requiredto report to the committee on a variety of matters, such as their
viewsonmanagement'sselectionof accountingprinciples,accountingadjustmentsarisingfromtheir
audits,anydisagreementordifficultiesencounteredinworkingwithmanagement,andanyidentified
fraud or illegal acts.
Role in oversight of the external auditor
Auditcommitteestypicallyapproveselectionof the externalauditor.The external auditor(alsocalled
a public accounting firm) reviews the entity's financial statements quarterly, audits the entity's
financial statements annually, and issues an opinion providing assurance on the entity's annual
financial statements.Changing an external auditor typically also requires audit committee approval.
Audit committees also help ensure the external auditor is independent, meaning no conflicts of
interest exist that might interfere with the auditor's ability to issue its opinion on the financial
statements.
Role in oversight of regulatory compliance
Audit committees discuss litigationor regulatory compliance risks with management, generallyvia
briefings or reports of the General Counsel, the top lawyer in the organisation. Larger corporations
may alsohave a Chief ComplianceOfficerorEthicsOfficerthatreportincidentsorrisksrelatedtothe
entity's code of conduct.
Role in monitoring the effectiveness of the internal control process and
of the internal audit
Internal control includes the policies and practices used to control the operations, accounting, and
regulatorycompliance of theentity.Managementandboththeinternal auditingfunctionandexternal
auditors provide reporting to the audit committee regarding the effectiveness and efficiency of
internal control.
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Role in oversight of risk management
Organizationshave avarietyof functionsthatperformactivitiestounderstandandaddressrisksthat
threaten the achievement of the organization's objectives. The policies and practices used by the
entitytoidentify,prioritize,andrespondtothe risks(oropportunities) are typicallydiscussedwiththe
audit committee. Having such a discussion is required for listing on the Stock Exchange. Many
organizations are developing their practices towards a goal of a risk-based management approach
called Enterprise risk management. Audit committee involvement in non-financial risk topics varies
significantly by entity.
Structure of Audit Committee:
1. The Committee is to include at least 3 members.
2. All of whom are non-executive directors and a majority of which are independent.
3. The Chair of the Committee is to be independent and not the Chair of the Board.
4. At least one member is to have relevant qualifications and experience.
Working of Audit Committee
The auditcommittee workscloselywithauditorstoensure thatcompany'sbooksare correctandthat
no conflicts of interest exist between auditors or any outside consulting firms employed by the
company.Ideally,the chairof the auditcommittee will be aCertifiedPublicAccountant(CPA).Often,
however,aCPA isnotavailableforthe auditcommittee,letaloneamemberof the boardof directors.
The auditcommittee shouldmeetatleastfourtimesa yearin orderto review the mostrecentaudit,
eitherin-personorviateleconferencing.Anadditionalmeetingshouldbe heldif otherissuesneedto
be addressed.2
Audit committees maintain communication with the company's chief financial officer (CFO) and
controller. The committee has the authority to initiate special investigations in cases where it is
determined that accounting practices are problematic or suspect, or when serious issues arise with
employees. An internal auditor would assist the committee in such efforts.
Threats to Auditors Independence and How can he Safeguard himself against it?
There are five potential threats of Auditors Independence
Self-Interest Threat
A self-interestthreatexistsif the auditorholdsadirectorindirectfinancial interestinthe companyor
depends on the client for a major fee that is outstanding.
Self-Review Threat
A self-review threatexistsif the auditorisauditinghisownworkorworkthatis done byothersinthe
same firm.
Advocacy Threat
An advocacy threat exists if the auditor is involved in promoting the client, to the point where their
objectivity is potentially compromised.
Familiarity Threat
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A familiaritythreatexistsif the auditoristoo personallyclose toorfamiliarwithemployees,officers,
or directors of the client company.
Intimidation Threat
An intimidationthreatexistsif the auditorisintimidatedbymanagementoritsdirectorsto the point
that they are deterred from acting objectively.
External Audit
External Audit is defined as the audit of the financial records of the company in which independent
auditorsperformthe task of examiningvalidityof financial recordsof the companycarefullyinorder
to findout if there is any misstatementin the records due to fraud,error or embezzlementandthen
reporting the same to the stakeholders of the company.
Role and Responsibilities of External Audit
The main responsibility is to verify the general ledger of the company and make all other
essential inquiries from the management of the company. It helps to determine the real
picture of the company’smarketsituationandthe financial situation,whichfurtherprovides
the basis for managerial decisions.
Examine the validity of financial records to find out if there is any misstatement in the
company’srecord because of fraud,error, or embezzlement.So,itincreasesthe authenticity
and credibility of financial statements as the financial statements of the company.
If there are errors inthe accounting processof the company,thenit may prohibitthe owner
of the company in taking the decisions which are best for the company. An audit helps in
overcomingthisproblemtoagreatextentasthe proceduresinthe auditare designedinsuch
a way that theyhelpindetectingthe errorsin the system and the other fraudulent activity.
The auditsalsoensure the recordingof accountingtransactionsasperthe generallyaccepted
accounting principle. helps the owner of the business to cover themselves when it comes to
following the different rules and regulations which the registered entity needs to follow.
Limitations of External Audit
The auditisconductedbyreviewingthe sample dataof the company,whichthe auditorthinks
is material for his examination.An auditor does not assess and review all the transactions
whichoccurred in the company.Thus, he merelyexpresseshisauditopiniononthe financial
statementsanddatabasedonthe sampledataprovidedtohim.Sothisdoesnotgive thetotal
assurance about the financial position of the company.
Expenses involved in conducting an audit may be very high.
In all stagesof the accounting,frompreparationtofinalizingthe financial statementsandfor
expressingthe auditopinion,there istheinvolvementof the humansandthusmakingitprone
to the error. Also, if there is a lack of knowledge or experience of an auditor in the relevant
field, then the purpose of the audit will not solve.
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Difference Between External Audit and Internal Audit
Features External audit Internal audit
Reports to
shareholders or
members who are
outside the organisations
governance structure.
The board and senior management who
are within the organisations governance
structure.
Objectives
Add credibility and
reliability to financial
reports from the
organisation to its
stakeholders by giving
opinion on the report
Evaluate and improve the effectiveness of
governance, risk management and control
processes. This provides members of the
boards and senior management with
assurance that helps them fulfil their
duties to the organisation and its
stakeholders.
Coverage
Financial reports,
financial reporting risks.
All categories of risk, their management,
including reporting on them.
Responsibility for
improvement
None, however there is a
duty to report problems.
Improvement is fundamental to the
purpose of internal auditing. But it is done
by advising, coaching and facilitating in
order to not undermine the responsibility
of management.
Internal Audit
The Institute of InternalAuditors(IIA)definesinternalauditasthe “independent,objectiveassurance,
and consulting activity designed to add value and improve an organization’s operations. It helps an
organizationaccomplishitsobjectivesbybringingasystematic,disciplinedapproachto evaluate and
improve the effectiveness of risk management, control, and governance processes.”
Role of Internal Auditor
Objectively assess a company’s IT and/or business processes
Assess the company’s risks and the efficacy of its risk management efforts
Ensure that the organization is complying with relevant laws and statutes
Evaluate internal control and make recommendations on how to improve
Identifying shortfalls or gaps in processes
Promote ethics and help identify improper conduct
Assure safeguards
Investigate fraud
Communicate the findings and recommendations
Provide an opinion (Unqualified, qualified, adverse, or disclaim)
Safeguarding against threats of Independence of Auditor:
Safeguards Created by Profession, Legislature and regulation: Education, train
Outsourcing of Internal Audit Function:
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Outsourcing is a process that involvesusing external suppliers to conduct internal functions. With
internal auditoutsourcing,companiescanuse external servicesfortheirinternal auditfunction.This
process involves hiring auditors that do not act as the company's employees.
Expertise:
Hiringan outsourcedinternal auditfunctionmaybringexpertise tomanycompanies.Asmentioned,
mostlarge companieshave adedicatedinternal auditfunctionthatisin-house.Forsmallercompanies,
however,thesame maynotbe possible.Therefore,itcanintroduce theexpertise theyneedtooperate
an effective and efficient internal audit function.
Time-Saving
Companiesoperatinginternal auditfunctionshavetogothroughvariousstepstoestablishit.Itusually
includes establishing the structure, hiring employees, determining the procedures, etc. All of these
tasks require time to complete. By outsourcing the internal audit function, companies can save the
time theywouldspendonthe above.Inaddition,withoutsourcing,companiescangetan immediate
audit department without going through a complicated process.
Cost-Saving
As mentioned, it can bring more expertise while also saving time. Through this, it can also be more
cost-efficient for companies.On top of that, internal audit outsourcing contracts are usually a fixed
amount. Therefore, companies will also find it easier to budget using this amount. Otherwise,
companieshave to pay many employees,includingbonuses.Therefore,itcan not onlymake it more
difficult to predict but also drive costs up.
Better Independence
One of the most critical issues with an in-house internal audit function is independence. Internal
auditors are a company’s employees. Therefore, the management may have undue influence over
theirwork.With internal auditoutsourcing,the same doesnot apply.Therefore,companieswillfind
outsourcing better for the independence of their internal audit function.
Disadvantages of Internal Audit Outsourcing
Taking the internal audit function out of the company may force loss of control. Companies that
outsource thisfunctioncannothave asayonhow the outsourcedinternal auditorswork.Itcanfurther
lead the company to change the processes or procedures they use internally. Overall, it can cause
unwanted problems for the company.
Not Suitable For Small Companies
Loss of Control
Internal auditoutsourcingcan be beneficial tomanycompanies.However,forsmall companieswith
a lownumberof transactionsand controls,the same may not apply.Usually,these companiesdon’t
needan internal auditfunctionat all.However,evenif theydo use internal audits,outsourcingmay
not be ideal given the requirements.
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Initial Costs
Internal auditoutsourcingmayresultinlowercosts.However,itmayalso require companiestobear
highexpensesinitially.Usually,companiesneedtodedicate resourcestohelpauditfirmstogetused
to their operations.Similarly,forcompaniesthathave an existingfunction,the costof redundancies
may be high. Companies may also need to invest in systems to keep the information confidential.
These may all add to the initial costs.
Audit Report
An AuditReportcan be definedasan opinionaboutthe financial statementsof the company.Issued
by the auditors, the main purpose is to convey the overall opinion about the integrity, and
completeness of the financial statements, of the engaging party.
An Audit Report should ideally have the following contents.
Title
This is generally addressed as ‘Independent Auditors Report’
Address
Given the fact that Auditors are appointed by the shareholders of the company, the Audit Report is
addressed to them, and it is subsequently declared so.
Furthermore, since they are the most important stakeholder group for which the Audit Report
matters, the Audit Report is addressed to the shareholders.
Responsibility – (Responsibility of the Management, as well as the Auditor)
Thisclearlymentionsthe overall responsibilityof the auditortogive a free andfairopinionaboutthe
financial statements, and it also stresses the management’s responsibility to cooperate with the
auditor.
The Scope of the Audit
The Scope of the Auditpart of the AuditReportmentionsthatthe audit has beenconductedbearing
in mind the overall accounting and auditing standards in the specific country.
In the same manner,it also talksabout the role of the auditor inensuringthat there are no material
misstatements, and all internal controls tests have been performed in order to determine the
correctness of the financial statements.
The Opinion of the Auditor
The Opinionof theAuditoristhemaincrux,notonlyof theAuditReportbutalsoof the overall auditing
process that had been carried out. The Audit Opinion can be qualified, unqualified, adverse, or
disclaimer of opinion, depending on the eventual outcome of the audit.
Basis of Opinion
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This is an extension that explains the basis on which the auditor issued the particular judgment. It
explains sufficient reasoning behind the judgment that was made.
Signature
Thisis dulysignedbythe auditor,asproof that he is well aware of hiswork,andit isaccountable and
responsible for the opinion that he has turned on.
Place, Date of the Signature and Date of the Audit Report
Emphasis of Matter
Additionally, the Audit Report can also contain a part titled Emphasis of Matter. This is to bring
attention to certain parts within the organization where the auditor believes attention should be
drawn.
Financial statements
The auditreportshouldalsoreportthefinancialstatementsthatthe reportingisissuing. Theseinclude
the income statement,balancesheet,statementof changeinequity,andnotetofinancialstatements.
