SA 700, SA 705 and SA 706

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Presentation on new Auditing Standards SA 700, 705 and 706 applicable from April 1, 2011

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SA 700, SA 705 and SA 706

  1. 1. Gaurav Sehgal 1
  2. 2. Standard on Auditing (SA) 700 Forming an Opinion and Reporting on Financial Statements 2
  3. 3. INTRODUCTION AND SCOPE This standard deals with the auditors’ responsibility to form an opinion on the financial statements and the form and content of the Auditors’ Report. SA 705 and 706 deal with form and content of modified opinion and emphasis of matter paragraph or other matter paragraph. This standard is effective for audits of financial statements for the period beginning April 1, 2011 or thereafter. 3
  4. 4. REQUIREMENTS OF FORMING AN OPINION The auditor shall form an opinion on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework including qualitative aspects of entity’s accounting policies and possible bias in management’s judgments. He shall conclude as to whether he has obtained reasonable assurance about whether the financial statements are free of material misstatements due to Fraud or Error based on  Sufficient and appropriate audit evidence;  Whether uncorrected misstatements are material, individually or in aggregate Auditors’ evaluation to include particularly the following:  Significant accounting policies applied  Consistency of those policies  Reasonable estimates are used by the management  Information presented in relevant, reliable, comparable and understandable  Disclosures are adequate to enable users to understand the effect of material transactions  Terminology used is appropriate 4
  5. 5. FORM OF OPINION When the auditors concludes that the financial statements are prepared, in all material respects, in accordance the applicable financial reporting framework, he shall express an UNMODIFIED OPINION If the auditor concludes: (a) that based on audit evidence, the financial statements are NOT free of material misstatements; (b) that he is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements are free of material misstatements; then he shall issue a modified opinion in accordance with SA 705. 5
  6. 6. STRUCTURE OF THE AUDITORS’ REPORT Title : Should have a clear title – “Independent Auditors’ Report” Addressee : Should be addressed as per the terms of engagement Introductory Paragraph : The following information to be mentioned  Identify whose financial statements have been audited  State the financial statements audited  Identify the title of each statement in the financial statements  Refer to the summary of significant accounting policies and explanatory information  Specify the date or period covered Management Responsibility Statement : Auditor shall describe the management responsibility for the preparation of financial statements which includes design, implementation and maintenance of internal control that the financial statements are free of material misstatements due to fraud or error. 6
  7. 7. STRUCTURE OF THE AUDITORS’ REPORT (contd.) Auditors’ Responsibility : State that the auditors’ responsibility is to express an opinion on the financial statements based on the audit. That the audit has been conducted in accordance with the Standards on Auditing issued by the Institute of Chartered Accountants of India (ICAI). He should also explain that he has to comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. The auditor should describe :  That he has performed procedures to obtain audit evidence  These procedures are based on auditors’ professional judgement  That the audit also includes assessment of appropriateness of accounting policies used and reasonableness of accounting estimates made The auditor shall state whether he believes that the audit evidence obtained is sufficient and appropriate to provide basis for his opinion 7
  8. 8. STRUCTURE OF THE AUDITORS’REPORT (contd.) Auditors’ Opinion : The auditors’ opinion shall state that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. If the applicable financial reporting framework is not the accounting standards issued by the ICAI, NACAS, ASB, etc, then the auditor shall identify the jurisdiction. Other reporting responsibilities : If other reporting responsibilities are addressed, they should be indicated. Signature : The report shall be signed in the name of the partner and the membership number and firm registration number should be mentioned Date : report should be dated no earlier that the date when he obtains sufficient appropriate audit evidence Place : The place of signature should also be mentioned 8
  9. 9. AUDIT REPORT PRESCRIBED BYLAW OR REGULATION Where the layout of the report is prescribed by a law or regulation, the auditor shall refer to Standards of Auditing only if, at a minimum, each of the following elements are included:  Title  Addressee  Introductory paragraph  Management Responsibility Paragraph  Auditors’ Responsibility Paragraph  Opinion Paragraph  Auditors’ Signature  Date  Place 9
  10. 10. Standard on Auditing (SA) 705Modifications to the Opinion in the Independent Auditor’s Report 10
  11. 11. INTRODUCTION AND SCOPE Deals with circumstances when the auditor concludes modification to the report is necessary. Types of modified opinions  Qualified Opinion  Adverse Opinion  Disclaimer of Opinion The decision on the type of opinion depends upon:  The nature of the matter giving rise to the modification i.e. whether the financial statements are materially misstated  Inability to obtain sufficient and appropriate audit evidence  Auditors’ judgment about the pervasiveness of the effects or possible effects of the matter The standard is effective for audits for periods beginning on or after April 1, 2011 11
  12. 12. MODIFICATIONS IN THE REPORT The auditor shall modify the opinion when:  He concludes that, based on audit evidence, the financial statements as a whole are NOT free of material misstatements; or  The auditor is UNABLE to obtain sufficient appropriate audit evidence to conclude that the financial statements are free of material misstatementsQualified OpinionThe auditor shall express qualified opinion when:  He concludes that the misstatements, individually or in aggregate, are MATERIAL, BUT NOT PERVASIVE to the financial statements  He is unable to obtain sufficient appropriate audit evidence but also concludes that the possible effects of undetected misstatements could be MATERIAL, BUT NOT PERVASIVEAdverse OpinionWhen the auditor concludes that having obtained sufficient appropriate audit evidence, themisstatements, individually or in aggregate, are BOTH MATERIAL AND PERVASIVE, heissues an adverse opinion. 12
  13. 13. MODIFICATIONS IN THEREPORT (contd.)Disclaimer of OpinionWhen the auditor is unable to obtain sufficient appropriate audit evidence and concludes that thepossible effects of undetected misstatements are BOTH MATERIAL AND PERVASIVE, he issuesan disclaimer of opinion.In extremely rare circumstances, having obtained sufficient appropriate audit evidence, BUT dueto multiple uncertainties, the auditor is not able to form an opinion, due to possible interaction ofthose uncertainties and their possible cumulative outcomes, he issues a disclaimer of opinion.Auditors’ Report Modification Matrix Auditors’ Judgment about the Pervasiveness of the EffectsNature of matter giving rise or Possible Effects on the Financial Statementsto the modification Material but not Material and pervasive PervasiveFinancial statements are Qualified opinion Adverse opinionmaterially misstatedInability to obtain sufficient Qualified opinion Disclaimer of opinionappropriate audit evidence 13
  14. 14. MATERIAL MISSTATEMENTS - EXPLAINED A misstatement is the difference between the amount of classification, presentation, or disclosure reported in the financial statements and the classification, presentation, or disclosure required as per the applicable financial reporting framework. This may arise in relation to :  Appropriateness of the selected accounting policies  Application of the selected accounting policies  Appropriateness or adequacy of disclosures in the financial statementsAppropriateness of the selected accounting policiesMaterial misstatements relating to appropriateness may arise when: Selected accounting policies are not consistent with the applicable financial reporting framework; Financial statements, including notes thereon, do not represent underlying transactions and events that achieves fair presentationApplication of selected accounting policiesMaterial misstatements relating to application may arise when: When accounting policies are not applied consistently, including consistency between periods, similar transactions and events; Method of application is erroneous 14
  15. 15. MATERIAL MISSTATEMENTS (contd.)Appropriateness or adequacy of disclosures in the financial statementsMaterial misstatements relating to appropriateness or adequacy of disclosures may arisewhen: Financial statements do not include all disclosures required by the applicable financial reporting framework Disclosures are not presented in accordance with the applicable financial reporting framework The financial statements do not provide the disclosures necessary to achieve fair presentation 15
  16. 16. INABILITY TO OBTAIN SUFFICIENTAPPROPRIATE AUDIT EVIDENCE Auditors’ inability to obtain sufficient appropriate audit evidence may arise from:  Circumstances beyond the control of the entity; eg. where records have been destroyed by fire, or seizure by government authority, etc  Circumstances relating to nature or timing of the auditors’ work eg. when auditor is appointed on such date that he cannot observe the physical count  Limitation imposed by the management In case limitation is imposed by the management, the auditor shall request the management to remove the limitation If the management still persists, he shall communicate it to those charged with governance and determine if alternative audit procedures are possible. If the auditor is unable to obtain sufficient appropriate audit evidence, he shall:  Resign from the engagement, where practicable and not prohibited by law  If resignation is not possible due to stage of the audit or legal or professional restriction, the auditor shall give a disclaimer of opinion Where the auditor decides to resign, he shall inform to those charged with the governance any matters regarding misstatements identified during the audit that would have given rise to modification in the report 16
  17. 17. FORM AND CONTENT OF MODIFIED REPORTIn addition to the elements of the auditors’ report referred in SA 700, the following need tobe added for modified reports:  Basis of modification paragraph  Amendments in the opinion paragraph  Amendments in the Auditors’ responsibility paragraphBasis of modification paragraph This is placed immediately before the opinion paragraph and under the heading “Basis of Qualified Opinion, Basis of Adverse Opinion, Basis of Disclaimer of Opinion” Modification may relate to:  Specific amounts in the financial statements – in this case, include the description and quantification of the financial effects, if practicable. If not practicable, state the fact in the report  Narrative disclosures in the financial statements – in this case explain how the disclosures are misstated  Non-disclosure of information required to be disclosed – in this case  Discuss the non-disclosure with those charged with governance  Describe the nature of omitted information  If practicable, not prohibited by law and if sufficient appropriate audit evidence relating to that item is obtained, include the omitted disclosure 17
  18. 18. FORM AND CONTENT OF MODIFIED REPORT If modification results from inability to obtain sufficient appropriate audit evidence, include the reason for inability Even if the auditor has expressed an adverse opinion or disclaimer of opinion, he shall describe other matters which he is aware that would have required a modificationAmendments in the opinion paragraph Use the heading – “Qualified Opinion”, “Adverse Opinion”, or “Disclaimer of Opinion” Must use the phrases - “with the foregoing explanation” or “subject to” or “except that” Where a qualified opinion is issued due to material misstatement the auditor shall state in the opinion paragraph that except for the matters described in the basis of qualified opinion, the financial statements have been prepared, in all material respects, in accordance with the applicable financial reporting framework When modification arises from inability to obtain sufficient appropriate audit evidence, the auditor shall use the corresponding phrase “except for the possible effects of the matter(s)…” for the modified opinion When issuing an adverse opinion, the auditor shall state:  That the financial statements DO NOT PRESENT a true and fair view; or  The financial statements have NOT been prepared, in all material respects, in accordance with the applicable financial reporting framework 18
  19. 19. FORM AND CONTENT OF MODIFIED REPORT When the auditor disclaims an opinion due to inability to obtain sufficient appropriate audit evidence, he shall state:  Because of the significance of the matter(s) described in the Basis for Disclaimer of opinion paragraph, the auditor has NOT been able to obtain sufficient appropriate audit evidence  The auditor does NOT express an opinion on the financial statementsAmendments in the Auditors’ responsibility paragraph In case of qualified opinion or adverse opinion, the auditor shall state that he believes that the audit evidence is sufficient and appropriate to provide a basis for his MODIFIED audit opinion In case of disclaimer of opinion due to inability to obtain sufficient appropriate audit evidence:  the auditor shall amend the introductory paragraph to state that he was engaged to audit the financial statements;  He shall amend the auditors’ responsibility paragraph and scope to include the following “because of the matter(s) described in the Basis for Disclaimer of Opinion paragraph, we have not been able obtain sufficient appropriate audit evidence to provide a basis for our audit opinion.” 19
  20. 20. Standard on Auditing (SA) 706Emphasis of Matter Paragraphsand Other Matter Paragraphs in the Independent Auditor’s Report 20
  21. 21. EMPHASIS OF MATTER PARAGRAPH The standard is effective for audit of financial statements for the period beginning on or after April 1, 2011 An emphasis of matter paragraph is useful when the auditor, having formed an opinion, intends to draw the attention of the users to:  A matter, though appropriately presented and disclosed, is of fundamental importance to the users to understand the financial statements;  Any other matter relevant to the users’ understanding of the audit, auditor’s responsibility or auditors’ report.  Where an emphasis of matter paragraph is required by any other auditing standard, the disclosure shall be as per this SA. Such a paragraph shall refer to information presented and disclosed The auditor should have obtained sufficient appropriate audit evidence that the matter is not materially misstated The emphasis of matter paragraph shall be placed immediately after the Opinion paragraph in the Auditors’ Report under the heading “Emphasis of Matter Paragraph” Include a clear reference to the matter being emphasized and to the relevant disclosures Indicate that the auditors’ opinion is NOT modified by using words like “Without qualifying our opinion” If auditor wants to communicate any other matter not prohibited by law, he may do so using an “Other Matter” paragraph immediately after the Emphasis of matter paragraph. 21
  22. 22. THANK YOU 22

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