AUDIT OF FINANCIAL STATEMENTS 2012-13: REVISED REPORTING REQUIREMENTS & OTHER IMPORTANT ISSUES Himanshu Kishnadwala 09 Aug 2013

AUDIT OF FINANCIAL STATEMENTS 2012-13:

REVISED REPORTING REQUIREMENTS &

OTHER IMPORTANT ISSUES

Himanshu Kishnadwala09 Aug 2013

Contractor, Nayak & Kishnadwala

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Introduction

Increased focus on role of auditor in recent times due to some wrong and some ‘right’ reasons

Audit consists of 3 major activities:a) Conduct of the audit (using SAs)b) Ensuring compliance of ASc) Ensuring adequate disclosure as per statute,

AS, etc. Since last several years, the focus of audit

has shifted to (b) and (c) ignoring (a).


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Contents

Revised Schedule VI and AS – Some Issues

ICAI Announcements Corporate Law Updates - MCA Circulars RBI Circulars Other Developments for FY 2012-13 Standards On auditing – SA 700 series Some issues on CARO

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Some Issues

Revised Schedule VI and AS


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Current vs. Non Current

A liability is classified as Current if it satisfies any of the following criteria:

a) it is expected to be settled in the company’s normal operating cycle;

b) it is held primarily for the purpose of being traded;

c) it is due to be settled within 12 months after the reporting date; or

d) the company does not have an unconditional right to defer settlement of the liability for at least 12 months after the reporting date.


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Current vs. Non Current …

An asset is classified as Current when it satisfies any of the following criteria:

(a) It is expected to be realized in, or is intended for sale or consumption in the company’s normal operating cycle;

(b) It is held primarily for the purpose of being traded;(c) It is expected to be realized within 12 months

after the reporting date; or(d) It is cash or cash equivalent unless it is

restricted from being exchanged or used to settle a liability for at least 12 months after reporting period date.

What is Operating Cycle?

An Operating Cycle (OC) is the time between the acquisition of assets for processing and their realization in cash or cash equivalents.

If an OC cannot be identified, it is assumed to have a duration of 12 months

If a company is engaged in multiple businesses, the OC can be different for each line of business


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Operating Cycle – some issues

Different OC for different customers based on different credit terms? say., PSU and non PSU customers

Can OC differ from year to year?Whether lead time for procuring raw material

should be included in OC? Is credit period allowed by supplier reduced in

determination of OC? To determine OC to consider:

Normal business behaviour Industry practice Liquidity position ??


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Operating Cycle – some issues…

Industry specific OC: Manufacturing Companies: To determine business-wise Real Estate Companies: Can be determined project-wise Finance Companies: Difficult to determine – to be

assumed at 12 months Service companies: To determine business-wise

Relevance of OC for classification of: Trade receivables / payables – OC relevant Supplier/Customer advances – OC relevant Borrowings – OC relevant Loans – 12 months period Other assets / liabilities – 12 months period


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Current vs. Non Current …

Determining Whether Current or Non-Current?For Assets: To consider expectation of receiptFor Liabilities: To consider obligation to pay

Whether accounting policy for classification of items into Current / Non Current is to be disclosed? Neither the RS VI nor the GN on RS VI requires such

disclosure However, disclosure preferable in case of OC > 12

months In other cases, though not required, maybe given as

it lends higher transparency to the FS

Classification may have impact on CARO reporting Whether funds raised on short term basis are used

for long term purposes?


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Trade Payables11

A payable shall be classified as ‘trade Payables’ if it is in respect of amount due on account of goods purchased or services received in the normal course of business.

Amount under contractual obligations can no longer be included within trade payables.

An argument can be made that any obligation, except statutory obligation, incurred by a Co pertains to goods & services received in normal course.

GN is unclear & subject to interpretations.Contractor Nayak and Kishnadwala

Trade Payables…

Contractor Nayak and Kishnadwala

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Considering the ambiguity only the following may be excluded from trade payables :

Liability towards purchase of Fixed Assets, including finance lease liability.

Statutory dues and all due to government/regulatory bodies.

Contractually reimbursable expenses incurred on behalf of third party which are not charged to Statement of P&L of the Co.

Can the following items be classified as Trade Payable: Outstanding Audit fees Amount due to party on account administration expenses


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Fixed Assets

Revised Schedule VI requires: “Except in the case of the first financial statements laid before

the company (after its incorporation) the corresponding amounts (comparatives) for the immediately preceding reporting period for all items shown in the financial statements including notes shall also be given.”

Thus, previous years figures for each class of Fixed Asset has to be given as against the current practice of just mentioning the previous years total of fixed assets.

To illustrate (FY 2011 – 12) : Tata Motors give their previous figures under each current year figure in

the table for fixed assets Grasim Industries reproduces the entire FA schedule of previous year

Investments14

Non Current Investments shall be classified as “trade Investment” or “Other Investments”.

The term “trade investments” is defined neither in Revised Schedule VI nor Accounting Standards.

The term “trade investment” is normally understood as an investment made by a company in shares or debentures of another company , to promote the trade or business of the first company. Whether investment in subsidiary to be

classified as “trade investment” or “other investment” ?Contractor Nayak and Kishnadwala

Investments…15

As per Revised Schedule VI:

Expected to be realised within 12 months of BS date

As per AS 13: Investment that by its nature is readily

realisable and intended to be held for not more than 1 year from the date of investment.

Investment made in December 2011 and expected to be realised in February 2013 (i.e. after 14 months) – whether current or non-current?

Since AS overrides RS VI, investment will be non-current, though expected to be realised within 12 months of next BS date (i.e. 31st March 2012)


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Statement of Profit and Loss

Whether Revenue should be Gross or Net?• As per GN on terms used in FS, Sales Turnover is defined

as: “aggregate amount for which sales are effected or services rendered by an enterprise”

• Guide to Company Audit mentions “Total turnover is the aggregate amount for which sales are effected, giving the amount of sales in respect of each class of goods dealt with by the company and indicating quantities separately”

• Statement of CARO and Part II of existing Schedule VI defines turnover as “aggregate amount for which sales are effected by the company. Sales effected would include sale of goods as well as services rendered by the company.”


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Whether Revenue should be Gross or Net? …

• As per GN on Tax Audit, turnover maybe interpreted to mean “the aggregate amount for which sales are effected or services rendered by an enterprise”

• Para 10 of AS 9 requires “disclosure of Gross Turnover with separate deduction for Excise Duty”.

• GN on VAT states “VAT is collected from customers on behalf of VAT authorities and … should not be recorded as revenue of the enterprise”

Statement of Profit and Loss…


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Whether Revenue should be Gross or Net? …Service Tax

• For Service Tax, sec 83 of the Finance Act, 1994, provides that the provisions of certain sections (like sec 9C, 12A, etc.) of the Central Excise Act, 1944 shall apply, so far as may be, in relation to service tax as they may apply to a duty of excise.

• Section 12 A of the Central Excise Act, 1944, which provides that the amount of excise duty shall form part of the price of the goods sold. On a similar analogy, service tax would form part of the price of the services provided.



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Whether Revenue should be Gross or Net? …

Excise Duty• Since format of RS VI clearly mentions Excise Duty

as a deduction from Sales, the same would be necessary.

Service Tax / VAT

GN On Revised Schedule VI• Such taxes are generally collected from the customer

on behalf of government. Depending on whether company is acting as agent or principal, such taxes should be included in Sales (i.e. Gross or excluded (i.e. Net).



Revenue from Operations – Other Operating Revenue vs. Other Income20

The term “Other Operating Revenue” is not defined by RS VI.

It would include Revenue arising from a company’s operating activities, i.e., either its principal or ancillary revenue-generating activities, but which is not revenue arising from the sale of products or rendering of services.

Whether a particular income constitutes “other operating revenue” or “other income” is to be decided based on the facts of each case and detailed understanding of the company’s activities.


Revenue from Operations – Other Operating Revenue vs. Other Income…21

Whether the following is “Other Operating Revenue” or “Other Income”? A Company engaged in manufacture and sale of

industrial and consumer products also has one real estate arm.

A consumer products company owns a 10 storied building. The company currently does not need one floor for its own use and has given the same temporarily on rent.

Sale of Fixed Assets Sale of Scrap Interest from customers on delayed payments Foreign Exchange GainsContractor Nayak and Kishnadwala

Revenue from Operations – Other Operating Revenue vs. Other Income


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Whether the following is “Other Operating Revenue” or “Other Income”? Sale of Carbon credits Dividend from Joint Venture/Subsidiary Insurance Claims Received – Kansai Nerolac

Paints Limited Indirect Tax Claims Received – Kansai Nerolac

Paints Limited.


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Are the following statements correct? The company follows the accrual basis of

accounting and the AS issued by ICAI. For Fixed Asset schedule previous years’ figures

not necessary for each asset Cost for the purpose of calculating Inventory is

determined on Moving Average basis. Provision is made for obsolete inventories Trade receivables due for a period exceeding 6

months

Disclosure of Accounting Policies

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ICAI Announcements


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Para 46 / 46A of AS 11 inserted by MCA in 2009 / 2011 Option available to add / deduct foreign exchange

differences arising on long-term foreign currency monetary items insofar as they relate to the acquisition of a depreciable capital asset to the cost of the asset

In other cases (i.e. for other than for depreciable assets), to be accumulated in a “ Foreign Currency Monetary Item Translation Difference Account (FCMITDA)” in the balance sheet.

The FCMIDTA can be credit or debit Issue is if it is debit, under Revised Schedule VI,

where is FCMITDA to be presented in the BS?

Presentation of FCMITDA in BS


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As per ICAI FAQs on AS 11 notification issued in May 2009:

“ The FCMITDA should be shown as a separate line item in the Balance Sheet, in line with treatment given to Deferred Tax Asset/Liability, i.e. after the head ‘Investments’ or after the head ‘Unsecured Loans’ as the case may be and separately from current assets and current liabilities.”

As per Revised Schedule VI, no line item has been specified for the presentation of FCMITDA

Companies were therefore following different practices for disclosure of such FCMITDA esp. when the balance was an asset.

Presentation of FCMITDA in BS…


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Council of ICAI vide announcement in April 2013 said:

“An asset is a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise.”

Where the balance in FCMITDA represents foreign currency translation loss, it does not meet the above definition of ‘asset’ as it is neither a resource nor any future economic benefit would flow to the entity therefrom. Accordingly, such balance cannot be reflected as an asset.



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Therefore, the Council decided that debit or credit balance in FCMITDA should be shown on the “Equity and Liabilities” side of the balance sheet under the head ‘Reserves and Surplus’ as a separate line item.

This would be a negative reserve.



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The Council of the Institute at its meeting held on January 2013 considering recent changes in the enhancement of tax audit limit, decided to change the applicability of Accounting Standards for Level II entities from Rs. 40 lakhs to Rs. 1 crore with effect from the accounting year commencing on or after April 01, 2012.

This has implications on applicability of ICAI notified AS to non-corporate entities

Change in criteria for Level II Entity

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MCA Circulars

Corporate Law Updates

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Sec 372A(3) of The Companies Act, 1956: “No company shall grant a loan to any body corporate at a rate of interest lower than the prevailing bank interest as made public under section 49 by RBI.”

Movement of bank rates over the last few years is as under:


Sec 372A of Companies Act, 1956

Period Bank Rate (%)

April 2003 To 13th February 2012 6.0

14th February, 2012 to 16th April, 2012 9.5

17th April, 2012 to 28th January, 2013 9.0

29th January, 2013 onwards 8.75


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Sec 372A of Companies Act, 1956 …

Section does not apply (among others) to loans: By companies whose principal business is

acquisition of securities By private companies (unless subsidiary of

public company) Loans or Guarantees to Wholly Owned

Subsidiary Position to be seen at time of giving loan


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Issue:

The restriction imposed by Section 372A(3) of The Companies Act, 1956, had resulted in companies not being able to invest in tax free bonds issued by the government which had interest in the range of 6.75% to 7.5%.

Clarification:

In view of the above difficulty, MCA issued a circular no. 06/2013 dated 14/03/2013 whereby it clarified that in cases where the effective yield (effective rate of return) on tax free bonds is greater than the yield on prevailing bank rate, there is no violation of Section 372A(3) of Companies Act, 1955.

Clarification on Sec 372A(3)…


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Companies (Acceptance of Deposits Amendment) Rules, 2013

In the definition of ‘deposits’ in the Companies (Acceptance of Deposits) Rules, 1975,:

Rule 2, in clause (b), for sub clause (x), currently excludes “any amount raised by the issue of bonds or debentures secured by the mortgage of any immovable property of the Company or with an option to convert them into shares in the Company provided that in the case of such bonds or debentures secured by the mortgage of any immovable property the amount of such bonds or debentures shall not exceed the market value of such immovable property”.


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Companies (Acceptance of Deposits Amendment) Rules, 2013 … This has been substituted as:-

“(x) any amount raised by the issue of bonds or debentures secured by the mortgage of any fixed assets referred to in Schedule VI of the Act excluding intangible assets of the Company or with an option to convert them into shares in the Company:

Provided that in the case of such bonds or debentures secured by the mortgage of any fixed assets referred to in Schedule VI of the Act excluding Intangible assets the amount of such bonds or debentures shall not exceed the market value of such fixed assets"


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Clarification by circular no. 04/2013 dated 11/02/2013:

Sec 117C of The Companies Act, 1956 requires companies to create a Debenture Redemption Reserve (DRR) to which 'adequate amounts' shall be credited out of its 'profits' every year until such debentures are redeemed, and shall utilize the same exclusively for redemption of a particular set or series of debentures only.

The revised requirements with regard to 'adequacy' of debenture redemption reserve (DRR) are as follows:

Debenture Redemption Reserve

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Circular dated 18/04/2002: Circular dated 11/02/2013:

For Manufacturing and Infrastructure Companies, adequacy of DRR:• For public issue: 50% of the

value of debentures• For Privately placed

debentures: 25% of the value of debentures

For Manufacturing and Infrastructure Companies, adequacy of DRR:• For public issue: 25% of the


debentures: 25% of the value of debentures

For NBFCs registered with RBI, adequacy of DRR:• For public issue: 50% of the


debentures: No DRR required

For NBFCs registered with RBI, adequacy of DRR:• For public issue: 25% of the


debentures: No DRR required

Debenture Redemption Reserve…


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Every company required to create/maintain DRR shall before the 30th April of each year, deposit or invest a sum not less than 15% of the amount of its debentures maturing during the year ending on the 31st March next following in any one or more of the following methods:

In deposits with any scheduled bank, free from charge or lien In unencumbered securities of the CG or SG; In unencumbered securities mentioned in clauses (a) to (d)

and (ee) of section 20 of the Indian Trusts Act, 1882; In unencumbered bonds issued by any other company which

is notified under clause (f) of section 20 of the Indian Trusts Act, 1882;



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The amount deposited or invested above shall not be utilized for any purpose other than for the repayment of debentures maturing during the year referred to above, provided that the amount remaining deposited or invested, shall not at any time fall below 15 % of the amount of debentures maturing during the 3lst day of March of that year.


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RBI Circulars


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Realisation of Export Proceeds

Master Circular on Export of Goods and Services dt. 02/07/2012:

Para B.3: “It is obligatory for the exporter to realise and repatriate the full value of goods or software to India within a stipulated period as under: Units in SEZs: No specific time period; Status Holder Exporters: Within12 months from the date of

export; 100 % EOUs: Within12 months from the date of export w.e.f

1/9/2004; Goods exported to a warehouse established outside India: As

soon as it is realised and in any case within 15 months from the date of shipment of goods;

In all other cases: W.e.f 3/6/2008, this period has been enhanced to 12 months from the date of export, till 30/9/2012.”

The relaxation extended w.e.f. 01/10/2012 to 31/3/2013 vide A.P. (DIR Series) Circular No. 52 dated 20/11/2012 issued by RBI.


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Write-off of unrealised export bills

A.P. (DIR Series) Circular No. 88 dated March 12, 2013:

The following liberalization in the limits of “write-offs” of unrealized export bills: Self “write-off” by an exporter (Other than Status

Holder Exporter): 5%* Self “write-off” by Status Holder Exporters: 10%* “Write-off” by Authorized Dealer bank :10%*

*of the total export proceeds realized during the previous calendar year.

The above limits will be related to total export proceeds realized during the previous calendar year and will be cumulatively available in a year.


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Clarification by A. P. (DIR Series) Circular No. 12 dated 31/7/2012 issued by RBI: In terms of Circular No. 124 dated May 10, 2012, it

was stipulated that in respect of all future forex earnings, an exchange earner will be eligible to retain only 50% of the export earnings in EEFC accounts and the balance 50% shall be surrendered for conversion to rupee balances.

It has now been decided that 100 % credit of forex earnings to the EEFC account have to be converted to Rupees before the last day of succeeding month

(after adjusting for utilization of the balances for approved purposes or forward commitments).

Retention of Forex earnings in EEFC account


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Accordingly, balances outstanding in an EEFC account as on July 31, 2012 and those balances that would accrue from August 1, 2012 shall get converted to Rupee balances on or before September 30, 2012.

Similar procedure may be followed for accruals during the subsequent months.

Retention of Forex earnings in EEFC account


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Circular DNBS.CC.PD.NO.265/03.10.01/2011-12, Dated 21.03.2012:NBFCs that are predominantly engaged in lending against the collateral of gold jewellery shall:

Hereafter maintain a Loan-to-Value(LTV) ratio not exceeding 60% for loans granted against the collateral of gold jewellery and

Disclose in their Balance Sheet a % of such loans to their total assets

Those NBFCs having such loans comprising 50% or more of their financial assets shall maintain a minimum Tier I Capital of 12% by April 1, 2014.

NBFCs should not grant any advance against bullion/primary gold and gold coins.

Circulars: NBFC

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Cost Accounting RecordsService TaxDeferred Tax Asset / LiabilityDomestic Transfer Pricing Sec 80 IB / 80 IC

Other Developments in FY 2012-13


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Coverage of certain sectors under Cost Accounting Records

The auditor has to report under CARO 2003, clause 4(viii) as under: “where maintenance of cost records has been

prescribed by the Central Government under clause (d) of sub-section (1) of section 209 of the Act, whether such accounts and records have been made and maintained;”

Every auditor thus needs to verify whether the company is covered by the new Cost Accounting Record Rules, 2011 and if yes whether the prescribed cost records have been maintained.


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Cost Accounting Record Rules, 2011 issued on June 3, 2012 state that:

These rules apply to every Company including a foreign company which is engaged in the production, processing, manufacturing, or mining activities and wherein:

aggregate value of net worth as on the last date of the immediately preceding financial year exceeds five crores of rupees or

the aggregate value of the turnover made by the company from sale or supply of all products or activities during the immediately preceding financial year exceeds twenty crores of rupees or

the company’s equity or debt securities are listed or are in the process of listing on any stock exchange, whether in India or outside India.

Coverage of certain sectors under Cost Accounting Records…


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Coverage of certain sectors under Cost Accounting Records …

The definition of processing activity is very wide. Several industries and sectors now fall in the ambit of these rules. “Processing Activity” includes any act, process,

procedure, function, operation, technique, treatment or method employed in relation to

i. altering the condition or properties of inputs for their use, consumption, sale, transport, delivery or disposal; or

ii. accessioning, arranging, describing, or storing products; or

iii. developing, fixing, and washing exposed photographic or cinematographic film or paper to produce either a negative image or a positive image; or

iv. printing, publishing, finishing, perforation, trimming, cutting, or packaging; or


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Coverage of certain sectors under Cost Accounting Records…v. pumping oil, gas, water, sewage or any other product; or vi. transforming or transmitting, distributing power or electricity; or vii. harboring, berthing, docking, elevating, lading, stripping, stuffing,

towing, handling, or warehousing products; or viii. preserving or storing any product in cold storage; or ix. constructing, reconstructing, reconditioning, repairing, servicing,

refitting, finishing or demolishing of buildings or structures; or x. farming, feeding, rearing, treating, nursing, caring, and stocking of

living organisms; or xi. telecasting, broadcasting, telecommunicating voice, text, picture,

information, data or knowledge through any mode or medium; or xii. obtaining, compiling, recording, maintaining, transmitting, holding

or using the information or data or knowledge; orxiii. executing instructions in memory to perform some transformation

and/or computation on the data in the computer's memory.


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Coverage of certain sectors under Cost Accounting Records…

Every company to which these rules apply, including all units and branches thereof shall, in respect of each of its financial year commencing on or after the 1st day of April, 2011, keep cost records as prescribed by the rules.

All such cost records and cost statements, maintained under these rules shall be reconciled with the audited financial statements for the financial year specifically indicating expenses or incomes not considered in the cost records or statements so as to ensure accuracy and to reconcile the profit of all product groups with the overall profit of the company.


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Service Tax has shifted from positive list to negative list. Earlier services specified in section 65(105) were subject to taxation.

Now this entire approach has changed and every services not specified in the negative list and specifically exempt is subject to service tax.

Also, reverse charge mechanism is implemented. Services where service tax will be payable by person other than service provider are covered in Notification 30/212 dt 20.06.2012 effective from 01.07.2012.

Place Of Provision(POP) Rules, 2012 have been introduced vide Notification No. 28/2012 dated 20.06.2012. w.e.f. 01/07/2012 which help in determining whether a particular service is provided in taxable territory or non taxable territory.

New Service Tax Provisions


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At what rate to measure DTL / DTA for 2012-13?

AS 22 ‘Accounting for Taxes on Income’ states that: “Deferred tax assets and liabilities are usually measured using the tax rates and tax laws that have been enacted. However, certain announcements of tax rates and tax laws by the government may have the substantive effect of actual enactment. In these circumstances, deferred tax assets and liabilities are measured using such announced tax rate and tax laws”.

Thus, Tax rates announced by the Finance Bill 2013 will have to be used for measuring DTA / DTL as on March 31, 2013.

Measurement of DTA / DTL


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Tax Rates for Domestic Company

Income Slab (`) Rate of Tax(%)

Surcharge(%)

EC/SHEC(%)

Effective Rate of Tax (%)

Up to 1crore 30 Nil 3 30.900

1 crore to 10 crore

30 5 3 32.445

Above 10 crore 30 10 3 33.990

Measurement of DTA / DTL …

Tax Rates for Foreign Company

Income Slab (`) Rate of Tax(%)

Surcharge(%)

EC/SHEC(%)

Effective Rate of Tax (%)

Up to 1crore 40 Nil 3 41.200

1 crore to 10 crore 40 2 3 42.024

Above 10 crore 40 5 3 43.260


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Domestic Transfer Pricing

With the advent of the provisions of Domestic transfer pricing, an entity will have to ensure that the disclosures presented under the following requirements do not contradict with each other:

Related Party Disclosures under AS 18

Disclosures under sec 40A(2)(b) and

Disclosures under Domestic Transfer Pricing


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Section 80 IB / 80 IC

The assessees which avail the benefit of Sec 80 IB / 80 IC of the Income Tax Act, 1961 will have to ensure that identical data is presented under disclosures: as per AS 17, Segment Reporting and that presented for sec 80 IB / 80 IC.

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SA 700, 705, 706, 710

Standards on Auditing


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New Standards on Audit

SA Number

Title of SA Old Numbe

r

SA 700 (R) Forming an Opinion and Reporting on FS

AAS 28

SA 705 Modifications to the Opinion in the Independent Auditor’s Report

None

SA 706 Emphasis of Matter Paragraphs and Other Paragraphs in the Independent Auditor’s Report

None

SA 710 (R) Comparative Information – Corresponding Figures and Comparative Financial Information

AAS 25


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New Standards on Audit …

SA Number

Title of SA Old Number

SA 800 Special Considerations-Audits of FS Prepared in Accordance with Special Purpose Framework

None

SA 805 Special Considerations-Audits of Single Purpose FS and Specific Elements, Accounts or Items of a FS

None

SA 806 Engagements to Report on Summary FS

None

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SA 700 (REVISED) FORMING AN OPINION & REPORTING ON FS

Effective for audits of financial statements for periods beginning on or after April 1, 2011

Announcement by ICAI in April 2012 to postpone applicability by one year i.e. April 1, 2012


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Earlier AAS 28 “The Auditors’ Report on FS”

SA 700 (R) deals with: Auditor’s responsibility to form an opinion on

FS Form / Content of auditor’s report issued as a

result of an audit of FSIn the context of general purpose financial statements

To promote consistency in audit reports To promote user’s understanding

Scope


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Auditor’s Objective

Form an opinion on FS based on evaluation of conclusions drawn from audit evidence obtained

AND

Express clearly that opinion through a written report that also describes the basis for opinion


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Definitions

General Purpose Financial Statements (GPFS): FS prepared in accordance with a general

purpose framework

General Purpose Framework: A Financial reporting framework (FRF)

designed to meet common financial information needs of a wide range of users. It may be a fair presentation framework or a compliance framework

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Fair Presentation Vs. Compliance


Fair Presentation Framework

Compliance Framework

Refers to FRF that requires compliance with requirements of the framework

AND

Refers to FRF that requires compliance with requirements of the framework

BUT

Acknowledges that the following may be necessary for fair presentation of FS:• Management may need to provide disclosures beyond those specifically required by FRF• Management may have to depart (in extremely rare situations) from a requirement of framework

Does not contain the acknowledgement as in fair presentation framework


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Issue:

Whether audit conducted under LLP Act would be Fair Presentation Framework or Compliance Framework?

Ans: LLP Act, 2008 read with LLP Rules, 2009 prescribes neither any strict format to maintain the books of accounts nor compliance with any accounting standards.Thus, audit under LLP Act would be a fair presentation framework.

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What is FRF?


FRF not defined in SA 700(R)

Para 22 of SA 700 (AAS 28) mentions: “Paragraph 3 of “Framework of Statements on Standard Auditing Practices and Guidance Notes on Related Services”, issued by the ICAI, discusses the financial reporting framework. The paragraph reads as under:

“Financial statements are ordinarily prepared and presented annually and are directed towards the common information needs of a wide range of users. Many of those users rely on FS as their major source of information because they do not have the power to obtain additional information to meet their specific information needs.”


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What is FRF? …

Thus, FS need to be prepared in accordance with one, or a combination of:

(a) relevant statutory requirements, e.g., the Companies Act, 1956, (b) Accounting Standards issued by ICAI; and(c) other recognised accounting principles and

practices, e.g., those recommended in the Guidance Notes issued by the ICAI”

The above Framework issued in 2001 has been withdrawn pursuant to the issuance of the “Framework for Assurance Engagements”, by the ICAI in July, 2007 which doesn’t define FRF.

What are the implications of the above ??


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Definitions …

Financial Statements (FS): Complete set of general purpose FS including related notes

which include Significant accounting policies and Other Explanatory Information

FRF determines what constitutes complete set of FS Unmodified Opinion:

Opinion expressed when the auditor concludes that the FS are prepared, in all material respects, in accordance with FRF.

Financial Reporting Standards means: AS promulgated by ICAI AS notified by Companies (AS) Rules, 2006 AS for Local Bodies promulgated by ICAI


69

Issue:

Whether audit conducted under Income Tax Act to be considered as General Purpose Financial Statements (GPFS)?

Ans: It is to be considered GPFS and SA 700 to be applied for audits for which we issue form 3CB.Footnote 9 to SA 800 states that “In India, financial statements prepared for filing with income tax authorities are considered to be general purpose financial statements.”

ICAI has however postponed the application of SA 700 (R) for Form 3CB upto 31st March 2014


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Forming an Opinion on FS

SA 700(R) requires the auditor to form an opinion on whether the FS are prepared in all material respects in accordance with the applicable FRF

To form that opinion, auditor to conclude, whether reasonable assurance has been obtained that the FS as a whole are free from material misstatement, whether due to fraud or error


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Forming an Opinion on FS …

The conclusion shall take into account: whether Sufficient Appropriate Audit Evidence (SAAE)

has been obtained in accordance with SA 330; whether uncorrected misstatements are material,

individually or in aggregate in accordance with SA 450;

The required evaluations are: Whether all material requirements of the applicable FRF

have been followed including consideration of qualitative aspects of entity’s accounting practices, indicators of possible bias in management’s judgements;


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Whether, in view of the requirements of the applicable FRF: The FS adequately disclose significant accounting

policies selected and applied; The accounting policies selected and applied are

consistent with the applicable FRF and are appropriate; The accounting estimates made by management are

reasonable; The information presented in the FS is relevant, reliable,

comparable and understandable; The FS provide adequate disclosures to enable the

intended users to understand the effect of material transactions and events on the information conveyed in the FS and

The terminology used in FS including the title is appropriate.


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When the FS are prepared in accordance with a fair presentation framework, evaluation to also include: Whether the FS achieve fair presentation by

considering the following: The overall presentation, structure and content of the

FS; and Whether the FS, including the related notes,

represent the underlying transactions and events in a manner that achieve fair presentation.

Whether the FS adequately refer to or describe the applicable FRF.


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Form of Opinion

The auditor shall express an unmodified opinion when the auditor concludes that the FS are prepared, in all material respects, in accordance with the applicable FRF.

The auditor shall modify the opinion in the auditor’s report in accordance with SA 705 if he:

concludes that, based on the audit evidence obtained, the financial statements as a whole are not free from material misstatement; or

is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement.


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Form of Opinion …

If FS prepared in accordance with the requirements of a fair presentation framework do not achieve fair presentation: the auditor shall discuss the matter with management

and, depending on the requirements of the applicable FRF

and how the matter is resolved, shall determine whether it is necessary to modify the opinion in the auditor’s report in accordance with SA 705.

When the FS are prepared in accordance with a compliance framework, the auditor is not required to evaluate whether the FS achieve fair presentation. However, if in extremely rare circumstances if he

concludes that such FS are misleading, the auditor shall discuss the matter with management and, depending on how it is resolved, shall determine whether, and how, to communicate it in the auditor’s report.


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Auditor’s Report

Elements of Audit Report *: Title Addressee Introductory Paragraph Management’s Responsibility for the FS Auditor’s Responsibility Auditor’s Opinion Other Reporting Responsibilities Signature of the Auditor Date of Auditor’s Report Place of Signature

* To be given in writing


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Auditor’s Report …

Title:

Independent Auditor’s Report It affirms that auditor has met all ethical

requirements w.r.t. independence It distinguishes AR from reports issued by others

Addressee:

Applicable law and regulation may specify “addressee”

Audit Report normally addressed to those for whom it is prepared – shareholders / Those charged with governance


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Introductory Para

Identify the entity whose FS have been audited

State that FS have been audited Identify title of each statement that comprises

FS (each statement forming part of FS to be named here)

Refer to summary of significant accounting policies and other explanatory information

Specify date or period covered by each FS


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Management’s Responsibility for the FS

Describe responsibility of those persons in the entity responsible for preparation of FS (SA 200).

Can be referred as ‘management’s’ or ‘Those charged with Governance’ (TCWG)

To describe the responsibility in the manner in which the same is described in the terms of the audit engagement

Responsibility to include … (next slide)


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Description to include: an explanation that management is responsible for

the preparation of the FS Designing, implementation and maintenance of

internal controls relevant to preparation of FS that are free from material misstatement, whether due to fraud or error.

Where the FS are prepared in accordance with a fair presentation framework, the explanation of management’s responsibility for the FS in the auditor’s report shall refer to “the preparation and fair presentation of these FS” or “the preparation of FS that give a true and fair view”, as appropriate in the circumstances.


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Auditor’s Responsibility

The auditor’s report shall state the following: the responsibility of the auditor is to express an

opinion on the financial statements based on the audit

the audit was conducted in accordance with SAs issued by ICAI and that the SAs require the auditor to:

Comply with ethical requirements plan and perform the audit to obtain

reasonable assurance about whether the financial statements are free from material misstatement


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Auditor’s Responsibility … The report shall describe an audit by stating that:

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the FS;

The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error.

In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. (phrase to be omitted if so required)


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Auditor’s Responsibility … Audit also includes evaluation of :

Appropriateness of accounting policies used; Reasonableness of management’s accounting estimates;

and Overall presentation of FS

Where the FS are prepared in accordance with a fair presentation framework, the description of the audit in the auditor’s report shall refer to “the entity’s preparation of FS that give T&F view”

The auditor’s report shall state whether the auditor believes that the audit evidence the auditor has obtained is sufficient and appropriate to provide a basis for the auditor’s opinion.


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Auditor’s Opinion Unmodified opinion expressed as :

In case of Fair Presentation framework: FS present fairly, in all material respects, in

accordance with {applicable FRF}

Or FS give a True & Fair view of in accordance

with {applicable FRF}

In case of Compliance framework: FS are prepared, in all material respects, in

accordance with {applicable FRF}


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Other Reporting Responsibilities

If the auditor addresses other reporting responsibilities in the auditor’s report on the FS that are in addition to the auditor’s responsibility under the SAs to report on the FS, these other reporting responsibilities shall be addressed in a separate section in the auditor’s report that shall be sub-titled “Report on Other Legal and Regulatory Requirements,” or otherwise as appropriate to the content of the section. For e.g. CARO requirements


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Other Reporting Responsibilities…

Format of Audit Report if it contains a separate section on other reporting responsibilities: Title Addressee Report on FS

Introductory Para Management Responsibility for FS Auditor’s Responsibility Auditor’s Opinion

Report on Other Legal & Regulatory Requirements


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Signature of Auditor

Audit Report to be signed in auditor’s personal name

Where firm appointed as auditor, report signed in personal name and in name of audit firm

Also, mention membership number issued by ICAI

Include, wherever applicable, the registration number of the firm, allotted by the ICAI


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Implementation Guide on SA 700 issued by ICAI mentions:Q. 21 Where a firm is appointed as auditor, the suggested manner to sign would be:For XYZ and CoChartered AccountantsFirm’s Registration Number

SignatureName of signing memberDesignation (Partner / Proprietor)Membership NumberPlace and Date:



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Date of Audit Report: Not earlier than date on which auditor has obtained sufficient & appropriate audit evidence on which to base auditor’s opinion.

It informs users that auditor has considered effect of events and transactions that occurred upto that date

Place of Signature: The auditor’s report shall name specific location, which is ordinarily the city where the audit report is signed.


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Auditor’s Report prescribed by any Law or Regulation

If the prescribed terms are significantly different from the requirements of SAs, SA 210 requires the auditor to evaluate whether users might misunderstand the assurance

obtained from the audit, and if so, whether providing additional explanation in the

auditor’s report can mitigate such misunderstanding. If the additional explanation in his report cannot

mitigate possible misunderstanding, SA 210 requires the auditor not to accept the audit engagement.


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Auditor’s Report prescribed by any Law or Regulation… If the applicable law or regulation compels an

auditor to accept such an engagement, then as per SA 210, such an audit does not comply with the SAs.

When reporting on such audits, the auditor does not include any reference to the audit having been conducted in accordance with the SAs in his Auditor’s Report

Auditor’s Report, in this case, to refer to Standards on Auditing only if it at minimum includes all elements as described by SA 700(R).


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What is different from SA 700 (AAS 28) and current audit reports? SA 700 lays down very specific formats,

title and manner of audit reports All reports now required to adhere to the

revised formats Revised reporting applicable even to Tax

Audit report in Form 3CB (or reports under other statutes where audits are carried out of GPFS)

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SA 705 MODIFICATIONS TO THE OPINION IN THE INDEPENDENT

AUDITOR’S REPORT




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Scope

SA 705 deals with the auditor’s responsibility to issue an appropriate report in circumstances when, in forming an opinion in accordance with SA 700(R), the auditor concludes that a modification to the auditor’s opinion on the financial statements is necessary.


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Types of Modified Opinion

SA establishes 3 types of modified opinions: Qualified Opinion Adverse Opinion Disclaimer of Opinion

Decision on which type of modified opinion is appropriate depends on: Nature of matter giving rise to the modification i.e.

whether the FS are materially misstated or in case of inability to obtain SAAE maybe materially misstated

And Auditor’s Judgement about the pervasiveness of the

effects or possible effects of the matter on the FS


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Definitions

Pervasive: In context of misstatements, to describe effects or possible effects on FS that are undetected due to an inability to obtain SAAE. Pervasive effects are those that, in the auditor’s judgment:

Are not confined to specific elements, accounts or items of the FS;

If so confined, represent or could represent a substantial proportion of the FS

In relation to disclosures, are fundamental to users’ understanding of the FS


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Report with Modified Opinion…

Circumstances when modification to Opinion is required:The auditor concludes that based on the audit evidence obtained, the FS as a whole are not free from material misstatement. The same may be due to: Appropriateness of the selected accounting

policies: Not consistent with applicable FRF; FS do not represent underlying transactions and

events in a manner that achieves fair presentation;


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Report with Modified Opinion…Circumstances when modification to Opinion is required: … Appropriateness of adequacy of disclosures in FS

FS do not include all disclosures required by applicable FRF; Disclosures not presented as per applicable FRF; FS do not contain disclosures necessary to achieve fair

presentation Inability to obtain SAAE

Circumstances beyond control of entity; (e.g. records destroyed or seized by authorities)

Circumstances relating to nature of timing of auditor’s work; (e.g. timing such that physical inventory cannot be taken )

Limitations imposed by management (e.g. auditors prevented from obtaining external confirmations, etc.)


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Determining Type of Modification

Nature of Matter giving rise to the Modification

Auditor’s Judgement about the Pervasiveness of the effects or possible effects on the FS

Material but not Pervasive

Material and Pervasive

• FS are materially misstated

Qualified Opinion Adverse Opinion

• Inability to obtain SAAE

Qualified Opinion Disclaimer of OpinionThe auditor shall disclaim an opinion when, in extremely

rare circumstances involving multiple uncertainties, the auditor concludes that, notwithstanding having obtained SAAE regarding each of the individual uncertainties, it is not possible to form an opinion on the FS due to the potential interaction of the uncertainties and their possible cumulative effect on the FS.


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Limitation after accepting Engagement

Auditor accepts

Engagement

Management imposes Limitation

Likely to result in

Qualification/Disclai

mer

Request Manageme

nt to remove

Limitation

Manageme

nt refuse

s

Communicate to Those

Charged with

Governance

Determine the possibility of performing alternative

procedures to obtain sufficient &

appropriate audit evidence

Unable to obtain SAAE

Determine possible

effect on FS

Material but not Pervasive

Material & Pervasive

Qualify the Opinion

Resign, if not possible, Disclaim

the opinion


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Form & Content of the Auditor’s Report

Basis of Modification Para

In addition to other elements as per SA 700 (R), amend Auditor’s Responsibility statement and provide description of matter giving rise to modification

It is to be placed immediately before the Opinion para with the heading “Basis for Modified Opinion”


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Description in Basis of Modification ParaCause of Modification Description in Basis of Modification

Para

a. Material Misstatement of FS relating to Specific amounts in FS

• Description & Quantification of financial effects of misstatements unless impracticable

• If it is impracticable to quantify the financial effects, state so.

b. Material misstatements of FS relating to narrative disclosures

Explanation of how disclosures are misstated

c. Material misstatement of FS relating to non-disclosure of information required to be disclosed

• Nature of omitted information• Include omitted disclosures if

• Not prohibited by law or regulation• It is practicable to do so• Sufficient & appropriate audit

evidence has been obtained about omitted information

d. Inability to obtain SAAE The reasons for that inability


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Auditor’s Opinion

Qualified Opinion is expressed as:

Except for the effects of the matter(s) described in the basis for qualified opinion para

In case of Fair Presentation framework: The FS present fairly, in all material respects (or give

a true & fair view) in accordance with the {applicable FRF}

In case of Compliance framework: The FS have been prepared, in all material respects in

accordance with the {applicable FRF}


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Auditor’s Opinion…

Adverse Opinion is expressed as: In the auditor’s opinion, because of the significance

of the matter(s) described in the Basis of Adverse Opinion para

In case of Fair Presentation framework: The FS do not present fairly, in all material respects (or

give a true & fair view) in accordance with the {applicable FRF}

In case of Compliance framework: The FS have not been prepared, in all material respects

in accordance with the {applicable FRF}


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Auditor’s Opinion…

Disclaimer of Opinion is expressed as:

Because of the significance of the matter(s) described in the Basis for Disclaimer of Opinion para, the auditor has not been able to obtain SAAE to provide a basis for an audit opinion & accordingly, the auditor does not express an opinion on the FS.


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Description of Auditor’s Responsibility

When the auditor expresses a qualified or adverse opinion:

the auditor shall amend the description of the auditor’s responsibility to state that the auditor believes that the audit evidence the auditor has obtained is sufficient and appropriate to provide a basis for the auditor’s modified audit opinion.

When the Auditor Disclaims an Opinion: The auditor shall amend the introductory paragraph of the auditor’s

report to state that the auditor was engaged to audit the FS Also, amend the description of the auditor’s responsibility: “Because of the matter(s) described in the Basis for

Disclaimer of Opinion paragraph, we were not able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion”


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Issue:

Whether Basis for Qualified Opinion paragraph to be stated in bold or italics?

SA 705 doesn’t require to highlight the modification. However, if the applicable statute requires the auditor to highlight the same, it should be so presented.

Thus, for audits under Companies Act, the qualification will have to be presented in bold or italics.


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What is different from current audit reports? SA 705 lays down very specific manner

in issuing modified audit reports Circumstances in which modified reports

need to be issued very clearly laid down There are several illustrations in the SA

and Implementation guide giving manner of issuing modified reports under revised SA.

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SA 706 EMPHASIS OF MATTER PARAGRAPHS AND OTHER

PARAGRAPHS IN THE INDEPENDENT AUDITOR’S REPORT




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Scope

This Standard deals with additional communication in the Auditor’s Report when auditor considers necessary to draw user’s attention to:

Matter(s) presented or disclosed in FS are of such importance that they are fundamental to user’s understanding of FS

Or Matter(s) other than those presented or disclosed in

FS that are relevant to user’s understanding of audit or auditor’s responsibilities or audit report


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Definitions

Emphasis of Matter Paragraph (EOM):

A paragraph included in the auditor’s report that refers to a matter appropriately presented or disclosed in the financial statements that, in the auditor’s judgment, is of such importance that it is fundamental to users’ understanding of the financial statements


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Definitions…

Other Matter Paragraph (OM):

A paragraph included in the auditor’s report that refers to a matter other than those presented or disclosed in the financial statements that, in the auditor’s judgment, is relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report.


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Requirements w.r.t EOM para

Auditor should obtain SAAE evidence that the matter is not materially misstated in the FS

EOM para shall refer only to information presented or disclosed in the FS

Widespread use of EOM para diminishes the effectiveness of the auditor’s communication of such matters, by implying that matter has not been appropriately presented or disclosed in FS


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Requirements w.r.t EOM para…

EOM paragraph is not a substitute for Need for expression of qualified opinion,

adverse opinion or Disclaimer of opinion; Disclosures to be made by the management in

FS as required by applicable FRF.

Placement: immediately after Opinion para

Heading: “Emphasis of Matter” or other appropriate heading to be used


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Requirements w.r.t EOM para…

EOM para must include a clear reference to

Matter being emphasised Where relevant, disclosure that fully

describes the matter can be found in FS Indicate that audit opinion is not modified in

respect of matter emphasised


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Circumstances to include EOM para in Auditor’s Report

An uncertainty relating to the future outcome of an exceptional litigation or regulatory action.

Early application (where permitted) of a new accounting standard that has a pervasive effect on the FS in advance of it’s effective date

A major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position.


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Requirements w.r.t OM para

Heading: Other Matter or other appropriate heading

Placement: Immediately after Opinion para and any EOM para; or elsewhere if content of other matter para is relevant to Other Reporting Responsibilities section.

Any matter can be included in this para provided not prohibited by Law and Regulation


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Communication to TCWG

If the auditor expects to include an EOM or OM paragraph in the auditor’s report, the auditor shall communicate with TCWG regarding this expectation and the proposed wording of this paragraph

Spot the auditor in the picture?

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SA 710 (R) COMPARATIVE INFORMATION – CORRESPONDING FIGURES AND

COMPARATIVE FINANCIAL STATEMENTS




120

Scope

The SA deals with the auditor’s responsibilities regarding comparative information in an audit of FS.

The nature of the comparative information that is presented in an entity’s FS depends on the requirements of the applicable FRF. There are two different broad approaches to the auditor’s reporting responsibilities in respect of such comparative information: corresponding figures and comparative FS.

This SA addresses separately the auditor’s reporting requirements for each approach.

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Definitions


Comparative information (CI) – The amounts and disclosures included in the FS in respect of one or more prior periods in accordance with the applicable FRF.

Corresponding Figures Comparative FS

Definition

CI where amounts and other disclosures for the prior period are included as an integral part of the current period FS, and are intended to be read only in relation to the amounts and other disclosures relating to the current period

CI where amounts and other disclosures for the prior period are included for comparison with the FS of the current period but, if audited, are referred to in the auditor’s opinion.

Level of Detail

dictated primarily by its relevance to the current period figures.

comparable with that of the FS of the current period.

Audit Reporting

the auditor’s opinion on the FS refers to the current period only

the auditor’s opinion refers to each period for which FS are presented


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Audit Procedures

The auditor shall determine whether the FS include the CI required by the applicable FRF and whether such information is appropriately classified. For this purpose, the auditor shall evaluate whether: The CI agrees with the amounts and other

disclosures presented in the prior period; and The accounting policies reflected in the CI are

consistent with those applied in the current period or, if there have been changes in accounting policies, whether those changes have been properly accounted for and adequately presented and disclosed.


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Audit Procedures…

If the auditor becomes aware of a possible material misstatement in the CI while performing the current period audit, the auditor shall perform such additional audit procedures as are necessary in the circumstances to obtain SAAE to determine whether a material misstatement exists.

If the auditor had audited the prior period’s FS, the auditor shall also follow the relevant requirements of SA 560 (R).

As required by SA 580 (R), the auditor shall request written representations for all periods referred to in the auditor’s opinion.

The auditor shall also obtain a specific written representation regarding any prior period item that is separately disclosed in the current year’s statement of profit and loss


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Audit Reporting for Corresponding Figures

When corresponding figures are presented, the auditor’s opinion shall not refer to the corresponding figures except in the circumstances described as under:

1. If the auditor’s report on the prior period, as previously issued, included a modification which is unresolved, the auditor shall modify his opinion on the current period’s FS.

In the Basis for Modification paragraph in the auditor’s report, he shall either:

Refer to both the current period’s figures and the corresponding figures in the Basis for modification para when the effects or possible effects of the matter on the current period’s figures are material; OR

In other cases, explain that the audit opinion has been modified because of the effects or possible effects of the unresolved matter on the comparability of the current period’s figures and the corresponding figures


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Audit Reporting for Corresponding Figures…2. If the auditor obtains audit evidence that a material misstatement exists in the prior period FS on which an unmodified opinion has been previously issued:

The auditor shall verify whether the misstatement has been dealt with as required under the applicable FRF and, if that is not the case, the auditor shall express a qualified opinion or an adverse opinion in the auditor’s report on the current period FS, modified with respect to the corresponding figures included therein.


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Audit Reporting for Corresponding Figures…3. If FS of prior period were audited by a predecessor auditor, and the auditor is allowed and decides to refer to the predecessor auditor’s report for the corresponding figures:

Then the auditor shall state in an OM para that the FS of the prior period were audited by the predecessor auditor, the type of opinion expressed by him along with the reasons for the same and the date of that report.

4. If the FS of prior period were not audited:The auditor shall state in an OM para that the corresponding figures are unaudited. However, it will not relieve the auditor from obtaining SAAE that the opening balances do not contain material misstatements that materially affect current period’s FS.

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Issues in CARO


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Introduction

Increased focus on role of auditor in recent times due to some wrong and some ‘right’ reasons

Audit consists of 3 major activities:a) Conduct of the audit (using SAs)b) Ensuring compliance of ASc) Ensuring adequate disclosure as per

statute, AS, etc. Focus in Audit has to shift to (a) to

conduct effective audits.


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Conclusion

Companies Bill 2012 lays done several additional restrictions, responsibilities and penalties for an auditor, penalties, etc. (including class action suits)

Globally also, auditor role and reporting is undergoing a change

Audits are becoming very challenging Adequate and advance planning necessary for

proper conduct of audit If proper audits not done, auditor will have to face

FRRB, QRB, NFRA, etc.


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Documents

AUDIT OF FINANCIAL STATEMENTS 2012-13: REVISED REPORTING REQUIREMENTS & OTHER IMPORTANT ISSUES Himanshu Kishnadwala 09 Aug 2013