Application and Other Explanatory Material
Scope of this SA (Ref: Para. 1)
A1. Assurance engagements, which include audit engagements, may only be accepted when the practitioner considers that relevant ethical requirements such as independence and professional competence will be satisfied, and when the engagement exhibits certain characteristics9. The auditor’s responsibilities in respect of ethical requirements in the context of the acceptance of an audit engagement and in so far as they are within the control of the auditor are dealt with in SA 22010. This SA deals with those matters (or preconditions) that are within the control of the entity and upon which it is necessary for the auditor and the entity’s management to agree.
Preconditions for an Audit
The Financial Reporting Framework (Ref: Para. 6(a))
A2. A condition for acceptance of an assurance engagement is that the criteria referred to in the definition of an assurance engagement are suitable and available to intended users11. Criteria are the benchmarks used to evaluate or measure the subject matter including, where relevant, benchmarks for presentation and disclosure. Suitable criteria enable reasonably consistent evaluation or measurement of a subject matter within the context of professional judgment. For purposes of the SAs, the applicable financial reporting framework provides the criteria the auditor uses to audit the financial statements, including where relevant their fair presentation. 7 SA 706(Revised). 8 SA 700(Revised), “Forming an Opinion and Reporting on Financial Statements”, paragraph 49. 9 “Framework for Assurance Engagements,” paragraph 16. 10 SA 220, paragraphs 9-11. 11 “Framework for Assurance Engagements,” paragraph 16(b)(ii).
A3. Without an acceptable financial reporting framework, management does not have an appropriate basis for the preparation of the financial statements and the auditor does not have suitable criteria for auditing the financial statements. In many cases the auditor may presume that the applicable financial reporting framework is acceptable, as described in paragraphs A8-A9.
Determining the Acceptability of the Financial Reporting Framework
A4. Factors that are relevant to the auditor’s determination of the acceptability of the financial reporting framework to be applied in the preparation of the financial statements include: ● The nature of the entity (for example, whether it is a business enterprise, or a not for profit organization); ● The purpose of the financial statements (for example, whether they are prepared to meet the common financial information needs of a wide range of users or the financial information needs of specific users); ● The nature of the financial statements (for example, whether the financial statements are a complete set of financial statements or a single financial statement); and ● Whether law or regulation prescribes the applicable financial reporting framework.
A5. Many users of financial statements are not in a position to demand financial statements tailored to meet their specific information needs. While all the information needs of specific users cannot be met, there are financial information needs that are common to a wide range of users. Financial statements prepared in accordance with a financial reporting framework designed to meet the common financial information needs of a wide range of users are referred to as general purpose financial statements.
A6. In some cases, the financial statements will be prepared in accordance with a financial reporting framework designed to meet the financial information needs of specific users. Such financial statements are referred to as special purpose financial statements. The financial information needs of the intended users will determine the applicable financial reporting framework in these circumstances. SA 800 discusses the acceptability of financial reporting frameworks designed to meet the financial information needs of specific users.12
A7. Deficiencies in the applicable financial reporting framework that indicate that the framework is not acceptable may be encountered after the audit 12 SA 800, “Special Considerations-Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks”, paragraph 8. engagement has been accepted. When use of that framework is prescribed by law or regulation, the requirements of paragraphs 19-20 apply. When use of that framework is not prescribed by law or regulation, management may decide to adopt another framework that is acceptable. When management does so, as required by paragraph 16, new terms of the audit engagement are agreed to reflect the change in the framework as the previously agreed terms will no longer be accurate.
General purpose frameworks
A8. At present, there is no objective and authoritative basis that has been generally recognised globally for judging the acceptability of general purpose frameworks. In the absence of such a basis, financial reporting standards established by organizations that are authorised or recognised to promulgate standards to be used by certain types of entities are presumed to be acceptable for general purpose financial statements prepared by such entities, provided the organizations follow an established and transparent process involving deliberation and consideration of the views of a wide range of stakeholders. Examples of such financial reporting standards include: Accounting Standards issued by the Institute of Chartered Accountants of
India (ICAI) and/ or Accounting Standards, notified by the Central
Government by publishing the same as the Companies (Accounting
Standards) Rules, 2006, as may be applicable; Accounting Standards for Local Bodies issued by the Institute of Chartered Accountants of India (ICAI);
International Financial Reporting Standards (IFRSs) issued by the
International Accounting Standards Board; and
International Public Sector Accounting Standards (IPSASs) issued by the International Public Sector Accounting Standards Board. These financial reporting standards are often identified as the applicable financial reporting framework in law or regulation governing the preparation of general purpose financial statements.
Financial reporting frameworks prescribed by law or regulation
A9. In accordance with paragraph 6(a), the auditor is required to determine whether the financial reporting framework, to be applied in the preparation of the financial statements, is acceptable. Appendix 2 contains guidance on determining the acceptability of the financial reporting framework. In case of some entities, law or regulation may prescribe the financial reporting framework to be used in the preparation of general purpose financial statements. In the absence of indications to the contrary, such a financial reporting framework is presumed to be acceptable for general purpose financial statements prepared by such entities. In the event that the framework is not considered to be acceptable, paragraphs 19-20 apply.
Agreement of the Responsibilities of Management (Ref: Para. 6(b))
A10. An audit in accordance with SAs is conducted on the premise that management has acknowledged and understands that it has the responsibilities set out in paragraph 6(b)13. In case of certain entities, such responsibilities may be specified in the applicable law or regulation. In others, there may be little or no legal or regulatory definition of such responsibilities. SAs do not override law or regulation in such matters. However, the concept of an independent audit requires that the auditor’s role does not involve taking responsibility for the preparation of the financial statements or for the entity’s related internal control, and that the auditor has a reasonable expectation of obtaining the information necessary for the audit in so far as management is able to provide or procure it. Accordingly, the premise is fundamental to the conduct of an independent audit. To avoid misunderstanding, agreement is reached with management that it acknowledges and understands that it has such responsibilities as part of agreeing and recording the terms of the audit engagement in paragraphs 9-12.
A11. The way in which the responsibilities for financial reporting are divided between management and those charged with governance will vary according to the resources and structure of the entity and any relevant law or regulation, and the respective roles of management and those charged with governance within the entity. In most cases, management is responsible for execution while those charged with governance have oversight of management. In some cases, those charged with governance will have, or will assume, responsibility for approving the financial statements or monitoring the entity’s internal control related to financial reporting. In larger or public entities, a subgroup of those charged with governance, such as an audit committee, may be charged with certain oversight responsibilities.
A12. SA 580 requires the auditor to request management to provide written representations that it has fulfilled certain of its responsibilities14. It may therefore be appropriate to make management aware that receipt of such written representations will be expected, together with written representations required by other SAs and, where necessary, written representations to support other audit evidence relevant to the financial statements or one or more specific assertions in the financial statements. 13 SA 200, Paragraph A2. 14 SA 580, “Written Representations”, paragraphs 10-11.
A13. Where management will not acknowledge its responsibilities, or agree to provide the written representations, the auditor will be unable to obtain sufficient appropriate audit evidence15. In such circumstances, it would not be appropriate for the auditor to accept the audit engagement, unless law or regulation requires the auditor to do so. In cases where the auditor is required to accept the audit engagement, the auditor may need to explain to management the importance of these matters, and the implications for the auditor’s report.
Preparation of the Financial Statements (Ref: Para. 6(b)(i))
A14. Most financial reporting frameworks include requirements relating to the presentation of the financial statements; for such frameworks, preparation of the financial statements in accordance with the financial reporting framework includes presentation. In the case of a fair presentation framework the importance of the reporting objective of fair presentation is such that the premise agreed with management includes specific reference to fair presentation, or to the responsibility to ensure that the financial statements will “give a true and fair view” in accordance with the financial reporting framework.
Internal Control (Ref: Para. 6(b)(ii))
A15. Management maintains such internal control as it determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. Internal control, no matter how effective, can provide an entity with only reasonable assurance about achieving the entity’s financial reporting objectives due to the inherent limitations of internal control16.
A16. An independent audit conducted in accordance with the SAs does not act as a substitute for the maintenance of internal control necessary for the preparation of financial statements by management. Accordingly, the auditor is required to obtain the agreement of management that it acknowledges and understands its responsibility for internal control. However, the agreement required by paragraph 6(b)(ii) does not imply that the auditor will find that internal control maintained by management has achieved its purpose or will be free of deficiencies.
A17. It is for management to determine what internal control is necessary to enable the preparation of the financial statements. The term “internal control” encompasses a wide range of activities within components that may be described as the control environment; the entity’s risk assessment process; the 15 SA 580, paragraph A26. 16 SA 315, “Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment,” paragraph A52. information system, including the related business processes relevant to financial reporting, and communication; control activities; and monitoring of controls. This division, however, does not necessarily reflect how a particular entity may design, implement and maintain its internal control, or how it may classify any particular component.17 An entity’s internal control (in particular, its accounting books and records, or accounting systems) will reflect the needs of management, the complexity of the business, the nature of the risks to which the entity is subject, and relevant laws or regulation.
A18. In some cases, law or regulation may refer to the responsibility of management for the adequacy of accounting books and records, or accounting systems. For example, in case of listed companies under the Companies Act, 2013 in India, the directors are required to lay down internal financial controls to be followed by the company and also ensure that they are adequate and operate effectively. The illustrative format of the engagement letter for audit of financial statements under the Companies Act, 2013 describes these responsibilities. See Appendix I.18 In some other cases, general practice may assume a distinction between accounting books and records or accounting systems on the one hand, and internal control or controls on the other. As accounting books and records, or accounting systems, are an integral part of internal control as referred to in paragraph A17, no specific reference is made to them in paragraph 6(b)(ii) for the description of the responsibility of management. To avoid misunderstanding, it may be appropriate for the auditor to explain to management the scope of this responsibility.
Additional Information (Ref: Para. 6(b)(iii)(b))
A19. Additional information that the auditor may request from management for the purpose of the audit may include when applicable, matters related to other information in accordance with SA 720(Revised). When the auditor expects to obtain other information after the date of the auditor’s report, the terms of the audit engagement may also acknowledge the auditor’s responsibilities relating to such other information including, if applicable, the actions that may be appropriate or necessary if the auditor concludes that a material misstatement of the other information exists in other information obtained after the date of the auditor’s report.
Considerations Relevant to Smaller Entities (Ref: Para. 6(b))
A20. One of the purposes of agreeing the terms of the audit engagement is to avoid misunderstanding about the respective responsibilities of management and 17 SA 315, paragraph A57 and Appendix 1. 18 The underlined text has been added pursuant to the decision of the Council of ICAI taken at its 350th meeting held in February 2016. the auditor. For example, when a third party has assisted with the preparation of the financial statements, it may be useful to remind management that the preparation of the financial statements in accordance with the applicable financial reporting framework remains its responsibility.
Agreement on Audit Engagement Terms
Agreeing the Terms of the Audit Engagement (Ref: Para. 9)
A21. The roles of management and those charged with governance in agreeing the terms of the audit engagement for the entity depend on the governance structure of the entity and relevant law or regulation. Audit Engagement Letter or Other Form of Written Agreement19 (Ref: Para. 10-11)
A22. It is in the interests of both the entity and the auditor that the auditor sends an audit engagement letter before the commencement of the audit to help avoid misunderstandings with respect to the audit. In some entities, however, the objective and scope of an audit and the responsibilities of management and of the auditor may be sufficiently established by law, that is, they prescribe the matters described in paragraph 10. Although in these circumstances paragraph 11 permits the auditor to include in the engagement letter only reference to the fact that relevant law or regulation applies and that management acknowledges and understands its responsibilities as set out in paragraph 6(b), the auditor may nevertheless consider it appropriate to include the matters described in paragraph 10 in an engagement letter for the information of management.
Form and Content of the Audit Engagement Letter
A23. The form and content of the audit engagement letter may vary for each entity. Information included in the audit engagement letter on the auditor’s responsibilities may be based on SA 20020. Paragraphs 6(b) and 12 of this SA deal with the description of the responsibilities of management. In addition to including the matters required by paragraph 10, an audit engagement letter may make reference to, for example: ● Elaboration of the scope of the audit, including reference to applicable legislation, regulations, SAs, and ethical and other pronouncements of professional bodies to which the auditor adheres. ● The form of any other communication of results of the audit engagement. 19 In the paragraphs that follow, any reference to an audit engagement letter is to be taken as a reference to an audit engagement letter or other suitable form of written agreement. 20 SA 200, paragraph 3-9. ● The requirement for the auditor to communicate key audit matters in the auditor’s report in accordance with SA 70121. ● The fact that because of the inherent limitations of an audit, together with the inherent limitations of internal control, there is an unavoidable risk that some material misstatements may not be detected, even though the audit is properly planned and performed in accordance with SAs. ● Arrangements regarding the planning and performance of the audit, including the composition of the audit team. ● The expectation that management will provide written representations (see also paragraph A13). ● The agreement of management to make available to the auditor draft financial statements and any accompanying other information in time to allow the auditor to complete the audit in accordance with the proposed timetable. ● The agreement of management to inform the auditor of facts that may affect the financial statements, of which management may become aware during the period from the date of the auditor’s report to the date the financial statements are issued. ● The basis on which fees are computed and any billing arrangements. ● A request for management to acknowledge receipt of the audit engagement letter and to agree to the terms of the engagement outlined therein. ● The fact that the audit process may be subjected to a peer review under the Chartered Accountants Act, 1949.
A24. When the auditor is not required to communicate key audit matters, it may be helpful for the auditor to make reference in the terms of the audit engagement to the possibility of communicating key audit matters in the auditor’s report and, in certain jurisdictions, it may be necessary for the auditor to include a reference to such possibility in order to retain the ability to do so.
A25. When relevant, the following points could also be made in the audit engagement letter: ● Arrangements concerning the involvement of other auditors and experts in some aspects of the audit. ●
Arrangements concerning the involvement of internal auditors and other
staff of the entity. ● Arrangements to be made with the predecessor auditor, if any, in the case of an initial audit. 21 SA 701, “Communicating key audit matters in the independent auditor’s report”. ● Any restriction of the auditor’s liability when such possibility exists. ● A reference to any further agreements between the auditor and the entity. ● Any obligations to provide audit working papers to other parties. An example of an audit engagement letter is set out in Appendix 1.
A26. When the auditor of a parent entity is also the auditor of a component, the factors that may influence the decision whether to send a separate audit engagement letter to the component include the following: ● Who appoints the component auditor; ● Whether a separate auditor’s report is to be issued on the component; ● Legal requirements in relation to audit appointments; ●
Degree of ownership by parent; and
Degree of independence of the component management from the parent
entity. Responsibilities of Management Prescribed by Law or Regulation (Ref: Para. 11- 12)
A27. If, in the circumstances described in paragraphs A23 and A29, the auditor concludes that it is not necessary to record certain terms of the audit engagement in an audit engagement letter, the auditor is still required by paragraph 11 to seek the written agreement from management that it acknowledges and understands that it has the responsibilities set out in paragraph 6(b). However, in accordance with paragraph 12, such written agreement may use the wording of the law or regulation if such law or regulation establishes responsibilities for management that are equivalent in effect to those described in paragraph 6(b).
A28. In case of certain entities, such as, Central/State governments and related government entities (for example, agencies, boards, commissions), law or regulation governing the operations of that entities generally mandate the appointment of the auditor and commonly set out the auditor’s responsibilities and powers, including the power to access an entity’s records and other information. When law or regulation prescribes in sufficient detail the terms of the audit engagement, the auditor may nonetheless consider that there are benefits in issuing a fuller audit engagement letter than permitted by paragraph 11.
Recurring Audits (Ref: Para. 13)
A29. The auditor may decide not to send a new audit engagement letter or other written agreement each period. However, the following factors may make it appropriate to revise the terms of the audit engagement or to remind the entity of existing terms: ● Any indication that the entity misunderstands the objective and scope of the audit. ● Any revised or special terms of the audit engagement. ● A recent change of senior management. ● A significant change in ownership. ● A significant change in nature or size of the entity’s business. ● A change in legal or regulatory requirements. ● A change in the financial reporting framework adopted in the preparation of the financial statements. ● A change in other reporting requirements. Acceptance of a Change in the Terms of the Audit Engagement Request to Change the Terms of the Audit Engagement (Ref: Para. 14)
A30. A request from the entity for the auditor to change the terms of the audit engagement may result from a change in circumstances affecting the need for the service, a misunderstanding as to the nature of an audit as originally requested or a restriction on the scope of the audit engagement, whether imposed by management or caused by other circumstances. The auditor, as required by paragraph 14, considers the justification given for the request, particularly the implications of a restriction on the scope of the audit engagement.
A31. A change in circumstances that affects the entity’s requirements or a misunderstanding concerning the nature of the service originally requested may be considered a reasonable basis for requesting a change in the audit engagement.
A32. In contrast, a change may not be considered reasonable if it appears that the change relates to information that is incorrect, incomplete or otherwise unsatisfactory. An example might be where the auditor is unable to obtain sufficient appropriate audit evidence regarding receivables and the entity asks for the audit engagement to be changed to a review engagement to avoid a qualified opinion or a disclaimer of opinion. Request to Change to a Review or a Related Service (Ref: Para. 15)
A33. Before agreeing to change an audit engagement to a review or a related service, an auditor who was engaged to perform an audit in accordance with SAs may need to assess, in addition to the matters referred to in paragraphs A30-A32 above, any legal or contractual implications of the change.
A34. If the auditor concludes that there is reasonable justification to change the audit engagement to a review or a related service, the audit work performed to the date of change may be relevant to the changed engagement; however, the work required to be performed and the report to be issued would be those appropriate to the revised engagement. In order to avoid confusing the reader, the report on the related service would not include reference to:
