Basics of Audit & Application of Standards on Auditing

Today mostly in small to mid-sized firms, audits are carried out by article trainees, new paid audit assistants without properly meeting the Standards for Auditing set out by ICAI. Hence, it is very important to know where to apply these standards and relevance of such standards. This is an engaging article that will help the audit learners and article trainees to know about the important/ major standards through a hypothetical example we are going to discuss.

First of all let us all know, what is Audit?

As per the ICAI, - "Audit is an independent examination of financial information of any entity whether profit oriented or not and irrespective of its size or legal form when such an examination is conducted with a view to expressing an opinion thereon."

Let us know the keywords underlined in the given definition in an elaborative manner:

• Independent Examination - Whether it be a Statutory Audit, Internal Audit, Tax Audit or any other kind of Audit, auditor should carry out the same independently e., his/ her judgment and opinion is not influenced by other factors.
• Profit oriented or not - Whether the entity is the one with a profit motive or a Not for Profit Organization, audit standards and guidelines and concept of independence shall be applicable to both of them,
• Irrespective of its size or Legal Form - The entity being the one with an yearly revenue of Rs. 2,500 Million or the one with yearly revenue of Rs. 2.5 Million, the standards and guidelines shall be the same for both. Further, the entity being a Corporate following schedule-III of Companies Act specified representation of Financial Statements(FS) or a Banking Organization representing its FS as specified by Banking Regulation Act, 1949 read with Companies Act, 2013, the standards, guidelines and basic essence of audit shall remain same in all the cases.
• Expressing an Opinion - After the audit function carried out by the auditor. He/ She is required to form an opinion on the FS and Internal Controls verified by him/ her that whether they depict true and fair view or not.

The Institute has issued several Standards for different situations and stages in an audit. The Standards on Auditing ranges between SA 200 to SA 810. Now, that we understand what does an audit mean, let us know and understand that on what areas, the said standards are applicable while carrying out the audit with a hypothetical example. Consider the below Company Financials, engage yourself as an auditor.

Mou Ltd. is a listed Company with the following draft financial statements for year ended 31/03/20XX -

(Amt. in Lacs)

UV&Co. has been appointed as the Statutory Auditor of MOU Ltd. for the year ended 31/03/20XX which is engaged in Iron and Steel manufacturing.

Additional Information

• MOU Ltd. has entered into a contract with another firm ‘Achinta&Co.' for book keeping services.
• The Company had 2 Subsidiaries and 1 Associate.
• MOU Ltd. employs Child Labour in its factory which violates Child Labour Rules due to which the Government has imposed penalty of Rs. 2,50,000. However, no provisions have been made regarding this.
• the Company does not invite quotations for Iron Ore.
• MOU Ltd.'s management refused to seek confirmation from a Debtor of Rs. 9,00,000 which were more than a year old balances.
• physical inspection of the inventories kept at the factory of Mou Ltd was carried on 30/04/20XX.
• UV&Co. referred to the Actuarial Valuation report by an independent actuarial valuer for the Gratuity.
• 10% Debentures of Rs. 7,50,000 was held @FVTPL as the same did not qualify the Business Model Test as per Ind AS 109.
• MOU Ltd. purchases Iron Ore from its subsidiaries at a higher rate than arms length price.
• On, 03/05/20XX, a fire occurred in the factory of MOU Ltd. which destroyed the raw materials worth Rs. 15,00,000.
• UV&Co. issues its report with applicable comments on 05/06/20XX

Let us start the discussion on the above e.g. through relevant SAs:

• As per SA 200, it is the overall responsibility of UV&Co. to obtain reasonable assurance that FS as a whole are free from MMS and it shall conduct the audit in accordance with standards issued by the Institute.
• As per SA 210, before appointment, UV&Co determines whether preconditions (whether FS are prepared as per applicable FRF, management acknowledges its responsibility to prepare and present FS, Design and maintenance of IC and provide the auditor with data/ information he needs). Also, the Management/ TCWG of MOU Ltd. and UV&Co. gain a common understanding through recording the terms agreed in an Agreement. (generally called Engagement letter).
• As per SA 315, UV&Co. obtains understanding of the MOU Ltd. and its environment for identifying and assessing the Risk of Material Misstatement(ROMM) for obtaining relevant information,

UV&Co may use data such as previous Annual Reports, Minutes of General meeting, Board Meetings, Annual and quarterly Budgetary Report, Previous Year Audit Files, Discussion with the Client, Client's Policy & Procedure Manual,Visit to Client's Premises, relevant publications related to industry of Iron and Steel etc.

After doing so, the auditor applies Risk Assessment Procedures(RAP) i.e., Inquiry with management and others, Observation, Inspection and Analytical Procedures on the above obtained data. By applying RAP, UV Corp. has identified one of the risk i.e., major purchase transactions with related parties that are MOU Ltd.'s own group Companies in the past years which UV Corp. identifies as significant Risk and will require Special Attention. Further, control mechanism for procurement policy is also identified as risk.

I have mentioned the application of three SAs i.e., SA 200, SA 210 and SA 315. The application of other SAs is to be understood and mentioned by you below this article. I am pretty sure that this healthy discussion and sharing of knowledge will connect us more to the audit world and ofcourse you can also make your own scenarios and add up to the example for your convenience and creativity.

However, it should be a mandate as a Chartered Accountancy student or as an audit learner to go through these standards from the Institute's issued material to gain indepth understanding and applying them in your assignment.