Audit and Assurance

Lecture 3
The Regulatory Framework

The requirement for an external

audit
In most countries there is a legal requirement for listed
and other large companies to have an external audit of
their published financial statements. This requirement is
imposed by law in order to protect the shareholders
In smaller family companies, where the shareholders
are also the directors, the requirement for assurance in
the form of an external audit is much less important
As consequence, in many countries there is an
exemption for small companies to have an annual
statutory audit
However, in Pakistan, S.252 of the Companies
Ordinance 1984 requires every company to appoint an
auditor

Regulation of Auditors
Requirements for the eligibility, registration
and training of auditors are extremely
important as they are designed to maintain
standards in the auditing profession
Most accountancy bodies are characterized
by the following attributes:
Stringent entrance requirements (exams and
practical experience)
Strict code of ethics
Technical updating of members

International Federation of
Accountants (IFAC)
International organization of
accountancy bodies
Through cooperation with member
bodies, coordinates and guides
efforts to achieve international
technical, ethical and educational
pronouncements for the accountancy
profession

Regulation, Monitoring and

Supervision

Education, examinations
and work experience
Eligibility
Supervision and
monitoring

Education, Examinations and

Experience
IFAC has issued guidelines on this
It sets minimum standards for accountancy
qualifications
IFAC assists member bodies in connection with the
education and development of their members and
students
Theoretical knowledge of relevant subjects should be
covered in depth
Objective evaluation of professional examinations
Completion of approved and properly supervised
practical experience primarily in the area of audit and
accountancy

Eligibility to act as an external

auditor

Auditor must hold qualifications laid down in the Companies Ordinance

The role of such a professional body normally includes the following:
Offering professional qualifications for auditors, to provide evidence that
auditors possess a minimum level of technical competence
Establishing procedures to ensure that the professional competence of
auditors is maintained. This includes matters such as:
ensuring that audits are performed only by persons, who act with
professional integrity
requiring that the members carry out their audit work in accordance
with appropriate technical standards (for example, in accordance with
International Standards on Auditing, known as ISAs)
ensuring that auditors remain technically competent and up to date
with modern auditing practice (for example, by following a programme
of continuing professional development)
providing procedures for monitoring and enforcing compliance by its
members with the rules of the regulatory body. This includes rules and
procedures for the investigation of complaints against members and
the implementation of disciplinary procedures where appropriate
Such a system is referred to as a system of self-regulation.

Supervisory and
Monitoring Roles
Regulatory body to implement
supervision and monitoring regime
Inspect auditors on a regular basis:
Audit approach
Quality control procedures
Adherence to ethical guidelines
Emphasis on technical competence
Adherence to fit and proper criteria
Charging appropriate fee per audit
assignment

Ineligibility to act as an external

auditor
According to S.254 (3) of the Companies Ordinance
1984, the following individuals are ineligible to act as an
external auditor in the context of a given company
A person who is, or at any time during the preceding 3 years
was, a director, other officer or employee of the company
A person who is a partner of, or in the employment of, a
director, officer or employee of the company
The spouse of a director of the company
A person who is indebted to the company
A body corporate ( another company)
A person or his spouse or minor children, or in the case of a firm,
all partners of such firm who holds any shares of an audit client
or any of its associated companies

Appointment of auditors
(1)

Usually the external auditors are appointed by the

shareholders at the annual general meeting (AGM) of
the company, and hold office until the next AGM
At the next AGM the auditors are re-appointed by the
shareholders, or different auditors are appointed.
However, directors appoint auditors in the following
circumstances, as a matter of practical convenience:
to fill a casual vacancy; for example where the
current auditor is no longer able to act
to appoint the first auditor of a newly-formed company
within sixty days of the date of incorporation
An auditor appointed by the directors will normally hold
office only until the next AGM, when they will have to
submit themselves for re-appointment by the shareholders.

Appointment of auditors
(2)
If neither the shareholders of the company nor its
directors have appointed auditors, the Securities
and Exchange Commission (SECP) may appoint a
person to fill the casual vacancy
In principle, the remuneration of the auditor is
set by whoever appoints him.
However, in practice, where the shareholders make
the appointment, it is usual to delegate to the board
of directors the power to set the auditors
remuneration
The board of directors may delegate the task of
recommending or approving the audit fee to the
audit committee
Every company shall, within 14 days from the date

Resignation of auditors

The auditor may choose to resign during his period of office

The company will generally provide certain safeguards to
ensure that the shareholders are made aware of any
relevant circumstances relating to the auditors resignation
The procedures for the resignation of the current auditors will
normally include the following:
The resignation should be made to the company in writing
The auditor should prepare a representation. This sets
out the circumstances leading to the resignation, if the
auditor believes that these are relevant to the shareholders
or creditors of the company. If no such circumstances exist,
the auditor should make a statement to this effect.
This representation should be sent by the company to all
persons entitled to receive a copy of the companys
financial statements (principally the shareholders).
The auditors may require the directors to call a meeting of
the shareholders in order to discuss the circumstances of

Removal of auditors (1)

S. 253 of the Companies Ordinance deals with removal of
auditors
A notice shall be required for a resolution at a companys annual
general meeting appointing as auditor a person other than a retiring
auditor.
The notice referred to above shall be given by a member of the
company to the company not less than fourteen days before the
annual general meeting, and the company shall forthwith send a copy
of such notice to the retiring auditor and shall also give notice thereof
to its members not less than seven days before the date fixed for the
annual general meeting and, if the company is a listed company, shall
also publish it at least in one issue each of a daily newspaper in
English language and a daily newspaper in Urdu language having
circulation in the Province in which the stock exchange on which the
company is listed is situated

Removal of auditors (2)

Where notice is given of such a resolution and the retiring auditor
makes with respect thereto a representation in writing to the
company not exceeding a reasonable length and requests its
communication to the members of the company, the company shall:
(a) in any notice of the resolution given to members of the company,
state the fact of the representation having been made; and
(b) send a copy of the representation to every member of the
company to whom notice of the meeting is sent whether before or after
receipt of the representation by the company; and if a copy of the
representation is not sent as aforesaid because it was received too late
or because of the companys default, the auditor may, without prejudice
to his right to be heard in person, require that the representation shall
be read out at the meeting:
Every company shall, within fourteen days from the date of retirement,
removal or otherwise ceasing to hold office of an auditor, send
intimation thereof to the registrar.

Powers and duties of

auditors (1)
S. 255. Powers and duties of auditors
(1) Every auditor of a company shall have a right of access at all times to the
books, papers, accounts and vouchers of the company, whether kept at the
registered office of the company or elsewhere, and shall be entitled to require from
the company and the directors and other officers of the company such
information and explanation as he thinks necessary for the performance of the
duties of the auditors.
(2) In the case of a company having a branch office outside Pakistan, it shall be
sufficient if the auditor is allowed access to such copies of, and extracts from, the
books and papers of the branch as have been transmitted to the principal office of
the company in Pakistan.
(3) The auditors shall make a report to the members of the company on the
accounts and books of accounts of the company and on every balance-sheet and
profit and loss account or income and expenditure account and on every other
document forming part of the balance-sheet and profit and loss account or income
and expenditure account, including notes, statements or schedules appended
thereto, which are laid before the company in general meeting during his tenure of
office

Powers and duties of

auditors (2)

The report shall state

whether or not the auditors have obtained all the information and
explanations which to the best of their knowledge and belief were
necessary for the purposes of the audit;
whether or not in their opinion proper books of accounts as required by
this Ordinance have been kept by the company;
whether or not in their opinion the balance-sheet and profit and loss
account or the income and expenditure account have been drawn up in
conformity with this Ordinance and are in agreement with the books of
accounts;
whether or not in their opinion and to the best of their information and
according to the explanations given to them, the said accounts give the
information required by this Ordinance in the manner so required and give
a true and fair view
in the case of the balance-sheet, of the state of the companys affairs as
at the end of its financial year;
in the case of the profit and loss account or the income and expenditure
account, of the profit or loss or surplus or deficit, as the case may be, for
its financial year; and
in the case of the statement of changes in financial position or sources and

Powers and duties of

auditors (3)
whether or not in their opinion the expenditure incurred during the year was for
the purpose of the companys business; and
the business conducted, investments made and
expenditure incurred during the year were in
accordance with the objects of the company ; and
whether or not in their opinion zakat deductible at
source under the Zakat and Usher Ordinance, 1980
(XVIII of 1980), was deducted by the company and
deposited in the Central Zakat Fund established
under section 7 of that Ordinance.

Powers and duties of

auditors (4)
The outcome of the statutory audit is an opinion on the
truth and fairness of the financial statements
The word opinion implies that the auditor has applied his
professional judgement in reaching his conclusion
This point is arguably one of the limitations of the
statutory audit. The audit report expresses an opinion, not
a statement of fact. It is therefore open to disagreement.
In carrying out his audit work, the auditor is unlikely to
check every transaction undertaken by the company
during the period
There is, therefore, a risk that the judgement he forms
may be inappropriate, because in performing the audit he
has missed an item of significance.

International Standards on Auditing

(ISAs)
The role of the audit is to provide a high level of assurance to the users of
the financial statements
This assurance will be of greater value to users if they know that the audit
has been carried out in accordance with established standards of practice.
In addition, if users compare the financial statements of a number of
companies, it is important that the user has confidence that consistent
auditing standards have been applied to the audits of all of the
companies
International Standards on Auditing (known as ISAs) apply
primarily to the external audit process
However, their provisions can also often be seen as good
practice for relevant areas of the work of the internal auditor
ISAs are produced the International Audit and Assurance Standards
Board (IAASB), a committee of the International Federation of
Accountants (IFAC). IFAC is an international organisation of professional
accountancy bodies

Advantages of statutory audits

An external audit provides the following benefits:
It increases the credibility of published financial statements
It confirms to management that they have performed their statutory
duties correctly
It provides assurance to management that they have complied with non
statutory requirements, such as corporate governance requirements
(where these are subject to audit or review)
It provides feedback on the effectiveness of internal controls. Where
internal controls are weak or inadequate, the auditor will give
recommendations for improvement .This will assist management in
reducing risk and improving the performance of the company
Even where a statutory audit is not required, an audit will increase the
credibility of published financial statements
This may be important for potential lenders to the company. Potential
lenders, such as banks, may insist on the company having an audit as a
pre-condition for lending money.

Limitations of statutory
audits
The main limitations of an audit are as
follows:
Its cost. The cost of an audit can be very high.
However, if the audit firm is already hired to carry
out non-audit work such as accounts preparation or
advisory work, the additional cost of an audit may
be fairly small.
The disruption caused to a companys staff during
the audit. The companys staff may be required to
assist the auditors by answering questions,
providing documents and other information, and so
on.