A CA is certainly not CIA

Many people have unreasonable expectations from auditors that go beyond the role and responsibilities of these financial professionals. This has led to the term ‘expectation gap'. Many believe that auditors should accept the prime responsibility for financial statements, perform a thorough check, give early warning about any likelihood of business failure, and detect every possible fraud.

The primary responsibility for the preparation of financial statements is that of the company management. An audit enhances the degree of confidence intended users have in the financial statements. The Institute of Chartered Accountants of India's standards on auditing (SA) define the role and responsibilities of an auditor. According to the standards, an audit is conducted on the premise that the management is responsible for preparing true and fair financial statements. The audit of the financial statements does not free the management of those responsibilities.

Zero audit risk?

The auditor is expected to obtain reasonable assurance that the financial statements as a whole are free from material misstatement, whether due to fraud or error. Reasonable assurance is a high level of assurance that the auditor has obtained sufficient and appropriate audit evidence to reduce audit risk (that is, the risk that the auditor expresses an inappropriate opinion when the financial statements are materially misstated) to an acceptably low level. However, reasonable assurance is not an absolute level of assurance, because there are inherent limitations in an audit. Most of the audit evidence on which the auditor bases his/her opinion is persuasive rather than conclusive.

The auditor is not expected to, and cannot, reduce audit risk to zero. Auditors cannot, therefore, obtain absolute assurance that the financial statements are free from material misstatement because of the inherent limitations.

Many items in the financial statement involve subjective decisions or a degree of uncertainty. A range of acceptable interpretations or judgments may be made. Consequently, such variability cannot be eliminated through additional auditing procedures. This is often the case with certain accounting estimates.

There is the possibility that the management or others may not provide, intentionally or unintentionally, the complete information. Fraud may involve sophisticated schemes designed to conceal it. Therefore, audit procedures may be ineffective in detecting an intentional misstatement that involves, for example, collusion to falsify documentation, leading the auditor to believe the audit evidence is valid. The auditor is neither trained, nor expected to be an expert in the authentication of documents. An audit is not an official investigation into alleged wrongdoing. Accordingly, the auditor is not given specific legal powers, such as the power to search, that may be necessary for such an investigation.

Resources at hand

The difficulty, time, or cost involved cannot be an excuse for the auditor to omit an audit procedure. Appropriate planning helps make available sufficient time and resources for the audit. Notwithstanding this, the relevance of information, and thereby its value, tends to diminish over time, and a balance has to be struck between the reliability of information and its cost. This is recognised in the “Framework for the Preparation and Presentation of Financial Statements” issued by the ICAI. Therefore, users of financial statements do expect that the auditor will form an opinion on the financial statements within a reasonable period of time and at reasonable cost, recognising that it is impractical to address all the information that may exist or pursue every matter exhaustively on the assumption that the information is in error or fraudulent until proved otherwise.

Because of the inherent limitations of an audit, there is an unavoidable risk that some material misstatements may not be detected even though the audit is properly planned and performed according to standards. Accordingly, the subsequent discovery of a material misstatement resulting from fraud or error does not by itself indicate a failure in the audit. However, the inherent limitations of an audit are not a justification for the auditor to be satisfied with less-than-persuasive audit evidence. Whether the auditor has conformed to the standards will be clear from the audit procedures used, the sufficiency and appropriateness of the audit evidence obtained and the suitability of the auditor's report based on an evaluation of that evidence in the light of the overall objectives of the auditor. These are not new-age principles in the standards on accounting but were espoused way back in 1896, when the appeal court clarified that the auditor was a watchdog but not a bloodhound.

The author is Partner and National Leader - IFRS Services, Ernst & Young Pvt Ltd.

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