CHAPTER 3:

THE STATUTORY AUDIT

BY: AYESHA MUNIR
OBJECTIVE OF STATUTORY AUDITS
Most companies are required to have an external audit by law, but some small
companies are exempt. The outcome of the audit is the auditor's report, which sets
out the auditor's opinion on the financial statements.

VALUE OF STATUTORY AUDITS

• To provide an independent opinion on the truth and fairness of the financial
statements. However, an external audit can be invaluable to an entity because it may
enhance the credibility of the financial statements, as they will have been examined
independently.
•The external audit can also highlight other issues as a result of work relating to the
financial statements, such as deficiencies in the internal control system of the entity,
which can be improved by the entity's management.
THE REQUIREMENT FOR AN EXTERNAL AUDIT
 In most countries there is a legal requirement for listed companies 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.
Small company audit exemption
 In smaller entities, where the shareholders are also the directors, the requirement
for assurance in the form of an external audit is much less important.
 As a consequence, many countries have a small company audit exemption. This
exempts small companies from the need for an annual statutory audit.
For example : In the UK, companies are exempted from the requirement to
have an external audit if their annual turnover does not exceed £6.5 million
 In Pakistan, New Companies Act 2017 has given exemption from audit
requirements for private companies having paid up capital not exceeding Rs.1
million.
 SMALLER ENTITY
 A smaller entity is an entity which typically possesses qualitative
characteristics, such as:
(a) Concentration of ownership and management in a small number of
individuals (often a single individual); and
(b) One or more of the following:
(i) Straightforward or uncomplicated transactions
(ii) Simple record-keeping
(iii) Few lines of business and few products within business lines
(iv) Few internal controls
(v) Few levels of management with responsibility for a broad range of controls
(vi) Few personnel, many having a wide range of duties (IFAC, 2016(b)).
 APPOINTMENT, REMOVAL AND RESIGNATION OF
AUDITORS
System of Self-regulation
 An individual or firm is only eligible for appointment as an external auditor if
the individual or firm: ̈ is a member of a recognized supervisory body, and ̈ is
eligible under the rules of that body
 The role of such recognized supervisory bodies 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 ‘fit and proper’ 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
Auditing Standards, known as ISAs)
• ensuring that auditors remain technically competent and up to date with modern
auditing practice
• providing procedures for monitoring and enforcing compliance by its members
with the rules of the regulatory body.
  Maintaining a list of ‘registered auditors’, which is made available to the public.
 Such a system is referred to as a system of self-regulation. In such a system, the
regulation of auditors is carried out by their own professional bodies

Regulation by government
 In Pakistan, New Companies Act 2017 states that certain individuals are
ineligible to act as an external auditor in the context of a given company, even if
they are a member of an appropriate supervisory body. These exclusions are
designed to help to establish the independence of the auditor.
 The following individuals are prohibited by the Companies Act 2017 from acting
as the auditor of a company:
 A person who has given guarantee;
 A person or firm has direct or indirect business relationship with the company.
 A person who is indebted to the company
 A person who has been convicted by court of an offence involving fraud; and
 A person who is not eligible to act as auditor under the code of ethics as adopted by
ICAP or ICMAP.
Appointment of Auditors

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 may be allowed to 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 or a company previously
exempt from audit

An auditor appointed by the directors will hold office only until the next AGM,
when they will have to submit themselves for re-appointment by the shareholders.

If neither the shareholders of the company nor its directors have appointed
auditors, company law allows for the Central government/Audit general to make the
appointment.
REMUNERATION OF THE AUDITOR
In principle, the remuneration of the auditor is set by whoever appoints the auditor.
However, in practice, where the shareholders make the appointment, it is usual to
delegate to the board of directors the power to set the auditor’s remuneration.

The directors are likely to be more familiar than the shareholders with the nature and
scope of the work involved in the audit process, and so the appropriate level of fees for
that work. (The board of directors of a listed company may delegate the task of
recommending or approving the audit fee to the audit committee.)
 Resignation of Auditors
Resignation procedures Auditors deposit written notice together with statement
of circumstances relevant to members/creditors or
statement that no such circumstances exist.

Notice of resignation Sent by company to regulatory authority

Statement of circumstances Sent by:
(a) Auditors to regulatory authority
(b) Company to everyone entitled to receive a copy of
accounts

Convening of general Auditors can require directors to call an extraordinary

meeting general meeting to discuss circumstances of resignation.
Directors must send out notice for meeting within 21
days of having received requisition by auditors.

Statement prior to general Auditors may require company to circulate (different)

meeting statement of circumstances to everyone entitled to
notice of meeting.

Other rights of auditors
Resignation of Auditors
Can receive all notices that relate to:
(a) A general meeting at which their term of office would
have expired
(b) A general meeting where casual vacancy caused by
their resignation is to be filled
Can speak at these meetings on any matter which
concerns them as auditors.

Removal of Auditors
In certain circumstances, the directors may be empowered to appoint auditors.
However, it would not be appropriate for the directors to have the power to remove the
auditors from office.

Therefore, as a general principle, only the ordinary shareholders should be able to

dismiss the auditor. The general points regarding removal process are:
 A simple majority (i.e. over 50%) of votes cast at a meeting of shareholders is sufficient to
remove the auditor.
 The auditor is allowed to attend such a meeting and make statements to the shareholders.
.
 Removal of Auditors

 Alternatively, the auditor can require written statements to be circulated to the shareholders
in advance of the meeting.
These procedures should ensure that the shareholders are given all the relevant
information to allow them to make a well-informed decision about the removal of the
auditors.

Once a resolution has been passed removing the auditor from office, the company
must notify the Registrar of Companies.
 AUDITOR RIGHTS AND DUTIES
Duties
The auditors are required to report on every statement of financial position (balance
sheet) and statement of profit or loss and comprehensive income (profit and loss
account) laid before the company in general meeting.
The auditors must consider the following.

DUTIES
Compliance with Whether the financial statements have been prepared
legislation in accordance with the relevant legislation

Truth and fairness of Whether the statement of financial position shows a

accounts true and fair view of the company's affairs at the end
of the period and the statement of profit or loss and
other comprehensive income (and statement of cash
flows) show a true and fair view of the results for that
period

Adequate accounting
records and returns
Agreement of accounts to
records
Consistency of other
information
Directors' benefits
DUTIES (cont.)
Whether adequate accounting records have been kept
and returns adequate for the audit received from
branches not visited by the auditor
Whether the accounts are in agreement with the
accounting records and returns
Whether the information in the directors' report is
consistent with the financial statements
Whether disclosure of directors' benefits has been made
in accordance with the Companies Act

Rights
The auditors must have certain rights to enable them to carry out their duties effectively.
The principal rights that auditors should have, excepting those dealing with resignation or
removal, are set out in the table that follows:
 RIGHTS
Access to records A right of access at all times to the books, accounts and
vouchers of the company (in whatever form they are
held

Information and A right to require from the company's officers such

explanations information and explanations as they think necessary for
the performance of their duties as auditors

Attendance at/notices of A right to attend any general meetings of the company

general meetings and to receive all notices of and other communications
relating to such meetings which any member of the
company is entitled to receive

Right to be heard at general A right to be heard at general meetings which they

meetings attend on any part of the business that concerns them as
auditors
Rights in relation to written A right to receive a copy of any written resolution
resolutions proposed

Note: If auditors have not received all the information and explanations they
consider necessary, they should state this fact in their auditor's report.
INTERNATIONAL FEDERATION OF ACCOUNTANTS (IFAC)
•IFAC, based in New York, is a non-profit, non-governmental, non-political international
organisation of accountancy bodies.
• IFAC came into being in the 1970s as a result of proposals put forward and eventually
approved by the International Congress of Accountants. IFAC's mission is:
“To serve the public interest by: contributing to the development, adoption and
implementation of high quality international standards and guidance; contributing to the
development of strong professional accountancy organisations and accounting firms, and to
high quality practices by professional accountants; promoting the value of professional
accountants worldwide; speaking out on public interest issues where the accountancy
profession's expertise is most relevant”. (IFAC, 2016(f))
•Members of IFAC automatically become members of the International Accounting
Standards Committee Foundation, which is an independent not-for-profit, private
sector organisation which sets international financial reporting standards through its
standard-setting body, the International Accounting Standards Board
 INTERNATIONAL FEDERATION OF ACCOUNTANTS (IFAC)
•Each country's regulation of external audits will differ. Most regimes do have certain
common elements:
→Education, examinations and experience
• Education: The theoretical knowledge to be contained in the body of knowledge of
accountants should include compulsory subjects (such as audit, consolidated accounts and
general accounting) and relevant subjects (such as law and economics).
• Examinations: Accountants should demonstrate that they have passed an examination of
professional competence. This examination must assess theoretical knowledge, practical
knowledge and Objective evaluation of professional examinations.
• Experience: Individuals should have completed an appropriate period of approved and
properly supervised practical experience primarily in the area of audit and accountancy and
in a suitable professional environment.
 INTERNATIONAL FEDERATION OF ACCOUNTANTS (IFAC)
→Supervisory and monitoring roles
•Some kind of supervision and monitoring regime should be implemented by the
regulatory body. This should inspect auditors on a regular basis.
•The following features should be apparent in each practice visited by the monitoring
regulatory body.
a) A properly structured audit approach, suitable for the range of clients served and work
undertaken by the practice
b) Carefully instituted quality control procedures, revised and updated constantly, to
which the practice as a whole is committed
c) Commitment to ethical guidelines, with an emphasis on independence issues
d) An emphasis on technical excellence
e) Adherence to the 'fit and proper' criteria by checking personnel records and references
f) Use of internal and, if necessary, external peer reviews, consultations etc
g) Charging appropriate fee per audit assignment
 INTERNATIONAL AUDITING AND ASSURANCE STANDARDS
BOARD (IAASB) & INTERNATIONAL STANDARDS ON AUDITING

International Standards on Auditing are set by the International Auditing and

Assurance Standards Board.
The IAASB was established to develop and issue standards and statements on
auditing, assurance and related services on behalf of IFA Board.
The IAASB’s objective is to serve the public interest by setting high-quality
auditing and assurance standards and by facilitating the convergence of
international and national auditing and assurance standards, thereby enhancing the
quality and consistency of practice throughout the world and strengthening public
confidence in the global auditing and assurance profession.
IAASB Members:
The IAASB consists of a full-time chairman and 17 volunteer members from around the
world comprising practitioners in public practice with significant experience in the field of
auditing and other assurance services and individuals who are not in public practice.
Members are appointed by the IFAC Board based on recommendations from the IFAC
Nominating Committee and are approved by the PIOB.
 THE AUTHORITY ATTACHED TO IAASB AND
OTHER PRONOUNCEMENTS
IAASB Pronouncements
International Standards on Auditing To be applied in the audit of historical financial information
(ISAs
International Standards on Review To be applied in the review of historical financial information
Engagements (ISREs)
International Standards on Assurance To be applied in assurance engagements dealing with subject
Engagements (ISAEs) matters other than historical financial information

International Standards on Related To be applied to compilation engagements, engagements to

Services (ISRSs) apply agreed-upon procedures to information and other related
services engagements as specified by the IAASB

International Standards on Quality To be applied for all services falling under the IAASB's
Control (ISQCs) engagement standards (ISAs, ISREs, ISAEs, ISRSs)

International Auditing Practice Notes (IAPNs)

(IAPNs) Provide practical assistance to auditors
 RELATIONSHIP BETWEEN ISAS AND
NATIONAL REGULATION
International Standards on Auditing are set by the International ISAs do not override
the local regulations referred to above governing the audit of financial or other
information in a particular country.
(a) To the extent that ISAs conform with local regulations on a particular subject, the audit of
financial or other information in that country in accordance with local regulations will
automatically comply with the ISA regarding that subject.
(b) In the event that the local regulations differ from, or conflict with, ISAs on a particular
subject, member bodies should comply with the obligations of members set forth in the IFAC
Constitution as regards these ISAs (i.e. encourage changes in local regulations to comply with
ISAs).
 WORKING PROCEDURES OF THE IAASB
Research and consultation
A project task force is established to develop a draft standard or practice statement.

Transparent debate
A proposed standard is discussed at a meeting, open to the public.

Exposure for public comment

Exposure drafts are put on the IAASB's website and widely distributed for comment
for a minimum of 120 days.

Consideration of comments
Any comments as a result of the exposure draft are considered at an open meeting
of the IAASB, and it is revised as necessary.

Affirmative approval
Approval is made by the affirmative vote of at least 2/3 of IAASB members. .
ADVANTAGES AND LIMITATIONS OF STATUTORY AUDITS
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 no 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.
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 company’s staff during the audit. The company’s staff
may be required to assist the auditors by answering questions, providing
documents and other information, and so on.
 Auditors only give reasonable assurance that the financial statements are free
from material misstatement.