Page 107 - DCOM204_AUDITING_THEORY

Unit 6: Laws and Regulations in Audit

of identified or suspected non-compliance with laws and regulations to the auditor’s Notes
attention.

6.2.4 The Auditor’s Consideration of Compliance with Laws and
Regulations

The auditor is not, and cannot be held responsible for preventing non-compliance. The fact that
an audit is carried out may, however, act as a deterrent.

An audit is subject to the unavoidable risk that some material misstatements of the financial
statements will not be detected, even though the audit is properly planned and performed in
accordance with SAPs and other generally accepted audit procedures. This risk is higher with
regard to material misstatements resulting from non-compliance with laws and regulations due
to factors such as:
1. Existence of laws and regulations, relating to the operating aspects of the entity that do not
have a material effect on the financial statements and are not captured by the accounting
and internal control systems.
2. The inherent limitations of the accounting and internal control systems and the testing
procedures.
3. Persuasive rather than conclusive nature of audit evidence, in general.
4. Deliberate designs, such as collusion, forgery, deliberate failure to record transactions,
senior management override of controls or intentional misrepresentations being made to
the auditor, to conceal non-compliance.
The auditor should plan and perform the audit recognizing that the audit may reveal conditions
or events that would lead to questioning whether an entity is complying with laws and
regulations.

In accordance with specific statutory requirements, the auditor may be specifically required to
report as part of the audit of the financial statements whether the entity complies with certain
provisions of laws or regulations. In these circumstances, the auditor would plan to test for
compliance with these provisions of the laws and regulations.
In order to plan the audit, the auditor should obtain a general understanding of the legal and
regulatory framework applicable to the entity and how the entity is complying with that
framework.

In obtaining this general understanding, the auditor would particularly recognize that non-
compliance of some laws and regulations may have a fundamental effect on the operations of
the entity and may even cause the entity to cease operations, or call into question the entity’s
continuance as a going concern.

Example: A Non-banking Financial Company might have to cease to carry on the business
of a non-banking financial institution if it fails to obtain a certificate of registration issued under
Chapter IIIB of the Reserve Bank of India Act, 1934 and if its Net Owned Funds are less than the
amount specified by the RBI in this regard.

To obtain the general understanding of laws and regulations, the auditor would ordinarily:
Use the existing knowledge of the entity’s industry and business.
1. Inquire of management as to the laws and regulations that may be expected to have a
fundamental effect on the operations of the entity.

LOVELY PROFESSIONAL UNIVERSITY 101