Query No. 25

Subject:   

A.  Facts of the Case

1. One of the clients of an auditor does not wish to offer the balance sheet and profit and loss account for the Limited Review under clause 41 of the Listing Agreement, nor does it wish these to be enclosed with the auditors’ review report.  The client wishes that the auditors should complete the Limited Review with respect to the trial balance and the ‘results’ as per the format required by clause 41 of the Listing Agreement.

2.  The auditor has given the following arguments supporting the supply of the balance sheet and the profit and loss account by the client for the purposes of Limited Review:

(i) ‘Guidance Note on Engagements to Review Financial Statements’ issued by the Institute of Chartered Accountants of India requires that the auditor determines whether the trial balance agrees with the general ledger and the financial statements (point no. 5 of Appendix 2).

(ii)  It requires the auditors to obtain the financial statements and discuss them with management (point no. 14 of Appendix 2).

(iii)  It requires the auditor to compare the financial statements with (a) the financial statements of prior periods and (b) with budgets and forecasts (point no. 16 of Appendix 2).

(iv)  The example engagement letter (Appendix 1) confirms that the auditor requires a balance sheet and related statement of profit and loss to perform a review.  Further, if required by the client the ‘results’ extracted therefrom may also be covered (Appendix 3, footnotes 4 and 5)

(v)  The financial statements have to be in accordance with the accounting standards and accounting policies (point no. 8 of Appendix 2).

(vi)  Since the Review Report states a conclusion which is related to ‘true and fair’ view (negative assurance basis), there is no doubt that a full set of financial statements are required (paragraph 26 of the Guidance Note).  By extending the ‘scope’ of the review, one may obtain a higher level of assurance of the same set of financial statements, called an ‘audit’

.

(vii)  The ‘Review’ can extend (‘encompass’) to other ‘financial information’ ‘also’, which means that it cannot reduce the coverage to less than full balance sheet and profit and loss account (paragraph 1).  The additional financial information in this case would be the extracts in the form of ‘results’ for submission to the stock exchanges.

(viii)  As per the opinion obtained by the auditor from some of the chartered accountants, audit firms and SEBI, a full set of financial statements have to be prepared.

(ix)  Similar Review Engagement Standards and interpretations issued by other international Institutes require that the auditor should not carry out a review unless the balance sheet, profit and loss account and a cash flow statement are submitted.

3.  The auditor has, however, also pointed out the following which in his opinion are apparent:

(i)   As per clause 41 of the listing agreement, the board of directors must adopt the half-yearly ‘results’.

(ii)  The financial statements, however, need not be so adopted, and, therefore, the chairman or managing director may sign them.

(iii)   As per clause 41, a copy of the Review Report shall be submitted to the stock exchange.  However, it does not require the financial statements (balance sheet, profit and loss account and cash flow statement) to be submitted to the stock exchange.

(iv)  A variance statement for more than 20% variances shall be prepared using the same financial statements which have been subject to the Limited Review by the auditors.

(v)  The variance statement shall be prepared by the board of directors.  However, the variance statement is not required to be reviewed by the auditors.  The company may extend the scope of the Limited Review if it so wishes.

4.   The auditor’s client has argued that the ‘Guidance Note on Engagements to Review Financial Statements’, issued by the Institute of Chartered Accountants of India, states in the introductory paragraphs that the Guidance Note is applicable to review of six-monthly results to the ‘extent relevant’.  In other words, the guidelines are general and are applicable only to the extent relevant.

5.  The client has also stated that as per clause 41 of the stock exchange Listing Agreement, the quarterly/six-monthly results are to be presented in the given proforma and the Limited Review is limited to reviewing all the information as per the proforma of quarterly/six-monthly results.  The client is of the view that it is not necessary to provide a balance sheet and profit and loss account for the Limited Review.  The information relevant for the purpose of the review of ‘Unaudited Financial Results’ can be directly extracted from the trial balance.

6.  As per the client, an auditor is required to give a qualified report of the Limited Review if the variation between the sum total of the figures of first and second quarter of unaudited results, and the corresponding figures after the Limited Review is 20% or more.  As per the guidelines of the Institute, the Limited Review is only a moderate assurance of the information being free of material misstatement.

7.  According to the client, considering the above, the auditors’ Review Report instead of starting with “We have reviewed the accompanying balance sheet of ABC company as at March 31, xxxx, and the related statement of profit and loss for the year then ended”, should be limited to the review of the ‘enclosed six-monthly results’.  The quarterly and six-monthly results declared by the company should form enclosure to the auditor’s Review Report.

8.  According to the auditor, the confusion (leading to the client’s interpretations stated above) has been caused by the footnotes 4 and 5 to Appendix 3, ‘Form of Unqualified Review Report’ of the Guidance Note which state as below respectively:

“⁴ In case financial information contained in some other statement(s) is reviewed, it may be so identified, e.g., Statement of Unaudited Financial Results for a period, prepared pursuant to Clause 41 of the Listing Agreement.”

“⁵ For example, where a review has been conducted on Unaudited Financial Results, prepared in accordance with the requirements of Clause 41 of the Listing Agreement, the opinion paragraph may appear as under:

Based on our review as aforesaid, nothing has come to our attention that causes us to believe that the accompanying statement of unaudited half-yearly financial results, does not give true and fair view in accordance with accounting standards, other recognised accounting policies and practices and clause 41 of the Listing Agreement.”

B. Query

9.  The auditor has sought the opinion of the Expert Advisory Committee on the correctness of the arguments forwarded by the auditor in paragraphs 2 and 3 above supporting the supply of balance sheet and profit and loss account for the Limited Review under clause 41 of the Listing Agreement.

C. Points Considered by the Committee

10. The Committee notes paragraph 2 of the ‘Guidance Note on Engagements to Review Financial Statements’ which states as below:

“2. This Guidance Note is directed towards the review of financial statements.  However, it is to be applied to the extent practicable to engagements to review other financial information also (the term ‘financial statements’ is used in this Guidance Note to encompass ‘other financial information’ also).....” (emphasis added).

11. From the above, the Committee observes that the Guidance Note issued by the Institute is a general purpose document relevant for all types of review engagements including the Limited Review of unaudited financial results for a half-year as per clause 41 of the Listing Agreement.

12. The Committee also notes the introductory paragraph of Appendix 2 to the Guidance Note, ‘Illustrative Detailed Procedures that may be Performed in an Engagement to Review Financial Statements’, which states that “it is not intended that all the procedures suggested apply to every review engagement”.

13. The procedures listed in Appendix 2 would need to be applied keeping in view the scope of the review assignment, for example, for the purpose of Limited Review under clause 41 of the Listing Agreement, point no. 16 would imply that the various items shown in the current statement of unaudited half-yearly financial results should be compared with the similar statement of comparable prior periods.  Similarly, point 14 in reference to the Limited Review under clause 41 would imply that the auditor should obtain ‘Statement of unaudited half-yearly results’ and discuss them with management.

14. The Committee also notes that the ‘truth and fairness’ is not associated with only the general purpose financial statements prepared annually.  The ‘true and fair’ view can be formed with reference to any type of information including the half-yearly results.  The Committee notes that the corresponding International Standard on Auditing (ISA) on ‘Engagements to Review Financial Statements’ issued by the International Federation of Accountants is applicable to review of other financial information besides the financial statements.  Accordingly, the requirement of reporting on truth and fairness is equally applicable to the other financial information.

15. The Committee also observes the footnotes given in Appendices 3 and 4 of the Guidance Note.  The Committee is of the view that while in the main text of the format of the Review Reports reference has been made to the profit and loss account and the balance sheet, it has been clarified by way of footnotes at relevant places that in case of review of unaudited financial results for the half-year, reference should be made in the report to the ‘statement of unaudited financial results for the half-year’ (instead of the profit and loss account and balance sheet) and that the auditor’s report would be on the said results (rather than the profit and loss account and the balance sheet).

16. The Committee further notes the various items to be disclosed in the ‘unaudited financial results’ as per the format prescribed in clause 41 of the Listing Agreement.  The Committee is of the view that preparation of the profit and loss account and the balance sheet may be useful for performing various review procedures and the auditor can ask for the same from the clients.  However, a review of the items contained in the said format does not necessarily require the preparation of the profit and loss account and the balance sheet.  The financial statements would form a part of the working papers of the auditor and are not required to be appended to the review report of the auditor.

17. The Committee also notes that clause 41 of the Listing Agreement states that “if the sum total of first and second quarterly un-audited results in respect of any item given in the same proforma format varies by 20% or more from the respective half-yearly results as determined after the ‘Limited Review’ by the auditors, the company shall send such a statement (approved by its board of directors) explaining the reasons to the stock exchanges along with Review Report”.

18. From the above, the Committee is of the view that an auditor is not required to review the variance statement prepared in accordance with the paragraph above.  It is only the company which is required to prepare and send such a statement duly approved by its board of directors, explaining the reasons for such variations to the stock exchange.

D. Opinion

19. On the basis of the above, the Committee is of the opinion that preparation of the balance sheet and profit and loss account would be useful for the purpose of Limited Review and the auditor can ask for the same from the clients.  However, the financial statements are not necessarily required to be prepared for the purpose.  In respect of individual arguments forwarded by the auditor in paragraphs 2 and 3 above, the Committee is of the following opinion:

(a)  Paragraph 2:  The Guidance Note is a general purpose document relevant for all types of review engagements including the Limited Review under clause 41 of the listing agreement.  Though the term ‘financial statements’ has been used in the Guidance Note, in reference to the Limited Review it would equally apply to the ‘statement of unaudited financial results for the half-year’.

(b) Paragraph 3, Points (i) to (iii) and (v):The interpretations of the auditor are correct.

Point (iv):  The variance statement for more than 20% variances shall be prepared using the same statement that has been subject to Limited Review (i.e., the ‘statement of unaudited financial results’).

1Opinion finalised by the Committee on 8.8.2000.