EXAMINING THE IMPACT OF RELEVANT LEGISLATIONS ON THE PERFORMANCE OF AUDIT.
The APB Statement of Auditing Standard 120 covers “Consideration of law and
regulations”. The IFAC International Standard on Auditing 250 also covers
“Consideration of law and regulations in an audit of financial statements”.
In planning an audit, the auditor should recognise that “non-compliance by
the entity with law or regulations may materially affect the financial
statements” (ISA 250). Consequently, the auditor should plan the audit
procedures to include:
(a) An assessment of the compliance of the entity with laws or regulations
affecting the business of the entity; and
(b) An evaluation and report on the results thereof.
The APB SAS 120 provides the following definitions:
Non-compliance with law or regulations’ refers to acts, omission or commission
by the entity being audited, either intentional or unintentional, which are
contrary to law (comprising common law and statute) or regulations. Such
acts include transactions entered into by, or in the name of, the entity or on its
behalf by its directors or employees. Non-compliance with law or regulations
does not include personal misconduct (unrelated to the business activities of
the entity) by the entity’s directors or employees. It does not also include civil
wrongs, for example breach of duties in contract or tort.
Directors’ means the directors of a company, partners, proprietors, committee
of management or trustees or other forms of entity, or equivalent persons
responsible for directing the entity’s operations and preparing its financial
statements.
Management means those persons who may include directors, who have
executive responsibility for the conduct of the entity’s operations and the
preparation of its financial statements.
Whether an act constitutes non-compliance with law or regulations is a legal
determination that is ordinarily beyond the auditors’ professional competence.
However, auditors’ training, experience and understanding of the entity and
its industry may enable them to recognise that some acts coming to their
attention may constitute non-compliance with law or regulations’ (Chitty, 2004).
The determination as to whether a particular act constitutes non-compliance
with law or regulations is generally:
Based on the advice of an informed expert qualified to practice law, but
ultimately can be determined only by a court of law. Laws and regulations
vary considerably in their relation to the financial statements. Some laws and
regulations relate directly to the preparation of, or the inclusion or disclosure
of specific items, in the financial statements. Laws and regulations provide a
legal framework within which an entity conducts its business. Thus, some
entities operate in heavily regulated industries (such as banks) while others
are subject only to the many laws and regulations that generally relate to the
operating aspects of the business.
Therefore, determining the type of procedures necessary in a particular instance
needs to take account of the particular entity concerned and the complexity of
the regulations with which it is required to comply (Chitty, 2004).
Non-compliance with law or regulations may result in financial consequences
for the entity, such as fines or litigation. The Central Bank of Nigeria Act and
Banks and Other Financial Institutions Act require auditors to report noncompliance
with the law and fines paid in the process.
Responsibilities of the Directors
It is the responsibility of the directors:(a) To take appropriate steps to provide reasonable assurance that the entity
complies with law and regulations applicable to its activities;
(b) To establish arrangements for preventing any non-compliance with law
or regulations and detecting any that occurs; and
(c) To prepare financial statements that give a true and fair view of the
state of affairs of a company and its profit or loss for the financial year.
The assignment of particular responsibilities to management or the audit
process does not relieve the directors of these fundamental responsibilities.
In addition, directors and officers of companies have responsibility to provide
information required by the auditors, to which they have a legal right of access
under the Companies and Allied Matters Act, Cap. C 20 LFN 2004.
The following steps, among others, may assist the directors in discharging their
responsibilities for the prevention and detection of non-compliance with law
or regulations:
(a) Maintaining an up-to-date register of significant laws and regulations
with which the entity has to comply within its particular industry;
(b) Monitoring legal requirements and any changes therein and ensuring
that operating procedures are designed to meet these requirements;
(c) Instituting and operating appropriate systems of internal control;
(d) Developing a Code of Conduct, ensuring employees are properly trained
in and understand its provisions, monitoring compliance and taking
appropriate disciplinary action in cases of non- compliance; and
(e) Engaging legal advisers to assist in monitoring legal requirements, and
maintaining a record of complaints.
In large entities, these policies and procedures may be supplemented by
assigning appropriate responsibility to:
(a) An internal audit function;
(b) A legal department;
(c) A compliance function; and/or
(d) An audit committee.
In certain sectors or activities (for example financial services), there are detailed
laws and regulations that specially require directors to have systems to ensure
compliance. These laws and regulations could, if breached, have a material
effect on the financial statements. In addition, the directors are required to
report certain instances of non-compliance to the proper authorities on a timely
basis” (Chitty, 2004). For example, In Nigeria banks are required by law to
report cases of fraud and attempted fraud to the Central Bank.
Considering the responsibility of the directors to prepare financial statements
that give a true and fair view of the state of affairs of a company and of its
profit or loss for the financial year, it is necessary, where possible noncompliance
with law or regulations has occurred, which may result in a material
misstatement in the financial statements, for the directors to ensure that the
matter is appropriately reflected and/or disclosed in the financial statements.
RESPONSIBILITIES OF THE AUDITORS
- Prevention
APB SAS 120 on Consideration of law and regulations states that: “it is not the
auditors’ function to prevent non-compliance with law or regulations. The fact
that an audit is carried out may, however, act as a deterrent”.
- Detection
The auditors plan, perform and evaluate their audit work in order to have a
reasonable expectation of detecting material misstatements in the financial
statements of the entity audited. When doing so, they recognise that material
misstatements may arise from non-compliance with law or regulations.
However, an audit cannot reasonably be expected to detect all possible noncompliance
with law and regulations. In an audit, there is 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 auditing standards. This risk is higher with regard to
misstatements resulting from non-compliance with law or regulations due to
such factors as the following:
(a) There are many laws and regulations, relating principally to the
operating aspects of the entity, that typically do not have a material
effect on the financial statements and where the consequences of any
non-compliance are not captured by the accounting and internal
financial control systems;
(b) The effectiveness of audit procedures is affected by the inherent
limitations of the accounting and internal control systems and by the
use of selective testing rather than the examination of all transactions;
(c) Much of the evidence obtained by the auditors is persuasive rather than
conclusive in nature; and
(d) Non-compliance with law or regulations may involve conduct designed
to conceal it, such as collusion, forgery, override or intentional
misrepresentations being made to the auditors (Chitty, 2004).
- The Auditors’ Consideration of Compliance with Law and Regulations
“The auditors plan, and perform the audit with an attitude of professional
scepticism. They should recognise that the audit may reveal conditions or events
that could lead to questioning whether, an entity is complying with law and
regulations. For audit purposes, laws and regulations relevant to the audit,
can be regarded as falling into two main categories:
(a) Those which relate directly to the preparation of, or the inclusion or
disclosure of specific items in, the financial statements of the entity,
and;
(b) Those which provide a legal framework within which the entity conducts
its business and which are central to the entity’s ability to conduct its
business and where non-compliance may reasonably be expected to
result in the entity ceasing operations, or call into question its continuance
as a going concern (Chitty, 2004).
APB SAS 120 requires the auditors to “obtain sufficient appropriate audit
evidence about compliance with those laws and regulations which relate directly
to the preparation of, or the inclusion or disclosure of specific items in the
financial statements”.
Those laws and regulations which relate directly to the preparation of, or the
inclusion or disclosure of specific items in, the financial statements include:
(a) Those which specify the form and content of financial statements, such
as, Schedule to the Companies and Allied Matters Act, 2004; and
(b) Those laws which require auditors expressly to report non-compliance,
such as, the requirements of the Companies and Allied Matters Act, 2004
relating to the maintenance of proper accounting records or the disclosure
of particulars of directors remuneration in a company’s financial
statements.
Financial reporting requirements for particular industries e.g. banks. Where
statutory requirements exist which require the auditors to report, as part of the
audit of the financial statements, whether the entity complies with certain
provisions of laws or regulations, for example the Companies and Allied Matters
Act, 1990, the auditors need to have a sufficient understanding of such laws
and regulations in order to consider them when auditing the assertions relating
to the determination of the amounts to be recorded and the disclosures to be
made; and to test for compliance with such provisions.
The auditors should perform procedures to help identify possible or actual
instances of non-compliance with those laws and regulations which provide a
legal framework within which the entity conducts its business and which are
central to the entity’s ability to conduct its business and hence to its financial
statements, by:
(a) Obtaining a general understanding of the legal and regulatory
framework which is applicable to the entity and the industry, and of the
procedures followed to ensure compliance with that framework;
(b) Inspecting correspondence with relevant licensing or regulatory
authorities;
(c) enquiring of the directors instances of non-compliance with law or
regulations; and
(d) obtaining written confirmation from the directors that they have
disclosed to the auditors all those events of which they are aware which
involve possible non-compliance, together with the actual contingent
consequences which may arise therefrom.
To obtain this general understanding, the auditors should:
(a) Enquire of management as to the laws or regulations (and any changes
therein) that may be central to the entity’s ability to conduct its business;
(b) Enquire of management concerning the entity’s policies and procedures
regarding compliance with laws and regulations, in particular, those
which may be central to its ability to conduct its business;
(c) Discuss with management the policies or procedures adopted for
identifying, evaluating and accounting for litigation, claims and
assessments;
(d) Use their existing knowledge of the entity’s industry and business and
of its regulatory environment; and
(e) Discuss the legal and regulatory framework with auditors of
subsidiaries in other countries (Chitty 2004).
APB SAS 120 stipulates that “when carrying out their procedures for the purpose
of forming an opinion on the financial statements, the auditors should in addition
be alert to instances of possible or actual non-compliance with law or regulations
which might affect the financial statement”.
The auditor may adopt the following procedures to bring to the fore instances
of non-compliance with the law and regulations:
(a) Reading minutes of board and management meetings;
(b) Enquiring of the entity’s directors and legal counsel concerning litigation,
claims and assessments; and
(c) Perform substantive tests of details of transactions or balances.
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