ATR 20 – Non Compliances with Laws or Regulations

Auditor’s Reporting Responsibilities with respect to Non Compliances with Laws or Regulations

1.    The statutory audit of financial statements in Pakistan is required to be conducted in accordance with the requirements of the International Standards on Auditing (ISAs) as have been adopted by the Institute of Chartered Accountants of Pakistan. The said standards should, therefore, be the primary basis for determining the auditor’s reporting responsibilities in case of an entity’s non-compliance with the applicable laws or regulations including with respect to the provisions of sections 195 or 208 of the Companies Ordinance, 1984 (the Ordinance).

2.    In relation to the above, ISA 250 (re-drafted) ‘Consideration of laws and regulations in an audit of financial statements’ prescribes as under:

“18. If the auditor becomes aware of information concerning an instance of non-compliance or suspected non-compliance with laws and regulations, the auditor shall obtain:

(a)     An understanding of the nature of the act and the circumstances in which it has occurred; and

(b) Further information to evaluate the possible effect on the financial statements.

25.     If the auditor concludes that the non-compliance has a material effect on the financial statements, and has not been adequately reflected in the financial statements, the auditor shall, in accordance with ISA 705 (Revised and Redrafted), express a qualified or adverse opinion on the financial statements.”

3.            It follows from the above that the basic objective of an auditor when confronted with instances of infraction of laws or regulations including with respect to the provisions of section 195 or 208 of the Ordinance, is to asses the impact of the same on the financial statements in terms of any monetary adjustments or requirements of disclosures.

4.            It should be noted that the provisions of sections 195 or 208 of the Ordinance do not deal with the determination of amounts that are to be included in the financial statements nor prescribe the form and content of disclosures in a company’s financial statements, instead, the said provisions prohibit the board of directors (BoD) of a company from undertaking certain specified transactions or require that approval from the shareholders’ be obtained before making investments in associates. Hence, any contravention of the said provisions of the Ordinance by the BoD of the company, although may be regarded as undertaking of transaction beyond the powers of the BoD, but the same cannot be deemed as being beyond the powers of the company. An act which is ultra vires the powers of the BoD would still be valid if it is intra vires the powers of the company having been permitted by its constitution. What is more important is to understand that such contraventions do not result in a misstatement in the financial statements if the transaction has been properly accounted for and disclosed in these financial statements. Accordingly, in such circumstances, a modification in the auditors’ opinion is not mandated by the ISAs.

5.            It should also be noted that it is not the purpose of the audit nor the responsibility of the auditor to highlight any contraventions of corporate and other laws by the company or its management.

6.            However, notwithstanding the above, in some instances, the transactions subject to non compliance with the provisions of sections 195 or 208 of the Ordinance may be so significant in the context of the overall financial statements, that a non disclosure of the matter in the financial statements may impair the users ability to understand the state of affairs of a company. Therefore, in such a situation, the auditor is not precluded from adding an emphasis of matter paragraph in his report to highlight the subject non compliance.

7.            Additionally, where a non compliance with the laws and regulations does occur and is in the knowledge of the auditor, ISA 250 (re-drafted) also requires the auditor to report the same to members of the management charged with governance. ISA 250 (re-drafted) states as follows in this respect:

“22. Unless all of those charged with governance are involved in management of the entity, and therefore are aware of matters involving identified or suspected non-compliance already communicated by the auditor, the auditor shall communicate with those charged with governance matters involving non-compliance with laws and regulations that come to the auditor’s attention during the course of the audit, other than when the matters are clearly inconsequential.

23.     If, in the auditor’s judgment, the non-compliance referred to in paragraph 22 is believed to be intentional and material, the auditor shall communicate the matter to those charged with governance as soon as practicable.

24.     If the auditor suspects that management or those charged with governance are involved in non-compliance, the auditor shall communicate the matter to the next higher level of authority at the entity, if it exists, such as an audit committee or supervisory board. Where no higher authority exists, or if the auditor believes that the communication may not be acted upon or is unsure as to the person to whom to report, the auditor shall consider the need to obtain legal advice.”

8.              In view of the above matters it is concluded that an infraction of laws or regulations, the financial implication of which is not material to the financial statements does not require a modification in the auditor’s opinion. However, the auditor should follow the guidance referred to in paragraphs 6 and 7 above.

This revised ATR-20 (2012) supersedes the requirements as contained in ATR-20 and is applicable for audits of financial statements for periods beginning on or after July 1, 2011. However earlier application is encouraged.

(230th meeting of the Council – December 17, 2011)