Why is consideration of laws and regulations needed in an audit of financial statements?

 

Laws ang regulations influence companies’ activities and financial reporting. Non-compliance with laws and regulations may result in fines, litigation or other consequences for the entity that may have a material effect on the financial statements.

Management under the supervision of those charged with governance is responsible to ensure that the company’s operations are conducted in accordance with the provisions of laws and regulations, including those laws and regulations that determine the reported amounts and disclosures in a company’s financial statements.


 The auditor is not responsible for preventing non-compliance with laws and regulations. The auditor is responsible for obtaining reasonable assurance that the financial statements, taken as a whole, are free from material misstatement. In conducting an audit of financial statements, the auditor takes into account the applicable legal and regulatory framework.

Auditors performing an audit of financial statements consider compliance by companies with two different categories of law or regulations:

·        The provisions of those laws and regulations generally considered to have a direct effect on the determination of material amounts and disclosures in the financial statements (pension law, tax law, labor law).

·        Other laws and regulations that do not have a direct effect on the determination of the amounts and disclosures in the financial statements, but compliance with which may be essential  to a company’s ability to continue its business (for example, compliance with the terms of an operating license).

Usually, auditors obtain sufficient audit evidence regarding the compliance with laws and regulations by performing following procedures:

(a) Inquiring of management and, where appropriate, those charged with governance, as to whether the company is following such laws and regulations; and

(b) Inspecting correspondence, if any, with the relevant licensing or regulatory authorities.

(c) Reading minutes.

(d) Inquiring of the company’s management and in-house legal counsel or external legal counsel concerning litigation, claims and assessments; and

(e)  Performing substantive tests of details of classes of transactions, account balances or disclosures.

In conclusion, consideration of laws and regulations in an audit of financial statements is very important in obtaining audit evidence and expressing an audit opinion on financial statements.

ISA 250

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