Specific Independent Auditing Standard No.18 - Noncompliance with Laws and Regulations

Specific Independent Auditing Standard No.18 - Noncompliance with Laws and Regulations Chapter 1 General provisions Article 1 This standard is prepared in accordance with the General Independent Auditing Standard to establish standards for Certified Public Accountants ("CPAs") on considering any noncompliance with laws and regulations which would have a material impact on the financial statements in the audit of financial statements, to define the relevant responsibilities and to ensure a high standard of professional work. Article 2 The term "laws and regulations" in this standard refers to State laws, administrative regulations, departmental rules and local laws and regulations other than the Accounting Standards for Business Enterprises and other relevant financial and accounting laws and regulations promulgated by the State. Article 3 Unless otherwise specified, CPAs should refer to this standard in performing audit work other than the audit of financial statements. Chapter 2 General principles Article 4 It is the responsibility of the entity’s management to establish sound internal controls to ensure that operations are conducted in accordance with the requirements of laws and regulations, and to prevent and promptly detect and correct any noncompliance. Article 5 The CPA should pay adequate attention to possible noncompliance with laws and regulations which would have a material impact on the financial statements when preparing and implementing an audit plan, and in evaluating and reporting the audit results in accordance with the requirements of the Independent Auditing Standards. Article 6 Due to the inherent limitations of audit tests and the entity’s internal controls, the CPA cannot ensure that all noncompliance with laws and regulations is detected even if the CPA acts in accordance with the Independent Auditing Standards in performing the audit work. Article 7 The audit of financial statements by a CPA is not specifically aimed at detecting noncompliance with laws and regulations. If the client specifically requires an audit of the possible existence of certain noncompliance with laws and regulations, the CPA should consider his own ability and the audit risk, and should contract the terms under a separate engagement letter. Chapter 3 Paying attention to noncompliance with laws and regulations in the preparation and implementation of the audit plan Article 8 When preparing and implementing the audit plan, the CPA should maintain professional scepticism and pay adequate attention to noncompliance with laws and regulations which would have a material impact on the financial statements. Article 9 When preparing the audit plan, the CPA should normally use the relevant existing knowledge of the entity and its industry, and should perform the following procedures to obtain a preliminary understanding of the laws and regulations applicable to the entity and its industry and an understanding of how the entity is complying with the laws and regulations: (1) enquire the management and its legal advisors about the laws and regulations which would have a material impact on the entity’s operations; (2) enquire the management about the policies and procedures adopted by the entity to comply with the relevant laws and regulations; (3) enquire internal auditors to what extent the entity has complied with the laws and regulations; (4) discuss with the management the policies and procedures adopted for identifying, evaluating and accounting for litigation, claims and tax disputes; and (5) discuss with other CPAs who audit the entity’s components the laws and regulations applicable to these components. Article 10 Based on the preliminary understanding, the CPA should perform the following procedures to help identifying instances of noncompliance with relevant laws and regulations which should be considered when the entity prepares the financial statements: (1) enquire the management whether the entity complies with the relevant laws and regulations; and (2) inspect the entity’s correspondences with the relevant government departments and legal advisors. Article 11 The CPA should obtain sufficient appropriate audit evidence to determine whether the entity complies with the relevant laws and regulations which would have a material impact on the financial statements. Article 12 The CPA should obtain written representations from the management to indicate that the entity has informed the CPA of all known actual or possible noncompliance with relevant laws and regulations which would affect the financial statements. Article 13 Procedures performed to form an audit opinion on the financial statements may bring to the CPA’s attention instances of possible noncompliance with laws and regulations by the entity which may affect the financial statements. The CPA should pay adequate attention these instances. Article 14 when implementing the audit plan, the CPA should pay adequate attention to the following instances which indicate that the entity may be noncompliant with the laws and regulations: (1) investigation or penalisation by the relevant government departments; (2) providing unusual loans or repayments for unspecified services; (3) existence of unusual transactions with related parties; (4) unusual payments of sales commissions or agency fees; (5) significant deviation between the market price and the purchasing and selling prices; (6) unusual cash receipts and payments; (7) unusual transactions with companies registered in tax havens; (8) payments for goods or services made to units or individuals other than providers of goods or services; (9) lack of proper control documentation on receipts and payments; (10) inability of the accounting system to provide a proper audit trail or sufficient evidence; (11) unauthorised or improperly recorded transactions; and (12) media comment. Chapter 4 Actions to be taken on discovery of possible existence of noncompliance with laws and regulations Article 15 When the CPA detects a possible instance of noncompliance with laws and regulations, he should obtain an understanding of its nature and the circumstances in which it occurred, and should obtain appropriate evidence to evaluate the possible impact on the financial statements. Article 16 When evaluating the impact of possible noncompliance with laws and regulations on the financial statements, the CPA should consider: (1) the potential financial consequences arising from fines, confiscation of illegal proceeds, expropriation of assets,forced discontinuation of operations and litigation etc; (2) whether the potential financial consequences mentioned above require disclosure; and (3) whether the potential financial consequences mentioned above will seriously affect the fair presentation of the financial statements. Article 17 When the CPA believes there may be noncompliance with laws and regulations which would affect the financial statements, he should discuss it with the entity’s management and document the relevant audit findings. If the entity’s management cannot provide appropriate evidence to prove that it is actually in compliance with the laws and regulations, the CPA should consult legal advisors, where appropriate, to determine: (1) whether noncompliance with laws and regulations exists in the entity; (2) the possible legal consequences; and (3) what further action should be taken. Article 18 When noncompliance with laws and regulations which would affect the financial statements does exist in the entity, the CPA should consider its impact on the audit. If necessary, the CPA should reassess the audit risk. Article 19 The CPA should inform the entity’s management of noncompliance with laws and regulations identified during the audit which would affect the financial statements. If the CPA believes the noncompliance is intentional and material, he should inform the entity’s management immediately. If the CPA suspects that members of senior management are involved in noncompliance with laws and regulations, he should report the matter to a higher level of the entity’s management. Article 20 When the most senior management is suspected of being involved in noncompliance with laws and regulations, or if the entity refuses to adopt the necessary measures to rectify any noncompliance, the CPA should consider taking appropriate steps. If necessary, the CPA should seek legal advice or terminate the engagement. Chapter 5 Impact of noncompliance with laws and regulations on the audit report Article 21 If the entity’s noncompliiance with laws and regulations has a material impact on the financial statements and has not been properly reflected in them, the CPA should express a qualified opinion or an adverse opinion. Article 22 If there are limitations, imposed by the entity on the scope of the audit, which preclude the CPA from obtaining sufficient appropriate audit evidence about any actual or possible noncompliance with laws and regulations which would have a material impact on the financial statements, the CPA should express a qualified opinion or disclaimer of opinion. Article 23 If there are limitations, imposed on the scope of the audit by circumstances other than by the entity,which preclude the CPA from determining whether noncompliance with laws and regulations has occurred, the CPA should consider the impact on the audit report. Article 24 If the local laws and regulations or rules relied upon by the entity are not consistent with the requirements of State laws, administrative regulations and departmental rules, and if this has an impact on the financial statements, the CPA should, depending on the importance, consider whether to ask the entity to disclose this in a proper manner in the financial statements. The CPA should also consider reflecting it properly in the audit report. Chapter 6 Supplementary provisions Article 25 The Chinese Institute of Certified Public Accountants is responsible for the interpretation of this standard. Article 26 This standard takes effect from 1 July 1999.