Prospective Financial Information and Other Assurance Services
7 theoretical questions from ICAI Study Material
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When the user entity uses the services of a service organisation, objectives of auditor of user entity are: (a) To obtain an understanding of the nature and significance of the services provided by the service organisation and their effect on the user entity’s internal control relevant to the audit, sufficient to identify and assess the risks of material misstatement and (b) To design and perform audit procedures responsive to those risks. Therefore, it is in line with the above requirements that auditors of STAR Limited require an assurance report from auditors of Little Solutions Private Limited. SA 402 casts such responsibility on user auditors. In accordance with requirements of SAE 3402, auditors of Little Solutions Private Limited should provide a type 2 report to auditors of STAR Limited. As auditors of STAR Limited want to be sure about description, design and operating effectiveness of controls at Little Solutions Pvt. Ltd. throughout the year and type 2 report deals with such matters, type 2 report should be provided by the auditors of the Little Solutions Pvt. Ltd. Type 2 report is a report on the description, design and operating effectiveness of controls at a service organization whereas type 1 report is a report on the description and design of controls at a service organization. (c) The opinion of auditors of Little Solutions Pvt. Ltd. would state whether, in all material respects, based on suitable criteria: - The description fairly presents the service organization’s system that had been designed and implemented throughout the specified period; The controls related to the control objectives stated in the service organization’s description of its system were suitably designed throughout the specified period and The controls tested, which were those necessary to provide reasonable assurance that the control objectives stated in the description were achieved, operated effectively throughout the specified period.
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Before accepting an engagement to examine prospective financial information, the auditor would consider, amongst other things: • The intended use of the information; • Whether the information will be for general or limited distribution; • The nature of the assumptions, that is, whether they are best estimates or hypothetical assumptions; • The elements to be included in the information; and • The period covered by the information. The auditor should not accept, or should withdraw from, an engagement when the assumptions are clearly unrealistic or when the auditor believes that the prospective financial information will be inappropriate for its intended use. The auditor should consider the extent to which reliance on the entity’s historical financial information is justified. To formalize the terms of the engagement, it is essential to agree on the terms with the client by sending an engagement letter, like in other engagements.
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Prospective financial information can be in the form of a forecast, a projection, or a combination of both, for example, a one year forecast plus a five- year projection. “Forecast” means prospective financial information prepared on the basis of: • Assumptions as to future events which management expects to take place and • The actions management expects to take as of the date the information is prepared (best-estimate assumptions- an assumption that reflects anticipated experience with no provision for risk of adverse deviation). PROSPECTIVE FINANCIAL INFORMATION AND OTHER ASSURANCE SERVICES Example- In present market conditions, supply availability, historical buying patterns and seasonal trends, the CFO of X Ltd. expects sales to increase by 5% over the next quarter. Therefore, a 5% sales increase is his financial forecast for the period. “Projection” means prospective financial information prepared on the basis of: • Hypothetical assumptions about future events and management actions which are not necessarily expected to take place, such as when some entities are in a start-up phase or are considering a major change in the nature of operations; or • A mixture of best-estimate and hypothetical assumptions (imagined or suggested) Example- X Ltd. may project a course of action to take when one or more hypothetical situations arise, such as creating a new product to meet the demand of expected market growth. As a result of assuming the possibility of different events occurring, financial projections typically serve as an outline for evaluating the desired outcomes X Ltd. expects to see, including its financial, cash flow and operational outcomes. Prospective financial information relates to events and actions that have not yet occurred and might not occur. While evidence may be available to support the assumptions on which the prospective financial information is based, such evidence is itself generally future- oriented and, therefore, speculative in nature, as distinct from the evidence ordinarily available in the examination of historical financial information. Therefore, an opinion as to whether the results shown in the prospective financial information will be achieved cannot be expressed.
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