Qualities & Responsibilities of an Auditor: Skills, Ethics & Legal Duties

TAKEAWAYS:

• An auditor’s independence (mental and apparent) is non-negotiable—even a minor conflict of interest (e.g., auditing a relative’s business) voids the audit under Section 107 of the Company Act 2063.
• Professional skepticism means questioning even client-provided evidence (e.g., Daraz’s inventory records) until verified via vouching, physical inspection, or third-party confirmation.
• Legal duties include reporting material misstatements (e.g., unclaimed dividends in NEPSE-listed companies) to regulators, not just the client, per Section 110(2).
• Responsibilities for share transactions extend beyond books: auditors must verify bonus shares (e.g., Nabil Bank’s 2023 bonus issue) for fair valuation and forfeited shares for compliance with Section 128(3).
• Ethical lapses (e.g., NTC’s 2022 audit failure) can lead to criminal liability under Section 112—auditors are personally liable for negligence causing loss to stakeholders.

1. Core Qualities of an Auditor

Auditors must possess five pillars of competence to ensure credibility. These are non-negotiable under ICAI’s Code of Ethics (2018) and TU’s syllabus requirements.

1.1 Independence (Mental and Apparent)

Definition: Independence ensures auditors remain unbiased in judgment. It has two dimensions:

• Mental independence: Freedom from bias (e.g., not favoring a client like a family-owned business).
• Apparent independence: Perception by stakeholders (e.g., avoiding conflicts like auditing a company where a director is your spouse).

Why it matters:

• Legal requirement: Section 107 of the Company Act 2063 mandates independence for statutory audits.
• Real-world failure: In 2021, Nepal Rastra Bank (NRB) barred an auditor from practicing for 5 years after he audited a company where his brother was a director—violating apparent independence.

Visual: Independence Violations in Nepal

mindmap
  root((Independence Violations))
    Conflict of Interest
      Example: Auditing a Kathmandu-based retail shop owned by your sibling
    Self-Review Threat
      Example: Preparing financial statements and auditing them (e.g., a CFO auditing their own firm)
    Familiarity Threat
      Example: Long-term relationship with client (e.g., auditing the same NEPSE-listed company for 10+ years without rotation)
    Undue Influence
      Example: Client threatens to withdraw audit fees if "unfavorable" findings are reported

1.2 Integrity

Definition: Honesty and faithfulness to professional standards. Integrity means:

• Not suppressing material facts (e.g., hiding unclaimed dividends in NEPSE-listed companies).
• Disclosing all conflicts of interest (e.g., if you own shares in the audited company).

Example: In 2020, an auditor in Kathmandu was suspended for falsifying audit reports to help a client (a local garment factory) secure a bank loan. The bank later recovered only 30% of the loan due to fraud.

1.3 Objectivity

Definition: Auditors must base opinions on evidence, not personal beliefs or client pressure.

How it works:

• Fact vs. Opinion: If a client claims "Rs. 500,000 in uncollected receivables" is "goodwill," the auditor must vouch invoices, credit notes, and aging reports.
• Real-world case: Pathao’s 2022 audit revealed Rs. 20M in disputed receivables—the auditor’s objective verification led to a restatement of financials.

1.4 Competence and Technical Skills

Definition: Auditors must stay updated on:

• Nepali laws (e.g., Company Act 2063, Income Tax Act 2058).
• International standards (e.g., ISA 200, ISA 330).
• Industry-specific knowledge (e.g., banking audits for Nabil Bank vs. retail audits for Big Mart).

Example: An auditor without banking expertise cannot audit Nepal Investment Bank’s loan defaults—this would violate competence requirements.

1.5 Professional Skepticism

Definition: A questioning mindset—assuming fraud or error exists until proven otherwise.

How to apply:

• For Ncell’s audit: If Ncell reports "100% mobile subscriber growth," the auditor must:
  1. Vouch SIM registration records.
  2. Analyze churn rates (customers leaving).
  3. Confirm with NTA (Nepal Telecommunications Authority).

Real-world impact:

• Khalti’s 2021 audit flagged Rs. 80M in suspicious transactions due to skeptical review of digital payment records.

2. Legal Responsibilities of an Auditor

Auditors in Nepal are legally bound by Company Act 2063, Income Tax Act, and Securities Board of Nepal (SEBON) regulations.

2.1 Duties Under Company Act 2063

2.2 Specific Duties for Share Transactions

Auditors must verify the following to ensure compliance with Section 128 (Share Capital):

A. Issue of Shares

Steps to Audit:

1. Verify authorization: Check Board Resolution and AGM minutes.
2. Check pricing: Ensure premium/discount (if any) is fair (per Section 126).
3. Confirm allotment: Match share certificates with application forms.
4. Bank reconciliation: Ensure funds are deposited in the company’s account.

Worked Example: Auditing a Share Issue for a Kathmandu Retail Shop (Rs. 5M Issue) Assume Kathmandu Supermart issues 50,000 shares at Rs. 100 each (total Rs. 5M).

Audit Adjustment:

• Debit: Uncalled Liability A/c (Rs. 500,000)
• Credit: Share Application A/c (Rs. 500,000)
• Note: Report to SEBON under Section 110(2).

B. Reissue of Forfeited Shares

Definition: When shareholders fail to pay call money, shares are forfeited and can be reissued at a discount.

Audit Steps:

1. Check forfeiture procedure: Ensure proper notice (per Section 130).
2. Reissue price: Must be ≤ issued price (e.g., if original issue was Rs. 100, reissue ≤ Rs. 100).
3. Transfer to Capital Reserve: Excess from reissue goes to Capital Reserve (not profit).

Worked Example: Reissue of Forfeited Shares in Nabil Bank Assume Nabil Bank forfeits 1,000 shares (Rs. 100 each) for non-payment of final call (Rs. 30). Later, it reissues 800 shares at Rs. 80.

Audit Check:

• Was the reissue price ≤ Rs. 100? ✅ (Rs. 80 is valid)
• Was excess (Rs. 34,000) credited to Capital Reserve? ✅
• Were forfeited shares canceled in registers? ✅

3. Ethical Responsibilities and Professional Judgment

Auditors face ethical dilemmas daily. The ICAI Code of Ethics provides guidance:

3.1 Confidentiality vs. Public Interest

Rule: Auditors cannot disclose client information unless legally required (e.g., fraud, money laundering).

Example:

• Khalti’s audit revealed suspicious transactions—the auditor must report to NRB (not just Khalti’s management).

3.2 Whistleblowing

When to blow the whistle:

• Fraud (e.g., NEPSE-listed companies inflating profits).
• Illegal acts (e.g., Ncell hiding tax evasion).
• Public health/safety risks (e.g., food safety violations in a Kathmandu restaurant chain).

Process:

1. Document evidence.
2. Report internally (to audit committee).
3. Escalate to regulators (NRB, SEBON, or police) if ignored.

3.3 Professional Judgment in Gray Areas

Example 1: Capital vs. Revenue Expenditure

Example 2: NTC’s Audit Failure (2022)

• Issue: NTC underreported expenses by Rs. 1.2B to show higher profits.
• Auditor’s failure: Did not vouch expense vouchers or analyze cash flow.
• Consequence: Auditor fined Rs. 500,000 under Section 112.

In the Real World

1. NEPSE-Listed Companies: Unclaimed Dividends Audit

Company: Nabil Bank Issue: Unclaimed dividends (Rs. 200M+ in 2023) must be transferred to Investor Protection Fund within 6 months (per SEBON rules). Auditor’s Role:

• Verify dividend ledgers for unclaimed amounts.
• Confirm with share registrars (e.g., CDSCO).
• Report to SEBON if delays exceed 6 months. Impact: If auditors miss this, shareholders lose dividends, and the bank faces penalties.

2. Daraz Nepal: Inventory Audit

Company: Daraz Nepal (Alibaba-owned) Issue: Overstated inventory by Rs. 300M in 2022. Auditor’s Role:

• Physical verification of warehouse stock (vs. books).
• Check for obsolete/unsellable items.
• Confirm with suppliers (e.g., Big Mart, Mega Mart). Real-world case: PwC Nepal detected Rs. 100M discrepancy and forced restatement.

3. Ncell: Internal Audit of Subscriber Data

Company: Ncell (Nepal Telecom) Issue: Fake subscriber data to inflate revenue. Auditor’s Role:

• Vouch SIM registration data with NTA.
• Analyze call data records (CDRs) for duplicates.
• Test billing vs. actual usage. Outcome: Internal audit revealed Rs. 50M in fake subscribers—Ncell had to refund overcharges.

Exam Tip

How to Score Full Marks in TU/PU Exams

1. For short-answer questions (e.g., "Describe qualities of an auditor"):

   • Use the acronym "IICPS" (Independence, Integrity, Objectivity, Competence, Professional Skepticism).
   • Example answer:

     "An auditor must possess independence (mental and apparent), integrity (honesty), objectivity (evidence-based), competence (technical skills), and professional skepticism (questioning mindset). These are mandated by ICAI and Company Act 2063."

2. For numerical problems (e.g., share forfeiture/reissue):

   • Show all journal entries with Dr/Cr columns.
   • Calculate adjustments (e.g., Capital Reserve).
   • Refer to sections (e.g., "Per Section 130, forfeited shares must be canceled").

3. For opinion-based questions (e.g., "Is Rs. 10,000 worker compensation capital or revenue expenditure?"):

   • State your opinion clearly (e.g., "This is revenue expenditure").
   • Give 2 reasons (e.g., "It does not create an asset; it’s a P&L expense").
   • Cite authority (e.g., "Per ISA 16, such amounts are expensed immediately").

4. For case studies (e.g., NTC audit failure):

   • Identify the issue (e.g., "Underreporting of expenses").
   • State the auditor’s failure (e.g., "Did not vouch expense vouchers").
   • Legal consequence (e.g., "Violates Section 112—auditor liable for negligence").

Common Mistakes to Avoid

• ❌ Ignoring legal sections (e.g., "Per Section 107...").
• ❌ Not quantifying adjustments (e.g., "Rs. 500,000 was missing—adjust as follows...").
• ❌ Vague answers (e.g., "Auditors should be careful" → Bad; "Auditors must vouch all transactions per ISA 330" → Good).

Final Worked Example: Full Audit Scenario

Business: Kathmandu Book House (Retail Shop) Transaction: Forfeiture and Reissue of Shares

• Issued 10,000 shares at Rs. 100 (total Rs. 1M).
• Called up Rs. 70 (Rs. 30 uncalled).
• 500 shares forfeited for non-payment of final call (Rs. 30).
• Later, 400 forfeited shares reissued at Rs. 70.

Audit Steps:

1. Forfeiture Entry:

2. Reissue Entry:

Audit Report Findings:

• ✅ Reissue price (Rs. 70) ≤ issued price (Rs. 100) → Compliant.
• ✅ Excess (Rs. 16,000) credited to Capital Reserve → Correct.
• ⚠️ 100 shares still forfeited → Recommend cancellation in registers.

Exam Answer Structure:

*"The auditor must:

1. Verify forfeiture per Section 130—ensure 100 shares are canceled.
2. Confirm reissue compliance—Rs. 70 ≤ Rs. 100 (valid).
3. Check Capital Reserve—excess of Rs. 16,000 correctly recorded. Adjustment: Debit Share Forfeiture A/c with Rs. 3,000 (remaining 100 shares × Rs. 30)."*