(Ref: Para. 3–9)

It is the responsibility of management, with the oversight of those charged with governance, to ensure that the entity’s operations are conducted in accordance with laws and regulations.  Laws and regulations may affect an entity’s financial report in different ways: for example, most directly, they may affect specific disclosures required of the entity in the financial report or they may prescribe the applicable financial reporting framework.  They may also establish certain legal rights and obligations of the entity, some of which will be recognised in the entity’s financial report.  In addition, laws and regulations may impose penalties in cases of non‑compliance.

The following are examples of the types of policies and procedures an entity may implement to assist in the prevention and detection of non‑compliance with laws and regulations:

• Monitoring legal requirements and ensuring that operating procedures are designed to meet these requirements.
• Instituting and operating appropriate systems of internal control.
• Developing, publicising and following a code of conduct.
• Ensuring employees are properly trained and understand the code of conduct.
• Monitoring compliance with the code of conduct and acting appropriately to discipline employees who fail to comply with it.
• Engaging legal advisors to assist in monitoring legal requirements.
• Maintaining a register of significant laws and regulations with which the entity has to comply within its particular industry and a record of complaints.

In larger entities, these policies and procedures may be supplemented by assigning appropriate responsibilities to the following:

• An internal audit function.
• An audit committee.
• A compliance function.

Responsibility of the Auditor

Non‑compliance by the entity with laws and regulations may result in a material misstatement of the financial report.  Detection of non‑compliance, regardless of materiality, may affect other aspects of the audit including, for example, the auditor’s consideration of the integrity of management, those charged with governance or employees.

Whether an act constitutes non‑compliance with laws and regulations is a matter to be determined by a court or other appropriate adjudicative body, which is ordinarily beyond the auditor’s professional competence to determine.  Nevertheless, the auditor’s training, experience and understanding of the entity and its industry or sector may provide a basis to recognise that some acts, coming to the auditor’s attention, may constitute non‑compliance with laws and regulations. 

In accordance with specific statutory requirements, the auditor may be specifically required to report, as part of the audit of the financial report, on whether the entity complies with certain provisions of laws or regulations.  In these circumstances, ASA 700[9] or ASA 800[10] deal with how these audit responsibilities are addressed in the auditor’s report.  Furthermore, where there are specific statutory reporting requirements, it may be necessary for the audit plan to include appropriate tests for compliance with these provisions of the laws and regulations. 

Categories of Laws and Regulations (Ref: Para. 6)

The nature and circumstances of the entity may impact whether relevant laws and regulations are within the categories of laws and regulations described in paragraphs 6(a) or 6(b).  Examples of laws and regulations that may be included in the categories described in paragraph 6 include those that deal with:

• Fraud, corruption and bribery. 
• Money laundering, terrorist financing and proceeds of crime. 
• Securities markets and trading. 
• Banking and other financial products and services. 
• Data protection.
• Tax and superannuation liabilities and payments. 
• Environmental protection. 
• Public health and safety. 

Considerations Specific to Public Sector Entities

In the public sector, there may be additional audit responsibilities with respect to the consideration of laws and regulations which may relate to the audit of the financial report or may extend to other aspects of the entity’s operations.

Additional Responsibilities Established by Law, Regulation or Relevant Ethical Requirements (Ref: Para. 9)

Law, regulation or relevant ethical requirements may require the auditor to perform additional procedures and take further action.  For example, the APES 110 Code of Ethics for Professional Accountants (including Independence Standards) issued by the Accounting Professional & Ethical Standards Board (the Code) requires the auditor to take steps to respond to identified or suspected non‑compliance with laws and regulations and determine whether further action is needed.  Such steps may include the communication of identified or suspected non‑compliance with laws and regulations to other auditors within a group, including a group engagement partner, component auditors or other auditors performing work at components of a group for purposes other than the audit of the group financial report.[11]

(Ref: Para. 12)

Acts of non‑compliance with laws and regulations include transactions entered into by, or in the name of, the entity, or on its behalf, by those charged with governance, by management or by other individuals working for or under the direction of the entity.

Non‑compliance also includes personal misconduct related to the business activities of the entity, for example, in circumstances where an individual in a key management position, in a personal capacity, has accepted a bribe from a supplier of the entity and in return secures the appointment of the supplier to provide services or contracts to the entity. 

Obtaining an Understanding of the Legal and Regulatory Framework (Ref: Para. 13)

To obtain a general understanding of the legal and regulatory framework, and how the entity complies with that framework, the auditor may, for example:

• Use the auditor’s existing understanding of the entity’s industry, regulatory and other external factors;
• Update the understanding of those laws and regulations that directly determine the reported amounts and disclosures in the financial report;
• Enquire of management as to other laws or regulations that may be expected to have a fundamental effect on the operations of the entity;
• Enquire of management concerning the entity’s policies and procedures regarding compliance with laws and regulations; and
• Enquire of management regarding the policies or procedures adopted for identifying, evaluating and accounting for litigation claims.

Laws and Regulations Generally Recognised to Have a Direct Effect on the Determination of Material Amounts and Disclosures in the Financial Report (Ref: Para. 6, 14)

Certain laws and regulations are well‑established, known to the entity and within the entity’s industry or sector, and relevant to the entity’s financial report (as described in paragraph 6(a)).  They could include those that relate to, for example:

• The form and content of a financial report;
• Industry‑specific financial reporting issues;
• Accounting for transactions under government contracts; or
• The accrual or recognition of expenses for income tax or superannuation costs. 

Some provisions in those laws and regulations may be directly relevant to specific assertions in the financial report (e.g., the completeness of income tax provisions), while others may be directly relevant to the financial report as a whole (e.g., the required statements constituting a complete set of financial statements).  The aim of the requirement in paragraph 14 is for the auditor to obtain sufficient appropriate audit evidence regarding the determination of amounts and disclosures in the financial report in compliance with the relevant provisions of those laws and regulations. 

Non‑compliance with other provisions of such laws and regulations and other laws and regulations may result in fines, litigation or other consequences for the entity, the costs of which may need to be provided for in the financial report, but are not considered to have a direct effect on the financial report as described in paragraph 6(a).

Procedures to Identify Instances of Non‑Compliance—Other Laws and Regulations (Ref: Para. 6, 15)

Certain other laws and regulations may need particular attention by the auditor because they have a fundamental effect on the operations of the entity (as described in paragraph 6(b)).  Non‑compliance with laws and regulations that have a fundamental effect on the operations of the entity may cause the entity to cease operations, or call into question the entity’s continuance as a going concern.[12] For example, non‑compliance with the requirements of the entity’s license or other entitlement to perform its operations could have such an impact (e.g., for a bank, non‑compliance with capital or investment requirements).  There are also many laws and regulations relating principally to the operating aspects of the entity that typically do not affect the financial report and are not captured by the entity’s information systems relevant to financial reporting.

As the financial reporting consequences of other laws and regulations can vary depending on the entity’s operations, the audit procedures required by paragraph 15 are directed to bringing to the auditor’s attention instances of non‑compliance with laws and regulations that may have a material effect on the financial report.

Non‑Compliance Brought to the Auditor’s Attention by Other Audit Procedures (Ref: Para. 16)

Audit procedures applied to form an opinion on the financial report may bring instances of non‑compliance or suspected non‑compliance with laws and regulations to the auditor’s attention.  For example, such audit procedures may include:

• Reading minutes;
• Enquiring of the entity’s management and in‑house legal counsel or external legal counsel concerning litigation, claims and assessments; and
• Performing substantive tests of details of classes of transactions, account balances or disclosures.

Written Representations (Ref: Para. 17)

Because the effect on a financial report of laws and regulations can vary considerably, written representations provide necessary audit evidence about management’s knowledge of identified or suspected non‑compliance with laws and regulations, whose effects may have a material effect on the financial report.  However, written representations do not provide sufficient appropriate audit evidence on their own and, accordingly, do not affect the nature and extent of other audit evidence that is to be obtained by the auditor.[13]

Indications of Non‑Compliance with Laws and Regulations (Ref: Para. 19)

The auditor may become aware of information concerning an instance of non‑compliance with laws and regulations other than as a result of performing the procedures in paragraphs 13–17 (e.g., when the auditor is alerted to non‑compliance by a whistle blower).

The following matters may be an indication of non‑compliance with laws and regulations:

• Investigations by regulatory organisations and government departments or payment of fines or penalties. 
• Payments for unspecified services or loans to consultants, related parties, employees or government employees. 
• Sales commissions or agent’s fees that appear excessive in relation to those ordinarily paid by the entity or in its industry or to the services actually received. 
• Purchasing at prices significantly above or below market price.
• Unusual payments in cash, purchases in the form of cashiers’ cheques payable to bearer or transfers to numbered bank accounts. 
• Unusual transactions with companies registered in tax havens. 
• Payments for goods or services made other than to the country from which the goods or services originated. 
• Payments without proper exchange control documentation.
• Existence of an information system which fails, whether by design or by accident, to provide an adequate audit trail or sufficient evidence.
• Unauthorised transactions or improperly recorded transactions.
• Adverse media comment.

Matters Relevant to the Auditor’s Evaluation (Ref: Para. 19(b))

Matters relevant to the auditor’s evaluation of the possible effect on the financial report include:

• The potential financial consequences of identified or suspected non‑compliance with laws and regulations on the financial report including, for example, the imposition of fines, penalties, damages, threat of expropriation of assets, enforced discontinuation of operations, and litigation. 
• Whether the potential financial consequences require disclosure.
• Whether the potential financial consequences are so serious as to call into question the fair presentation of the financial report, or otherwise make the financial report misleading.

Audit Procedures and Communicating Identified or Suspected Non‑Compliance with Management and Those Charged with Governance (Ref: Para. 20)

The auditor is required to discuss the suspected non‑compliance with the appropriate level of management and, where appropriate, those charged with governance, as they may be able to provide additional audit evidence.  For example, the auditor may confirm that management and, where appropriate, those charged with governance have the same understanding of the facts and circumstances relevant to transactions or events that have led to the  suspected non‑compliance with laws and regulations. 

In the case of an audit conducted under the Corporations Act 2001, the auditor may need to consider the provisions relating to the protection for whistleblowers contained in Part 9.4AAA of the Corporations Act 2001 when communicating identified or suspected non-compliance with management and those charged with governance.

However, in some jurisdictions, law or regulation may restrict the auditor’s communication of certain matters with management and those charged with governance.  Law or regulation may specifically prohibit a communication, or other action, that might prejudice an investigation by an appropriate authority into an actual, or suspected, illegal act, including alerting the entity, for example, when the auditor is required to report the identified or suspected non‑compliance to an appropriate authority pursuant to anti‑money laundering legislation.  In these circumstances, the issues considered by the auditor may be complex and the auditor may consider it appropriate to obtain legal advice. 

If management or, as appropriate, those charged with governance, do not provide sufficient information to the auditor that the entity is in fact in compliance with laws and regulations, the auditor may consider it appropriate to consult with the entity’s in‑house or external legal counsel about the application of the laws and regulations to the circumstances, including the possibility of fraud, and the possible effects on the financial report.  If it is not considered appropriate to consult with the entity’s legal counsel or if the auditor is not satisfied with the legal counsel’s opinion, the auditor may consider it appropriate to consult on a confidential basis with others within the firm, a network firm, a professional body, or with the auditor’s legal counsel as to whether a contravention of a law or regulation is involved, including the possibility of fraud, the possible legal consequences, and what further action, if any, the auditor would take.

Evaluating the Implications of Identified or Suspected Non‑Compliance (Ref: Para. 22)

As required by paragraph 22, the auditor evaluates the implications of identified or suspected non‑compliance in relation to other aspects of the audit, including the auditor’s risk assessment and the reliability of written representations.  The implications of particular identified or suspected non‑compliance will depend on the relationship of the perpetration and concealment, if any, of the act to specific controls and the level of management or individuals working for, or under the direction of, the entity involved, especially implications arising from the involvement of the highest authority within the entity.  As noted in paragraph 9, the auditor’s compliance with law, regulation or relevant ethical requirements may provide further information that is relevant to the auditor’s responsibilities in accordance with paragraph 22.

Examples of circumstances that may cause the auditor to evaluate the implications of identified or suspected non‑compliance on the reliability of written representations received from management and, where applicable, those charged with governance include when:

• The auditor suspects or has evidence of the involvement or intended involvement of management and, where applicable, those charged with governance, in any identified or suspected non‑compliance.
• The auditor is aware that management and, where applicable, those charged with governance. have knowledge of such non‑compliance and, contrary to legal or regulatory requirements, have not reported, or authorised reporting of, the matter to an appropriate authority within a reasonable period.

In certain circumstances, the auditor may consider withdrawing from the engagement, where permitted by law or regulation, for example when management or those charged with governance do not take the remedial action that the auditor considers appropriate in the circumstances or the identified or suspected non‑compliance raises questions regarding the integrity of management or those charged with governance, even when the non‑compliance is not material to the financial report.  The auditor may consider it appropriate to obtain legal advice to determine whether withdrawal from the engagement is appropriate.  When the auditor determines that withdrawing from the engagement would be appropriate, doing so would not be a substitute for complying with other responsibilities under law, regulation or relevant ethical requirements to respond to identified or suspected non‑compliance.  Furthermore, paragraph A55 of ASA 220[14] indicates that some ethical requirements may require the predecessor auditor, upon request by the proposed successor auditor, to provide information regarding non‑compliance with laws and regulations to the successor auditor.

Potential Implications of Identified or Suspected Non‑Compliance for the Auditor’s Report (Ref: Para. 26–28)

Identified or suspected non‑compliance with laws and regulation is communicated in the auditor’s report when the auditor modifies the opinion in accordance with paragraphs 26–28.  In certain other circumstances, the auditor may communicate identified or suspected non‑compliance in the auditor’s report, for example: 

• When the auditor has other reporting responsibilities, in addition to the auditor’s responsibilities under the Australian Auditing Standards, as contemplated by paragraph 43 of ASA 700; 
• When the auditor determines that the identified or suspected non‑compliance is a key audit matter and accordingly communicates the matter in accordance with ASA 701,^[15] unless paragraph 14 of that Auditing Standard applies; or 
• In exceptional cases when management or those charged with governance do not take the remedial action that the auditor considers appropriate in the circumstances and withdrawal from the engagement is not possible (see paragraph A25), the auditor may consider describing the identified or suspected non‑compliance in an Other Matter paragraph in accordance with ASA 706.^[16]

If, in the case of an audit conducted under the Corporations Act 2001, the auditor identifies non‑compliance with an Australian Accounting Standard, defects or irregularities in the financial report or deficiencies, failures or shortcomings in respect of section 307 of the Act, the auditor’s report is to include the information required by the Act.*  The auditor needs to consider any other relevant laws and regulations.  If the auditor is in doubt as to the proper interpretation of laws or regulations, or whether non‑compliance has in fact occurred, the auditor ordinarily seeks legal advice before expressing an opinion on the financial report.

Law or regulation may preclude public disclosure by either management, those charged with governance or the auditor about a specific matter.  For example, law or regulation may specifically prohibit a communication, or other action, that might prejudice an investigation by an appropriate authority into an actual, or suspected, illegal act, including a prohibition on alerting the entity.  When the auditor intends to communicate identified or suspected non‑compliance in the auditor’s report under the circumstances set out in paragraph A26 or otherwise, such law or regulation may have implications for the auditor’s ability to describe the matter in the auditor’s report, or in some circumstances to issue the auditor’s report.  In such cases, the auditor may consider obtaining legal advice to determine the appropriate course of action. 

Reporting Identified or Suspected Non‑Compliance to an Appropriate Authority outside the Entity (Ref: Para. 29)

Reporting identified or suspected non‑compliance with laws and regulations to an appropriate authority outside the entity may be required or appropriate in the circumstances because:

1. Law, regulation or relevant ethical requirements require the auditor to report (see paragraph A29);
2. The auditor has determined reporting is an appropriate action to respond to identified or suspected non‑compliance in accordance with relevant ethical requirements (see paragraph A30); or
3. Law, regulation or relevant ethical requirements provide the auditor with the right to do so (see paragraph A31).

In some jurisdictions, the auditor may be required by law, regulation or relevant ethical requirements to report identified or suspected non‑compliance with laws and regulations to an appropriate authority outside the entity.  For example, in some jurisdictions, statutory requirements exist for the auditor of a financial institution to report the occurrence, or suspected occurrence, of non‑compliance with laws and regulations to a supervisory authority.  Also, misstatements may arise from non‑compliance with laws or regulations and, in some jurisdictions, the auditor may be required to report misstatements to an appropriate authority in cases where management or those charged with governance fail to take corrective action.

In certain circumstances, the auditor has a statutory responsibility to report instances of non‑compliance with laws and regulations.  For example, in certain circumstances, the auditor is required under the Corporations Act 2001, to report to the Australian Securities and Investments Commission (ASIC).*  Establishing the appropriate authority to which such a report would be made in a particular instance will depend on the nature and circumstances of the non‑compliance.  When in doubt, the auditor would ordinarily seek legal advice.

In other cases, the relevant ethical requirements may require the auditor to determine whether reporting identified or suspected non‑compliance with laws and regulations to an appropriate authority outside the entity is an appropriate action in the circumstances.  For example, the Code requires the auditor to take steps to respond to identified or suspected non‑compliance with laws and regulations and determine whether further action is needed, which may include reporting to an appropriate authority outside the entity.[17] The Code explains that such reporting would not be considered a breach of the duty of confidentiality under the Code.[18]

Even if law, regulation or relevant ethical requirements do not include requirements that address reporting identified or suspected non‑compliance, they may provide the auditor with the right to report identified or suspected non‑compliance to an appropriate authority outside the entity.  For example, when auditing the financial report of financial institutions, the auditor may have the right under law or regulation to discuss matters such as identified or suspected non‑compliance with laws and regulations with a supervisory authority. 

In other circumstances, the reporting of identified or suspected non‑compliance with laws and regulations to an appropriate authority outside the entity may be precluded by the auditor’s duty of confidentiality under law, regulation or relevant ethical requirements.

The determination required by paragraph 29 may involve complex considerations and professional judgements.  Accordingly, the auditor may consider consulting internally (e.g., within the firm or a network firm) or on a confidential basis with a regulator or professional body (unless doing so is prohibited by law or regulation or would breach the duty of confidentiality).  The auditor may also consider obtaining legal advice to understand the auditor’s options and the professional or legal implications of taking any particular course of action. 

Considerations Specific to Public Sector Entities

A public sector auditor may be obliged to report on identified or suspected non‑compliance to the legislature or other governing body or to report them in the auditor’s report. 

(Ref: Para. 30)

The auditor’s documentation of findings regarding identified or suspected non‑compliance with laws and regulations may include, for example:

• Copies of records or documents.
• Minutes of discussions held with management, those charged with governance or parties outside the entity. 

Law, regulation or relevant ethical requirements may also set out additional documentation requirements regarding identified or suspected non‑compliance with laws and regulations.[19]