During an audit engagement, the audit team discovers several instances of potential noncompliance with laws and regulations by the client. These instances, while not directly material to the financial statements, could result in significant fines and reputational damage. The auditor's primary responsibility in this situation is to:
- ADisclose the potential noncompliance in the auditor's report as an 'Emphasis-of-Matter' paragraph.
- BIgnore the noncompliance if it does not have a direct and material effect on the financial statements.
- CObtain sufficient understanding of the act and its potential effects, then discuss with management and, if appropriate, those charged with governance.
- DReport the noncompliance directly to regulatory authorities.
Show answer & explanationAnswer & explanation
Correct answer: C. Obtain sufficient understanding of the act and its potential effects, then discuss with management and, if appropriate, those charged with governance.
For noncompliance with laws and regulations (NOCLAR), the auditor's primary responsibility is to understand the nature and potential impact of the act, then communicate it to the appropriate level of management and, if necessary, to those charged with governance. Direct reporting to external authorities is generally not the auditor's role unless required by law or regulation.
Why the other options are wrong
- A. Disclosing in the audit report might be considered if management does not take appropriate action, but it's not the primary or first step.
- B. Ignoring the noncompliance is a breach of professional duty, as it could have indirect effects on the financial statements or the auditor's opinion.
- D. Direct reporting to external authorities is typically not the auditor's role unless specific laws or regulations require it, or in rare circumstances to prevent future harm.
Noncompliance with Laws & Regulations (NOCLAR)
Acts of omission or commission by the entity, either intentional or unintentional, which are contrary to the prevailing laws or regulations.
- Auditor's responsibility is to obtain reasonable assurance that financial statements are free from material misstatement due to NOCLAR.
- Auditor performs procedures to identify noncompliance that may affect financial statements.
- Communication with management and those charged with governance is key.
Memory trick: When laws are broken, the auditor must speak, to management and governance, a clear critique.