SA 402 Service Organisations
SA 402
Audit Considerations Relating to an Entity
Using a Service Organisation
(Effective for audits of financial statements for periods
beginning on or after April 1, 2010)
Contents
Paragraph(s)
Introduction
Scope of this SA......................................................................................1-5
Effective Date ............................................................................................ 6
Objectives ................................................................................................. 7
Definitions ................................................................................................ 8
Requirements
Obtaining an Understanding of the Services Provided by a
Service Organization, Including Internal Control............................. .....9-14
Responding to the Assessed Risks of Material Misstatement.............15-17
Type 1 and Type 2 Reports that Exclude the Services of a
Subservice Organization ...... ................................................................... 18
Fraud, Non-Compliance with Laws and Regulations and Uncorrected
Misstatements in Relation to Activities at the Service Organization ....... 19
Reporting by the User Auditor ............................................................20-22
Application and Other Explanatory Material
Obtaining an Understanding of the Services Provided by a
Service Organization, Including Internal Control ............................ A1-A23
Responding to the Assessed Risks of Material Misstatement ....... A24-A39
Type 1 and Type 2 Reports that Exclude the Services of a
Subservice Organization ...... ................................................................ A40
Fraud, Non-Compliance with Laws and Regulations and Uncorrected
Misstatements in Relation to Activities at the Service Organization .... A41
Published in August, 2009 issue of the Journal.
Handbook of Auditing Pronouncements-I.A
Reporting by the User Auditor ....................................................... A42-A44
Material Modifications to ISA 402, “Audit Considerations Relating to an
Entity Using a Service Organisation”
Standard on Auditing (SA) 402, “Audit Considerations Relating to an
Entity Using a Service Organisation”, should be read in the context of the
“Preface to the Standards on Quality Control, Auditing, Review, Other
Assurance and Related Services”, which sets out the authority of SAs
and SA 200, “Overall Objectives of the Independent Auditor and the
Conduct of an Audit in Accordance with Standards on Auditing”.
SA 402 2
Introduction
Scope of this SA
1. This Standard on Auditing (SA) deals with the user auditor’s responsibility
to obtain sufficient appropriate audit evidence when a user entity uses the
services of one or more service organisations. Specifically, it expands on how
the user auditor applies SA 3151 and SA 3302 in obtaining an understanding of
the user entity, including internal control relevant to the audit, sufficient to identify
and assess the risks of material misstatement and in designing and performing
further audit procedures responsive to those risks.
2. Many entities outsource aspects of their business to organisations that
provide services ranging from performing a specific task under the direction of an
entity to replacing an entity’s entire business units or functions, such as the tax
compliance function. Many of the services provided by such organisations are
integral to the entity’s business operations; however, not all those services are
relevant to the audit.
3. Services provided by a service organisation are relevant to the audit of a
user entity’s financial statements when those services, and the controls over
them, are part of the user entity’s information system, including related business
processes, relevant to financial reporting. Although most controls at the service
organisation are likely to relate to financial reporting, there may be other controls
that may also be relevant to the audit, such as controls over the safeguarding of
assets. A service organisation’s services are part of a user entity’s information
system, including related business processes, relevant to financial reporting if
these services affect any of the following:
(a) The classes of transactions in the user entity’s operations that are
significant to the user entity’s financial statements;
(b) The procedures, within both information technology (IT) and manual
systems, by which the user entity’s transactions are initiated, recorded,
processed, corrected as necessary, transferred to the general ledger and
reported in the financial statements;
(c) The related accounting records, either in electronic or manual form,
supporting information and specific accounts in the user entity’s financial
statements that are used to initiate, record, process and report the user
entity’s transactions; this includes the correction of incorrect information
and how information is transferred to the general ledger;
1 SA 315, “Identifying and Assessing the Risks of Material Misstatement Through Understanding the
Entity and Its Environment”.
2 SA 330, “The Auditor’s Responses to Assessed Risks”.
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(d) How the user entity’s information system captures events and conditions,
other than transactions, that are significant to the financial statements;
(e) The financial reporting process used to prepare the user entity’s financial
statements, including significant accounting estimates and disclosures; and
(f) Controls surrounding journal entries, including non-standard journal entries
used to record non-recurring, unusual transactions or adjustments.
4. The nature and extent of work to be performed by the user auditor
regarding the services provided by a service organisation depend on the nature
and significance of those services to the user entity and the relevance of those
services to the audit.
5. This SA does not apply to services provided by financial institutions that are
limited to processing, for an entity’s account held at the financial institution,
transactions that are specifically authorised by the entity, such as the processing
of checking account transactions by a bank or the processing of securities
transactions by a broker. In addition, this SA does not apply to the audit of
transactions arising from proprietary financial interests in other entities, such as
partnerships, corporations and joint ventures, when proprietary interests are
accounted for and reported to interest holders.
Effective Date
6. This SA is effective for audits of financial statements for periods beginning
on or after April 1, 2010.
Objectives
7. The objectives of the user auditor, when the user entity uses the services of
a service organisation, 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.
Definitions
8. For purposes of the SAs, the following terms have the meanings attributed
below:
(a) Complementary user entity controls – Controls that the service organisation
assumes, in the design of its service, will be implemented by user entities,
and which, if necessary to achieve control objectives, are identified in the
description of its system.
SA 402 4
(b) Report on the description and design of controls at a service organisation
(referred to in this SA as a Type 1 report) – A report that comprises:
(i) A description, prepared by management of the service organisation,
of the service organisation’s system, control objectives and related
controls that have been designed and implemented as at a specified
date; and
(ii) A report by the service auditor with the objective of conveying
reasonable assurance that includes the service auditor’s opinion on
the description of the service organisation’s system, control objectives
and related controls and the suitability of the design of the controls to
achieve the specified control objectives.
(c) Report on the description, design, and operating effectiveness of controls at
a service organisation (referred to in this SA as a Type 2 report) – A report
that comprises:
(i) A description, prepared by management of the service organisation,
of the service organisation’s system, control objectives and related
controls, their design and implementation as at a specified date or
throughout a specified period and, in some cases, their operating
effectiveness throughout a specified period; and
(ii) A report by the service auditor with the objective of conveying
reasonable assurance that includes:
a. The service auditor’s opinion on the description of the service
organisation’s system, control objectives and related controls,
the suitability of the design of the controls to achieve the
specified control objectives, and the operating effectiveness of
the controls; and
b. A description of the service auditor’s tests of the controls and
the results thereof.
(d) Service auditor – An auditor who, at the request of the service organisation,
provides an assurance report on the controls of a service organisation.
(e) Service organisation – A third-party organisation (or segment of a third-
party organisation) that provides services to user entities that are part of
those entities’ information systems relevant to financial reporting.
(f) Service organisation’s system – The policies and procedures designed,
implemented and maintained by the service organisation to provide user
entities with the services covered by the service auditor’s report.
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(g) Subservice organisation – A service organisation used by another service
organisation to perform some of the services provided to user entities that
are part of those user entities’ information systems relevant to financial
reporting.
(h) User auditor – An auditor who audits and reports on the financial
statements of a user entity.
(i) User entity – An entity that uses a service organisation and whose financial
statements are being audited.
Requirements
Obtaining an Understanding of the Services Provided by a Service
Organisation, Including Internal Control
9. When obtaining an understanding of the user entity in accordance with SA
315,3 the user auditor shall obtain an understanding of how a user entity uses the
services of a service organisation in the user entity’s operations, including: (Ref:
Para. A1-A2)
(a) The nature of the services provided by the service organisation and the
significance of those services to the user entity, including the effect thereof
on the user entity’s internal control; (Ref: Para. A3-A5)
(b) The nature and materiality of the transactions processed or accounts or
financial reporting processes affected by the service organisation; (Ref:
Para. A6)
(c) The degree of interaction between the activities of the service organisation
and those of the user entity; and (Ref: Para. A7)
(d) The nature of the relationship between the user entity and the service
organisation, including the relevant contractual terms for the activities
undertaken by the service organisation. (Ref: Para. A8-A11)
10. When obtaining an understanding of internal control relevant to the audit in
accordance with SA 315,4 the user auditor shall evaluate the design and
implementation of relevant controls at the user entity that relate to the services
provided by the service organisation, including those that are applied to the
transactions processed by the service organisation. (Ref: Para. A12-A14)
11. The user auditor shall determine whether a sufficient understanding of the
nature and significance of the services provided by the service organisation and
3 SA 315, paragraph 11.
4 SA 315, paragraph 12.
SA 402 6
their effect on the user entity’s internal control relevant to the audit has been
obtained to provide a basis for the identification and assessment of risks of
material misstatement.
12. If the user auditor is unable to obtain a sufficient understanding from the
user entity, the user auditor shall obtain that understanding from one or more of
the following procedures: (Ref: Para. A15-A20)
(a) Obtaining a Type 1 or Type 2 report, if available;
(b) Contacting the service organisation, through the user entity, to obtain
specific information;
(c) Visiting the service organisation and performing procedures that will
provide the necessary information about the relevant controls at the service
organisation; or
(d) Using another auditor to perform procedures that will provide the necessary
information about the relevant controls at the service organisation.
Using a Type 1 or Type 2 Report to Support the User Auditor’s
Understanding of the Service Organisation
13. In determining the sufficiency and appropriateness of the audit evidence
provided by a Type 1 or Type 2 report, the user auditor shall be satisfied as to:
(Ref: Para. A21)
(a) The service auditor’s professional competence (except where the service
auditor is a member of the Institute of Chartered Accountants of India) and
independence from the service organisation; and
(b) The adequacy of the standards under which the Type 1 or Type 2 report
was issued.
14. If the user auditor plans to use a Type 1 or Type 2 report as audit evidence
to support the user auditor’s understanding about the design and implementation
of controls at the service organisation, the user auditor shall: (Ref: Para. A22-
A23)
(a) Evaluate whether the description and design of controls at the service
organisation is at a date or for a period that is appropriate for the user
auditor’s purposes;
(b) Evaluate the sufficiency and appropriateness of the evidence provided by
the report for the understanding of the user entity’s internal control relevant
to the audit; and
(c) Determine whether complementary user entity controls identified by the
7 SA 402
Handbook of Auditing Pronouncements-I.A
service organisation are relevant to the user entity and, if so, obtain an
understanding of whether the user entity has designed and implemented
such controls.
Responding to the Assessed Risks of Material Misstatement
15. In responding to assessed risks in accordance with SA 330, the user
auditor shall: (Ref: Para. A24-A28)
(a) Determine whether sufficient appropriate audit evidence concerning the
relevant financial statement assertions is available from records held at the
user entity; and, if not,
(b) Perform further audit procedures to obtain sufficient appropriate audit
evidence or use another auditor to perform those procedures at the service
organisation on the user auditor’s behalf.
Tests of Controls
16. When the user auditor’s risk assessment includes an expectation that
controls at the service organisation are operating effectively, the user auditor
shall obtain audit evidence about the operating effectiveness of those controls
from one or more of the following procedures: (Ref: Para. A29-A30)
(a) Obtaining a Type 2 report, if available;
(b) Performing appropriate tests of controls at the service organisation; or
(c) Using another auditor to perform tests of controls at the service
organisation on behalf of the user auditor.
Using a Type 2 Report as Audit Evidence that Controls at the Service
Organisation Are Operating Effectively
17. If, in accordance with paragraph 16(a), the user auditor plans to use a Type
2 report as audit evidence that controls at the service organisation are operating
effectively, the user auditor shall determine whether the service auditor’s report
provides sufficient appropriate audit evidence about the effectiveness of the
controls to support the user auditor’s risk assessment by: (Ref: Para. A31-A39)
(a) Evaluating whether the description, design and operating effectiveness of
controls at the service organisation is at a date or for a period that is
appropriate for the user auditor’s purposes;
(b) Determining whether complementary user entity controls identified by the
service organisation are relevant to the user entity and, if so, obtaining an
understanding of whether the user entity has designed and implemented
such controls and, if so, testing their operating effectiveness;
(c) Evaluating the adequacy of the time period covered by the tests of controls
and the time elapsed since the performance of the tests of controls; and
SA 402 8
(d) Evaluating whether the tests of controls performed by the service auditor
and the results thereof, as described in the service auditor’s report, are
relevant to the assertions in the user entity’s financial statements and
provide sufficient appropriate audit evidence to support the user auditor’s
risk assessment.
Type 1 and Type 2 Reports that Exclude the Services of a Subservice
Organisation
18. If the user auditor plans to use a Type 1 or a Type 2 report that excludes
the services provided by a subservice organisation and those services are
relevant to the audit of the user entity’s financial statements, the user auditor
shall apply the requirements of this SA with respect to the services provided by
the subservice organisation. (Ref: Para. A40)
Fraud, Non-Compliance with Laws and Regulations and
Uncorrected Misstatements in Relation to Activities at the Service
Organisation
19. The user auditor shall inquire of management of the user entity whether
the service organisation has reported to the user entity, or whether the user
entity is otherwise aware of, any fraud, non-compliance with laws and
regulations or uncorrected misstatements affecting the financial statements
of the user entity. The user auditor shall evaluate how such matters affect the
nature, timing and extent of the user auditor’s further audit procedures,
including the effect on the user auditor’s conclusions and user auditor’s
report. (Ref: Para. A41)
Reporting by the User Auditor
20. The user auditor shall modify the opinion in the user auditor’s report in
accordance with SA 705(Revised)5 if the user auditor is unable to obtain
sufficient appropriate audit evidence regarding the services provided by the
service organisation relevant to the audit of the user entity’s financial
statements. (Ref: Para. A42)
21. The user auditor shall not refer to the work of a service auditor in the
user auditor’s report containing an unmodified opinion unless required by law
or regulation to do so. If such reference is required by law or regulation, the
user auditor’s report shall indicate that the reference does not diminish the
user auditor’s responsibility for the audit opinion. (Ref: Para. A43)
22. If reference to the work of a service auditor is relevant to an understanding
5 SA 705(Revised), “Modifications to the Opinion in the Independent Auditor’s Report”, paragraph 6.
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of a modification to the user auditor’s opinion, the user auditor’s report shall
indicate that such reference does not diminish the user auditor’s responsibility for
that opinion. (Ref: Para. A44)
***
Application and Other Explanatory Material
Obtaining an Understanding of the Services Provided by a Service
Organisation, Including Internal Control
Sources of Information (Ref: Para. 9)
A1. Information on the nature of the services provided by a service organisation
may be available from a wide variety of sources, such as:
User manuals.
System overviews.
Technical manuals.
The contract or service level agreement between the user entity and the
service organisation.
Reports by service organisations, internal auditors or regulatory authorities
on controls at the service organisation.
Reports by the service auditor, including management letters, if available.
A2. Knowledge obtained through the user auditor’s experience with the service
organisation, for example through experience with other audit engagements, may
also be helpful in obtaining an understanding of the nature of the services provided
by the service organisation. This may be particularly helpful if the services and
controls at the service organisation over those services are highly standardised.
Nature of the Services Provided by the Service Organisation (Ref: Para.
9(a))
A3. A user entity may use a service organisation such as one that processes
transactions and maintains related accountability, or records transactions and
processes related data. Service organisations that provide such services include,
for example, bank trust departments that invest and service assets for employee
benefit plans or for others; mortgage bankers that service mortgages for others;
and application service providers that provide packaged software applications
and a technology environment that enables customers to process financial and
operational transactions.
A4. Examples of service organisation services that are relevant to the audit
include:
SA 402 10
Maintenance of the user entity’s accounting records.
Management of assets.
Initiating, recording or processing transactions as agent of the user entity.
Considerations Specific to Smaller Entities
A5. Smaller entities may use external bookkeeping services ranging from
the processing of certain transactions (e.g., payment of payroll taxes) and
maintenance of their accounting records to the preparation of their financial
statements. The use of such a service organisation for the preparation of its
financial statements does not relieve management of the smaller entity and,
where appropriate, those charged with governance of their responsibilities for
the financial statements. 6
Nature and Materiality of Transactions Processed by the Service
Organisation (Ref: Para. 9(b))
A6. A service organisation may establish policies and procedures that affect
the user entity’s internal control. These policies and procedures are at least
in part physically and operationally separate from the user entity. The
significance of the controls of the service organisation to those of the user
entity depends on the nature of the services provided by the service
organisation, including the nature and materiality of the transactions it
processes for the user entity. In certain situations, the transactions
processed and the accounts affected by the service organisation may not
appear to be material to the user entity’s financial statements, but the nature
of the transactions processed may be significant and the user auditor may
determine that an understanding of those controls is necessary in the
circumstances.
The Degree of Interaction between the Activities of the Service
Organisation and the User Entity (Ref: Para. 9(c))
A7. The significance of the controls of the service organisation to those of
the user entity also depends on the degree of interaction between its
activities and those of the user entity. The degree of interaction refers to the
extent to which a user entity is able to and elects to implement effective
controls over the processing performed by the service organisation. For
example, a high degree of interaction exists between the activities of the user
entity and those at the service organisation when the user entity authorises
transactions and the service organisation processes and does the accounting
for those transactions. In these circumstances, it may be practicable for the
6 SA 200, paragraph 4 and A2-A3.
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user entity to implement effective controls over those transactions. On the
other hand, when the service organisation initiates or initially records,
processes, and does the accounting for the user entity’s transactions, there
is a lower degree of interaction between the two organisations. In these
circumstances, the user entity may be unable to, or may elect not to,
implement effective controls over these transactions at the user entity and
may rely on controls at the service organisation.
Nature of the Relationship between the User Entity and the Service
Organisation (Ref: Para. 9(d))
A8. The contract or service level agreement between the user entity and the
service organisation may provide for matters such as:
The information to be provided to the user entity and responsibilities for
initiating transactions relating to the activities undertaken by the service
organisation;
The application of requirements of regulatory bodies concerning the
form of records to be maintained, or access to them;
The indemnification, if any, to be provided to the user entity in the event
of a performance failure;
Whether the service organisation will provide a report on its controls
and, if so, whether such report would be a Type 1 or Type 2 report;
Whether the user auditor has rights of access to the accounting records
of the user entity maintained by the service organisation and other
information necessary for the conduct of the audit; and
Whether the agreement allows for direct communication between the
user auditor and the service auditor.
A9. There is a direct relationship between the service organisation and the
user entity and between the service organisation and the service auditor.
These relationships do not necessarily create a direct relationship between
the user auditor and the service auditor. When there is no direct relationship
between the user auditor and the service auditor, communications between
the user auditor and the service auditor are usually conducted through the
user entity and the service organisation. A direct relationship may also be
created between a user auditor and a service auditor, taking into account the
relevant ethical and confidentiality considerations. A user auditor, for
example, may use a service auditor to perform procedures on the user
auditor’s behalf, such as:
SA 402 12
(a) Tests of controls at the service organisation; or
(b) Substantive procedures on the user entity’s financial statement transactions
and balances maintained by a service organisation.
A10. Auditors generally have broad rights of access established by legislation.
However, there may be situations where such rights of access are not available,
for example when the service organisation is located in a different jurisdiction. In
such situations, the auditor may need to obtain an understanding of the
legislation applicable in the different jurisdiction to determine whether appropriate
access rights can be obtained. In such cases, the auditor may also obtain or ask
the user entity to incorporate rights of access in any contractual arrangements
between the user entity and the service organisation.
A11. In the above context, the auditors may also use another auditor to perform
tests of controls or substantive procedures in relation to compliance with law,
regulation or other authority.
Understanding the Controls relating to Services provided by the Service
Organisation (Ref: Para. 10)
A12. The user entity may establish controls over the service organisation’s
services that may be tested by the user auditor and that may enable the user
auditor to conclude that the user entity’s controls are operating effectively for
some or all of the related assertions, regardless of the controls in place at the
service organisation. If a user entity, for example, uses a service organisation to
process its payroll transactions, the user entity may establish controls over the
submission and receipt of payroll information that could prevent or detect
material misstatements. These controls may include:
Comparing the data submitted to the service organisation with reports of
information received from the service organisation after the data has been
processed.
Recomputing a sample of the payroll amounts for clerical accuracy and
reviewing the total amount of the payroll for reasonableness.
A13. In this situation, the user auditor may perform tests of the user entity’s
controls over payroll processing that would provide a basis for the user auditor to
conclude that the user entity’s controls are operating effectively for the assertions
related to payroll transactions.
A14. As noted in SA 315, 7 in respect of some risks, the user auditor may
judge that it is not possible or practicable to obtain sufficient appropriate
7 SA 315, paragraph 30.
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audit evidence only from substantive procedures. Such risks may relate to
the inaccurate or incomplete recording of routine and significant classes of
transactions and account balances, the characteristics of which often permit
highly automated processing with little or no manual intervention. Such
automated processing characteristics may be particularly present when the
user entity uses service organisations. In such cases, the user entity’s
controls over such risks are relevant to the audit and the user auditor is
required to obtain an understanding of, and to evaluate, such controls in
accordance with paragraphs 9 and 10 of this SA.
Further Procedures When a Sufficient Understanding Cannot Be
Obtained from the User Entity (Ref: Para. 12)
A15. The user auditor’s decision as to which procedure, individually or in
combination, in paragraph 12 to undertake, in order to obtain the information
necessary to provide a basis for the identification and assessment of the
risks of material misstatement in relation to the user entity’s use of the
service organisation, may be influenced by such matters as:
The size of both the user entity and the service organisation;
The complexity of the transactions at the user entity and the complexity
of the services provided by the service organisation;
The location of the service organisation (for example, the user auditor
may decide to use another auditor to perform procedures at the service
organisation on the user auditor’s behalf if the service organisation is in
a remote location);
Whether the procedure(s) is expected to effectively provide the user
auditor with sufficient appropriate audit evidence; and
The nature of the relationship between the user entity and the service
organisation.
A16. A service organisation may engage a service auditor to report on the
description and design of its controls (Type 1 report) or on the description
and design of its controls and their operating effectiveness (Type 2 report).
Type 1 or Type 2 reports may be issued under Standard on Assurance
Engagements (SAE) 3402 8 or under standards established by an authorised
or recognised standards setting organisation (which may identify them by
different names, such as Type A or Type B reports).
A17. The availability of a Type 1 or Type 2 report will generally depend on
whether the contract between a service organisation and a user entity includes
8 SAE 3402, Assurance Reports on Controls at a Service Organisation.
SA 402 14
the provision of such a report by the service organisation. A service organisation
may also elect, for practical reasons, to make a Type 1 or Type 2 report available
to the user entities. However, in some cases, a Type 1 or Type 2 report may not
be available to user entities.
A18. In some circumstances, a user entity may outsource one or more significant
business units or functions, such as its entire tax planning and compliance
functions, or finance and accounting or the controllership function to one or more
service organisations. As a report on controls at the service organisation may not
be available in these circumstances, visiting the service organisation may be the
most effective procedure for the user auditor to gain an understanding of controls
at the service organisation, as there is likely to be direct interaction of
management of the user entity with management at the service organisation.
A19. Another auditor may be used to perform procedures that will provide the
necessary information about the relevant controls at the service organisation. If a
Type 1 or Type 2 report has been issued, the user auditor may use the service
auditor to perform these procedures as the service auditor has an existing
relationship with the service organisation. The user auditor using the work of
another auditor may find the guidance in SA 6009 useful as it relates to
understanding another auditor (including that auditor’s independence and
professional competence10), involvement in the work of another auditor in
planning the nature, extent and timing of such work, and in evaluating the
sufficiency and appropriateness of the audit evidence obtained.
A20. A user entity may use a service organisation that in turn uses a sub-
service organisation to provide some of the services provided to a user entity
that are part of the user entity’s information system relevant to financial
reporting. The sub-service organisation may be a separate entity from the
service organisation or may be related to the service organisation. A user
auditor may need to consider controls at the sub-service organisation. In
situations where one or more sub-service organisations are used, the
interaction between the activities of the user entity and those of the service
organisation is expanded to include the interaction between the user entity,
the service organisation and the sub-service organisations. The degree of
this interaction, as well as the nature and materiality of the transactions
processed by the service organisation and the sub-service organisations are
the most important factors for the user auditor to consider in determining the
significance of the service organisation’s and sub-service organisation’s
controls to the user entity’s controls.
9 SA 600, Using the Work of Another Auditor.
10 Except where such other auditor is a member of the Institute of Chartered Accountants of India.
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Using a Type 1 or Type 2 Report to Support the User Auditor’s
Understanding of the Service Organisation (Ref: Para. 13-14)
A21. The user auditor may make inquiries about the service auditor to the
service auditor’s professional organisation or other practitioners and inquire
whether the service auditor is subject to regulatory oversight. The service
auditor may be practicing in a jurisdiction where different standards are
followed in respect of reports on controls at a service organisation, and the
user auditor may obtain information about the standards used by the service
auditor from the standard setting organisation.
A22. A Type 1 or Type 2 report, along with information about the user entity,
may assist the user auditor in obtaining an understanding of:
(a) The aspects of controls at the service organisation that may affect the
processing of the user entity’s transactions, including the use of
subservice organisations;
(b) The flow of significant transactions through the service organisation to
determine the points in the transaction flow where material
misstatements in the user entity’s financial statements could occur;
(c) The control objectives at the service organisation that are relevant to
the user entity’s financial statement assertions; and
(d) Whether controls at the service organisation are suitably designed and
implemented to prevent or detect processing errors that could result in
material misstatements in the user entity’s financial statements.
A Type 1 or Type 2 report may assist the user auditor in obtaining a sufficient
understanding to identify and assess the risks of material misstatement. A type
1 report, however, does not provide any evidence of the operating
effectiveness of the relevant controls.
A23. A Type 1 or Type 2 report that is as of a date or for a period that is
outside of the reporting period of a user entity may assist the user auditor in
obtaining a preliminary understanding of the controls implemented at the
service organisation if the report is supplemented by additional current
information from other sources. If the service organisation’s description of
controls is as of a date or for a period that precedes the beginning of the
period under audit, the user auditor may perform procedures to update the
information in a Type 1 or Type 2 report, such as:
Discussing the changes at the service organisation with user entity
personnel who would be in a position to know of such changes;
Reviewing current documentation and correspondence issued by the
service organisation; or
Discussing the changes with service organisation personnel.
SA 402 16
Responding to the Assessed Risks of Material Misstatement (Ref:
Para. 15)
A24. Whether the use of a service organisation increases a user entity’s risk of
material misstatement depends on the nature of the services provided and the
controls over these services; in some cases, the use of a service organisation
may decrease a user entity’s risk of material misstatement, particularly if the user
entity itself does not possess the expertise necessary to undertake particular
activities, such as initiating, processing, and recording transactions, or does not
have adequate resources (e.g., an IT system).
A25. When the service organisation maintains material elements of the
accounting records of the user entity, direct access to those records may be
necessary in order for the user auditor to obtain sufficient appropriate audit
evidence relating to the operations of controls over those records or to
substantiate transactions and balances recorded in them, or both. Such access
may involve either physical inspection of records at the service organisation’s
premises or interrogation of records maintained electronically from the user entity
or another location, or both. Where direct access is achieved electronically, the
user auditor may thereby obtain evidence as to the adequacy of controls
operated by the service organisation over the completeness and integrity of the
user entity’s data for which the service organisation is responsible.
A26. In determining the nature and extent of audit evidence to be obtained in
relation to balances representing assets held or transactions undertaken by a
service organisation on behalf of the user entity, the following procedures may
be considered by the user auditor:
(a) Inspecting records and documents held by the user entity: the reliability of
this source of evidence is determined by the nature and extent of the
accounting records and supporting documentation retained by the user
entity. In some cases, the user entity may not maintain independent
detailed records or documentation of specific transactions undertaken on its
behalf.
(b) Inspecting records and documents held by the service organisation: the
user auditor’s access to the records of the service organisation may be
established as part of the contractual arrangements between the user entity
and the service organisation. The user auditor may also use another
auditor, on its behalf, to gain access to the user entity’s records maintained
by the service organisation.
(c) Obtaining confirmations of balances and transactions from the service
organisation: where the user entity maintains independent records of
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Handbook of Auditing Pronouncements-I.A
balances and transactions, confirmation from the service organisation
corroborating the user entity’s records may constitute reliable audit
evidence concerning the existence of the transactions and assets
concerned. For example, when multiple service organisations are used,
such as an investment manager and a custodian, and these service
organisations maintain independent records, the user auditor may confirm
balances with these organisations in order to compare this information with
the independent records of the user entity.
If the user entity does not maintain independent records, information
obtained in confirmations from the service organisation is merely a
statement of what is reflected in the records maintained by the service
organisation. Therefore, such confirmations do not, taken alone, constitute
reliable audit evidence. In these circumstances, the user auditor may
consider whether an alternative source of independent evidence can be
identified.
(d) Performing analytical procedures on the records maintained by the user
entity or on the reports received from the service organisation: the
effectiveness of analytical procedures is likely to vary by assertion and will
be affected by the extent and detail of information available.
A27. Another auditor may perform procedures that are substantive in nature for
the benefit of user auditors. Such an engagement may involve the performance,
by another auditor, of procedures agreed upon by the user entity and its user
auditor and by the service organisation and its service auditor. The findings
resulting from the procedures performed by another auditor are reviewed by the
user auditor to determine whether they constitute sufficient appropriate audit
evidence. In addition, there may be requirements imposed by governmental
authorities or through contractual arrangements whereby a service auditor
performs designated procedures that are substantive in nature. The results of the
application of the required procedures to balances and transactions processed
by the service organisation may be used by user auditors as part of the evidence
necessary to support their audit opinions. In these circumstances, it may be
useful for the user auditor and the service auditor to agree, prior to the
performance of the procedures, to the audit documentation or access to audit
documentation that will be provided to the user auditor.
A28. In certain circumstances, in particular when a user entity outsources some
or all of its finance function to a service organisation, the user auditor may face a
situation where a significant portion of the audit evidence resides at the service
organisation. Substantive procedures may need to be performed at the service
organisation by the user auditor or another auditor on its behalf. A service auditor
SA 402 18
may provide a Type 2 report and, in addition, may perform substantive
procedures on behalf of the user auditor. The involvement of another auditor
does not alter the user auditor’s responsibility to obtain sufficient appropriate
audit evidence to afford a reasonable basis to support the user auditor’s opinion.
Accordingly, the user auditor’s consideration of whether sufficient appropriate
audit evidence has been obtained and whether the user auditor needs to perform
further substantive procedures includes the user auditor’s involvement with, or
evidence of, the direction, supervision and performance of the substantive
procedures performed by another auditor.
Tests of Controls (Ref: Para. 16)
A29. The user auditor is required by SA 33011 to design and perform tests of
controls to obtain sufficient appropriate audit evidence as to the operating
effectiveness of relevant controls in certain circumstances. In the context of a
service organisation, this requirement applies when:
(a) The user auditor’s assessment of risks of material misstatement includes
an expectation that the controls at the service organisation are operating
effectively (i.e., the user auditor intends to rely on the operating
effectiveness of controls at the service organisation in determining the
nature, timing and extent of substantive procedures); or
(b) Substantive procedures alone, or in combination with tests of the operating
effectiveness of controls at the user entity, cannot provide sufficient
appropriate audit evidence at the assertion level.
A30. If a Type 2 report is not available, a user auditor may contact the service
organisation, through the user entity, to request that a service auditor be
engaged to provide a Type 2 report that includes tests of the operating
effectiveness of the relevant controls or the user auditor may use another auditor
to perform procedures at the service organisation that test the operating
effectiveness of those controls. A user auditor may also visit the service
organisation and perform tests of relevant controls if the service organisation
agrees to it. The user auditor’s risk assessments are based on the combined
evidence provided by the work of another auditor and the user auditor’s own
procedures.
Using a Type 2 Report as Audit Evidence that Controls at the Service
Organisation Are Operating Effectively (Ref: Para. 17)
A31. A Type 2 report may be intended to satisfy the needs of several different
user auditors; therefore tests of controls and results described in the service
11 SA 330, paragraph 8.
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Handbook of Auditing Pronouncements-I.A
auditor’s report may not be relevant to assertions that are significant in the user
entity’s financial statements. The relevant tests of controls and results are
evaluated to determine that the service auditor’s report provides sufficient
appropriate audit evidence about the effectiveness of the controls to support the
user auditor’s risk assessment. In doing so, the user auditor may consider the
following factors:
(a) The time period covered by the tests of controls and the time elapsed since
the performance of the tests of controls;
(b) The scope of the service auditor’s work and the services and processes
covered, the controls tested and tests that were performed, and the way in
which tested controls relate to the user entity’s controls; and
(c) The results of those tests of controls and the service auditor’s opinion on
the operating effectiveness of the controls.
A32. For certain assertions, the shorter the period covered by a specific test and
the longer the time elapsed since the performance of the test, the less audit
evidence the test may provide. In comparing the period covered by the Type 2
report to the user entity’s financial reporting period, the user auditor may
conclude that the Type 2 report offers less audit evidence if there is little overlap
between the period covered by the Type 2 report and the period for which the
user auditor intends to rely on the report. When this is the case, a Type 2 report
covering a preceding or subsequent period may provide additional audit
evidence. In other cases, the user auditor may determine it is necessary to
perform, or use another auditor to perform, tests of controls at the service
organisation in order to obtain sufficient appropriate audit evidence about the
operating effectiveness of those controls.
A33. It may also be necessary for the user auditor to obtain additional evidence
about significant changes to the relevant controls at the service organisation
outside of the period covered by the Type 2 report or determine additional audit
procedures to be performed. Relevant factors in determining what additional
audit evidence to obtain about controls at the service organisation that were
operating outside of the period covered by the service auditor’s report may
include:
The significance of the assessed risks of material misstatement at the
assertion level;
The specific controls that were tested during the interim period, and
significant changes to them since they were tested, including changes in
the information system, processes, and personnel;
The degree to which audit evidence about the operating effectiveness of
those controls was obtained;
SA 402 20
The length of the remaining period;
The extent to which the user auditor intends to reduce further substantive
procedures based on the reliance on controls; and
The effectiveness of the control environment and monitoring of controls at
the user entity.
A34. Additional audit evidence may be obtained, for example, by extending tests
of controls over the remaining period or testing the user entity’s monitoring of
controls.
A35. If the service auditor’s testing period is completely outside the user
entity’s financial reporting period, the user auditor will be unable to rely on
such tests for the user auditor to conclude that the user entity’s controls are
operating effectively because they do not provide current audit period
evidence of the effectiveness of the controls, unless other procedures are
performed.
A36. In certain circumstances, a service provided by the service organisation
may be designed with the assumption that certain controls will be
implemented by the user entity. For example, the service may be designed
with the assumption that the user entity will have controls in place for
authorising transactions before they are sent to the service organisation for
processing. In such a situation, the service organisation’s description of
controls may include a description of those complementary user entity
controls. The user auditor considers whether those complementary user
entity controls are relevant to the service provided to the user entity.
A37. If the user auditor believes that the service auditor’s report may not
provide sufficient appropriate audit evidence, for example, if a service
auditor’s report does not contain a description of the service auditor’s tests of
controls and results thereon, the user auditor may supplement the
understanding of the service auditor’s procedures and conclusions by
contacting the service organisation, through the user entity, to request a
discussion with the service auditor about the scope and results of the service
auditor’s work. Also, if the user auditor believes it is necessary, the user
auditor may contact the service organisation, through the user entity, to
request that the service auditor perform procedures at the service
organisation. Alternatively, the user auditor, or another auditor at the request
of the user auditor, may perform such procedures.
A38. The service auditor’s Type 2 report identifies results of tests, including
exceptions and other information that could affect the user auditor’s
conclusions. Exceptions noted by the service auditor or a modified opinion in
21 SA 402
Handbook of Auditing Pronouncements-I.A
the service auditor’s Type 2 report do not automatically mean that the service
auditor’s Type 2 report will not be useful for the audit of the user entity’s
financial statements in assessing the risks of material misstatement. Rather,
the exceptions and the matter giving rise to a modified opinion in the service
auditor’s Type 2 report are considered in the user auditor’s assessment of
the testing of controls performed by the service auditor. In considering the
exceptions and matters giving rise to a modified opinion, the user auditor
may discuss such matters with the service auditor. Such communication is
dependent upon the user entity contacting the service organisation, and
obtaining the service organisation’s approval for the communication to take
place.
Communication of Deficiencies in Internal Control identified during the Audit
A39. The user auditor is required to communicate in writing significant
deficiencies identified during the audit to both management and those
charged with governance on a timely basis. 12 The user auditor is also
required to communicate to management at an appropriate level of
responsibility on a timely basis other deficiencies in internal control identified
during the audit that, in the user auditor’s professional judgment, are of
sufficient importance to merit management’s attention. 13 Matters that the user
auditor may identify during the audit and may communicate to management
and those charged with governance of the user entity include:
Any monitoring of controls that could be implemented by the user entity,
including those identified as a result of obtaining a Type 1 or Type 2
report;
Instances where complementary user entity controls are noted in the Type
1 or Type 2 report and are not implemented at the user entity; and
Controls that may be needed at the service organisation that do not appear
to have been implemented or that are not specifically covered by a Type 2
report.
Type 1 and Type 2 Reports that Exclude the Services of a Subservice
Organisation (Ref: Para. 18)
A40. If a service organisation uses a subservice organisation, the service
auditor’s report may either include or exclude the subservice organisation’s
relevant control objectives and related controls in the service organisation’s
12 SA 265, “Communicating Deficiencies in Internal Control to Those Charged with Governance and
Management”, paragraph 9 and 10.
13 SA 265, paragraph 9.
SA 402 22
description of its system and in the scope of the service auditor’s engagement.
These two methods of reporting are known as the inclusive method and the
carve-out method, respectively. If the Type 1 or Type 2 report excludes the
controls at a subservice organisation, and the services provided by the
subservice organisation are relevant to the audit of the user entity’s financial
statements, the user auditor is required to apply the requirements of this SA in
respect of the subservice organisation. The nature and extent of work to be
performed by the user auditor regarding the services provided by a subservice
organisation depend on the nature and significance of those services to the user
entity and the relevance of those services to the audit. The application of the
requirement in paragraph 9 assists the user auditor in determining the effect of
the subservice organisation and the nature and extent of work to be performed.
Fraud, Non-Compliance with Laws and Regulations and Uncorrected
Misstatements in Relation to Activities at the Service Organisation
(Ref: Para. 19)
A41. A service organisation may be required under the terms of the contract with
user entities to disclose to affected user entities any fraud, non-compliance with
laws and regulations or uncorrected misstatements attributable to the service
organisation’s management or employees. As required by paragraph 19, the
user auditor makes inquiries of the user entity management regarding whether
the service organisation has reported any such matters and evaluates whether
any matters reported by the service organisation affect the nature, timing and
extent of the user auditor’s further audit procedures. In certain circumstances,
the user auditor may require additional information to perform this evaluation,
and may request the user entity to contact the service organisation to obtain the
necessary information.
Reporting by the User Auditor (Ref: Para. 20)
A42. When a user auditor is unable to obtain sufficient appropriate audit
evidence regarding the services provided by the service organisation relevant to
the audit of the user entity’s financial statements, a limitation on the scope of the
audit exists. This may be the case when:
The user auditor is unable to obtain a sufficient understanding of the
services provided by the service organisation and does not have a basis for
the identification and assessment of the risks of material misstatement;
A user auditor’s risk assessment includes an expectation that controls at
the service organisation are operating effectively and the user auditor is
unable to obtain sufficient appropriate audit evidence about the operating
effectiveness of these controls; or
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Handbook of Auditing Pronouncements-I.A
Sufficient appropriate audit evidence is only available from records held at
the service organisation, and the user auditor is unable to obtain direct
access to these records.
Whether the user auditor expresses a qualified opinion or disclaims an opinion
depends on the user auditor’s conclusion as to whether the possible effects on the
financial statements are material or pervasive.
Reference to the Work of a Service Auditor (Ref: Para. 21-22)
A43. In some cases, law or regulation may require a reference to the work of a
service auditor in the user auditor’s report, for example, for the purposes of
transparency in the public sector. In such circumstances, the user auditor may
need the consent of the service auditor before making such a reference.
A44. The fact that a user entity uses a service organisation does not alter the
user auditor’s responsibility under SAs to obtain sufficient appropriate audit
evidence to afford a reasonable basis to support the user auditor’s opinion.
Therefore, the user auditor does not make reference to the service auditor’s
report as a basis, in part, for the user auditor’s opinion on the user entity’s
financial statements. However, when the user auditor expresses a modified
opinion because of a modified opinion in a service auditor’s report, the user
auditor is not precluded from referring to the service auditor’s report if such
reference assists in explaining the reason for the user auditor’s modified opinion.
In such circumstances, the user auditor may need the consent of the service
auditor before making such a reference.
Material Modifications to ISA 402, “Audit Considerations
Relating to an Entity Using a Service Organisation”
1. Paragraphs A10 and A11 of ISA 402 (A10 & A11 of SA 402) deal with the
application of the requirements of ISA 402 to public sector auditors who
have broad rights of access established by legislation. Since as mentioned
in the “Preface to the Standards on Quality Control, Auditing, Review, Other
Assurance and Related Services”, the Standards issued by the Auditing and
Assurance Standards Board, apply equally to all entities, irrespective of their
form, nature and size, a specific reference to applicability of the Standard to
public sector entities has been deleted.
However, since the situation envisaged in paragraphs A10 and A11 in ISA
may be possible even in case of auditors of non-public sector entities, the
spirit of paragraphs A10 and A11 has been retained and made generic.
2. Paragraph 13 (a) and paragraph A19 of ISA 402 (Paragraph 13(a) and A19
of SA 402) deal with assessment of the service auditor’s professional
SA 402 24
competence and independence from the service organisation for obtaining
sufficient and appropriate audit evidence and for reporting purposes. The
corresponding paragraphs of SA 402 also require such assessment of
professional competence except where the service auditor is also a member
of the Institute of Chartered Accountants of India.
25 SA 402