1. Introduction: Assurance Beyond Historical Financial Statements
Evolution of the Attest Function: Past to Future & Non-Financial Assurance
Traditionally, the attest function performed by a Chartered Accountant in practice has been in relation to past events (historical financial statements). However, modern corporate commerce and lending institutions now actively seek professional association in exercises relating to the future and in non-financial operational matters:
- Future-Oriented Appraisals: Banks, financial institutions, and prospective investors require projected cash flow and profitability statements for appraisal of loan applications and equity investments. These institutions place greater reliance on such statements if examined or reported upon by Chartered Accountants.
- Non-Financial Control Assurances: With massive business process outsourcing (cloud ERP, SaaS, payroll, transfer agency), user entities and their auditors require independent assurance on internal controls operated by third-party service organizations.
- Transaction Impact Illustrations: In capital markets (IPOs/Rights Issues), investors require pro forma financial statements illustrating what the financial statements would have looked like had a major acquisition or restructuring taken place at an earlier date.
Standards on Assurance Engagements (SAEs): Apply when an assurance engagement relates to subject matters OTHER than an audit or review of historical financial statements!
Case Story: XP Limited, Chirag & The NOIDA Food Processing Project
XP Limited, a paint manufacturing company, decided to diversify into food processing by setting up a plant at NOIDA following investor-friendly policies announced in a Global Investors Summit. Being a new line of activity, the management asked Chirag (an MBA Finance senior executive) to prepare detailed projections and feasibility for bank borrowing.
Chirag prepared elaborate 7-year projections covering land acquisition, building, plant machinery, turnover targets, profits, debt service coverage ratio (DSCR), payback period, and internal rate of return (IRR), complete with charts and bar graphs. The study was submitted to the consortium of bankers.
The bankers insisted on an assurance report from a professional accountant on the prospective information. Bewildered, Chirag met the CFO and practicing Chartered Accountant CA Dilip.
What CA Dilip Explained:
For issuing an assurance report on prospective financial information under SAE 3400, the CA examines whether the information is prepared on the basis of assumptions; whether those assumptions are not unreasonable and are consistent with the purpose; whether the information is prepared on a consistent basis with historical financial statements using appropriate accounting principles; and provides negative assurance without vouching for the accuracy of future results.
The 3 Cornerstone Standards on Assurance Engagements (SAEs)
| Standard | Title & Core Subject Matter | Level of Assurance & Nature |
|---|---|---|
| SAE 3400 | The Examination of Prospective Financial Information (Forecasts & Projections) |
Moderate Level of Assurance (Negative Assurance on reasonableness of assumptions; Opinion on preparation & historical consistency). |
| SAE 3402 | Assurance Reports on Controls at a Service Organisation (Type 1 & Type 2 SOC Reports) |
Reasonable Assurance regarding description, design, and operating effectiveness of controls. |
| SAE 3420 | Assurance Engagements to Report on the Compilation of Pro Forma Financial Information Included in a Prospectus | Reasonable Assurance that pro forma information has been compiled, in all material respects, on the basis of applicable criteria. |
2. SAE 3400: The Examination of Prospective Financial Information
Meaning of "Prospective Financial Information" (PFI)
Under SAE 3400, "Prospective Financial Information" (PFI) is defined as:
"Financial information based on assumptions about events that may occur in the future and possible actions by an entity."
PFI is highly subjective in nature and its preparation requires the exercise of considerable judgment. It can be in the form of a forecast, a projection, or a combination of both (for example, a one-year forecast plus a five-year projection).
Forecast vs. Projection: The Decisive Distinction (TYK 7)
A frequent ICAI examination question tests the vital technical differences between a Forecast and a Projection:
| Dimension | Financial Forecast | Financial Projection |
|---|---|---|
| Core Definition | Prospective financial information prepared on the basis of assumptions as to future events which management expects to take place and the actions management expects to take as of the date the information is prepared. | Prospective financial information prepared on the basis of hypothetical assumptions about future events and management actions which are not necessarily expected to take place, or a mixture of best-estimate and hypothetical assumptions. |
| Nature of Assumptions | Based on Best-Estimate Assumptions (assumptions reflecting anticipated experience with no provision for risk of adverse deviation). | Based on Hypothetical Assumptions (imagined or suggested scenarios, e.g. entities in a start-up phase or considering a major change in operations). |
| Practical Example (ICAI) | In present market conditions and historical buying trends, the CFO of X Ltd. expects sales to increase by 5% over the next quarter. This 5% sales increase is a financial forecast. | X Ltd. projects outcomes assuming it develops a completely new electric vehicle to capture a hypothetical 20% European market share. This outline of desired outcomes under "what-if" scenarios is a financial projection. |
| Intended Purpose | Typically prepared for ongoing business planning or general distribution to lenders and investors. | Typically serves as an outline for evaluating alternative courses of action or hypothetical scenarios. |
Scope & Exclusions of SAE 3400 (Para 2.1)
PFI can include financial statements or one or more elements of financial statements and may be prepared:
- As an internal management tool (e.g. capital expenditure appraisal); or
- For distribution to third parties, such as in a prospectus for an IPO, in an annual report for shareholders, or in a project report for bank loan appraisal.
What SAE 3400 Does NOT Apply To: SAE 3400 does NOT apply to the examination of prospective financial information expressed in general or narrative terms (such as management’s discussion and analysis in an annual report), though many procedures may be helpful.
Nature of Assurance Regarding PFI (Paras 2.2 & 2.5 & TYK 7)
A fundamental principle governing SAE 3400 is the speculative nature of future evidence:
"Prospective financial information relates to events and actions that have not yet occurred and might not occur. While evidence may be available to support the assumptions, such evidence is itself generally future-oriented and therefore speculative in nature. ACCORDINGLY, AN OPINION AS TO WHETHER THE RESULTS SHOWN IN THE PROSPECTIVE FINANCIAL INFORMATION WILL BE ACHIEVED CANNOT BE EXPRESSED!"
The Practitioner Expresses a MODERATE Level of Assurance (Negative Assurance):
- Reasonableness of Assumptions: The practitioner provides negative assurance on whether anything has come to attention causing belief that the assumptions do not provide a reasonable basis for the PFI.
- Proper Preparation: An opinion on whether the PFI is properly prepared on the basis of the assumptions.
- Presentation & Accounting Consistency: An opinion on whether the PFI is properly presented, all material assumptions are adequately disclosed, and the PFI is prepared on a consistent basis with historical financial statements using appropriate accounting principles.
Management Responsibility & Clause 3 Part I Second Schedule CA Act, 1949 (TYK 4)
Under Para 2.3 of SAE 3400, management is solely responsible for the preparation and presentation of the prospective financial information, including the identification and disclosure of the assumptions on which it is based.
Clause 3, Part I, Second Schedule of the Chartered Accountants Act, 1949:
A Chartered Accountant in practice is deemed to be guilty of professional misconduct if they:
"permit their name or the name of their firm to be used in connection with an estimate of earnings contingent upon future transactions in a manner which may lead to the belief that they vouch for the accuracy of the forecast."
How a CA Can Lawfully Be Associated with PFI Without Violating Clause 3 (ICAI Council Guidelines):
A Chartered Accountant can be associated with PFI and issue an examination report without violating the CA Act, provided they comply with the following 4 conditions:
- State Sources of Information: The report clearly indicates the sources of information relied upon.
- State Basis of Forecast & Assumptions: The report clearly states the basis of the forecast and the major assumptions underlying the PFI.
- Explicit Non-Vouching Disclaimer: The CA makes it crystal clear in the report that they DO NOT VOUCH FOR THE ACCURACY OF THE FORECAST!
- Compliance with SAE 3400: The examination is conducted strictly in accordance with SAE 3400.
Duties of Member & Acceptance Precautions (Paras 2.4 & 2.6 & TYK 6, 11)
1. Precautions Before Accepting the Engagement (Para 2.6 & TYK 6):
Before accepting an engagement to examine PFI, the auditor shall consider:
- The intended use of the information;
- Whether distribution will be general or limited;
- The nature of the assumptions (best-estimate vs hypothetical);
- The elements to be included and the period covered by the PFI;
- The extent to which reliance on the entity’s historical financial information is justified.
Mandatory Refusal / Withdrawal: The auditor SHALL NOT ACCEPT, OR SHALL WITHDRAW FROM, an engagement when the assumptions are clearly unrealistic, or when the auditor believes that the PFI will be inappropriate for its intended use!
2. Duties of Member Examining PFI (Para 2.4 & TYK 11 - RBR Infrastructure):
While examining PFI, the CA is not a mere proof-reader of figures. The member has an affirmative professional duty to:
- Ascertain Purpose: Determine the intended purpose of the PFI.
- Examine Assumptions for Reasonableness: Critically assess whether the assumptions are realistic. In RBR Infrastructure, assuming 0% increase in material costs when inflation is 6-8%, and projecting revenues from unsubmitted bids, is clearly unrealistic and misleading!
- Examine Supporting Evidence: Obtain sufficient appropriate evidence supporting management's assumptions.
- Verify Accounting Consistency: Check that PFI is prepared on a consistent basis with historical financial statements using appropriate accounting principles.
- Mathematical Accuracy: Check the arithmetical accuracy of calculations.
Examination Procedures under SAE 3400 (Para 2.7 & TYK 8, 12)
When determining the nature, timing, and extent of examination procedures, the practitioner considers:
Factors Influencing Audit Procedures (TYK 8)
- The knowledge of the entity’s business and industry;
- The reliability of historical financial information;
- Competence of management regarding PFI preparation;
- The degree to which PFI is affected by management judgment;
- The length of the period covered by the PFI (longer period = greater uncertainty);
- The likelihood of material misstatement.
CA Madhu / ED Motors Case (TYK 12)
Management is new to international marketing; 20% European market share assumed requires production exceeding installed capacity; mixed internal and analyst reports used.
CA Madhu must perform in-depth procedures: evaluate capacity constraints, challenge feasibility of European market penetration, verify whether assumptions are realistic, and corroborate external analyst reports!
Presentation, Disclosure & Reporting under SAE 3400 (Paras 2.8 - 2.9 & TYK 9)
1. Presentation and Disclosure Assessment (Para 2.8 & TYK 9 - PQ Pharma IPO):
When assessing PFI presentation and disclosure, the CA ensures:
- Presentation is informative and not misleading;
- Accounting policies are clearly disclosed in the notes;
- Assumptions are adequately disclosed (distinguishing best-estimates from hypothetical assumptions);
- The date as of which PFI was prepared is clearly stated;
- A statement cautions that actual results are likely to differ from projected results.
2. Prescribed Elements of Examination Report (Para 2.9):
| Report Element | Prescribed Standard Statement |
|---|---|
| Title & Addressee | Report on Examination of Prospective Financial Information, addressed to appointing authority. |
| Identification & Responsibility | Identify PFI; statement that management is responsible; statement that CA's responsibility is to examine and report. |
| Reference to SAE 3400 | Conducted in accordance with SAE 3400 issued by ICAI. |
| Negative Assurance Statement | "Based on our examination of the evidence supporting the assumptions, nothing has come to our attention which causes us to believe that these assumptions do not provide a reasonable basis for the forecast/projection." |
| Positive Opinion on Preparation | "Further, in our opinion, the forecast/projection is properly prepared on the basis of the assumptions and is presented on a consistent basis with historical financial statements, using appropriate accounting principles." |
| Mandatory Difference Caveat | "Actual results are still likely to be different from the forecast/projection since anticipated events frequently do not occur as expected and the variation may be material." |
| Intended Use Warning | When projection is examined: a statement that PFI is prepared for [intended purpose] and users are cautioned that the projection may not be suitable for other purposes. |
Modifications to the Examination Report:
- Qualified or Adverse Opinion: When presentation and disclosure are not adequate, or when the practitioner believes that one or more significant assumptions do not provide a reasonable basis for the PFI.
- Disclaimer of Opinion or Withdrawal: When a limitation on the scope of the examination prevents obtaining necessary evidence.
Scenario: CA Hemant (Income Tax Depreciation Used in PFI Without Disclosure)
A company approached CA Hemant for an assurance report in respect of prospective financial information of a project under SAE 3400.
On going through project details, it is noticed that depreciation on proposed fixed assets has been calculated in accordance with the provisions of the Income Tax Act, 1961 (rather than the Companies Act, 2013). No disclosure is made in this respect.
ICAI Model Answer:
1. Principle of Consistency with Historical Financial Statements:
Under SAE 3400, it is the duty of the professional accountant to ensure that prospective financial information is prepared on a consistent basis with historical financial statements, using appropriate accounting principles.
2. Evaluation of Depreciation Calculation:
In the case of a company, historical financial statements are prepared considering the requirements of the Companies Act, 2013 (Schedule II depreciation). Calculating depreciation under the Income-tax Act, 1961 for financial reporting projections without disclosure is inconsistent and improper.
3. Action & Reporting by CA Hemant:
• CA Hemant must request management to correct the calculation or make adequate disclosures.
• The fact that the projection has not been prepared on a consistent basis with historical financial statements using appropriate accounting principles must be clearly stated.
• When presentation and disclosure are not adequate, CA Hemant SHALL ISSUE A QUALIFIED OR ADVERSE OPINION, OR WITHDRAW FROM THE ENGAGEMENT as appropriate!
3. SAE 3402: Assurance Reports on Controls at a Service Organisation
Context & Purpose: The Rise of Outsourced Business Processes
In modern commercial enterprise, entities routinely outsource critical operational and accounting functions to specialized third-party service providers (e.g. cloud SaaS platforms, IT hosting, payroll processing, investment accounting, registrar and share transfer services).
"A Service Organisation refers to a third-party organisation (or segment of a third-party organisation) that provides services to user entities that are likely to be relevant to user entities’ internal control as it relates to financial reporting."
Controls at a service organization related to operations and compliance are relevant to a user entity’s financial statements if the outsourced activities affect transaction initiation, recording, processing, or reporting in the user entity's general ledger.
The Four Key Actors in a Service Organisation Ecosystem
| Actor Term | Technical Definition & Practical Role |
|---|---|
| User Entity | An entity that uses a service organisation and whose financial statements are being audited (e.g., STAR Limited or Bansi Group). |
| User Auditor | An auditor who audits and reports on the financial statements of a user entity. |
| Service Organisation | A third-party organisation that provides services to user entities that are relevant to financial reporting (e.g., Little Solutions Pvt. Ltd. or Easy Solutions Ltd.). |
| Service Auditor | A practitioner who, at the request of the service organisation, provides an assurance report on the controls of the service organisation under SAE 3402. |
The Statutory Interlinkage Between SA 402 and SAE 3402 (TYK 5(a))
Why do user auditors require an assurance report from the service auditor?
User Auditor's Mandatory Objectives under SA 402:
Under SA 402 (Audit Considerations Relating to an Entity Using a Service Organisation), the auditor of the user entity has a statutory responsibility to:
- Obtain an understanding of the nature and significance of 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 risks of material misstatement; and
- Design and perform audit procedures responsive to those assessed risks.
Because the user auditor cannot practically perform direct audits inside the premises of independent third-party vendors across the globe, SA 402 explicitly permits the user auditor to rely upon an independent assurance report issued by the Service Auditor under SAE 3402!
Scope & Objectives of the Service Auditor (Paras 3.1 - 3.2)
The service auditor’s objectives in accordance with SAE 3402 are to obtain reasonable assurance about whether, in all material respects, based on suitable criteria:
Objective (a): System Description
The service organisation’s description of its system fairly presents the system that has been designed and implemented.
Objective (b): Design Suitability
The controls related to the control objectives stated in the description were suitably designed to achieve those objectives.
Objective (c): Operating Effectiveness (Type 2 Reports Only)
The controls operated effectively throughout the specified period to provide reasonable assurance that the control objectives were achieved.
Type 1 Report vs. Type 2 Report: The Decisive Comparison (Para 3.3 & TYK 5(b))
SAE 3402 establishes two distinct types of service auditor assurance reports:
| Comparison Dimension | Type 1 Report (Description & Design) | Type 2 Report (Description, Design & Operating Effectiveness) |
|---|---|---|
| Scope of Coverage | Covers the description and design of controls at a service organization. | Covers the description, design, AND operating effectiveness of controls. |
| Time Horizon | Evaluated as at a specified date (a single point in time, e.g., March 31, 2026). | Evaluated throughout a specified period (a range of time, e.g., April 1, 2025 to March 31, 2026). |
| Testing of Controls | NO testing of operating effectiveness is performed. Only evaluates whether controls are placed in operation and suitably designed. | Tests of operating effectiveness are MANDATORY. The auditor tests controls across the entire period. |
| Report Contents | Includes description, management assertion, and service auditor's opinion on description & design as at that date. | Includes description, management assertion, opinion on description, design & operating effectiveness, plus a detailed description of tests of controls performed and test results/deviations! |
| Utility to User Auditor | Helps user auditor gain an understanding of internal controls, but CANNOT be used to reduce control risk or reduce substantive testing. | Provides audit evidence of operating effectiveness, allowing the user auditor to assess control risk below maximum and reduce substantive testing. |
Fieldwork & Methodology under SAE 3402 (Para 3.4)
The execution of an SAE 3402 assurance engagement involves a collaborative structure:
Service Organisation Management's Mandatory Submissions:
- Description of System: Documenting the policies, procedures, software, personnel, and controls operating in the service organization.
- Written Assertion: A formal written assertion that the description fairly presents the system, controls were suitably designed, and (for Type 2) operated effectively throughout the specified period.
Service Auditor Reporting & Opinions Expressed (Para 3.5 & TYK 5(c))
In a Type 2 Report, the service auditor expresses a reasonable assurance opinion on the following THREE SPECIFIC MATTERS:
| # | Matter of Opinion | Standard Opinion Formulation (TYK 5(c)) |
|---|---|---|
| 1 | Fairness of System Description | Whether, in all material respects, based on suitable criteria, the description fairly presents the service organisation's system that had been designed and implemented throughout the specified period. |
| 2 | Suitability of Control Design | Whether the controls related to the control objectives stated in the description were suitably designed throughout the specified period to provide reasonable assurance that control objectives would be achieved if operated as designed. |
| 3 | Operating Effectiveness | Whether the controls tested, which were those necessary to provide reasonable assurance that control objectives were achieved, operated effectively throughout the specified period. |
Restricted Distribution Clause: The service auditor’s report contains an explicit statement that the report is intended SOLELY for the information and use of the service organisation, user entities of the service organisation, and their independent user auditors, and is not suitable for any other purpose.
Scenario: Bansi Group (Postgraduate Admissions Outsourced to Easy Solutions Ltd)
Bansi Group is a leading institution running prestigious postgraduate management courses. Its financial statements are audited by an independent auditor.
Before the start of the academic session, the Board outsourced its entire process of inviting applications, submission of applications, and collection of application fees including late fees to Easy Solutions Limited.
The auditors of Bansi Group want to be sure about the design and operating effectiveness of controls at Easy Solutions Limited.
ICAI Model Answer:
1. User Auditor's Needs under SA 402:
The auditors of Bansi Group (the user auditor) require assurance regarding the design and operating effectiveness of controls at the service organization (Easy Solutions Limited) that handles the collection of fees and application processing, as these directly affect the revenue and cash balances of Bansi Group.
2. Selection of Report Type under SAE 3402:
A Type 2 Report is a report on the description, design, and operating effectiveness of controls at a service organization throughout a specified period.
Conclusion:
The auditors of Easy Solutions Limited should provide a TYPE 2 REPORT giving reasonable assurance on the description, suitability of design, and operating effectiveness of controls throughout the academic session. The report must also include a detailed description of the tests of controls performed by the service auditor and the results/deviations found.
4. SAE 3420: Assurance Engagements to Report on the Compilation of Pro Forma Financial Information Included in a Prospectus
Meaning & Significance of "Pro Forma Financial Information" (Para 4.2 & TYK 2)
In capital markets, when a company issues a prospectus for a public offering (IPO / FPO / Rights Issue) and has undergone a significant corporate event (such as a major acquisition, merger, demerger, or capital restructuring), historical financial statements alone do not reflect the current reality of the enterprise.
"Pro Forma Financial Information refers to financial information shown together with adjustments to illustrate the impact of an event or transaction on unadjusted financial information as if the event had occurred or the transaction had been undertaken at an earlier date selected for purposes of the illustration."
Significance in a Prospectus (TYK 2):
Pro forma financial information is included in an offer document to demonstrate the financial effect of a significant transaction on the company's financial statements as if those transactions had occurred at an earlier date (e.g. at the beginning of the financial year). It provides prospective investors with essential comparative context to evaluate the combined entity's ongoing earnings power, assets, and liabilities.
Nature of Practitioner’s Reasonable Assurance under SAE 3420 (Paras 4.1 & 4.3)
An engagement under SAE 3420 is a reasonable assurance engagement:
Dual Objectives of Practitioner (Para 4.1):
- Obtain Reasonable Assurance: About whether the pro forma financial information has been compiled, in all material respects, by the responsible party on the basis of the applicable criteria; and
- Report: In accordance with the practitioner's findings.
Precise Boundaries of Practitioner's Responsibility (Para 4.3):
The practitioner’s role is strictly confined to reporting on the COMPILATION PROCESS:
- It does NOT involve the practitioner updating or re-issuing any previously issued audit or review reports on the underlying historical financial statements.
- It does NOT involve conducting an audit or review of the financial information used in compiling the pro forma financial information.
- The practitioner’s sole responsibility is to evaluate whether the responsible party applied the criteria properly to illustrate the hypothetical impact of the transaction.
Preconditions & Responsible Party Responsibilities (Para 4.4.1 & TYU 3)
Before accepting the engagement, the practitioner shall obtain the agreement of the responsible party acknowledging and understanding its responsibilities for:
| Responsible Area | Mandatory Company Responsibility (TYU 3 - S Ltd) |
|---|---|
| 1. Disclose Applicable Criteria | Adequately disclosing and describing the applicable criteria to the intended users if these are not publicly available. |
| 2. Compilation per Criteria | Compiling the pro forma financial information on the basis of the applicable criteria. |
| 3. Full Access to Information | Providing the practitioner with access to all information (including, when needed, information of the acquiree(s) in a business combination), such as records, documentation, and contracts relevant to evaluating compilation. |
| 4. Access to Personnel & Advisors | Providing access to those within the entity and the entity's advisors (merger advisors, investment bankers), as well as appropriate individuals within the acquiree company in a business combination. |
Evaluating Unadjusted Financial Information & Pro Forma Adjustments (Para 4.4.2 & TYK 3, 10)
1. Source of Unadjusted Financial Information (TYK 10(i) - Smart Technology):
When planning and performing the engagement, the practitioner must evaluate:
- Appropriateness of Source: Obtain evidence about the appropriateness of the source from which unadjusted financial information is extracted.
- Unaudited Source Protocol: If there is no audit or review report on the source (e.g. unaudited interim results of an acquired subsidiary), the practitioner SHALL PERFORM PROCEDURES to be satisfied that the source is appropriate and reliable!
- Accurate Extraction: Determine whether the responsible party has appropriately and accurately extracted the unadjusted financial information from the source.
2. What are "Pro Forma Adjustments"? (TYK 3 & TYK 10(ii)):
Under SAE 3420, in relation to unadjusted financial information, Pro Forma Adjustments include:
- Transaction Impact Adjustments: Adjustments to unadjusted financial information that illustrate the impact of a significant event or transaction as if the event had occurred or the transaction had been undertaken at an earlier date selected for illustration (e.g., fair value adjustments of acquired assets, elimination of pre-acquisition intercompany sales, finance costs on new acquisition debt).
- Accounting Consistency Adjustments: Adjustments to unadjusted financial information that are necessary for the pro forma financial information to be compiled on a basis consistent with the applicable financial reporting framework of the reporting entity and its accounting policies under that framework (e.g. aligning an acquired foreign entity's US GAAP numbers to Ind AS).
Preparing the Assurance Report & Opinion Formulation (Paras 4.4.4 - 4.4.5)
1. Unmodified Opinion Wording (Reasonable Assurance):
"In our opinion:
(a) The pro forma financial information has been properly compiled on the basis stated; and
(b) Such basis is consistent with the accounting policies of [Company]."
2. Key Elements of the Practitioner's Assurance Report under SAE 3420:
- Title: Independent Practitioner's Assurance Report on the Compilation of Pro Forma Financial Information Included in a Prospectus.
- Addressee: Board of Directors of the company issuing the prospectus.
- Identification: Clear identification of the pro forma financial information and the source of unadjusted financial info.
- Responsible Party Responsibility: Stating management’s responsibility for compilation on basis of criteria.
- Practitioner Responsibility: Stating that the practitioner’s responsibility is to express an opinion under SAE 3420; compliance with ethical requirements and independence.
- Description of Work: Stating that procedures include evaluating criteria, source appropriateness, and pro forma adjustments.
- Opinion: Reasonable assurance opinion on proper compilation per criteria.
- Date, Place, Signature & UDIN: Date of report, place, signature of CA, and mandatory UDIN.
Modified Opinions under SAE 3420:
The practitioner expresses a qualified or adverse opinion if the pro forma financial information has not been properly compiled on the basis of criteria, if adjustments are inappropriate, or a disclaimer of opinion if a scope limitation prevents obtaining necessary evidence.
Scenario: S Ltd. (Pre-Acceptance Responsibilities for Pro Forma Compilation)
The management of S Ltd. requests you to accept an engagement to report on the compilation of pro forma financial information to be included in a prospectus under SAE 3420.
ICAI Model Answer:
Under Para 4.4.1 of SAE 3420, before accepting the engagement, the practitioner must ensure that S Ltd. formally acknowledges and understands its responsibility for the following FOUR CRITICAL MATTERS:
- Disclosing Criteria: Adequately disclosing and describing the applicable criteria to the intended users if these are not publicly available.
- Compilation: Compiling the pro forma financial information on the basis of the applicable criteria.
- Providing Access to Information: Providing the practitioner with access to all information (including, when needed for a business combination, information of the acquiree(s)), such as records, documentation, and contracts relevant to evaluating the compilation; and additional information requested.
- Access to Individuals: Providing access to persons within the entity and the entity's advisors from whom evidence is necessary, and (when needed in a business combination) access to appropriate individuals within the acquiree company.
Integrated Case Scenario: Top Edge Limited (Ratnagiri Project PFI Report)
Draft Examination Report: Top Edge Limited Upcoming Ratnagiri Project
Below is given the draft text of the “Report on Examination of Prospective Financial Information” of Top Edge Limited in relation to the company’s upcoming project, prepared by a staff member in a CA firm unfamiliar with drafting such reports. The report has been drafted in a casual manner and may consist of omissions and errors.
REPORT ON EXAMINATION OF PROSPECTIVE FINANCIAL INFORMATION
To The Board of Directors, Top Edge Limited
We have examined the projection of the upcoming project to come up at Ratnagiri of Top Edge Limited for the period from April 2026 to March 2032 as given in the Prospective Financial Information from page 1 to 250 in accordance with Standard on Assurance Engagement 3400, “The Examination of Prospective Financial Information”, issued by the Institute of Chartered Accountants of India.
The preparation and presentation of the projection is the responsibility of the Management and has been approved by the Board of Directors of the company.
Our responsibility is to examine the evidence supporting the assumptions (excluding the hypothetical assumption) and other information in the prospective financial information.
The projection has been prepared using a set of assumptions that include hypothetical assumptions about future events and management’s actions that are not necessarily expected to occur.
We have carried out our examination of the prospective financial information thoroughly.
Further, in our opinion the projection is properly prepared on the basis of the assumptions as set out in Note 1 to 50 to the Prospective Financial Information and on a consistent basis with the historical financial statements, using appropriate accounting principles. Even if the events anticipated under the hypothetical assumptions described above occur, actual results are still likely to be different from the projection since other anticipated events frequently do not occur as expected and the variation may be material.
For PCK & Co., Chartered Accountants
Signature | Designation | Membership number
Multiple Choice Questions (Solved with ICAI Rationale)
1. Whose responsibility is it to list out assumptions underlying prospective financial information?
ICAI Rationale: Under Para 2.3 of SAE 3400, management is exclusively responsible for the prospective financial information, including the identification and disclosure of the underlying best-estimate and hypothetical assumptions.
2. Which of the following statements is most appropriate regarding “use of prospective financial information” to be included in such a report?
ICAI Rationale: Para 2.9 of SAE 3400 mandates that when a projection is examined, the report must state the purpose for which it was prepared and explicitly caution users that the projection may not be appropriate for other purposes.
3. Which of the following statements is most appropriate regarding the examination of prospective financial information by a Chartered Accountant in accordance with SAE 3400?
ICAI Rationale: Under SAE 3400 and Clause 3 of Part I of Second Schedule of CA Act, 1949, future results cannot be guaranteed. The CA does NOT vouch for the accuracy of the projections or forecast.
4. Which of the following statements is most appropriate regarding UDIN in context of examination of prospective financial information by a Chartered Accountant?
ICAI Rationale: Generating a Unique Document Identification Number (UDIN) is strictly mandatory for all certificates and assurance reports issued by practicing CAs in India pursuant to the ICAI Council mandate.
Test Your Knowledge (All 12 ICAI Questions Fully Solved)
The following 12 theoretical and practical case questions cover every dimension of SAE 3400, SAE 3402, and SAE 3420 tested by ICAI. Each question contains a fully articulated model answer with exact ICAI terminology and legal reasoning:
TYK 1: Ayurda Ltd — SaaS Software Company Assurance on Controls
SAE 3402 ApplicationICAI Model Answer:
Yes, a practicing Chartered Accountant can provide such an assurance report under SAE 3402.
Standard Provisions & Rationale:
As per SAE 3402 (Assurance Reports on Controls at a Service Organisation), a practitioner in public practice may be engaged by a service organization (like Ayurda Ltd.) to provide an independent assurance report on the controls it operates.
Because Ayurda Ltd. provides cloud-based software solutions that affect the business and accounting operations of user entities, controls operated by Ayurda Ltd. are relevant to user entities and their independent user auditors under SA 402. The practitioner can issue either a Type 1 Report (description & design) or a Type 2 Report (description, design & operating effectiveness throughout a specified period).
TYK 2: Significance of Pro Forma Financial Information in a Prospectus
SAE 3420 ConceptICAI Model Answer:
Under SAE 3420, the purpose of pro forma financial information included in a prospectus is to:
- Demonstrate Transaction Impact: Illustrate the financial effect of a significant event or transaction (such as a major acquisition, merger, hive-off, or debt restructuring) on unadjusted historical financial information as if the event had occurred at an earlier date selected for illustration.
- Provide Comparable Investor Context: Enable prospective investors and lenders to evaluate the ongoing performance, financial position, and cash flows of the restructured or combined corporate entity.
- Regulatory Compliance: Comply with securities market regulations (e.g. SEBI ICDR Regulations) requiring offer documents to present a true reflection of the post-transaction enterprise.
TYK 3: Meaning of "Pro Forma Adjustment" under SAE 3420
DefinitionICAI Model Answer:
As per Para 4.4.2 of SAE 3420, in relation to unadjusted financial information, Pro Forma Adjustments include:
- Impact Adjustments: Adjustments to unadjusted financial information that illustrate the impact of a significant event or transaction as if the event had occurred or the transaction had been undertaken at an earlier date selected for purposes of the illustration (e.g., recognizing fair value of acquired net assets, eliminating pre-acquisition transactions).
- Accounting Policy Alignment Adjustments: Adjustments to unadjusted financial information that are necessary for the pro forma financial information to be compiled on a basis consistent with the applicable financial reporting framework of the reporting entity and its accounting policies under that framework.
TYK 4: CA Association with PFI & Clause 3 Part I Second Schedule
Professional EthicsICAI Model Answer:
Under Clause 3 of Part I of the Second Schedule to the Chartered Accountants Act, 1949, a CA in practice is guilty of misconduct if they permit their name or firm name to be used in connection with an estimate of earnings contingent upon future transactions in a manner which may lead to the belief that they vouch for the accuracy of the forecast.
Compliance with Council Guidelines & SAE 3400:
A CA can lawfully examine and report on PFI provided the examination report strictly incorporates:
- The sources of information relied upon;
- The basis of the forecast and the major assumptions underlying the projection;
- An explicit statement that the CA does NOT vouch for the accuracy of the forecast; and
- A statement that actual results are likely to be different since anticipated events frequently do not occur as expected.
TYK 5: STAR Limited / Little Solutions — Outsourced Payroll Controls
SAE 3402 & SA 402(a) Why do auditors of STAR Ltd require an assurance report? Which standard casts duty?
(b) Which type of report should be provided? Justify.
(c) State matters on which opinion is provided.
ICAI Model Answer:
(a) Why Required & Applicable Standard:
Under SA 402 (Audit Considerations Relating to an Entity Using a Service Organisation), the user auditor must obtain an understanding of internal controls at the service organization relevant to the audit and design procedures responsive to assessed risks. Late tax remittances create substantial interest and penalty liabilities for STAR Ltd. SA 402 casts this responsibility.
(b) Type of Report:
The auditors of Little Solutions should provide a TYPE 2 REPORT. A Type 2 report covers the description, design, AND operating effectiveness of controls throughout a specified period, and includes tests of controls and results. A Type 1 report only covers design as at a single date without testing operating effectiveness.
(c) Matters on which Opinion is Provided (TYK 5(c)):
The opinion of the service auditor states whether, in all material respects, based on suitable criteria:
- The description fairly presents the service organisation’s system that had been designed and implemented throughout the specified period;
- The controls were suitably designed throughout the specified period to achieve specified control objectives; and
- The controls tested operated effectively throughout the specified period.
TYK 6: Mr. Vineet / Qub Ltd — Factors Before Accepting PFI Engagement
Acceptance ProtocolICAI Model Answer:
1. Factors to Consider Before Accepting (Para 2.6):
• The intended use of the PFI;
• General vs. limited distribution;
• Nature of assumptions (best-estimate vs hypothetical);
• Elements to be included and period covered;
• Extent to which reliance on historical financial information is justified.
2. Conditions to Decline or Withdraw:
The auditor SHALL NOT ACCEPT, OR SHALL WITHDRAW FROM, the engagement when the assumptions are clearly unrealistic, or when the auditor believes that the PFI will be inappropriate for its intended use.
3. Formalizing Terms:
Agree on terms in a formal written engagement letter prior to performing the engagement, confirming acceptance and outlining scope, management responsibilities, and non-vouching reporting caveats.
TYK 7: Forecast vs. Projection & Nature of Assurance (SAE 3400)
Core StandardICAI Model Answer:
1. Forecast vs Projection:
• Forecast: Prepared on best-estimate assumptions reflecting events and actions management expects to take. Example: CFO expects sales to increase by 5% next quarter based on current contracts and seasonal trends.
• Projection: Prepared on hypothetical assumptions about future events not necessarily expected to occur, or a mixture of best-estimate and hypothetical. Example: Projections based on developing a new product line assuming a hypothetical 20% market share capture.
2. Nature of Assurance:
Because future evidence is speculative, the practitioner cannot express an opinion that results will be achieved. The practitioner provides moderate level of assurance (negative assurance) on the reasonableness of assumptions, and positive opinions on preparation and historical accounting consistency.
TYK 8: M/s Viva Limited — Investor Meet PFI Examination Procedures
Audit ProceduresICAI Model Answer:
As per Para 2.7 of SAE 3400, while determining examination procedures, the practitioner considers:
- Knowledge of Business: Knowledge of the entity’s business, operations, products, and industry.
- Reliability of Historical Info: The reliability and audit status of historical financial statements.
- Management Competence: Competence of management regarding preparation of PFI.
- Period Covered: The length of the projection period (longer period = greater uncertainty).
- Degree of Management Judgment: The extent to which PFI is affected by subjective estimates.
- Intended Use: Presentation at an Investor Meet indicates wider distribution, requiring greater rigor.
TYK 9: PQ Pharma Limited — Assessing Presentation & Disclosure in IPO PFI
Presentation & DisclosureICAI Model Answer:
Under Para 2.8 of SAE 3400, CA Z must consider whether:
- Informative Presentation: The presentation of PFI is informative and not misleading.
- Accounting Policies Stated: The accounting policies are clearly disclosed in the notes to the PFI.
- Assumptions Adequately Disclosed: The assumptions are adequately disclosed, clearly indicating whether they are best-estimate assumptions or hypothetical assumptions.
- Date Stated: The date as of which the PFI was prepared is clearly stated.
- Difference Warning: A clear statement cautions readers that actual results are likely to differ from projected results, and variations may be material.
TYK 10: Smart Technology / Cloud Computing — Pro Forma Assurance (SAE 3420)
SAE 3420 Case(i) State aspects considered while evaluating source of unadjusted financial info.
(ii) Explain what obtaining evidence about appropriateness of pro forma adjustments includes.
ICAI Model Answer:
(i) Evaluating Source of Unadjusted Info (Para 4.4.2):
• Obtain evidence about the appropriateness of the source.
• Unaudited Source Protocol: If there is no audit or review report on the source (e.g. unaudited subsidiary statements), perform procedures to be satisfied that the source is appropriate.
• Determine whether the responsible party has appropriately extracted the information from the source.
(ii) Appropriateness of Pro Forma Adjustments:
The practitioner obtains evidence that adjustments are directly attributable, factually supportable, and include:
- Transaction Impact: Adjustments illustrating impact as if the transaction had occurred at an earlier date (e.g. fair value adjustments of net assets).
- Accounting Consistency: Adjustments necessary to compile the info on a basis consistent with the reporting entity's framework and accounting policies.
TYK 11: RBR Infrastructure — Smart Highways 0% Inflation & Duties of CA J
Unrealistic AssumptionsICAI Model Answer:
1. Critical Evaluation of Assumptions (Para 2.4 & 2.6):
Under SAE 3400, the CA has a professional duty to examine whether assumptions are reasonable and realistic. Assuming 0% inflation when industry predicts 6-8%, and projecting revenues from bids not yet submitted, represents CLEARLY UNREALISTIC AND MISLEADING ASSUMPTIONS.
2. Affirmative Action by CA J:
• CA J must challenge management's assumptions and request management to revise them using realistic inflation rates and firm contracts.
• CA J CANNOT VOUCH FOR ACCURACY and cannot sign off on unrealistic projections.
3. Reporting / Withdrawal Duty:
If management refuses to correct the assumptions, CA J SHALL NOT ACCEPT OR SHALL WITHDRAW FROM THE ENGAGEMENT, or issue an ADVERSE OPINION stating that the assumptions do not provide a reasonable basis for the PFI!
TYK 12: ED Motors Ltd / CA Madhu — ₹ 450 Cr Bank Loan PFI Procedures
Detailed Audit ProceduresICAI Model Answer:
Under SAE 3400, CA Madhu must perform the following extensive examination procedures:
- Challenge Capacity Constraints: Examine whether installed domestic capacity can physically produce the projected volumes. If production exceeds capacity without planned capital expansion, the assumption is invalid.
- Examine Hypothetical European Market Share: Verify market penetration feasibility, international distribution agreements, homologation regulatory approvals, and pricing models.
- Corroborate Industry Analyst Reports: Independently evaluate the objectivity and relevance of external analyst reports relied upon by management.
- Verify Consistency with Historical Records: Compare projected costs and margins with ED Motors' 4-year historical audited figures.
- Check Mathematical Computations: Test the formulas and debt service coverage ratios (DSCR) submitted to the bank consortium.
Master Comparative Matrix: SAE 3400 vs SAE 3402 vs SAE 3420
Standards on Assurance Engagements (SAEs) Side-by-Side
| Standard | Target Subject Matter | Assurance Level | Reporting Format | Primary Standard Caveat |
|---|---|---|---|---|
| SAE 3400 | Prospective Financial Information (Forecasts & Projections) | Moderate Assurance (Negative) | Negative statement on assumptions; Opinion on preparation | DOES NOT vouch for accuracy of future results |
| SAE 3402 | Controls at a Third-Party Service Organisation | Reasonable Assurance | Type 1 (Design as at date) or Type 2 (Operating throughout period) | Restricted distribution to user entities & auditors |
| SAE 3420 | Compilation of Pro Forma Financial Info in a Prospectus | Reasonable Assurance | Opinion on proper compilation per criteria & accounting consistency | Does NOT audit underlying historical data |
High-Frequency Exam Traps for Chapter 11
A CA can NEVER vouch for the accuracy of PFI. Doing so is professional misconduct under Clause 3 Part I Second Schedule!
A user auditor CANNOT reduce substantive testing relying on a Type 1 report, because Type 1 does not test operating effectiveness!
If unadjusted info is from an unaudited source (e.g. acquired subsidiary), the practitioner MUST perform procedures to satisfy appropriateness!
Generating a UDIN is mandatory for all examination reports under SAE 3400, 3402, and 3420 without exception!