Auditing – Study Notes Chapter 4 Auditor’s Report & Types of Opinions

CHAPTER FOUR
AUDITOR’S REPORT & TYPES OF
OPINIONS

ICAP'S STUDY TEXT

LO # LEARNING OBJCTIVE
REFERENCE*
PART A – AUDITOR’S REPORT
15.5.3
LO 1 ELEMENTS OF AUDITOR’S REPORT
15.5.4
FORMAT OF AUDITOR’S REPORT (FORM 35A OF COMPANIES
LO 2 15.6.1
RULES 1985)
PART B – AUDITOR’S OPINIONS ON FINANCIAL STATEMETNS

LO 3 MATTERS TO BE EVALUATED BEFORE FORMING OPINION 15.5.2

WHAT IS MEANT BY MISSTATEMENTS AND SCOPE 15.7.2
LO 4
LIMITATIONS 15.7.3
15.7.4
WHAT IS MEANT BY IMMATERIAL, MATERIAL AND
LO 5 3.2.4
PERVASIVE 1.1.3
DECIDING TYPE OF OPINION ON FINANCIAL 15.7.1
LO 6
STATEMENTS 15.7.4
PART C – APPENDICES
Appendix DIFFERENCE BETWEEN FORMATS OF AUDITOR’S
15.6.4
1 REPORT (FORM 35A VS. ISA)
Appendix 15.7.2
HOW TO ATTEMPT REPORTING CASE STUDY IN EXAM
2 15.7.3

*Explanation of Reference:
First digit in Study Text’s Reference represents chapter number, second and third digits represents
section and sub-section number. Contents in brackets (if any) represent part of the sub-section
which is covered by the learning objective.

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Auditing – Study Notes Chapter 4 Auditor’s Report & Types of Opinions

PART A – AUDITOR’S REPORT

LO 1: ELEMENTS OF AUDITOR’S REPORT:

Auditor’s Report is always in written form with following elements/contents:

Sr. # Content Brief Explanation

Auditor’s report shall have a title clearly indicating that it is “auditor’s
1. Title report”. Title is necessary to differentiate auditor’s report from other
type of reports included in annual report.
Addressee is the stakeholder to whom report is issued. Report may be
2. Addressee addressed to any appropriate addressee according to circumstances
e.g. “Members”, or “Board of Directors”.
This paragraph states:
 That an audit has been conducted.
Introductory
3.  Entity whose financial statements have been audited.
Paragraph
 Description of financial statements that have been audited.
 Period covered by each statement.
This paragraph describes responsibilities of management:
Management’s
 for preparation of financial statements in accordance with
4. Responsibility
AFRF.
Paragraph
 for such internal controls as are necessary.
This paragraph describes
Auditor’s 1.auditor’s responsibility to express an opinion on financial
5. Responsibility statements based on audit .
Paragraph 2. brief description of audit.
3. that his audit provides a reasonable basis for his opinion
Basis for Modified Whenever auditor modifies the opinion on financial statements, he
Opinion Paragraph includes an additional paragraph in auditor’s report that provides
6.
(if modified opinion information of the matter giving rise to the modification. This is called
is expressed) “Basis for Qualified/Adverse/ Disclaimer of Opinion Paragraph”.
This is most important paragraph in which auditor states:
 whether financial statements are prepared in accordance with
Auditor’s Opinion AFRF and (Where IFRSs are not used as the FRF, auditor shall
7.
Paragraph jurisdiction of FRF).
 whether financial statements present true and fair view (if fair
presentation framework is used).
Other Reporting If auditor is required by local laws and regulations to report on
8. Responsibilities matters other than financial statements, such matter shall also be
(if any) covered by auditor in his report.
Emphasis of Matter Paragraph is included if auditor considers it
Emphasis of Matter necessary to draw users’ attention to a disclosure in the financial
Paragraph statements that is fundamental to users’ understanding of the
or financial statements.
9.
Other Matter Other Matter Paragraph is included if auditor considers it necessary
Paragraph to communicate a matter which is not disclosed in the financial
(if any) statements but is relevant to users’ understanding of the audit,
auditor’s responsibilities or auditor’s report

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Auditing – Study Notes Chapter 4 Auditor’s Report & Types of Opinions

This section contains signature by auditor:

10. Signature  in his personal name (if auditor is sole-proprietor)
 in the name of partnership firm (if auditor is partnership firm)
Date indicates the date on which auditor signs auditor’s report after
obtaining sufficient appropriate audit evidence. This will not be
11. Date earlier than date of approval of F/S by directors/management.
Date also indicates that auditor has considered the effect of
subsequent events on F/S and auditor’s report till that date.
12. Auditor’s Address This is the name of city where auditor practices.
If local laws/regulations require different format/wording of auditor’s report, auditor shall refer to
ISAs only when, at minimum, element # 1, 2, 3, 4, 5, 7, 10, 11 and 12 are included in auditor’s
report.

LO 2: FORMAT OF AUDITOR’S REPORT (FORM 35A OF COMPANIES RULES 1985):

Auditor’s Report to the Members
We have audited the annexed balance sheet of Star Chemicals Limited (the Company) as at June 30,
2014 and the related profit and loss account, cash flow statement and statement of changes in
equity together with the notes forming part thereof, for the year then ended and we state that we
have obtained all the information and explanations which, to the best of our knowledge and belief,
were necessary for the purposes of our audit.

It is the responsibility of the company’s management to establish and maintain a system of internal
control, and prepare and present the above said statements in conformity with the approved
accounting standards and the requirements of the Companies Ordinance, 1984. Our responsibility
is to express an opinion on these statements based on our audit.

We conducted our audit in accordance with the auditing standards as applicable in Pakistan. These
standards require that we plan and perform the audit to obtain reasonable assurance about
whether the above said statements are free of any material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the above said
statements. An audit also includes assessing the accounting policies and significant estimates made
by management, as well as, evaluating the overall presentation of the above said statements. We
believe that our audit provides a reasonable basis for our opinion and, after due verification, we
report that:
(a) in our opinion, proper books of accounts have been kept by the company as required by the
Companies Ordinance, 1984;

(b) in our opinion:

(i) the balance sheet and profit and loss account together with the notes thereon have
been drawn up in conformity with the Companies Ordinance, 1984, and are in
agreement with the books of accounts and are further in accordance with accounting
policies consistently applied, except for the changes as stated in note # xxx with
which we concur;
(ii) the expenditure incurred during the year was for the purpose of the company’s
business; and
(iii) the business conducted, investments made and the expenditure incurred during the
year were in accordance with the objects of the company;

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Auditing – Study Notes Chapter 4 Auditor’s Report & Types of Opinions

(c) in our opinion and to the best of our information and according to the explanations given to
us, the balance sheet, profit and loss account, cash flow statement and statement of changes
in equity together with the notes forming part thereof conform with approved accounting
standards as applicable in Pakistan, and, give the information required by the Companies
Ordinance, 1984, in the manner so required and respectively give a true and fair view of the
state of the company’s affairs as at June 30, 2014 and of the profit (or loss), its cash flows
and changes in equity for the year then ended; and

(d) in our opinion, Zakat deductible at source under the Zakat and Ushr Ordinance, 1980 (XVIII
of 1980), was deducted by the company and deposited in the Central Zakat Fund established
under section 7 of that Ordinance(N–1).
ABC & Co.
August 13, 2014
Lahore
Engagement partner: XYZ
N – 1: Where no Zakat is deductible, substitute “in our opinion, no Zakat was deductible at source
under the Zakat and Ushr Ordinance, 1980”.

PART B – AUDITOR’S OPINIONS ON FINANCIAL STATEMETNS

LO 3: MATTERS TO BE EVALUATED BEFORE EXPRESSING OPINION:

Before forming an opinion, auditor shall conclude:
1) Whether there is a misstatement or scope limitation.
2) Whether effect of misstatements or scope limitation is immaterial, material or pervasive.

Auditor shall also evaluate following:

 Whether AFRF is adequately described.
 Whether accounting policies are selected, applied and disclosed in accordance with AFRF.
 Whether accounting estimates are reasonable.
 If an accounting policy is changed, auditor shall:
a. Obtain evidence that it has been changed, applied and disclosed in accordance with
AFRF.
b. Refer to the change in auditor’s report.
c. State in auditor’s report whether he concurs with the change or not.
 Financial statements provide adequate disclosures.
 Financial statements present true and fair view (if fair presentation framework is used).

LO 4: WHAT IS MEANT BY MISSTATEMENTS AND SCOPE LIMITATIONS:

Types/Situations Examples
1. Accounting Policy is not selected in accordance with AFRF.
Accounting Policies 2. Accounting policy is not applied correctly (errors in application)
are not appropriate. 3. Accounting policy is not applied consistently and auditor does not
concur with change.
Transactions/Events 1. Not recording depreciation on fixed assets.
are not recorded in 2. Impairment loss not recorded on fixed assets.
financial statements. 3. Not recording inventory at lower of cost and NRV.

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Auditing – Study Notes Chapter 4 Auditor’s Report & Types of Opinions

4. Not recording provision for bad debts on bankrupt debtor.

5. Not recording provision on legal cases filed against company.
6. Not recording liabilities (e.g. gratuity, finance lease obligations).
Disclosures are not 1. Non-disclosure of information (which is required by AFRF to be
appropriate in disclosed.)
financial statements. 2. Wrong disclosure of information (i.e. not in accordance with AFRF).

Study Tip
Disclosure of misstatement in financial statements is not a substitute for correct
accounting treatment.

Types/Situations Examples
a. Management prevents auditor from requesting confirmation from
debtors.
Limitations imposed b. Management does not provide representation letter to auditor.
by c. Management does not provide minutes of meetings of
management/entity Shareholders/TCWG to auditor.
d. Management does not allow auditor to communicate with predecessor
auditor.
Limitations by a. Accounting records of entity have been destroyed due to fire,
circumstances beyond computer virus or other natural disaster.
the control of entity b. Accounting records of entity have been seized by govt. authorities.
Limitations by a. Auditor is appointed after year-end and is unable to observe the
circumstances relating inventory count.
to the nature or timing b. For Consolidation, financial statements of subsidiary are not available.
of the auditor’s work

Study Tip
1. There will be no scope limitation if auditor is able to obtain evidence from
alternative audit procedures in above cases.
2. Scope limitation (of any type) affects auditor’s report. However if there is a
scope limitation by management which is unreasonable, it also affects other
aspects of audit.

LO 5: WHAT IS MEANT BY IMMATERIAL, MATERIAL AND PERVASIVE:

Material and Pervasive are terms used to describe the effects of misstatement or scope limitation
on financial statements and audit.

Material:
Effects of misstatement/scope limitation are considered material if they,
individually or in aggregate, could reasonably be expected to influence the
economic decisions of users taken on the basis of the financial statements.

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Auditing – Study Notes Chapter 4 Auditor’s Report & Types of Opinions

Pervasive:
Effects of misstatement/scope limitation are considered pervasive, if they:
i. Are not confined to specific accounts of the financial statements;
ii. If so confined, represent substantial proportion of the financial
statements; or
iii. In relation to disclosures, are fundamental to users’ understanding of
the financial statements.
(Pervasive effect is greater than Material effect and both depend on auditor’s
judgment.)

LO 6: DECIDING TYPE OF OPINION ON FINANCIAL STATEMENTS:

Which opinion to express in what Circumstances:
There are four types of audit opinions, expressed by an auditor.

Immaterial effect Material effect Pervasive effect

Misstatement Adverse Opinion

Unmodified Opinion Qualified Opinion
Scope Limitation Disclaimer of Opinion

When to express Unmodified Opinion:

1. In compliance framework, when auditor has obtained sufficient appropriate evidence that
financial statements have been prepared, in all material respects, in accordance with AFRF.
2. In fair presentation framework, when auditor has obtained sufficient appropriate evidence that
financial statements given a true and fair view in accordance with AFRF.

When to express Modified Opinion:

1. When auditor has obtained sufficient appropriate audit evidence that there are misstatements
in financial statements whose effect is either Material or Pervasive.
2. When auditor is unable to obtain sufficient appropriate evidence on which to base the opinion
and possible effect of undetected misstatements in financial statements is either Material or
Pervasive.

When to express Qualified Opinion:

1. When auditor has obtained sufficient appropriate evidence that there are misstatements in
financial statements whose effect is material (but not pervasive).
2. When auditor is unable to obtain sufficient appropriate evidence on which to base the opinion
and possible effect of undetected misstatements in financial statements is material (but not
pervasive).

When to express Adverse Opinion:

When auditor has obtained sufficient appropriate evidence that there are misstatements in
financial statements whose effect is pervasive.

When to express Disclaimer of Opinion:

1. When auditor is unable to obtain sufficient appropriate evidence on which to base the opinion
and possible effect of undetected misstatements in financial statements is pervasive.

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 Auditing – Study Notes Chapter 4 Auditor’s Report & Types of Opinions

2. When there are multiple uncertainties and it is not possible to form an opinion due to these
uncertainties.

Study Tips
1. There will be only one opinion in an audit report.
2. Qualified Opinion, Adverse Opinion and Disclaimer of Opinion are collectively
called “Modified Opinions”.
3. The term “Modified Report” means report contains either:
(a) Modified Opinion or
(b) “Emphasis of Matter” or “Other Matter”.

PART C – APPENDICES

APPENDIX 1: DIFFERENCE BETWEEN FORMATS OF AUDITOR’S REPORT (FORM 35A

VS. ISA):

Form 35A Requirements ISA Requirements

This report is used in Statutory This Report is used in non-statutory audits only e.g. in
Use of Report Audits only. audits of Sole-proprietor, Partnership, non-statutory
audit of a company.
Title does not include the word Title is “Independent Auditor’s Report”
Title
“Independent”.
Report of statutory audit shall be Report may be addressed to any appropriate
Addressee addressed to Members of the addressee according to circumstances e.g. “Board of
company. Directors”, “Bankers” or “Prospective Investors”.
Introductory paragraph states No such statement is given.
Introductory whether auditor has obtained
Paragraph necessary information and
explanations from management.
Management’s No heading prescribed. A heading is required.
Responsibility for AFRF is “approved accounting Any framework may be used e.g. IFRS or GAAP.
the Financial standards and the requirements of
Statements the Companies Ordinance 1984”.
No heading prescribed. A heading is required.
Audit shall be conducted in Audit shall be conducted in accordance with
accordance with “auditing “International Standards on Auditing”
standards as applicable in
Pakistan”
Auditor’s
Following statements are added in auditor’s
Responsibility
responsibility paragraph:
(i) Auditor complies with ethical requirements.
N/A
(ii) Auditor’s procedures depend on auditor’s judgment
and risk assessment, and auditor considers internal
control for risk assessment.

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 Auditing – Study Notes Chapter 4 Auditor’s Report & Types of Opinions

No heading prescribed. A heading is required.

Auditor’s opinion is under “Fair Auditor’s opinion could be under “Fair Presentation
Presentation Framework” Framework” or “Compliance Framework”.
Auditor expresses opinion on Auditor expresses opinion on Financial Statements
Financial Statements as well as only.
Auditor’s Opinion
Five Additional Opinions ***
Auditor’s opinion mentions Auditor’s opinion does not mention statement of
complete set of financial changes in equity and notes to the accounts.
statements as mentioned in
introductory paragraph.
No difference in requirements. Signature could be in individual’s name (in case of sole-
proprietor) or in firm’s name (in case of partnership).
Signature
However, ICAP’s ATR – 19 requires that if signature is in firm’s name, Name of Engagement
Partner shall also be mentioned.
*** Refer to Auditor’s Report (under Form 35A) for detail of such opinions.

APPENDIX 2: HOW TO ATTEMPT REPORTING CASE STUDY IN EXAM:

Types of Question:
In exam, usually three types of questions are set to test reporting skill of students i.e.
1. You will be given a short situation, and requirement will be to explain implication of
situation on auditor’s opinion or auditor’s report.
2. You will be asked to draft whole or part of auditor’s report.
3. You will be asked to identify errors from whole or part of auditor’s report.

Exam Tips
1. In the absence of information, assume that Auditor’s Report is to be drafted in accordance with
“Form 35A of Companies Rules 1985”.
2. If you are required to identify errors, write errors alongwith correct treatment. But, DO NOT
redraft report; otherwise you will get zero marks.

Suggested Approach (when expressing effect on opinion/report):

SUGGESTED APPROACH TO SOLVE REPORTING CASE STUDIES IN EXAM

1. State the basis for your decisions i.e.

 Whether it is case of misstatement or scope limitation. (prove from facts given in case)
 Whether effect is Immaterial, Material or Pervasive (mention how you determined this).
2. State your decision i.e.
 If effect on Opinion is required:
o State opinion on financial statements
o State additional opinions (when relevant)
 If effect on Report is required, in addition to opinion, also include following:
o Basis for qualified/adverse/disclaimer of opinion Paragraph (whichever is relevant)
o Emphasis of Matter or Other Matter Paragraphs (when relevant)
o Reference to change in accounting policy (when relevant)

(You can get FULL marks in such questions if you follow this simple-systematic approach)

8 By: Muhammad Asif, ACA

Auditing – Study Notes Chapter 4 Auditor’s Report & Types of Opinions

Exam Tip: Is Effect Immaterial, Material or Pervasive

Three situations are possible in exam in this regard:
1. It will be clearly mentioned whether item is material or pervasive. (words “significant” or
“major” in question means “not immaterial”).
2. If it is not clearly mentioned, use Financials (given in question) to determine materiality
using Rule of Thumb:
 Materiality = 5% or more of Profit before tax
 Pervasive = 50% or more of Profit before tax
3. If Financials are also not given, cover Both situations i.e. if Material, if Pervasive.

HOW TO ATTEMPT REPORTING CASE STUDY IN EXAM – AN EXAMPLE

Question:
Below are two independent situations, you are required to state type of opinion you would express in each
situation.
(a) Net realizable value of inventory is lower than cost of inventory but management has not written down
inventory to net realizable value. Effect of this event is material.
(b) Auditor was appointed after the year end date and the accounting records are not sufficiently reliable to
ensure accuracy of the year-end inventory balances.

Solution:
(a)
̶ This is a case of misstatement in financial statements. IFRSs require to record inventory at lower of cost
and NRV but management has not written down inventory to NRV.
̶ Effect is Material (clearly mentioned in case).
̶ Auditor shall express Qualified Opinion.
(b)
̶ This is a case of scope limitation on audit. Auditor is unable to obtain evidence on inventory balance.
Alternative procedures also, do not provide sufficient appropriate audit evidence.
̶ Effect could be Material or Pervasive.
̶ If effect is material, auditor shall express Qualified Opinion. If effect is pervasive, auditor shall express
Disclaimer of Opinion.

9 By: Muhammad Asif, ACA