Lecture 5

Audit Reports-Revisit

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Learning outcomes
 Determine the appropriate audit report
for a given audit situation
 Describe the parts of the standard
unqualified audit report.
 Describe the conditions required to issue
to issue the standard unqualified audit
report.
 Identify the types of audit reports that
can be issued when the unqualified
opinion is not justified
 Specify the conditions required to issue
the standard unqualified audit report

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 Concept of Reasonable
Assurance
 Auditorsperform audit test on sampling
approach
 Inherent limitation of internal control
 Evidence is persuasive and not conclusive
 Auditors apply professional judgements

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 Introduction - Reporting
 Final phase of the audit process
 Concept of Reasonable Assurance
 Majority of audit reports are “unmodified”, which
means
• Auditor is satisfied that the financial statements
present a “true and fair view” according to
Act.
• In compliance with the Companies Act 2016 in
line with
The provision of the Act
The approved auditing standards
The applicable approved accounting standards

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 ISA 700 The Auditor’s Report
on Financial Statements
 The auditor should review and assess the
conclusions drawn from the audit evidence
obtained as the basis for the expression of an
opinion on the financial statements.
 The auditor’s report should contain a clear
written expression of opinion on the financial
statements taken as a whole

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Various types of auditor’s opinion

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 Overview of auditor’s opinion
Immaterial
Matters That Do Affect Matters That Do Not
the Auditor’s Opinion Affect the Auditor’s (Unmodified)
Opinion

Unmodified
Material with emphasis
Scope limitation Disagreement of matter para
Emphasis of matter

“Qualified”
Except For
Material &
Pervasive
Disclaimer Adverse 7
 Overview of auditor’s opinion
Immaterial
Matters That Do Affect Matters That Do Not
the Auditor’s Opinion Affect the Auditor’s (Unmodified)
Disagreement
Opinion

Unmodified
Material with emphasis f
Scope limitation Disagreement-material misstatement matter para
Disagreement
Emphasis of matter
(Inability to obtain sufficient & appropriate evidence

“Qualified”
Except For
Material &
Pervasive
Disclaimer Adverse 8
 Unmodified report
 Unmodified report to be expressed when auditor
is satisfied that all material aspects of the
financial statements is presently fairly in
accordance with:-
 Accounting standards(MFRS/MPERS)
 Relevant statutory and other requirements
 Standard wordings on
 Introductory paragraph
 Scope paragraph
 Opinion paragraph 9
 Matters That Do Not Affect
the Auditor’s Opinion
 Example – unmodified audit opinion but material uncertainty exists in
relation to going concern and the disclosures are adequate
 The auditor should include a separate section in the auditor’s report to
highlight a material matter regarding a going concern problem
 Material uncertainty related to going concern
We draw attention to Note 6 in the financial statements, which indicates that
the Company incurred a net loss of $125,000 during the year ended 31
December 2015 and, as of that date, the Company’s current liabilities
exceeded its total assets by $106,000. As stated in Note 6, these events or
conditions, along with other matters as set forth in Note 6, indicate that a
material uncertainty exists that may cast significant doubt on the Company’s
ability to continue as a going concern. Our opinion is not modified in respect of
this matter. 10
 Substantial Doubt About
Going Concern
1. Significant recurring operating losses
or working capital deficiencies.
2. Inability of the company to pay its
obligations as they come due.
3. Loss of major customers, the occurrence
of uninsured catastrophes.
4. Legal proceedings, legislation that might
jeopardize the entity’s ability to operate.

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 Matters That Do Not Affect
the Auditor’s Opinion

 The auditor should consider modifying the auditor’s report

by adding a paragraph if there is a significant uncertainty
(other than a going concern problem), the resolution of
which is dependent upon future events and which may
affect the financial statements.
 An uncertainty is a matter whose outcome depends on
future actions or events not under the direct control of the
entity but that may affect the financial statements. ie
litigation

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 Key Audit Matters
 ISA 701, Communicating Key Audit Matters in the Independent
Auditor’s Report. This standard is required to be applied to the audit
of all listed entities. The objectives of ISA 701 are for the auditor to:
 determine those matters which are to be regarded as KAM; and
 communicate those matters in the auditor’s report.
 The term ‘key audit matters’ is defined in ISA 701 as:
 ‘Those matters that, in the auditor’s professional
judgment, were of most significance in the audit of the
financial statements of the current period. Key audit
matters are selected from matters communicated with
those charged with governance.’ (1)

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 Communicating KAM
Once the auditor has determined which matters will be
included as KAM, the auditor must ensure that each matter
is appropriately described in the auditor’s report including a
description of:
Why the matter was determined to be one of most
significance and therefore a key audit matter, and
How the matter was addressed in the audit (which may
include a description of the auditor’s approach,
A brief overview of procedures performed with an indication
of their outcome and any other key observations in respect
of the matter).

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 Emphasis of matter
 If the auditor considers it necessary to draw users’
attention to a matter presented or disclosed in the
financial statements that, in the auditor’s judgment, is of
such importance that it is fundamental to users’
understanding of the financial statements.
 The auditor shall include an Emphasis of Matter paragraph
in the auditor’s report provided the auditor has obtained
sufficient appropriate audit evidence that the matter is
not materially misstated in the financial statements.
 Such a paragraph shall refer only to information presented
or disclosed in the financial statements. (Ref: Para. A1-A2)

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Examples of circumstances where the auditor may consider it
necessary to include an Emphasis of Matter paragraph are:

 An uncertainty relating to the future outcome of

exceptional litigation or regulatory action.
• Early application (where permitted) of a new
accounting standard (for example, a new
International Financial Reporting Standard) that
has a pervasive effect on the financial statements
in advance of its effective date.
• A major catastrophe that has had, or continues to
have, a significant effect on the entity’s financial
position.
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 Example of emphasis of
matter
 We draw attention to Note X of the financial
statements, which describes the effects of a
fire in the Company’s production facilities.
Our opinion is not modified in respect of this
matter.

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 Other Matter Paragraphs in
the Auditor’s Report
 If the auditor considers it necessary to communicate a
matter other than those that are presented or disclosed in
the financial statements that, in the auditor’s judgment, is
relevant to users’ understanding of the audit, the auditor’s
responsibilities or the auditor’s report and this is not
prohibited by law or regulation, the auditor shall do so in a
paragraph in the auditor’s report, with the heading “Other
Matter,” or other appropriate heading. The auditor shall
include this paragraph immediately after the Opinion
paragraph and any Emphasis of Matter paragraph, or
elsewhere in the auditor’s report if the content of the
Other Matter paragraph is relevant to the Other Reporting
Responsibilities section. (Ref: Para. A5-A11)
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Departure from UnMODIFIED
Auditors’ Report

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 Matters That Do Affect the
Auditor’s Opinion

 Whenever the auditor expresses an opinion that is

other than unmodified, a clear description of all
the substantive reasons should be included in the
report and, unless impracticable, a quantification
of the possible effect(s) on the financial
statements.

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 Matters That Do Affect the Auditor’s
Opinion – QUALIFED OPINION
A qualified opinion should be expressed when the
auditor concludes that an unmodified opinion
cannot be expressed but that the effect of any
disagreement with management, or limitation on
scope is not so material and pervasive as to
require an adverse opinion or a disclaimer of
opinion.
 A qualified opinion should be expressed as being
‘except for’ the effects of the matter to which
the qualification relates.

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Matters That Do Affect the Auditor’s
Opinion – DISCLAIMER OF OPINION

A disclaimer of opinion should be expressed when

the possible effect of a limitation on scope is so
material and pervasive that the auditor has not
been able to obtain sufficient appropriate audit
evidence and accordingly is unable to express an
opinion on the financial statements.

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Matters That Do Affect the Auditor’s
Opinion – ADVERSE OPINION
 An adverse opinion should be expressed when the
effect of a disagreement is so material and
pervasive to the financial statements that the
auditor concludes that a qualification of the report
is not adequate to disclose the misleading or
incomplete nature of the financial statements.

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Inability to obtain sufficient
appropriate audit evidence
 Not able to get sufficient appropriate audit
evidence on some components of the
accounts
 Client limits scope of engagement
may prevent discovery of material
misstatement
 Circumstances of the audit
E.g. auditor could not participate in
inventory counting
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Inability to obtain sufficient appropriate audit
evidence-Limitation on Scope

A limitation on the scope of the auditor’s work

may sometimes be imposed by the entity (for
example, when the terms of the engagement
specify that the auditor will not carry out an audit
procedure that the auditor believes is necessary).
 A scope limitation may be imposed by
circumstances (for example, when the timing of
the auditor’s appointment is such that the auditor
is unable to observe the counting of physical
inventories).

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 Inability to obtain sufficient appropriate
audit evidence
 If auditor could do alternative audit procedure
 Issue a standard unmodified report
 Else,

a qualified except for report (material – overall

accounts still true and fair) or
disclaimer (material and pervasive)
 ISA 700 (revised) – when scope limitation causes
the auditors to consider a disclaimer necessary,
usually auditor will not take up the engagement
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Example : Inability to obtain
sufficient appropriate evidence—
Qualified Opinion
 We did not observe the counting of the physical inventories as of
December 31, 20X1, since that date was prior to the time we were
initially engaged as auditors for the Company. Owing to the nature
of the Company’s records, we were unable to satisfy ourselves as
to inventory quantities by other audit procedures.

 In our opinion, except for the effects of such adjustments, if any,

as might have been determined to be necessary had we been able
to satisfy ourselves as to physical inventory quantities, the
financial statements give a true and ...
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 Example : Limitation on Scope
—Disclaimer of Opinion
 We were engaged to audit the accompanying balance sheet of the ABC
Company as of December 31, 20X1, and the related statements of income and
cash flows for the year then ended. These financial statements are the
responsibility of the Company’s management. (Omit the sentence stating the
responsibility of the auditor).
 (The paragraph discussing the scope of the audit would either be omitted or
amended according to the circumstances.)
 (Add a paragraph discussing the scope limitation as follows:)
 We were not able to observe all physical inventories and confirm accounts
receivable due to limitations placed on the scope of our work by the
Company.
 Because of the significance of the matters discussed in the preceding
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paragraph, we do not express an opinion on the financial statements.”
Statements not in Accordance with the Applicable
Financial Reporting Framework (Disagreement)

 When the accounts are affected by non

compliance with approved accounting
standards and The views of auditors differ
from the views expressed by management
 Auditors may disagree with the accounting
standards selected, the method of applying
the standards & adequacy of disclosure

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Statements not in Accordance with the Applicable
Financial Reporting Framework (Disagreement)
with Management
 The auditor may disagree with management about
matters such as the acceptability of accounting
policies selected, the method of their application,
or the adequacy of disclosures in the financial
statements.
 If such disagreements are material to the financial
statements, the auditor should express a qualified
or an adverse opinion.

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Examples:
Qualified opinion due to a material misstatement of the financial statements
Statements not in Accordance with the Applicable Financial Reporting Framework on
Accounting Policies-Inappropriate Accounting Method—Qualified Opinion

 We conducted our audit in accordance with ...

 As discussed in Note X to the financial statements, no depreciation has been

provided in the financial statements which practice, in our opinion, is not in
accordance with International Accounting Standards. The provision for the
year ended December 31, 20X1, should be xxx based on the straight-line
method of depreciation using annual rates of 5% for the building and 20% for
the equipment. Accordingly, the fixed assets should be reduced by
accumulated depreciation of xxx and the loss for the year and accumulated
deficit should be increased by xxx and xxx, respectively.

 In our opinion, except for the effect on the financial statements of the matter
referred to in the preceding paragraph, the financial statements give a true
and ... 31
Example: Disagreement on Accounting Policies—
Inadequate Disclosure—Adverse Opinion
 We conducted our audit in accordance with ...

 (Paragraph(s) discussing the disagreement).

 In our opinion, because of the effects of the matters

discussed in the preceding paragraph(s), the financial
statements do not give a true and fair view of (or do not
‘present fairly’) the financial position of the Company as
of December 20, 19X1, and of the results of its operations
and its cash flows for the year then ended in accordance
with International Accounting Standards 32
 The effects of materiality example
 Auditor is not able to do certain audit procedures
necessary to determine the fairness of client’s inventory
balance
 Inventory represents 10% of total assets
May be material but not to the extent that the
overall accounts do not represent a true and fair
view
Therefore a QUALIFIED opinion
 But inventory represents 50% of total assets
Effect is highly material
Therefore a DISCLAIMER is necessary because
the auditors could not do further audit
procedure, i.e. a scope limitation
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Reporting on Internal Control
over Financial Reporting
Auditors of public companies subject to Section
404 of the Sarbanes-Oxley Act must
report on the effectiveness of internal
control over financial reporting.

PCAOB Auditing Standard 5 requires

the audit of internal control to be integrated
with the audit of the financial statements.

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 Sarbanes-Oxley Act-S 404

Separate Report on Financial Statements and

Internal Control Over Financial Reporting

1. Introductory paragraph
2. Scope paragraph
3. Definition paragraph
4. Inherent limitations paragraph
5. Opinion paragraph
6. Cross Reference Paragraph

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Materiality

A misstatement in the financial statements

can be considered material if knowledge of
the misstatement would affect a decision
of a reasonable user of the statements.

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Levels of Materiality

Amounts are immaterial.

Amounts are material but do not overshadow

the financial statements as a whole.

Amounts are so material or so pervasive that

overall fairness of the statements is in question.

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 Relationship of Materiality to
Type of Opinion
Materiality Significance in Terms of Type of
Level Reasonable Users’ Decisions Opinion
Users’ decisions are unlikely
Immaterial to be affected. Unqualified

Users’ decisions are likely

Material to be affected. Qualified

Highly Users’ decisions are likely Disclaimer

material to be significantly affected. or adverse
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End of Lecture

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