THE AUDITING FUNCTION- PART 2

LECTURER: SHAUNTAI
BURKE
DATE: FEBRUARY 5,
2024
TIME: 6PM
 DE-STRESS
https://www.youtube.com/watch?v=IJOvIRifPyY

https://www.youtube.com/watch?v=2x9efwgb9ag
 LESSON OVERVIEW

.
 LESSON OBJECTIVES
STUDENTS AFTER STUDYING THIS UNIT, YOU
WILL BE ABLE TO
1. IDENTIFY THE TYPES OF AUDIT REPORTS THAT CAN BE ISSUED WHEN AN
UNQUALIFIED OPINION IS NOT JUSTIFIED.
2. EXPLAIN HOW MATERIALITY AFFECTS AUDIT REPORTING DECISIONS.
3. DRAFT APPROPRIATELY MODIFIED AUDIT REPORTS UNDER A VARIETY OF
CIRCUMSTANCES.
4. DETERMINE THE APPROPRIATE AUDIT REPORT FOR A GIVEN AUDIT SITUATION.
5. DISCUSS THE IMPACT OF E-COMMERCE ON AUDIT REPORTING.
 SCHOOL CHALLENGE
ACTIVITY
1. WHY HAVE AN AUDIT?
I. TO ACCOMMODATE STEWARDSHIP FOR THE SHAREHOLDERS’ PURPOSE, FOR PERSONAL
BENEFIT
II. TO ENABLE COMPANIES TO OBTAIN CAPITAL THROUGH THE SECURITIES MARKET, TO
REDUCE ERRORS AND FRAUD
III. FOR COMPANIES TO OBTAIN FINANCING THROUGH BANKS AND OTHER LENDING
INSTITUTIONS, ATTRACT INVESTORS AND COMPLY WITH INTERNATIONAL STANDARDS
IV. TO PROMOTE OPERATIONAL EFFICIENCY, TO REDUCE ERRORS AND FRAUD, TO SATISFY
LEGAL REQUIREMENTS
A. I, II, IV
B. I ONLY
C. III AND IV
D. II AND IV
 SCHOOL CHALLENGE
ACTIVITY
2. ________ RISK REFLECTS THE POSSIBILITY THAT THE INFORMATION UPON
WHICH THE BUSINESS DECISION WAS MADE WAS INACCURATE.
A. CLIENT ACCEPTANCE
B. INFORMATION
C. BUSINESS
D. CONTROL
 SCHOOL CHALLENGE
ACTIVITY
3. WHICH OF THE FOLLOWING CAN BE USED AS A CRITERION FOR EVALUATING
INFORMATION BEING AUDITED?
A. INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS)
B. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)
C. INTERNAL REVENUE CODE (IRC)
D. ALL OF THE ABOVE
 SCHOOL CHALLENGE
ACTIVITY
4. WHICH OF THE FOLLOWING BEST DESCRIBES WHY AN INDEPENDENT AUDITOR IS ASKED
TO EXPRESS AN OPINION ON THE FAIR PRESENTATION OF FINANCIAL STATEMENTS?
A. IT IS DIFFICULT TO PREPARE FINANCIAL STATEMENTS THAT FAIRLY PRESENT A COMPANY’S
FINANCIAL POSITION, OPERATIONS, AND CASH FLOWS WITHOUT THE EXPERTISE OF AN
INDEPENDENT AUDITOR.
B. IT IS MANAGEMENT’S RESPONSIBILITY TO SEEK AVAILABLE INDEPENDENT AID IN THE
APPRAISAL OF THE FINANCIAL INFORMATION SHOWN IN ITS FINANCIAL STATEMENTS.
C. THE OPINION OF AN INDEPENDENT PARTY IS NEEDED BECAUSE A COMPANY MAY NOT BE
OBJECTIVE WITH RESPECT TO ITS OWN FINANCIAL STATEMENTS.
D. IT IS A CUSTOMARY COURTESY THAT ALL STOCKHOLDERS OF A COMPANY RECEIVE AN
INDEPENDENT REPORT ON MANAGEMENT’S STEWARDSHIP OF THE AFFAIRS OF THE BUSINESS.
 SCHOOL CHALLENGE
ACTIVITY
5. WHICH OF THE FOLLOWING IS AN ACCURATE STATEMENT REGARDING
ASSURANCE SERVICES?
A. ASSURANCE SERVICES MUST BE PERFORMED BY A CPA.
B. AN ATTESTATION SERVICE IS NOT A TYPE OF ASSURANCE SERVICE.
C. ASSURANCE SERVICES IMPROVE THE QUALITY OF INFORMATION FOR
DECISION MAKERS.
D. ASSURANCE SERVICES CAN ONLY BE PERFORMED ON FINANCIAL DATA.
 UNQUALIFIED OPINION – CLEAN REPORT

An unqualified opinion doesn't have any kind of adverse

comments and it doesn't include any disclaimers about any
clauses or the audit process. This type of report indicates that
the auditors are satisfied with the company's financial
reporting.
 TYPES OF AUDIT REPORTS THAT CAN BE ISSUED
WHEN AN UNQUALIFIED OPINION IS NOT JUSTIFIED

Four Different Types of Auditor Opinions

Auditors have the option of choosing among four different types of auditor opinion
reports. An auditor opinion report is a letter that auditors attach to the statutory
audit report that reflects their opinion of the audit.
 TYPES OF AUDIT REPORTS THAT CAN BE ISSUED
WHEN AN UNQUALIFIED OPINION IS NOT JUSTIFIED
Unqualified opinion-clean report
An unqualified opinion is considered a clean report.
This is the type of report that auditors give most often.
This is also the type of report that most companies
expect to receive.
An unqualified opinion doesn’t have any kind of
adverse comments and it doesn’t include any
disclaimers about any clauses or the audit process.
This type of report indicates that the auditors are
satisfied with the company’s financial reporting. The
auditor believes that the company’s operations are in
compliance with governance principles and applicable
laws. The company, the auditors, the investors and the
public perceive such a report to be free from material
misstatements.
Qualified opinion-qualified report
When an auditor isn’t confident about any specific
process or transaction that prevents them from issuing
an unqualified, or clean, report, the auditor may
choose to issue a qualified opinion. Investors don’t
find qualified opinions acceptable, as they project a
negative opinion about a company’s financial status.
Auditors write up a qualified opinion in much the
same way as an unqualified opinion, with the
exception that they state the reasons they’re not able
to present an unqualified opinion.
A common for reason for auditors issuing a qualified
opinion is that the company didn’t present its records
with GAAP.
 TYPES OF AUDIT REPORTS THAT CAN BE ISSUED
WHEN AN UNQUALIFIED OPINION IS NOT JUSTIFIED
Disclaimer of opinion-disclaimer report

When an auditor issues a disclaimer of opinion report, it means that they are distancing
themselves from providing any opinion at all related to the financial statements.
Some of the reasons that auditors may issue a disclaimer of opinion are because they felt
like the company limited their ability to conduct a thorough audit or they couldn’t get
satisfactory explanations for their questions. They may not have been able to decipher the
correct nature of some transactions or to secure enough evidence to support good financial
reporting.
Auditors that aren’t allowed an opportunity to observe operational procedures or to review
particular procedures may feel like they’re not able to express a definite opinion, so they
feel a disclaimer is necessary and in order.
The general consensus is that a disclaimer of opinion constitutes a very harsh stance. As a
result, it creates an adverse image of the company.
 TYPES OF AUDIT REPORTS THAT CAN BE ISSUED
WHEN AN UNQUALIFIED OPINION IS NOT JUSTIFIED
Adverse Opinion-Adverse Audit Report
The final type of audit opinion is an adverse opinion. Auditors who aren’t at all satisfied
with the financial statements or who discover a high level of material misstatements or
irregularities know that this creates a situation in which investors and the government will
mistrust the company’s financial reports.
An auditor’s adverse opinion is a big red flag. An adverse audit report usually indicates
that financial reports contain gross misstatements and have the potential for fraud.
Adverse opinions send out a high alert that the company’s records haven’t been prepared
according to GAAP. Financial institutions and investors take this opinion seriously and
will reject doing any kind of business with the company.
 MATERIALITY
The common definition of materiality as it applies to accounting and, therefore, to audit
reporting is:
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.
Materiality relates to both the content of the financial statements and the level and type
of testing to be done. The decision is based on judgements about the size, nature and
particular circumstances of misstatements (or omissions) that could influence users
of the financial reports.
TYPES OF OPINIONS
 HOW MATERIALITY AFFECTS AUDIT REPORTING
DECISIONS

The concept of materiality is essentially an accounting term that has been

defined by the international accounting standards board (IASB) (2010) as:
“information is material if omitting it or misstating it could influence decisions
that users make on the basis of financial information about a specific reporting
entity. In other words, materiality is an entity-specific aspect of relevance based
on the nature or magnitude, or both, of the items to which the information
relates in the context of an individual entity’s financial report”.
 HOW MATERIALITY AFFECTS AUDIT REPORTING
DECISIONS

Auditing adopted this definition of materiality. In auditing, the materiality

concept is used to design and perform an audit that provides reasonable
assurance of detecting misstatements that are of a sufficient magnitude to
affect the judgment of reasonable financial statement users, as it is not the
goal to perform an audit that catches every misstatement no matter how small
(eilifsen et al. 2014). Auditors assess materiality for the financial statements
as a whole and decide on performance materiality for significant accounts or
disclosures.
 HOW MATERIALITY AFFECTS AUDIT REPORTING
DECISIONS
Audit reporting:
• An auditor must determine many things about a company during the planning and
risk assessment process. These judgements are essential to performing an audit that is
thorough per auditing standards.
• Auditors have to determine materiality in the planning phase of the audit. This may
change during the audit. The materiality level determines if misstatements that the
auditor finds is material and can skew a users perception about the company. If the
misstatement is deemed immaterial then the auditor can still issue a clean audit report
even if the immaterial misstatement remains.
 HOW MATERIALITY AFFECTS AUDIT REPORTING
DECISIONS

Materiality and users

In the audit of financial statements, the auditor's judgment as to matters that are
material to users of financial statements is based on consideration of the needs of
users as a group rather than individually; the auditor does not consider the possible
effect of misstatements on specific individual users, whose needs may vary widely.
 HOW MATERIALITY AFFECTS AUDIT REPORTING DECISIONS
Materiality and users
The evaluation of whether a misstatement could influence decisions of users, and therefore be material,
involves consideration of the characteristics of those users. Users are assumed to:
1. A. Have an adequate understanding of business and economic activities and accounting and a
willingness to study the information in the financial statements with an appropriate diligence;
2. B. Understand that financial statements are prepared and audited to certain levels of materiality;
3. C. Recognize the uncertainties inherent in the measurement of amounts based on the use of estimates,
judgments, and the consideration of future events; and
4. D. Make appropriate economic decisions on the basis of the information in the financial statements.
The determination of materiality, therefore, takes into account how users with such characteristics as
identified above could reasonably be expected to be influenced in making economic decisions.
 HOW MATERIALITY AFFECTS AUDIT REPORTING DECISIONS

Materiality and disclosure

The general public tends to expect absolute or complete assurance from auditors, who
however can only provide reasonable assurance.
The success or otherwise of disclosing materiality information can be tied to a proper
understanding of materiality and audit methodologies by users of the financial statements.
Without such an understanding, the results of disclosure are likely to be twofold. On one hand,
the disclosures would not be comprehended and would therefore not have much of an effect.
On the other hand, users could read more into disclosures than they actually represent or start
questioning audit methodologies, resulting in misunderstandings. It is clear from the findings
of the survey that practitioners think that users’ perception of materiality do not coincide with
theirs.
 HOW MATERIALITY AFFECTS AUDIT REPORTING DECISIONS

Upon disclosure, auditors must justify the materiality levels chosen,

especially since different thresholds may be applied to different clients. This
may increase the workload and push up audit fees. Nevertheless, threshold
disclosures can provide insurance against litigation. The enhanced
transparency means auditor can no longer be held liable for unknown errors
below materiality levels disclosed.
 ACTIVITY 2: DISCUSSION

• In two groups students should:

Group 1:
Identify the different types of modified audit reports and give an example
for which each would be required.
Group 2
Determine the appropriate audit report for a given audit situation.
IMPACT OF E-COMMERCE ON AUDIT REPORTING

• E-commerce, or e-business, via the internet is now bringing fundamental

changes to the way business is conducted. In the midst of these changes in
the business environment, the auditor's responsibility to provide an opinion
on the financial report has remained unchanged.
• Although communication and transactions over networks and through
computers are not new features of the business environment, the increasing
use of the internet for e-commerce introduces new variables of risk and
control requiring audit consideration.
 IMPACT OF E-COMMERCE ON AUDIT REPORTING

• The auditor requires appropriate skills to understand how an entity's e-commerce

strategy addresses the business risks that arise. Audit risk assessment for e-commerce
requires a shift in the way auditors consider client entities and the way auditors plan
audit procedures to reduce audit risk to an acceptable level. The auditor will consider
e-commerce business risks only in so far as they affect audit risk.
• Audit risk relates to the risk that the entity's financial report is materially misstated.
Another area of e-commerce that causes concern to the auditor relates to the
availability of both audited and unaudited financial information on an entity's website.
 ACTIVITY ASSIGNMENT (GROUP REVIEW
QUESTION #3)
Brown and co provides lab services to a wide range of clients. Typical assignments range from testing food for illegal
additives to providing forensic analysis on items used to commit crimes to assist law enforcement officers.
The annual audit is nearly complete. As audit senior you have reported to the engagement partner that brown and co.
Is having some financial difficulties. Income has fallen due to the adverse effect of two high-profile court cases,
where brown and co’s services to assist the prosecution were found to be in error.
Not only did this provide adverse publicity for brown and co, but a number of clients withdrew their contracts. A
senior employee then left brown and co , stating lack of investment in new analysis machines was increasing the risk
of incorrect information being provided by the company.
A cash flow forecast prepared internally shows brown and co requiring significant additional cash within the next 12
months to maintain even the current level of services. Brown and co’s auditors have been asked to provide a negative
assurance report on this forecast.
Required:
In the context of the cash flow forecast, define the term ‘negative assurance’ and explain how this differs from the
assurance provided by an audit report on statutory financial statements.
 REFERENCE

• FUNDAMENTAL OF FINANCIAL ACCOUNTING – PHILLIPS, LIBBY , LIBBY

• ISSUE 8. GLOBAL PERSPECTIVES AND INSIGHTS INTERNAL AUDIT AND EXTERNAL
AUDIT DISTINCTIVE ROLES IN ORGANIZATIONAL GOVERNANCE
HTTPS://GLOBAL.THEIIA.ORG/KNOWLEDGE/PUBLIC%20DOCUMENTS/GPI-DISTINC
TIVE-ROLES-IN-ORGANIZATIONAL-GOVERNANCE.PDF