The independent auditor’s report
The objectives of the auditor are:
- To form an opinion on the financial statements based on an evaluation of the conclusions drawn from the audit evidence obtained, and
- To express clearly that opinion through a written report.
[ISA 700 Forming an Opinion and Reporting on Financial Statements, 6]
The auditor forms an opinion on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. In order to do that they must conclude whether they have obtained reasonable assurance about whether the financial statements as a whole are free from material misstatement (whether due to fraud or error).
In particular the auditor should evaluate whether:
- The financial statements adequately disclose the significant accounting policies.
- The accounting policies selected are consistently applied and appropriate.
- Accounting estimates made by management are reasonable.
- Information is relevant, reliable, comparable and understandable.
- The financial statements provide adequate disclosures to enable the users to understand the effects of material transactions and events.
- The terminology used is appropriate.
[ISA 700, 13]
When the auditor concludes that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework they issue an unmodified opinion in the auditor’s report. [ISA 700, 16]
If there are no other matters which the auditor wishes to draw to the attention of the users, they will issue an unmodified report.
Illustration 1 – Unmodified auditor’s report
INDEPENDENT AUDITOR’S REPORT
To the Shareholders of Murray Company
Report on the Audit of the Financial Statements [sub-title is not included if there is no separate Report on Other Legal and Regulatory Requirements]
Opinion
We have audited the financial statements of the Murray Company (the Company), which comprise the statement of financial position as at 31 December, 20X4, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies.
In our opinion, the accompanying financial statements present fairly, in all material respects, (or give a true and fair view of) the financial position of the Company as at December 31, 20X4, and its performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards.
Basis for Opinion
We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the financial statements in [jurisdiction], and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.
Key audit matters
Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the financial statements of the current period. These matters were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters.
[Description of each key audit matter in accordance with ISA 701]
Other information
Management is responsible for the other information. The other information comprises the Chairman’s statement, but does not include the financial statements and the auditor’s report thereon.
Our opinion on the financial statements does not cover the other information and we do not express any form of assurance conclusion thereon.
In connection with our audit of the financial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit or otherwise appears to be materially misstated. If, based on the work we have performed, we conclude that there is a material misstatement of this information, we are required to report that fact. We have nothing to report in this regard.
Responsibilities of Management and Those Charged With Governance for the Financial Statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.
In preparing the financial statements, management is responsible for assessing the Company’s ability to continue as a going concern, disclosing as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Company or to cease operations, or has no realistic alternative but to do so.
Those charged with governance are responsible for overseeing the Company’s financial reporting process.
Auditor’s Responsibilities for the Audit of the Financial Statements
Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements.
As part of an audit in accordance with ISAs, we exercise professional judgment and maintain professional scepticism throughout the audit. We also:
- Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.
- Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control.
- Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management.
- Conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Company’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the Company to cease trading as a going concern.
- Evaluate the overall presentation, structure and content of the financial statements, including the disclosures, and whether the financial statements represent the underlying transactions and events in a manner that achieves fair presentation.
We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant findings, including any significant deficiencies in internal control that we identify during our audit.
We also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards.
From the matters communicated with those charged with governance, we determine those matters that were of most significance in the audit of the financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditor’s report unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should not be communicated in our report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication.
Report on Other Legal and Regulatory Requirements
[As required by local law, regulation or national auditing standards]
The engagement partner on the audit resulting in this independent auditor’s report is Don Henman.
Wimble & Co
Wimble & Co, London
18 February 20X5
[ISA 700, Appendix]
Explanations of the sections
| Section | Purpose | |
| 1 | Title | To clearly identify the report as an Independent |
| Auditor’s Report. | ||
| 2 | Addressee | To identify the intended user of the report. |
| 3 | Auditor’s Opinion | Provides the auditor’s conclusion as to whether |
| the financial statements give a true and fair | ||
| view. | ||
| 4 | Basis for Opinion | Provides a description of the professional |
| standards applied during the audit to provide | ||
| confidence to users that the report can be | ||
| relied upon. | ||
| 5 | Key Audit Matters | To draw attention to any other significant |
| matters of which the users should be aware, to | ||
| aid their understanding of the entity. (Note: | ||
| This section is only compulsory for listed | ||
| entities.) | ||
| 6 | Other Information | To clarify that management are responsible for |
| the other information such as the Chairman’s | ||
| statement. The auditor’s opinion does not | ||
| cover the other information and the auditor’s | ||
| responsibility is only to read the other | ||
| information and report in accordance with | ||
| ISA 720. | ||
| 7 | Responsibilities | To clarify that management are responsible for |
| of Management | preparing the financial statements and for the | |
| and Those | internal controls. Included to help minimise the | |
| Charged with | expectations gap. | |
| Governance for | ||
| the Financial | ||
| Statements |
| 8 | Auditor’s | To clarify that the auditor is responsible |
| Responsibilities for | for expressing reasonable assurance as | |
| the Audit of the | to whether the financial statements give a | |
| Financial Statements | true and fair view and express that | |
| opinion in the auditor’s report. The | ||
| section also describes the auditor’s | ||
| responsibilities in respect of risk | ||
| assessment, internal controls, going | ||
| concern and accounting policies. | ||
| Included to help minimise the | ||
| expectations gap. | ||
| 9 | Report on Other | To highlight any additional reporting |
| Legal and Regulatory | responsibilities, if applicable. This may | |
| Requirements | include responsibilities in some | |
| jurisdictions to report on the adequacy of | ||
| accounting records, internal controls over | ||
| financial reporting, or other information | ||
| published with the financial statements. | ||
| 10 | Name of the | To identify the person responsible for the |
| engagement partner | audit opinion in case of any queries. | |
| 11 | Signature | Shows the engagement partner or firm |
| accountable for the opinion. | ||
| 12 | Auditor’s address | To identify the specific office of the |
| engagement partner in case of any | ||
| queries. | ||
| 13 | Date | To identify the date up to which the audit |
| work has been performed. Any |
information that comes to light after this
date will not have been considered by the
auditor when forming their opinion. The
report must be signed and dated after the
date the directors approved the financial
statements. Often, the financial
statements are approved and the
auditor’s report signed on the same day.
As can be seen from the diagram above, the report can be:
- Unmodified – the financial statements show a true and fair view. (ISA 700)
- Modified without modifying the opinion – the financial statements show a true and fair view but there is additional communication required to bring something to the attention of the user.
- Modified with a modified opinion – the financial statements don’t fully show a true and fair view or the auditor has not obtained sufficient appropriate evidence to make that conclusion. (ISA 705 Modifications to the Opinion in the Independent Auditor’s Report).
3 Modified report with unmodified opinion
In certain circumstances auditors are required to make additional communications in the auditor’s report even though the financial statements show a true and fair view. Issues requiring communication include:
- Material Uncertainty Related to Going Concern (ISA 570 Going Concern)
- Emphasis of Matter paragraph (ISA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in an Auditor’s Report)
- Other Matter paragraph (ISA 706)
- Inconsistencies in the Other Information (ISA 720 The Auditor’s Responsibilities Relating to Other Information)
It is important to note that these do not impact the wording of the opinion and do not constitute either a qualified, adverse or disclaimer of opinion.
Material Uncertainty Related to Going Concern
Purpose
This section is included when there is a material uncertainty regarding the going concern status which the directors have adequately disclosed in the financial statements. The auditor uses this section to draw the attention of the user to the client’s disclosure note. [ISA 570, 22]
Position in the auditor’s report
Below the Basis for Opinion section.
Emphasis of Matter paragraph
Purpose
An Emphasis of Matter paragraph is used to refer to a matter that has been appropriately presented or disclosed in the financial statements by the directors. The auditor’s judgment is that these matters are of such fundamental importance to the users’ understanding of the financial statements that the auditor should emphasise the disclosure. [ISA 706, 7a]
Examples of such fundamental matters include:
- Where the financial statements have been prepared on a basis other than the going concern basis.
- An uncertainty relating to the future outcome of exceptional litigation or regulatory action.
- A significant subsequent event occurs between the date of the financial statements and the date of the auditor’s report.
- Early application of a new accounting standard.
- Major catastrophes that have had a significant effect on the entity’s financial position.
- Where the corresponding figures have been restated.
- Where the financial statements have been recalled and reissued or when the auditor provides an amended auditor’s report.
[ISA 706, A5]
Position in the auditor’s report
Below the Basis for Opinion section.
When a Key Audit Matters section is presented in the auditor’s report, an Emphasis of Matter paragraph may be presented either directly before or after the Key Audit Matters section, based on the auditor’s judgment as to the relative significance of the information included in the Emphasis of Matter paragraph.
The heading of the paragraph can be amended to provide further context, for example, Emphasis of Matter – Subsequent event. [ISA 706, A16]
Tutorial notes
An Emphasis of Matter paragraph is not used to draw attention to immaterial misstatements. The fact that they are immaterial means they do not warrant the attention of the shareholders.
An Emphasis of Matter paragraph can only be used when adequate disclosure has been made of the matters mentioned above. The auditor can only emphasise something that is already included.
Where adequate disclosure has not been made the opinion will need to be modified and an Emphasis of Matter paragraph should NOT be used.
An Emphasis of Matter should not be used to highlight an issue already included in the Key Audit Matters section. The auditor must use judgment to determine which section they consider is the most appropriate to highlight the issue.
Other Matter paragraph
Purpose
An Other Matter paragraph is included in the auditor’s report if the auditor considers it necessary to communicate to the users regarding matters other than those presented or disclosed in the financial statements that, in the auditor’s judgment, are relevant to understanding the audit, the auditor’s responsibilities, or the auditor’s report.
[ISA 706, 7b]
Examples of its use include:
- To communicate that the auditor’s report is intended solely for the intended users, and should not be distributed to or used by other parties. [ISA 706, A14]
- When law, regulation or generally accepted practice requires or permits the auditor to provide further explanation of their responsibilities.
[ISA 706, A11]
- To explain why the auditor has not resigned, when a pervasive inability to obtain sufficient appropriate evidence is imposed by management
(e.g. denying the auditor access to books and records) but the auditor is unable to withdraw from the engagement due to legal restrictions.
[ISA 706, A10]
- To communicate audit planning and scoping matters where laws or regulations require. [ISA 706, A9]
- Where an entity prepares one set of accounts in accordance with a general purpose framework and another set in accordance with a different one (e.g. one according to UK and one according to International standards) and engages the auditor to report on both sets.
[ISA 706, A13]
Position in the auditor’s report
When an Other Matter paragraph is included to draw the users’ attention to a matter relating to other reporting responsibilities addressed in the auditor’s report, the paragraph may be included in the Report on Other Legal and Regulatory Requirements section.
When relevant to all auditor’s responsibilities or users’ understanding of the auditor’s report, the Other Matter paragraph may be included as a separate section following the Report on the Other Legal and Regulatory Requirements.
The heading may be amended to provide further context, for example, Other
Matter – Scope of the audit.
[ISA 706, A16]
Tutorial notes
An Other Matter paragraph does not include confidential information or information required to be provided by management. [ISA 706, A15]
Other Information
Other information refers to financial or non-financial information, other than the financial statements and auditor’s report thereon, included in the entity’s annual report that is not necessarily subject to audit.
Examples of other information include:
- Chairman’s report
- Operating and financial review
- Social and environmental reports
- Corporate governance statements.
Purpose
If the auditor obtains the final version of the other information before the date of the auditor’s report, they must read it to identify any material inconsistencies with the financial statements or the auditor’s knowledge obtained during the audit. [ISA 720, 3]
If the auditor identifies a material inconsistency they should:
- Perform limited procedures to evaluate the inconsistency. The auditor should consider whether it is the financial statements or the other information that requires amendment. [ISA 720, 16]
- Discuss the matter with management and ask them to make the correction. [ISA 720, 17a]
- If management refuse to make the correction, communicate the matter to those charged with governance. [ISA 720, 17b]
- If the matter remains uncorrected the auditor must describe the material misstatement in the auditor’s report. [ISA 720, 18a]
- Alternatively, the auditor should withdraw from the engagement if possible under applicable law or regulation as the issue casts doubt over management integrity. [ISA 720, 18b]
A separate section is included in the auditor’s report under the heading ‘Other Information’. [ISA 720, 21]
This section:
- Identifies the other information obtained by the auditor prior to the date of the auditor’s report.
- States that the auditor has not audited the other information and accordingly does not express an opinion or conclusion on that information.
- Includes a description of the auditor’s responsibilities with respect to the other information.
- States either that the auditor has nothing to report or provides a description of the material misstatement if applicable.
[ISA 720, 22]
Position in the auditor’s report
The Other Information section is included in the auditor’s report below the Basis for Opinion and Key Audit Matters section (if applicable) and above the Responsibilities of Management.
Tutorial notes
Misstatement of other information exists when the other information is incorrectly stated or otherwise misleading (including because it omits or obscures information necessary for a proper understanding of a matter).
Material misstatements or inconsistencies in the other information may undermine the credibility of the financial statements and the auditor’s report. [ISA 720, 2]
The auditor must not be knowingly associated with information which is misleading. [ISA 720, 4]
The auditor must retain a copy of the final version of the other information on the audit file. [ISA 720, 25b]
If the auditor issues a disclaimer of opinion on the financial statements, the Other Information section should not be included in the auditor’s report as to do so may overshadow the disclaimer of opinion. [ISA 720, A58]
4 Modified report with modified opinion
Modifications to the audit opinion
The auditor may decide they need to modify the opinion when they conclude that:
- Based upon the evidence obtained the financial statements as a whole are not free from material misstatement. This is where the client has not complied with the applicable financial reporting framework.
- They have been unable to gather sufficient appropriate evidence to be able to conclude that the financial statements as a whole are free from material misstatement. This is evidence the auditor would expect to exist to support the figures in the financial statements.
[ISA 705, 6]
The nature of the modification depends upon whether the auditor considers the matter to be material but not pervasive, or material and pervasive, to the financial statements.
Material but not pervasive – Qualified opinion
- If the misstatement or lack of sufficient appropriate evidence is material but not pervasive, a qualified opinion will be issued.
- This means the matter is material to the area of the financial statements affected but does not affect the remainder of the financial statements.
- ‘Except for‘ this matter, the financial statements give a true and fair view.
- Whilst significant to users’ decision making, a material matter can be isolated whilst the remainder of the financial statements may be relied upon.
[ISA 705, 7]
Material and pervasive
A matter is considered ‘pervasive‘ if, in the auditor’s judgment:
- The effects are not confined to specific elements, accounts or items of the financial statements
- If so confined, represent or could represent a substantial proportion of the financial statements, or
- In relation to disclosures, are fundamental to users’ understanding of the financial statements.
[ISA 705, 5a]
In brief, a pervasive matter must be fundamental to the financial statements, therefore rendering them unreliable as a whole.
Adverse opinion
An adverse opinion is issued when a misstatement is considered material and pervasive. [ISA 705, 8]
This will mean the financial statements do not give a true and fair view.
Examples include:
- Preparation of the financial statements on the wrong basis.
- Non-consolidation of a subsidiary.
- Material misstatement of a balance which represents a substantial proportion of the assets or profits e.g. would change a profit to a loss.
Disclaimer of opinion
A disclaimer of opinion is issued when the auditor has not obtained sufficient appropriate evidence and the effects of any possible misstatements could be pervasive. [ISA 705, 9]
The auditor does not express an opinion on the financial statements in this situation.
Examples include:
- Failure by the client to keep adequate accounting records.
- Refusal by the directors to provide written representation.
- Failure by the client to provide evidence over a single balance which represents a substantial proportion of the assets or profits or over multiple balances in the financial statements.
Impact of a disclaimer of opinion
Where a disclaimer of opinion is being issued:
- The statement that sufficient appropriate evidence to provide a basis for the auditor’s opinion has been obtained is not included.
- The statement that the financial statements have been audited is changed to ‘we were engaged to audit the financial statements’.
[ISA 705, 19]
- The statements regarding the audit being conducted in accordance with ISAs, and independence and other ethical responsibilities, are positioned within the Auditor Responsibilities section rather than the Basis for Disclaimer of Opinion section. [ISA 705, A25]
- The Key Audit Matters section is not included in the report as to do so would suggest the financial statements are more credible in relation to those matters which would be inconsistent with the disclaimer of opinion on the financial statements as a whole. [ISA 705, 29]
Basis for modified opinion
When the auditor decides to modify the opinion, they must amend the heading ‘Basis for Opinion’ to ‘Basis for Qualified Opinion’, ‘Basis for Adverse Opinion’ or ‘Basis for Disclaimer of Opinion’, as appropriate.
- Where a qualified or adverse opinion is being issued, the auditor must amend the statement ‘…the audit evidence is sufficient and appropriate to provide a basis for the auditor’s qualified/adverse opinion.’
[ISA 705, 20a]
- The section will explain the reason why the opinion is modified e.g. which balances are misstated, which disclosures are missing or inadequate, which balances the auditor was unable to obtain sufficient appropriate evidence over and why. [ISA 705, 20b]
- If possible, a quantification of the financial effect of the modification will be included. [ISA 705, 21]
- If the material misstatement relates to narrative disclosures, an explanation of how the disclosures are misstated should be included, or in the case of omitted disclosures, the disclosure should be included if the information is readily available. [ISA 705, 22]
The following table illustrates the impact on the audit opinion and auditor’s report. [ISA 705, A1]
| Material but Not | Material & | ||
| Pervasive | Pervasive | ||
| Financial statements | Qualified Opinion | Adverse Opinion | |
| are materially | Except for … | FS do not give a | |
| misstated | |||
| Basis for qualified | true and fair view | ||
| opinion | Basis for adverse | ||
| opinion | |||
| Inability to obtain | Qualified Opinion | Disclaimer of | |
| sufficient appropriate | Except for … | Opinion | |
| audit evidence | Basis for qualified | Do not express an | |
| opinion | opinion | ||
| Basis for disclaimer | |||
| of opinion | |||
Management imposed limitation of scope
- If after accepting the engagement management impose a limitation of scope that will result in a modified opinion, the auditor will request management remove the limitation. [ISA 705, 11]
- If management refuse, the matter must be discussed with those charged with governance. [ISA 705, 12]
- The auditor should perform alternative audit procedures to obtain sufficient appropriate evidence, if possible. [ISA 705, 12]
- If the auditor is unable to obtain sufficient appropriate evidence and the matter is material but not pervasive, the auditor must issue a qualified audit opinion. [ISA 705, 13a]
If the matter is considered pervasive, the auditor must withdraw from the audit. [ISA 705, 13bi]
- If withdrawal is not possible before issuing the auditor’s report, a disclaimer of opinion should be issued. [ISA 705, 13bii]
- If the auditor decides to withdraw from the audit, the auditor must communicate any material misstatements identified during the audit to those charged with governance before withdrawing.
[ISA 705, 14]
| Going concern reporting implications | ||||||
| Situation | Impact on audit | Impact on auditor’s | ||||
| opinion | report | |||||
| No material | Unmodified – | Unmodified. | ||||
| uncertainty exists | Financial statements | |||||
| regarding going | give a true and fair | |||||
| concern. | view. | |||||
| Material uncertainty | Unmodified – | Modified with a section | ||||
| exists and is | Financial statements | headed ‘Material | ||||
| adequately disclosed | give a true and fair | Uncertainty Related to | ||||
| by management. | view. | Going Concern’. | ||||
| Material uncertainty | Modified – qualified | Modified. Basis for | ||||
| exists which is not | or adverse. | qualified/adverse | ||||
| adequately disclosed | opinion explaining the | |||||
| or is omitted | going concern issues | |||||
| altogether. | management have | |||||
| failed to disclose | ||||||
| adequately. | ||||||
| Company is not a | Unmodified – | Modified with emphasis | ||||
| going concern and | Financial statements | of matter paragraph. | ||||
| has prepared the | give a true and fair | |||||
| financial statements | view. | |||||
| on the break up basis | ||||||
| appropriately and | ||||||
| made adequate | ||||||
| disclosure of this fact | ||||||
| Company is not a | Modified – adverse | Modified. Basis for | ||||
| going concern and | opinion. | modified opinion | ||||
| has prepared the | explaining the going | |||||
| financial statements | concern issues | |||||
| using the going | management have | |||||
| concern basis of | failed to account for | |||||
| accounting. | appropriately. | |||||
| The period assessed | Modified – qualified | Modified. Basis for | ||||
| by management is | or disclaimer due to | qualified/disclaimer | ||||
| less than twelve | an inability to obtain | opinion explaining that | ||||
| months from the | sufficient appropriate | sufficient appropriate | ||||
| statement of financial | audit evidence | evidence was not | ||||
| position date and | regarding the use of | obtained to form a | ||||
| management is | the going concern | conclusion on the | ||||
| unwilling to extend the | assumption. | going concern | ||||
| assessment. | assumption. | |||||
5 Key Audit Matters
ISA 701 Communicating Key Audit Matters in the Independent Auditor’s Report requires auditors of listed companies to determine key audit matters and to communicate those matters in the auditor’s report. [ISA 701, 5]
Auditors of non-listed entities may voluntarily, or at the request of management or those charged with governance, include key audit matters in the auditor’s report.
Key audit matters are those that in the auditor’s professional judgment were of most significance in the audit and are selected from matters communicated to those charged with governance. [ISA 701, 8]
The purpose of including these matters is to assist users in understanding the entity, and to provide a basis for the users to engage with management and those charged with governance about matters relating to the entity and the financial statements. [ISA 701, 3]
Each key audit matter should describe why the matter was considered to be significant and how it was addressed in the audit.
Key audit matters include:
- Areas of higher assessed risk of material misstatement, or significant risks identified in accordance with ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment.
- Significant auditor judgments relating to areas in the financial statements that involved significant management judgment, including accounting estimates that have been identified as having high estimation uncertainty.
- The effect on the audit of significant events or transactions that occurred during the period.
[ISA 701, 9]
Specific examples include:
- Significant fraud risk
- Goodwill
- Valuation of financial instruments
- Fair values
- Effects of new accounting standards
- Revenue recognition
- Material provisions such as a restructuring provision
- Implementation of a new IT system, or significant changes to an existing system.
Note that a matter giving rise to a qualified or adverse opinion, or a material uncertainty related to going concern are by their nature key audit matters. However, they would not be described in this section of the report. Instead, a reference to the Basis for qualified or adverse opinion or the going concern section would be included. [ISA 701, 15]
If there are no key audit matters to communicate, the auditor shall:
- Discuss this with the engagement quality control reviewer, if one has been appointed.
- Communicate this conclusion to those charged with governance. [ISA 701, 17b]
- Explain in the key audit matters section of the auditor’s report that there are no matters to report. [ISA 701, 16]
6 Illustrations
Illustration 2 – Material Uncertainty Related to Going Concern
We draw attention to Note 6 in the financial statements, concerning the uncertainty of Murray Company’s future funding. The Company is seeking new funding through an initial public offering of shares. In the event that the initial public offering does not proceed, this will require the Company’s existing banking arrangements to be renegotiated and additional funding to be raised from either existing or new investors. This condition indicates the existence of a material uncertainty which may cast significant doubt on the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that would result if the Company was unable to continue as a going concern. Our opinion is not modified in respect of this matter.
Illustration 3 – Emphasis of Matter Paragraph
We draw attention to Note 12 of the financial statements, which describes the effects of a fire at the premises of a third party warehouse provider. Our opinion is not modified in respect of this matter.
Illustration 4 – Other Matter Paragraph
The financial statements of Murray Co for the year ended December 31, 20X3, were audited by another auditor who expressed an unmodified opinion on those statements on May 31, 20X4.
Illustration 5 – Murray Co Qualified opinion 1
Example where the auditor concludes that the financial statements are
materially (but not pervasively) misstated:
Qualified Opinion
We have audited the financial statements of Murray Company (the Company), which comprise the statement of financial position as at 31 December, 20X4, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies.
In our opinion, except for the effects of the matter described in the
Basis for Qualified Opinion section of our report, the accompanying financial statements give a true and fair view………………. (remainder
of wording as per an unmodified report).
Basis for Qualified Opinion
No allowance has been provided in the financial statements for a receivable for which recoverability is in doubt, which, in our opinion, is not in accordance with International Financial Reporting Standards. The allowance for the year ended 31 December 20X4 should be $211,000 based on the value of the receivable in current assets and the likely recoverability of the amount. Accordingly, current assets should be reduced by an allowance of $ 211,000 and the profit for the year and accumulated profit should be decreased by the same amount.
We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the financial statements in [jurisdiction], and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified opinion.
Key Audit Matters
Except for the matter described in the Basis for Qualified Opinion section, we have determined that there are no other key audit matters to communicate in our report.
Illustration 6 – Murray Co Qualified opinion 2
Example where the auditor concludes that they have been unable to
gather sufficient appropriate evidence and the possible effects are deemed to be material but not pervasive:
Qualified Opinion
We have audited the financial statements of the Murray Company (the Company), which comprise the statement of financial position as at 31 December, 20X4, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies.
In our opinion, except for the possible effects of the matter described in the Basis for Qualified Opinion section of our report, the accompanying financial statements give a true and fair
view……………(remainder of wording as per an unmodified report).
Basis for Qualified Opinion
As described in note 8 to the financial statements, Murray Company is the defendant in a lawsuit alleging constructive dismissal. The Company has filed a counter action, and preliminary hearings and discovery proceedings on both actions are in progress. The liability has been disclosed as contingent in accordance IAS 37 Provisions, Contingent Liabilities and Contingent Assets. We have been unable to obtain a response to our request for information from the solicitors representing Murray Company in the case. We were unable to confirm or verify by alternative means the likely success of the lawsuit and therefore unable to determine whether disclosure of a contingent liability is appropriate, or whether a provision for the value of the claim of $280,000 should be included in the statement of financial position as at 31 December 20X4 and an associated expense included in the statement of profit or loss for the year ended 31 December 20X4. Consequently, we were unable to determine whether any adjustments to these amounts were necessary.
We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the financial statements in [jurisdiction], and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified opinion.
Key Audit Matters
Except for the matter described in the Basis for Qualified Opinion section, we have determined that there are no other key audit matters to communicate in our report.
Illustration 7 – Murray Co Adverse opinion
Example where the auditor concludes that the financial statements are
materially and pervasively misstated:
Adverse Opinion
We have audited the financial statements of the Murray Company (the Company), which comprise the statement of financial position as at 31 December, 20X4, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies.
In our opinion, because of the significance of the matter discussed in the Basis for Adverse Opinion section of our report, the accompanying financial statements do not give a true and fair view………. (remainder of wording as per an unmodified report).
Basis for Adverse Opinion
As explained in note 12 to the financial statements, the financial statements have been prepared on the going concern basis. However, in our opinion, due to the number and significance of the material uncertainties, Murray Co is not a going concern in accordance with IAS 1 Presentation of Financial Statements and therefore the financial statements should not be prepared on the going concern basis….
[explanation of the various effects on the amounts presented in the financial statements].
We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the financial statements in [jurisdiction], and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our adverse opinion.
Key Audit Matters
Except for the matter described in the Basis for Adverse Opinion section, we have determined that there are no other key audit matters to communicate in our report.
Illustration 8 – Murray Co Disclaimer of opinion
Example where the auditor concludes that they have been unable to gather sufficient appropriate evidence and the possible effects are deemed to be both material and pervasive.
Disclaimer of Opinion
We were engaged to audit the financial statements of Murray Company (the Company), which comprise the statement of financial position as at 31 December, 20X4, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies.
We do not express an opinion on the accompanying financial statements. Because of the significance of the matter described in the Basis for Disclaimer of Opinion section of our report, we have not been able to obtain sufficient appropriate evidence to provide a basis for an audit opinion on these financial statements.
Basis for Disclaimer of Opinion
Due to a fire at a third party warehouse provider’s premises, the records relating to inventory held there were destroyed. We were unable to confirm or verify by alternative means closing inventory of $1,054,000 deducted from cost of sales included in the statement of profit or loss for the year ended 31 December 20X4, and the inventory balance of $1,054,000 included in the statement of financial position as at 31 December 20X4.
As a result, we were unable to determine whether any adjustments to the financial statements might have been necessary in respect of recorded or unrecorded inventory or cost of sales, and the associated elements of the statement of changes in equity and statement of cash flows.
Responsibilities of Management and Those Charged With Governance for the Financial Statements
[Wording as per ISA 700]
Auditor’s Responsibilities for the Audit of the Financial Statements
Our responsibility is to conduct an audit of the financial statements in accordance with International Standards on Auditing and to issue an auditor’s report. However, because of the matter described in the Basis for Disclaimer of Opinion section of our report, we were not able to obtain sufficient appropriate evidence to provide a basis for an audit opinion on these financial statements.
We are independent of the Company in accordance with ethical requirements that are relevant to our audit of the financial statements in [jurisdiction], and we have fulfilled our other ethical responsibilities in accordance with these requirements.
Illustration 9 – Key Audit Matter
Integrated website and finance How our audit addressed the Key
systems Audit Matter
During the year the company introduced a new website which enables customers to order online. The website is integrated with the finance system. There is a risk of material misstatement in relation to completeness of revenue.
- Obtaining an understanding of the new system and the controls management implemented to ensure the system works effectively.
- Testing controls over the new website and finance system.
- Performing substantive tests of detail over completeness of income.
Exam question approach
The exam will regularly feature a requirement asking for the implications for the auditor’s report if issues identified during the audit are not resolved. The following approach should be taken to answer this type of requirement.
Explain the implications for the auditor’s report
- Materiality assessment – if the issue is not material it won’t affect the auditor’s report. Calculate the percentage of assets and profit the issue represents and state whether this is material or not material.
- Identify the type of issue
– Material misstatement – non-compliance with an accounting standard.
– Inability to obtain sufficient appropriate evidence – evidence the auditor would expect to obtain hasn’t been obtained.
– Material uncertainty – significant events where the outcome will only be known in the future.
– Inconsistency with the other published information – contradiction between the financial statements and the other information which is not subject to audit e.g. directors’ report, chairman’s statement, CSR report, etc.
– A matter that is of importance to the scope of the audit, the auditor’s assessment of materiality, assessment of risk of material misstatement or other key audit matter that the auditor should specifically refer to in their report.
- Comment on the issue
– Which accounting standard has not been complied with and why?
– Which piece of evidence has not been obtained and why?
– What event/outcome is uncertain?
– What is the contradiction in the unaudited information?
– Explain why the auditor focused specifically on the key audit matters described in greater detail in the auditor’s report e.g. involved a high degree of management judgment, required complex accounting treatment creating significant risk of material misstatement.
- State whether the issue is material but not pervasive or material and pervasive. If it is isolated or relatively small in impact it will be material but not pervasive. If it makes the financial statements as a whole unreliable it will be material and pervasive.
- Conclude on the opinion
– Unmodified – if there are no material misstatements and sufficient appropriate evidence has been obtained
– Qualified – if there is a material (but not pervasive) misstatement or a lack of evidence over a material balance
– Adverse – if there is a pervasive misstatement
– Disclaimer – if there is a lack of evidence which is considered pervasive.
- State any other reporting implications
– Basis for modified opinion if the opinion is modified
– Material Uncertainty Related to Going concern section
– Emphasis of matter paragraph
– Other matter paragraph
– Requires inclusion in the Key Audit Matters section for a listed entity.
ISA 260 Communication with Those Charged with Governance and ISA 265 Communicating Deficiencies in Internal Control to Those Charged with Governance and Management, require the external auditor to engage in communications with management.
The main forms of formal communication between the auditors and management are: the engagement letter (see ‘ ‘ ); and another written communication, usually sent at the end of the audit, which is often referred to as ‘the management letter.’
In addition, the auditor will communicate with those charged with governance throughout the audit as required.
Reasons for communicating to those charged with governance
- To communicate responsibilities of the auditor and an overview of the scope and timing of the audit.
- To obtain information relevant to the audit.
- To report matters from the audit on a timely basis.
- To promote effective two-way communication.
[ISA 260, 9]
Matters that should be reported to those charged with governance
- The auditor’s responsibilities in relation to the financial statements audit. [ISA 260, 14]
- The planned scope and timing of the audit including, for example:
– The auditor’s approach to internal control relevant to the audit
– The extent to which the auditor is planning to use the work of internal audit and the arrangements for so doing
– Business risks that may result in material misstatements
– Communications with regulators.
[ISA 260, 15 & A14]
- Significant findings from the audit, such as:
– The auditor’s views about qualitative aspects of the entity’s accounting practices/policies
– Significant difficulties encountered during the audit
– Significant matters arising during the audit that were discussed with management
– Written representations the auditor is requesting
– Circumstances that affect the form and content of the auditor’s report, if any. This includes any expected modifications to the report and key audit matters to be communicated in accordance with ISA 701 Communicating Key Audit Matters in the Independent Auditor’s Report
– Other matters that, in the auditor’s opinion, are significant to the oversight of the reporting process.
[ISA 260, 16 & A24]
- Matters of auditor independence. [ISA 260, 17]
Ultimately what constitutes a matter requiring the attention of those charged with governance is a matter of professional judgment. Typical examples include:
- Delays in obtaining information for the audit.
- An unreasonably brief time within which to complete the audit.
- Expected limitations on the audit, either imposed by management or other circumstances.
- The potential effect on the financial statements of any material risks and exposures, such as pending litigation, that are required to be disclosed in the financial statements.
- A summary of identified misstatements, whether corrected or not by the entity and a request that they are adjusted.
- Material uncertainties related to events and conditions that may cast significant doubt on the entity’s ability to continue as a going concern.
- Any other matters agreed upon in the terms of the audit engagement.
Timing of communication with those charged with governance
| Stage of audit | Communication required |
| Planning | Significant risks identified by the auditor |
| How the auditor plans to address the | |
| risks | |
| Auditor’s approach to internal control | |
| relevant to the audit | |
| Application of materiality in the context of | |
| an audit | |
| During the audit | If any situation occurs and it would not be |
| appropriate to delay communication until | |
| the audit is concluded | |
| Conclusion of the audit | Major findings from the audit work. |
| Delays caused by management | |
The auditor must take care not to compromise the effectiveness of the audit by communicating too much information about the planned scope and timing of the audit to such an extent that procedures become too predictable.
Test your understanding 1
Murray case study: Auditor’s report
As a result of the going concern review undertaken at the completion stage, the audit engagement partner has decided that there is a material uncertainty regarding the going concern status of Murray Co. He has requested that the directors make adequate disclosure in the final version of the financial statements for the year ended 31 December 20X4.
Required:
Describe the impact on the auditor’s report for the year ended 31 December 20X4 if:
- The directors include disclosure regarding the material uncertainty over going concern, which in the partner’s view is adequate.
(3 marks)
- The directors refuse to include any disclosure on the matter.
(3 marks)
Test your understanding 2
In terms of an independent auditor’s report, explain the term ‘modified’.
(2 marks)
Test your understanding 3
ISA 260 Communication with Those Charged with Governance deals with the auditor’s responsibility to communicate with those charged with governance in relation to an audit of financial statements.
Required:
- Describe TWO specific responsibilities of those charged with governance.
(2 marks)
- Explain FOUR examples of matters that might be communicated to them by the auditor.
(4 marks)
Test your understanding 4
Henry
- Aragon Co operates a perpetual inventory system. No year-end count is performed. You have reviewed the level of adjustments made each month after each perpetual count and concluded that due to the significance of the adjustments, the inventory system is not reliable. You have requested that a full year-end count is performed but management have refused saying it would be too disruptive. The inventory balance is $4 million. Sales revenue is $50 million and profit for the year is $15 million.
- Boleyn Co has not made allowance for an irrecoverable debt of $50,000 in respect of a customer declared bankrupt just after the year-end. Profit for the year is $500,000.
- Seymour Co is being sued by a competitor for the theft of intellectual property. The amount of the claim is material and the case could go either way. The claim is not mentioned anywhere in the financial statements.
- Howard Co is a cash retailer. There is no system to confirm the accuracy of cash sales.
- Cleves Co has neglected to include a statement of profit or loss in its financial statements.
- Parr Co is involved in a major court case that would bankrupt the company if lost. The directors assess and disclose the case as a contingent liability in the accounts. The auditors agree with the treatment and disclosure.
Required:
For each of the above situations describe the implications for the independent auditor’s report.
(18 marks)
Test your understanding 5
You are the audit manager of Brakes Co, a listed client. Brakes Co is a global manufacturer of braking systems for use in domestic and commercial motor vehicles. $250,000 was raised through a new share issue in the year. Draft profit before tax is $9m and total assets are $37m. The audit is nearly complete and you are undertaking an overall review of the audit evidence on file.
- Explain the importance of the overall review of evidence obtained.
(3 marks)
- During your review you notice that the section of the file relating to share capital and reserves is incomplete.
Required:
Describe audit procedures that should be performed in respect of Brake’s share capital and reserves.
(4 marks)
- The following matters arising during the audit of Brakes Co have been noted on file for your attention:
- A customer of Brakes Co had to withdraw one of their family car models this year due to concerns over the safety of the braking system. The customer has lodged a legal claim against Brakes Co for $10 million for the negligent supply of faulty braking systems. The company’s lawyers believe that there is an 80% chance that Brakes Co will lose the case but the directors believe that their quality control procedures have always been robust and that the braking systems will be proven to have been safe. They have however decided to disclose the matter in the financial statements as a contingent liability.
(5 marks)
- Brakes Co also produces and sells brake fluid. Another customer has recently returned a small batch of brake fluid because the fluid appeared to be contaminated with oil. Brakes Co issued the customer with a credit note for the full value of $137,500 and correctly accounted for this in the draft financial statements. As the brake fluid was returned before the year-end, Brakes Co has included it in the year-end inventory listing at cost of $125,000. Brakes Co may be able to re-filter and re-sell the brake fluid at the original selling price, but filtering will cost a further $62,500.
(4 marks)
- Four months ago, Brakes Co began renting some additional warehouse space from a third party storage provider, Wheels Co. At the year end, raw materials with a value of $3.2 million belonging to Brakes were stored at Wheels Co’s premises. The directors of Brakes Co did not make you aware of the new third party storage facility. Consequently, no audit procedures were performed to verify the raw materials.
(4 marks)
Required:
Discuss each of these issues and describe the impact on the independent auditor’s report if the above issues remain unresolved.
Note: The mark allocation is shown against each of the three issues above.
(13 marks)
(Total: 20 marks)
Test your understanding 6
You are about to issue the auditor’s report for Exmouth Co, a listed client. Half way through the year the company suffered a major computer systems failure which destroyed the accounting records for the year to date. Backups had not been kept and so the company has had to reconstruct the figures for the first six months.
- Which opinions are most appropriate for Exmouth Co? A Qualified or adverse
B Unmodified or adverse C Unmodified or disclaimer D Qualified or disclaimer
- What is the purpose of the Basis for Opinion paragraph in an unmodified report?
A To state the opinion on the financial statements
B To confirm the audit has been conducted in accordance with ISAs and ethical requirements
C To highlight a material uncertainty relating to going concern which has been adequately disclosed
D To highlight management’s responsibilities to the users of the financial statements
- Which of the following shows the correct order of the elements to be included in the auditor’s report of Exmouth Co?
A Opinion, date, auditor’s address, signature B Title, opinion, signature, key audit matters
C Addressee, opinion, auditor’s responsibilities, date
D Responsibilities of management, basis for opinion, date, addressee
- Which of the following describes the wording of a disclaimer of opinion?
A The financial statements give a true and fair view
B The financial statements do not give a true and fair view C The auditor does not express an opinion on the financial
statements
D Except for the matter described, the financial statements give a true and fair view
- Which of the following statements is correct in relation to the auditor’s report of Exmouth Co?
A The Key Audit Matters section should be used to describe the matter giving rise to the modified opinion, in this case that the auditor has been unable to obtain sufficient appropriate evidence
B If a disclaimer of opinion is to be issued, the Key Audit Matters section should not be included in the auditor’s report as to do so may suggest other aspects of the financial statements are reliable
C An Emphasis of Matter paragraph should be included to draw attention to the inability to obtain sufficient appropriate evidence
D The auditor will conclude that the financial statements do not give a true and fair view
Test your understanding 7
You are about to issue the auditor’s report for two listed clients, Kalgoorlie Co and Cundeelee Co. The financial statements show the following:
| Kalgoorlie | Cundeelee | |
| $000 | $000 | |
| Profit before tax | 10 | 245 |
| Total assets | 2,300 | 6,500 |
| Uncorrected misstatements: | ||
| Overstatement of receivables due to an | 15 | |
| irrecoverable debt not being written off | ||
| Overstatement of inventory due to failure to | 85 | |
| value at lower of cost and NRV |
- Which of the following is the most appropriate opinion for Kalgoorlie Co?
A Adverse B Disclaimer C Qualified D Unmodified
- Which of the following is the most appropriate opinion for Cundeelee Co?
A Adverse B Disclaimer C Qualified D Unmodified
- How would your answer change for Cundeelee Co if the misstatement of inventory had been $10,000 instead of $85,000?
A Adverse opinion
B Unmodified opinion with emphasis of matter C Qualified opinion
D Unmodified opinion and report
- You have also identified material uncertainties relating to going concern during your audit of Kalgoorlie Co. These have been adequately disclosed by management. How will this impact the auditor’s report?
A The report should include a section titled ‘Emphasis of Matter’ which will refer to the management’s disclosure note
B The report should include a section titled ‘Material Uncertainty Related to Going Concern’ which will refer to the management’s disclosure note
C The report should include a section titled ‘Going concern issues’ which will refer to the management’s disclosure note
D As management have adequately disclosed the uncertainties relating to going concern, the auditor does not need to modify the report as the financial statements include the appropriate information
- Included within the financial statements of Cundeelee Co is a provision for a legal case of which the outcome is uncertain at this date. Adequate disclosure of the matter has been included by management. The case represents a significant uncertainty and you have included an emphasis of matter in the auditor’s report to refer to the client’s disclosure of the uncertainty.
What other modifications, if any, will be required to the report in respect of this matter?
A The opinion should be modified as a result of the significant uncertainty
B No further modifications to the report are required
C The Key Audit Matters section should describe the uncertainty D The Basis for Opinion section should describe the uncertainty
8 summary
Test your understanding 1
- If the directors make adequate disclosures regarding the material uncertainty over the going concern status of Murray Co, the financial statements will show a true and fair view.
As there is no material misstatement, or lack of sufficient appropriate evidence on this matter, the audit opinion can remain unmodified.
The auditor’s report will be modified, as there would need to be a Material Uncertainty Related to Going Concern paragraph included in the report. This will draw the shareholder’s attention to the disclosure note.
The paragraph would state that our opinion is not modified in this respect.
The paragraph would be inserted below the basis for modified opinion paragraph.
- If the directors refuse to make any disclosures, then in the auditor’s opinion the financial statements are materially misstated.
The auditor’s report and opinion will need to be modified due to this material misstatement.
The type of opinion given would depend on whether the auditor considers the misstatement to be material and pervasive or material but not pervasive.
If it is pervasive, an adverse opinion will be given. The opinion will state ‘In our opinion the financial statements do not give a true and fair view/are not fairly presented’.
If it is not considered pervasive, a qualified opinion can be given. The opinion would state ‘Except for the matter described in the basis for qualified opinion paragraph below, in our opinion the financial statements show a true and fair view/are fairly presented’.
The basis for opinion paragraph will need to change to a basis for qualified/adverse opinion and will explain the reason for the modified opinion.
Test your understanding 2
An auditor modifies the auditor’s report in any situation where it is inappropriate to provide an unmodified report.
The auditor may need to provide additional information to the user, for example by including an emphasis of matter paragraph (which does not affect the auditor’s opinion).
The auditor may modify the opinion because the financial statements as a whole are not free from material misstatement or the auditor is unable to obtain sufficient appropriate evidence to conclude that the financial statements are free from material misstatement.
Test your understanding 3
- Those charged with governance are responsible for overseeing:
– The strategic direction of the entity
– Obligations related to the accountability of the entity. This includes overseeing the financial reporting process
– Promotion of good corporate governance
– Risk assessment processes
– The establishment and monitoring of internal controls
– Compliance with applicable law and regulations
– Implementation of controls to prevent and detect fraud and errors.
- General audit matters that might be communicated to those charged with governance are:
- The auditor’s responsibilities in relation to financial statement audit. This would include:
– A statement that the auditor is responsible for forming and expressing an opinion on the financial statements.
– That the auditor’s work is carried out in accordance with ISAs and in accordance with local laws and regulations.
- Planned scope and timing of the audit. This would include:
– The audit approach to assessing the risk of serious misstatement, whether arising from fraud or error.
– The audit approach to the internal control system and whether reliance will be placed on it.
– The timing of interim and final audits, including reporting deadlines.
- Significant findings from the audit. This could include:
– Significant difficulties encountered during the audit, including delays in obtaining information from management.
– Significant deficiencies in internal control and recommendations for improvement.
– Audit adjustments, whether or not recorded by the entity, that have, or could have, a material effect on the entity’s financial statements. For example, the bankruptcy of a material receivable shortly after the year-end that should result in an adjusting entry.
- A statement on independence issues affecting the audit. This would include:
– That the audit firm has ensured that all members of the audit team have complied with the ethical standards of ACCA.
– That appropriate safeguards are in place where a potential threat to independence has been identified.
Test your understanding 4
- Aragon
– Inventory is material as it represents 8% of sales revenue and 27% of profit.
– There is a lack of sufficient appropriate audit evidence over inventory. The auditor cannot form a conclusion as to whether inventory is materially misstated or free from material misstatement.
– The auditor’s report and opinion should be modified.
– A qualified opinion using the ‘except for’ wording will be issued as the matter is material but not pervasive.
– The basis for opinion section will be amended to basis for qualified opinion.
– The basis for qualified opinion section will explain the reason for the qualified opinion and quantify the effect of the issue on the financial statements.
- Boleyn
– The balance is material as it represents 10% of profit.
– An irrecoverable debt has not been written off. The financial statements will be materially misstated due to overstatement of receivables.
– The auditor’s report and opinion should be modified.
– A qualified opinion using the ‘except for’ wording will be issued as the matter is material but not pervasive.
– The basis for opinion section will be amended to basis for qualified opinion.
– The basis for qualified opinion section will explain the reason for the qualified opinion and quantify the effect of the issue on the financial statements.
- Seymour
– The claim is material and represents an uncertainty that should
be communicated to the users of the financial statements.
– As the claim could go either way, a contingent liability should be disclosed. Failure to do this will mean the financial statements are materially misstated.
– The auditor’s report and opinion should be modified.
– A qualified opinion using the ‘except for’ wording will be issued as the matter is material but not pervasive.
– The basis for opinion section will be amended to basis for qualified opinion.
– The basis for qualified opinion section will explain the reason for the qualified opinion and quantify the effect of the issue on the financial statements.
- Howard
– There is no system to confirm cash sales therefore the auditor cannot form a conclusion as to whether revenue is materially misstated or free from material misstatement.
– The auditor is unable to obtain sufficient appropriate evidence for a significant class of transactions in the financial statements.
– The issue is pervasive.
– The auditor’s report and opinion should be modified.
– A disclaimer of opinion will be issued stating that the auditor does not express an opinion on the financial statements.
– The basis for opinion section will be amended to a basis for disclaimer of opinion.
– The basis for disclaimer of opinion section will explain the reason for the disclaimer and quantify the effect of the issue on the financial statements.
– The statement referring to the audit being conducted in accordance with ISAs and ethical requirements will be moved from the basis for opinion section and included in the Auditor responsibilities section.
– The statement within the auditor’s report that sufficient appropriate evidence has been obtained will be removed.
– The statement that the financial statements have been audited will be changed to the auditor was engaged to audit the financial statements.
- Cleves
– The financial statements do not contain a statement of profit or loss which is one of the primary financial statements and must be presented.
– The financial statements are misstated and the effect is pervasive.
– The auditor’s report and opinion should be modified.
– An adverse opinion will be issued stating that the financial statements do not give a true and fair view.
– The basis for opinion section will be amended to a basis for adverse opinion.
– The basis for adverse opinion section will explain the reason for the adverse opinion and quantify the effect of the issue on the financial statements.
- Parr
– The claim is material and represents an uncertainty that should
be communicated to the users of the financial statements.
– The directors have correctly disclosed the matter in the financial statements.
– The audit opinion should be unmodified as the financial statements give a true and fair view.
– The report should be modified by bringing the disclosure made by the client to the attention of the user.
– This could be achieved by including an emphasis of matter paragraph. The emphasis of matter paragraph will refer to the client’s disclosure of the court case to make the users aware of it.
– Alternatively, the auditor may consider the issue a material uncertainty related to going concern and refer to the court case by including a going concern section in the report instead of an emphasis of matter.
– The choice of how the auditor should refer to the matter in the auditor’s report is a matter of professional judgment.
Test your understanding 5
- Reasons why the overall review of evidence obtained is important: It enables the auditor to ensure:
– sufficient appropriate evidence has been obtained.
– the evidence supports any conclusions reached, and is appropriately documented.
– work has been performed in accordance with professional standards.
For the appraisal and development of staff.
- Audit procedures: Share capital
– Agree authorised share capital and nominal value disclosures to underlying shareholding agreements/statutory constitution documents.
– Inspect the cash book for evidence of cash receipts from share
issues and ensure amounts not yet received are correctly disclosed as share capital called-up not paid in the financial statements.
– Inspect board minutes to verify the issue of share capital during the year.
Audit procedures: Reserves
– Agree opening reserves to prior-year closing reserves and reconcile movements.
– Agree movements in reserves to supporting documentation (e.g. agree revaluation reserve movements to an independent valuer’s report).
- Impact on auditor’s report:
- Faulty brake systems
The amount of $10m is 111% ($10m/$9m) of profit before tax and is therefore material.
The $10m provision would turn a profit of $9m into a loss of $1m and is also therefore pervasive.
It is probable that Brakes Co will lose the legal case and therefore the claim of $10m should be provided for in the financial statements in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
The auditor’s report and opinion should be modified as the financial statements are materially misstated.
An adverse opinion will be issued stating that the financial statements do not give a true and fair view.
The basis for opinion section will be amended to a basis for adverse opinion.
The basis for adverse opinion section will explain the reason for the adverse opinion and quantify the effect of the issue on the financial statements.
The Key Audit Matters section will reference the ‘Basis for Adverse Opinion’.
- Contaminated brake fluid
Inventory should be valued at the lower of cost and net realisable value (IAS 2 Inventories, 9).
The contaminated brake fluid cost $125,000. If sold at the original price charged of $137,500, the net realisable value will be $75,000 ($137,500 less $62,500 re-filtering costs). Inventory is therefore overstated by $50,000.
$50,000 is not material at 0.6% of profit ($50,000/$9m) and 0.1% of total assets ($50,000/$37m).
As the misstatement is not material, the audit opinion would not be modified in respect of this matter and no reference to the misstatement would be made in the auditor’s report.
The misstatement should be brought to the attention of management and they should be asked to correct it.
- Inventory held at third party premises
The auditor has not obtained sufficient appropriate evidence over the inventory held at third party premises.
The inventory is material to the statement of profit or loss at 36% of profit ($3.2m/$9m) and the statement of financial position at 8.6% of total assets ($3.2m/$37m).
If alternative sources of evidence cannot be obtained, it will be necessary to modify the audit opinion due to an inability to obtain sufficient appropriate evidence.
A qualified opinion using the ‘except for’ wording would be necessary.
The basis for opinion section will be amended to a basis for qualified opinion.
The basis for qualified opinion section will explain the reason for the qualified opinion and quantify the effect of the issue on the financial statements.
The Key Audit Matters section will reference the ‘Basis for Qualified Opinion’.
Test your understanding 6
| (1) | D | Qualified or disclaimer. Six months of accounting | ||
| records have been lost meaning sufficient appropriate | ||||
| evidence will not be available. Whether the matter is | ||||
| deemed material or material and pervasive will depend | ||||
| on the auditor’s assessment of the reconstruction of | ||||
| figures for the first six months. | ||||
| (2) | B | A ‘basis for opinion’ paragraph confirms the audit has | ||
| been conducted in accordance with ISAs and ethical | ||||
| requirements. | ||||
| (3) | C | Addressee, opinion, auditor’s responsibilities, date. | ||
| (4) | C | A disclaimer of opinion is where the auditor does not | ||
| express an opinion. | ||||
| (5) | B | ISA 705 states that where a disclaimer of opinion is | ||
| issued, the Key Audit Matters section should not be | ||||
| included in the auditor’s report. | ||||
| Test your understanding 7 | ||||
| (1) | A | Whilst the misstatement represents less than 1% of total | ||
| assets, it represents 150% of PBT and would turn the | ||||
| profit to a loss which is pervasive. Therefore an adverse | ||||
| opinion would be appropriate. | ||||
| (2) | C | The misstatement represents 35% of PBT and 1.3% of | ||
| total assets. This is material but not pervasive. | ||||
| A qualified opinion is appropriate. | ||||
| (3) | D | The misstatement would represent 4.1% of PBT and | ||
| 0.15% of total assets. This is not material. An | ||||
| unmodified report and opinion would be appropriate. | ||||
| (4) | B | A section titled ‘Material Uncertainty Related to Going | ||
| Concern’ will be included in the auditor’s report. | ||||
| (5) | B | No further modifications are required. The Key Audit | ||
| Matters section should not describe matters already | ||||
| described in an Emphasis of Matter paragraph. The | ||||
| Basis for Opinion section would only describe matters | ||||
| giving rise to a modified opinion. As management have | ||||
| included the provision and disclosure of the legal case in | ||||
| the financial statements there is no reason to modify the | ||||
| audit opinion. | ||||
