OVERVIEW
Objective
¾
To explain the elements of an independent auditor’s report and the expression of an opinion on financial statements.BASIC PRINCIPLES
UNQUALIFIED OPINION
OTHER THAN AN UNQUALIFIED
OPINION *
¾ Basic principles ¾ Standard forms
¾ Circumstances
¾ Summary
¾ Illustrations ¾ Basic principles
¾ Illustration
¾ Other reporting responsibilities ¾ Reporting under ISA
¾ Basic elements ¾ Report vs opinion
EMPHASIS OF MATTER *
¾ Purpose
¾ Form
¾ Circumstances
DISAGREEMENT LIMITATION ON SCOPE
¾ Circumstances
¾ Summary
¾ Illustrations
* Collectively called “modified reports” +/–
REPORTING ON COMPLIANCE
WITH IFRS
1
BASIC PRINCIPLES
The conclusions drawn from evidence obtained (which provide the basis for the expression of an opinion) should be reviewed and assessed.
An opinion on the financial statements as a whole should be clearly expressed in writing.
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Considerations: the financial reporting framework (e.g. IFRSs); and statutory requirements.
1.1
Basic elements
The basic elements are all required within ISA 700 “The Independent Auditor’s Report on a Complete Set of General Purpose Financial Statements”.
Commentary
Uniformity of form and content is desirable because it helps to promote a reader’s understanding and to identify unusual circumstances.
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Title, e.g. independent auditor’s report¾
Addressee, e.g. to the shareholders of …..¾
Opening or introductory paragraph identify the entity
state that the financial statements have been audited identify each statement audited
refer to the summary of significant accounting policies refer to relevant explanatory notes
date and period covered
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Statement of management’s responsibility for: designing, implementing and maintaining internal control relevant to the
preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error;
selecting and applying appropriate accounting policies;
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Statement of auditor’s responsibility: to express an opinion on the financial statements based on their audit; that the audit was conducted in accordance with ISAs or relevant national
standards or practices;
explains that ISA requires the auditor to comply with ethical requirements; and
that the audit was planned and performed to obtain reasonable assurance about whether the financial statements are free of material misstatement.
¾
A ‘scope’ paragraph that describes the audit in that: the audit involves the performance of procedures to obtain audit evidence about the amounts and disclosures in the financial statements;
the procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error;
in making risk assessments the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements 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 entity’s internal control);
the auditor:
−
evaluates the appropriateness of the accounting policies used;−
assesses the reasonableness of accounting estimates made by management; and−
assesses the overall presentation of the financial statements.¾
Opinion paragraph identify financial reporting framework used (e.g. IFRS)
“true and fair view” (or “present fairly, in all material respects”) in accordance with International Financial Reporting Standards (or in accordance with the financial reporting framework of …1); and
compliance with requirements of statutes or law.
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Date of the auditor’s report must not be earlier than the completion of the audit, nor before date financial statements are signed or approved by management.¾
Auditor’s address¾
Auditor’s signature and the firm and/or personal name of auditor.1.2
Report
vs
opinion
Auditor’s reports should contain a clear expression of opinion . . .
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That opinion may be: unqualified; or qualified (including disclaimer of opinion and adverse opinion).
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The report may be further modified by an emphasis of matterCommentary
An emphasis of matter is a modification to the auditor’s report NOT the opinion (whether qualified or unqualified)
2
UNQUALIFIED OPINION
2.1
Basic principle
When the financial statements give a true an fair view (or equivalent) in accordance with an identified financial reporting framework an unqualified opinion should be expressed.
2.2
Illustration
Reference can be by page numbers (“on pages XX to XX”) Detailed responsibilities including reference to internal controls, accounting policies, estimates and fraud Reasonable, but not absolute, assurance Unqualified opinion implies that, for example, changes in accounting principles etc have been properly determined and disclosed Must include
INDEPENDENT AUDITOR’S REPORT TO ………
We have audited the accompanying financial statements of ABC Company, which comprise the statement of financial position as at December 31, 20X1, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and a summary of significant accounting policies and other explanatory notes.
Management’s Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance with International Financial Reporting Standards. This responsibility includes: designing, implementing and
maintaining internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances.
Auditor’s Responsibility
Our responsibility is to express an opinion on these financial
statements based on our audit. We conducted our audit in accordance with International Standards on Auditing. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements 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 entity’s internal control. An audit also includes evaluating the appropriateness of
accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the financial statements give a true and fair view of
the financial position of ABC Company as of December 31, 20X1, and of its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards … (and comply with …).
2.3
Other reporting responsibilities
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When the auditor is required (e.g. by local statute) to address other reportingresponsibilities within the auditor’s report, these must be addressed through a separate section in the auditor’s report that follows the opinion paragraph.
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The auditor may, under local statute, have additional responsibilities to report on certain matters that are supplementary to their responsibility to express an opinion on the financial statements. For example, to report certain matters if they come to their attention during the course of the audit (e.g. breach of liquidity ratio ranges) or to explicitly express an opinion on specific matters (e.g. the adequacy of accounting books and records).¾
Relevant standards or laws may require the auditor to report on these otherresponsibilities within the auditor’s report on the financial statements. In other cases, the auditor may be required to report on them in a separate report.
¾
Where the auditor is required to make such a report within their auditor’s report on the financial statements, a separate section of the audit report is used to clearly distinguish such reports from the their responsibilities for, and opinion on, the financial statements.Illustration 1
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion
Opinion
In our opinion, the financial statements give a true and fair view of the financial position of ABC Company as of December 31, 20X1, and of its
financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards … (and comply with …). Report on Other Legal and Regulatory Matters
[Form and content of this section of the auditor’s report will vary depending on the
nature of the auditor’s other reporting responsibilities as detailed in local auditing
3
MODIFIED REPORTS
¾
Dealt with by ISA 701 Modifications to the Independent Auditor’s Report:Matters that DO NOT affect
the auditor’s opinion Matters that DO affect the auditor’s opinion
⇒ “emphasis of a matter” ⇒ qualified opinion, disclaimer of opinion or adverse opinion
4
EMPHASIS OF A MATTER
4.1
Purpose
To highlight a material matter affecting the financial statements which is included in a note to the financial statements that more extensively discusses the matter.
¾
Does NOT affect the auditor’s opinion. The opinion can be unqualified, or qualified for some reason unrelated to the matter emphasised.4.2
Form
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Separate paragraph, after the opinion paragraph¾
Ordinarily refers to fact that auditor’s opinion is not qualified in this respect.4.3
Circumstances when used
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Material matter regarding a going concern problem. See Session 31.¾
Significant uncertainty (other than a going concern problem), the resolution of which is dependent upon future events (not under direct control of entity) and which may affect the financial statements.¾
Material matters that have no impact on the financial statements, but to which the auditor needs to draw attention (e.g. an amendment to other information issued with the financial statements is necessary to remove a material inconsistency, but the directors refuse to make that amendments).Illustration 2
“In our opinion ... (remaining words are the same as illustrated in the unqualified opinion paragraph above).
Without qualifying our opinion we draw attention to Note X to the financial statements. The Company is the defendant in a lawsuit alleging infringement of certain patent rights and claiming royalties and punitive damages. The Company has filed a counter action, and preliminary hearings and discovery proceedings on both actions are in progress. The ultimate outcome of the matter cannot presently be determined, and no provision for any liability that may result has been made in the financial statements.”
¾
Reference to a note is critical. If the auditor has to “make good” a lack of disclosure in the audit report the auditor must disagree with inadequate disclosure which is grounds for qualification.5
OTHER THAN UNQUALIFIED OPINIONS
Commentary
Often referred to collectively as “qualified” opinions the term “qualified opinion” is also used in a narrower sense to mean “except for”.
5.1
Basic principles
When an opinion is “other than unqualified” the report should include:
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a clear description or the reasons; and¾
quantification of possible effects, when practicable. For a limitation on scope:¾
the limitation should be described;¾
possible adjustments should be indicated.A qualified or adverse opinion should be expressed for material disagreement with management.
5.2
Standard forms
Qualified (expressed as “except for”) – a disagreement or limitation on scope is not so material and pervasive as to require an adverse opinion or a disclaimer of opinion. Disclaimer – the possible effect of a limitation on scope is so material and pervasive that sufficient evidence has not been obtained as a basis for expressing an opinion.
Adverse – the effect of a disagreement is so material and pervasive that a qualification is not adequate to disclose the extent to which the financial statements are misleading or
incomplete.
5.3
Circumstances
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There are only two grounds for an opinion that is other than unqualified: disagreement; and limitation on scope (i.e. lack of evidence reasonably expected to be available).
¾
The grounds should always be apparent because they are mutually exclusive – theremust be sufficient evidence in situations for disagreement.
there is a LIMITATION ON THE SCOPE of the
auditor's work there is DISAGREEMENT
with management regarding accounting policies selected or financial statement disclosures
Inadequate disclosure (eg failure to comply with relevant ISA or
legislation) EXP R ESSIO N S O F O PIN IO N
Imposed by entity (auditor would not normally accept
engagement)
"So material AND pervasive" that unable to express
opinion DISCLAIMER "So material AND pervasive"
that qualification is not adequate (financail statememts
misleading/incomplete) ADVERSE
Not "so material and pervasive" QUALIFIED OPINION
"EXCEPT FOR"
Imposed by circumstances (eg appointed after physical
inventory count or inadequate accounting records) G R OUND S FO R Q U AL IF IC AT IO N
Describe in a separate paragraph preceding the opinion paragraph (may refer to discussion in note to financial statements) - see 5.5 illustrations Inappropriate
accounting method
Not so material and pervasive QUALIFIED OPINION
5.4
Summary
Decision 2
Material So material AND pervasive that . . .
D e c i s
Disagreement Qualified ie “Except for”
... financial statements are seriously misleading incomplete
Adverse i
o n 1
Limitation
on scope Qualified ie “Except for”
. . . unable to express an opinion Disclaimer
5.5
Illustrations
5.5.1
Limitation on Scope
−
Qualified Opinion
“We have audited ....
Management is responsible for …..
Our responsibility is to express an opinion on these financial statements based on our audit.
Except * as discussed in the following paragraph, we conducted our audit in accordance
with ....
We did not observe the counting of the physical inventories as of the end of the reporting period, 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 ....”
5.5.2
Limitation on Scope
−
Disclaimer of Opinion
“We were engaged to audit the accompanying statement of financial position of the ABC Company as of December 31 20X1, and the related statements of income, and cash flows for the year then ended.
Management is responsible for …..
(Omit the sentence stating the responsibility of the auditor*.)
(Omit or amend paragraph discussing scope of audit 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 paragraph, we do not express an opinion on the financial statements.”
* it would be a nonsense to state “our responsibility is to an express opinion”
5.5.3
Disagreement on Accounting Policies
−
Inappropriate Accounting Method
−
Qualified Opinion
“We have audited ...
Management is responsible for ….. Our responsibility is to …..
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 Standard 16 “Property, Plant and Equipment”. The allowance for the reporting period 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 tangible non-current 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.
5.5.4
Disagreement on Accounting Policies
−
Inadequate Disclosure
−
Qualified Opinion
“We have audited ....
Management is responsible for ….
Our responsibility is to …..
On January 15 20X2, the Company issued debentures in the amount of xxx for the purpose of financing a factory expansion. The debenture agreement restricts the payment of future cash dividends to earnings after December 31 20X7. In our opinion, disclosure of this information is required by ...[reference to IASs or statute].
In our opinion, except for the omission of the information included in the preceding paragraph, the financial statements give a true and ....”
5.5.5
Disagreement on Accounting Policies
−
Inadequate Disclosure
−
Adverse Opinion
“We have audited ....
Management is responsible for ….
Our responsibility is to …..
(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 31 20X1, of its financial
performance and its cash flows for the reporting period then ended in accordance with ...[standards] and do not comply with ...[statute]."
6
REPORTING ON COMPLIANCE WITH IFRS
6.1
Matters addressed
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In June 2003 IFAC’s IAASB issued IAPS 1014 Reporting on Compliance with InternationalFinancial Reporting Standards to provide additional guidance when the auditor expresses
an opinion on financial statements prepared in accordance with: International Financial Reporting Standards (IFRSs) solely;
6.2
Financial statements prepared solely in accordance with IFRSs
6.2.1
IAS 1
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Financial statements should not be described as complying with IFRSs unless they comply with all the requirements of each applicable standard and each applicable interpretation of IFRIC (IAS 1 Presentation of Financial Statements).6.2.2
Indicators of non-compliance
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Indications that financial statements that have not been prepared in accordance with IFRSs include the following: A note to the financial statements indicates that they have been prepared in accordance with IFRSs but then go on to specify certain departures (eg non-disclosure of sales for geographical segments).
A note identifies specific IFRS requirements used to prepare the financial statements, but these do not include all the requirements necessary for full compliance.
A note discloses partial compliance with IFRSs without reference to specific departures. For example, the financial statements are:
−
“based on IFRSs”; or−
“comply with the significant requirements of IFRSs”.6.2.3
Unqualified opinion
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This may be expressed only when the auditor is able to conclude that the financial statements give a true and fair view (or are presented fairly, in all material respects) in accordance with the identified financial reporting framework.¾
An unqualified opinion cannot indicate compliance with IFRSs if the financial statements contain any material departure.¾
Such a departure results in disagreement with management regarding: the accounting policies selected; or the adequacy of financial statement disclosures.
A qualified opinion or an adverse opinion is then necessary.
6.3
Financial statements prepared in accordance with IFRSs and a
National Financial Reporting Framework (NFRF)
6.3.1
Issue
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A note may indicate that the financial statements comply both with: IFRSs; and a NFRF.
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Such financial statements must comply, simultaneously, with each of the indicated frameworks individually – without need for reconciliation.¾
Financial statements prepared in accordance with one framework (eg IFRS) that contain a note or supplementary statement reconciling the results to those that would be shown under another framework (eg US gaap) are not prepared in accordance with that other framework.¾
Because the financial statements themselves do not showall the information required in the manner required by that framework.¾
Simultaneous compliance with IFRSs and a NFRF is unlikely (unless the country has adopted IFRSs as its NFRF).¾
In practice, the ability to comply fully with more than one financial reporting framework is rare.6.3.2
Action by auditor
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To help decide which of the frameworks is predominant, discuss financial statements that purport to have been prepared in accordance with more than one financial reporting framework with: management; and
those charged with governance.
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Management should then be encouraged to prepare the financial statements in accordance with the predominant financial reporting framework only.¾
The auditor’s report can then worded in terms of preparation in accordance with that financial reporting framework.¾
If management insists on indicating compliance with more than one framework, each framework requires separate audit consideration.6.3.3
Audit opinion
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If the financial statements are in accordance with only one of the frameworks then: an unqualified opinion on compliance with that framework is expressed; and a qualified opinion or an adverse opinion on compliance with the otherExample 1
Draft a suitably modified audit opinion for the following situation:
Investment properties are measured under the cost model in accordance with the relevant national financial reporting framework. There is no disclosure of fair values.
Solution
6.4
Financial statements prepared in accordance with a NFRF with
disclosure of extent of compliance with IFRSs
6.4.1
Issue
¾
Financial statements prepared in accordance with an acceptable financial reporting framework other than IFRSs (eg UK or US gaap) may disclose, in the notes to those statements the extent to which they comply with IFRSs.6.4.2
Audit considerations
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Whether assertions made in the notes with respect to the extent of such compliance are factually correct and not misleading.¾
The effect of that disclosure on the auditor’s report.Illustration 3
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The effect of applying a certain IFRS would be material and pervasive. An assertion of proper preparation in accordance with IFRS except for the application of that particular standard may be misleading without fully disclosing the effect of not applying that standard.Recommendation
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It may be more appropriate for the notes: not to comment about the extent of compliance with IFRS; or to state that the financial statements have not been prepared in
Illustration 4
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A note indicates only partial compliance with IFRSs (eg “based on”) without reference to specific departuresAnalysis
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This misleads readers because it implies compliance while failing toprovide sufficient information for readers to determine the extent to which the financial statements do not comply with IFRSs.
6.4.3
Audit opinion
¾
If disclosures are misleading, the auditor’s report expresses a qualified or an adverse opinion.Illustration 5
Note 1 to the financial statements indicates that the financial statements have been prepared in accordance with [relevant NFRF] and are substantially in accordance with International Financial Reporting Standards (IFRSs) except that they do not comply with IAS 12 “Income Taxes”. Given the significant effect in this case on the company’s financial statements of non-compliance with IAS 12 and given that the company has not disclosed the effect of this departure from IFRSs, the reference to compliance with IFRSs is considered misleading.
In our opinion, except for the inclusion of the reference to compliance with IFRSs, the financial statements present fairly in all material respects the
financial position of the Company as of December 31, 20X1, and of its financial performance and its cash flows for the reporting period then ended in
accordance with [financial reporting framework2] and comply with [relevant
statutes or law].
FOCUS
You should now be able to:
¾
describe and analyse the format and content of unmodified audit reports;¾
describe and analyse the format and content of modified audit reports.EXAMPLE SOLUTION
Solution 1 — Financial statements prepared in accordance with IFRSs and a
NFRF
For the purpose of this exercise it should clearly be assumed that the matter is material.
Commonsense should dictate that it could not be pervasive. It should also be assumed that there are no other relevant matters on which to report – since to assume otherwise would be speculative and a fabrication.
“Note 1 to the financial statements indicates that the financial statements have been prepared in accordance with [relevant NFRF] and IFRSs3. As discussed in Note # to the
financial statements, the Company has investment properties carried at cost less
accumulated depreciation amounting to $x. This accounting is required by [relevant NFRF] and permitted by IFRSs. The fair value of these investment properties of $X has not been disclosed. Such disclosure is not required by [relevant NFRF], but is required by IFRS 40 “Investment properties”.
