Chapter 19 – Audit Reports on Financial Statements PDF

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Chapter 19 – Audit Reports on Financial StatementsThe Audit Opinion and The Auditors’ Reporting Responsibilities When auditors perform the financial statement audit, they have the responsibility to (1) form an opinion on the financial statements, and (2) issue the opinion in a written report that d...

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Chapter 19 – Audit Reports on Financial Statements The Audit Opinion and The Auditors’ Reporting Responsibilities 

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When auditors perform the financial statement audit, they have the responsibility to (1) form an opinion on the financial statements, and (2) issue the opinion in a written report that describes the basis of the conclusion CAS 700, Forming an opinion and reporting on financial statements, the reporting standards aim to address an appropriate balance between the need for consistency and comparability in auditor reporting globally and the need to provide the most relevant information to users

The Unmodified Audit Opinion 

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Unmodified audit opinion is the opinion (also referred to as an “unqualified” or “clean” opinion) a public accountant issues when all auditing conditions have been met, no significant misstatements have been discovered and left uncorrected, and the auditor believes that the financial statements are fairly stated in accordance with the applicable financial reporting framework When issuing an unmodified audit opinion, the auditor concludes that the financial statements are fairly stated in accordance with the applicable financial reporting framework and all material misstatements have been corrected In order for the auditor to issue an unmodified opinion, the following conditions must be met: o An audit engagement has been undertaken to express an opinion on financial statements o The auditor followed generally accepted auditing standards (GAAS) o The auditor is independent and complies with the relevant ethical standards o The auditor was able to obtain sufficient appropriate evidence to conclude that the financial statements as a whole are free from material misstatement o The financial statements, which include the balance sheet, the income statement, the statement of retained earnings, the cash flow statement, and the notes to the financial statements, are fairly presented in accordance with an appropriate applicable financial reporting framework

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Elements of the Auditor’s Reports Opinion Paragraph  

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Makes the simple statement that the public accounting firm has done an audit It lists the financial statements that were audited, including the statement of financial position (or balance sheet) date and the period for the (comprehensive) income statement, the statement of changes in equity (retained earnings), and the statement of cash flows, and other explanatory information, which would include the notes to the financial statements The opinion paragraph states the auditor’s conclusions based on the results of the audit The opinion paragraph is stated as an opinion, rather than as a statement of absolute fact or as a guarantee The ASPE financial reporting framework normally requires the auditor to report only on the current year’s financial statements, called the corresponding figures approach You will note that audit report refers to both periods under audit, called the comparative financial statements approach

Basis for Opinion 

Following the opinion paragraph is a brief overview of the basis for the conclusion—that the auditors believe they have obtained sufficient and appropriate evidence

Key Audit Matters   

Key audit matters (KAM) is those audit matters that, in the auditor’s professional judgment, are of most significance to the audit in the current period How key audit matters are described in the audit report is open to professional judgment, which means there will be considerable variation among audit reports CAS 701 indicates that descriptions will always include the following: (1) why the matter was considered of most significance to the audit, (2) how the matter was addressed in the audit (e.g., an overview of procedures), and (3) reference to key disclosure(s) in the financial statements, if any

Other Information   

Other information refers to information, whether financial or non-financial (other than the financial statements and the auditors’ report), included in the entity’s annual report In this section of the audit report, it is explained clearly that the auditor does not express any form of assurance conclusion on the other information However, the auditor has the responsibility to read the information and consider whether the other information is materially consistent with the financial statements or the auditor’s knowledge obtained in the audit

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Paragraphs on the Responsibilities of Management and Those in Charge of Governance 

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The paragraph also high-lights management’s responsibility for the internal controls: this includes designing and implementing controls; selecting and applying appropriate accounting policies; making reasonable accounting estimates; and preventing material misstatements due to fraud or error The second paragraph clearly explains management’s responsibility for assessing the entity’s ability to continue as a going concern The last paragraph explains that those charged with governance are responsible for overseeing the financial reporting process

Paragraphs on the Auditor’s Responsibility 

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The first paragraph affirms that the auditor followed generally accepted auditing standards and explains the purpose of the audit—to obtain reasonable assurance that the statements are free of material misstatement The next paragraph and related bullet points briefly describe what an audit does and does not include o The section starts by explaining that the auditor exercises professional judgment and maintains professional skepticism throughout the audit The next three paragraphs highlight the auditor’s reporting responsibilities to those charged with governance

Report on Other Legal and Regulatory Matters 

If the auditor addresses other reporting responsibilities in the auditor’s report in addition to those responsibilities under CASs, the audit report will include them in this section

Name of Engagement Partner and Auditor’s Signature 

In the case of listed entities, the name of the engagement partner is included in the audit report

Date of the Auditor’s Report  

The audit report can be dated only when the board of directors (or, in the case of smaller organizations, the primary shareholder) has approved the financial statements This date is important to users because it indicates the last day that the auditor is responsible for the review of significant events that occurred after the date of the financial statements

Double Dating the Auditor’s Report  

Double dating is done when a material event occurs after the date of the auditor’s report and before the date the report is issued If the effect of the event was so material as to change the 2018 financial statements significantly, the auditor would probably extend the audit for the financial statements as a whole and date the report with the revised date as approved by the board 3

Reporting Material Uncertainty for Going Concern 

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Going concern, if adequate disclosure is made in the financial statements about material events or uncertainties that would cause doubt about the entity’s ability to continue as a going concern The section should (1) draw the users’ attention to the note in the financial statements, and (2) state the events or conditions that indicate a material uncertainty

Identify and Disclose Key Audit Matters  

Significant matters are those that often involve difficult and complex auditor judgments Key audit matters include (1) areas of higher assessed risk of material misstatement and items that require significant judgment (such as estimates); (2) items for which the auditor encountered significant difficulty (such as in obtaining sufficient evidence); and (3) modifications to the planned approach due to control deficiencies

Key Audit Matters and Going Concern  

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If the auditor has doubt over the going concern, then the audit strategy will be adjusted accordingly Where the auditor has identified conditions that cast doubt over going concern, but audit evidence confirms that no material uncertainty exists, this is what is referred to as a “close call” that can be disclosed as a KAM as defined by CAS 701 Close calls are to be disclosed

Determine Whether Emphasis of Matter or Other Matter Paragraphs Are Necessary Emphasis of Matter(s) Paragraph 

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The emphasis of matter paragraph does not affect the audit opinion; however, there may be certain matters that, even if they are clearly disclosed in the financial statement, are such that the auditor considers it necessary to draw the user’s attention to them Examples of circumstances in which an emphasis of matter paragraph may be necessary include the following: o Significant uncertainty regarding the future outcome of exceptional litigation or regulatory action (such as income taxes that may be collectible or payable) o Early application of a new accounting standard that has a pervasive effect on the financial statements o A major catastrophe that has had or continues to have an impact on the entity o Threats of expropriation of assets o Significant transactions with related parties o Unusually important subsequent events

Other Matter(s) Paragraph

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CAS 706, A5–A9, highlights possible circumstances in which the auditor may consider other matter(s) paragraph(s) necessary: o Law, regulations, or a common practice requires or permits the auditor to elaborate on certain matters o The auditor has other reporting responsibilities that are in addition to the financial statements o The entity has prepared more than one set of financial statements; for example, one in accordance with a national framework and one in accordance with IFRS o The financial statements were prepared for a special purpose and the auditor considers it necessary to highlight that the distribution of the report is restricted to certain intended users

Key Audit Matters Versus Emphasis of Matter and Other Matter Paragraph 

There may be instances when a matter is not a KAM (because it did not require significant auditor attention), but is fundamental to users’ understanding of the financial statements, the audit, the auditor’s responsibilities, or the auditor’s report (such as a subsequent event)

Decide Whether Modifications to the Audit Opinion Are Necessary   

Whenever the auditor faces either a GAAP departure or a scope limitation, and it is material, a report other than an unmodified audit opinion must be issued By modifying the opinion, the auditor brings to the readers’ attention any concerns auditors have about the quality of the financial statement The four main types of modified auditor’s reports issued under these two conditions are (1) qualified opinion—GAAP departure; (2) qualified opinion—scope limitation; (3) adverse opinion; and (4) dis-claimer of opinion o A condition that is considered material but not pervasive has a limited and isolated effect on the financial statements o In contrast, a material and pervasive condition is such that its effect(s) cannot be isolated to specific accounts or items, meaning that it has an extensive effect on the financial statements and it impacts many assertions

Communication with Those Charged with Governance 

Whenever the auditor believes that additional paragraphs, such as going concern, emphasis of matter, or other matters, are necessary, and regardless of whether the opinion remains unqualified, the auditor is required to communicate this fact to those charged with governance as soon as possible

Qualified Audit Opinions

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Whenever an auditor issues a qualified opinion, he or she must use the term except for or, less frequently, except that or except as in the opinion paragraph o This implies that the auditor is satisfied that the overall financial statements are fairly stated “except for” a particular part

Qualified Audit Opinion: Financial Statements Are Materially Misstated but Not Pervasive    

An inappropriate accounting treatment (for example, expensing capital assets); An inappropriate or unreasonable estimate (for example, failure to provide an adequate allowance for doubtful accounts); and A failure to disclose essential information in an informative manner (for example, failure to adequately disclose a going concern problem or a material contingency) When the auditor knows that the financial statements may be misleading because of material misstatements due to inappropriate accounting treatment or valuation of an item, the auditor should issue a qualified or adverse opinion, depending upon the pervasiveness of its effects o The opinion must clearly state the nature and the amount of the misstatement, if it is known

Qualified Audit Opinion: Scope Limitation That Is Material but Not Pervasive 

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A scope restriction refers to the auditor’s inability to obtain sufficient appropriate evidence o These restrictions may occur due to conditions beyond the client’s control, or circumstances related to the timing and nature of the auditor’s work, or may be imposed by client management o For instance, the records may be lost, destroyed, or seized indefinitely by government authorities The reasons for client-imposed scope restrictions may be to save audit fees or, as in the case of receivable confirmations, to prevent possible conflicts between the client and customer when amounts differ or hide fraud If the auditor cannot resign or this is considered impractical, only then would the auditor issue a disclaimer of opinion in the audit report

Reliance on Another Auditor or a Specialist   

When other auditors perform part of the audit, the group (parent company) auditor is required to make reference to the other (component) auditors However, the group auditor takes responsibility for the audit opinion, and only the name of the group auditor appears on the auditor’s report If the group auditor is unable to remedy the quality of the component’s auditors’ work, and the group auditor decides that he or she is unable to rely upon the work of the component auditors, a qualified opinion or disclaimer of opinion is the most appropriate course of action

Adverse Audit Opinion 6

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Adverse audit opinions are rare and should cause concern for users of the financial statements An adverse opinion is used only when the auditor concludes that the financial statements contain material and pervasive misstatement(s); this also includes lack of important disclosures that are pervasive o This means that the auditor has concluded that the financial statements, taken as a whole, are materially misstated or misleading

Disclaimer of Opinion  

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A disclaimer of opinion is issued whenever the auditor has been unable to satisfy him-or herself that the overall financial statements are fairly presented The necessity for denying (“disclaiming”) happens because of a severe limitation on the scope of the audit examination, which would prevent the auditor from expressing an opinion on the financial statements as a whole Rare occurrence

How the Audit Report Adds Value 

Qualified opinions, adverse opinions, and disclaimer of opinions can lead to lower credit ratings, lower share price, and/or higher interest rates charged by lenders

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