Chapter Six

Audit Reports and Opinions

6.0. Introduction
The ultimate goal of auditing is to express opinion on the fair presentation of financial
statements. Audit opinion is expressed in an audit report - the final phase of a financial
statement audit. The auditor must comply with relevant Auditing Standards when reporting on
audited financial statements. Depending on the circumstances, the auditor may issue an
unqualified audit report; a qualified audit report that expresses one of three other types of
opinion; or an unqualified opinion with an emphasis of matter. When expressing a qualified
opinion, the report must contain a clear statement as to the reasons for the qualification and the
effect thereof. The auditor must exercise due care in conducting the audit so as to obtain a
reasonable basis for an opinion and to express the opinion justified by the findings.

This chapter deals with the nature of audit reports, purpose and forms of audit reports, and the
types of opinions in an audit report.

Dear learner! Before you directly go to study the chapter, let me give you definition of some key
words which are helpful to understand it. The following table provides the definitions.

Definition of Key Words

Adverse – unfavorable, harmful, in opposition

Disclose – Make known, uncover

Going Concern – (of an enterprise) expected to continue to operate at a profit in the foreseeable
future

Qualify – (for an opinion) – Limit, make less general

Opinion – A belief based on incomplete knowledge

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6.1. Nature and forms of Audit Reports

Auditing is an attest function. Auditors provide their own objective opinion on the fair
presentation of financial statements. Audit opinion is provided in an audit report – a report that
communicates the results of the audit work to interested parties.

6.1.1. Nature of Audit Reports

Financial statements are not the responsibilities of auditors; they are the responsibilities of the
client's management. Management is primarily responsible for the fairness and completeness
of all disclosures contained in the financial statements. The auditor may suggest changes on
financial statements which, he thinks, are required by IFRS. But the client is not bound to make
those changes. However, the auditor may note this issue, in her/his report, if the client refuses to
make such changes.

Another important point is that audit reports use cautious languages such as "reasonable",
"we believe", "our opinion" etc. Why?

This indicates that the auditor didn’t examine each and every aspect of the statements. In
essence she/he is never 100% sure that the financial statements are "correct". The reason for this
is that it costs too much to examine each and every aspect of the statements. It is up to the
auditor to decide when he has done enough work to be sure enough about the financial
statements – which is the art of auditing.

6.1.2. Forms of Audit Reports

An auditor’s opinion regarding financial statements of a client is expressed in the form of a

report known as an audit report. Therefore, the purpose of an audit report is to communicate
an auditor's own and objective opinion to the different users of the financial statements.
Through this report, the auditor lends credibility as to the fair presentation of financial statements
of a client.
Typically the client is sent a draft report before approval. This draft should be clearly marked as
such. If an auditor’s report containing an unqualified opinion is to be issued, the draft financial
statement is usually accompanied by a clearly marked draft opinion or no report.
An audit reports can be prepared in two forms. These are long form and short form audit
reports.
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 i. Long-Form Audit Report
In many countries it is customary for the auditor to prepare a ‘long-form’ report to the entity’s
board of directors in addition to the publicly published ‘short-form’ report. This form of report
shows information including overview of the audit engagement, analysis of financial statements,
risk management and internal control, reportable conditions, fees and optional topics. Let you
study them.
 Overview of the audit engagement: The first content of this form of report is an over view
of the engagement. In the overview, the report discusses the nature, scope, organization, level
of materiality, new audit work, and work with other auditors and experts.
 Analysis of Financial Statements: the second issue included is analysis of financial
statements. Accounting issues requiring subjective judgment, changes in accounting policies,
accounting developments that may affect the client, acquisitions and disinvestments and their
affect on the accounts, financial position, and quality of profits etc are included.
 Risk Management and Internal Control: An auditor should, as soon as practicable, either
communicate with the audit committee, the board of directors and senior management, or
obtain evidence that they are appropriately informed, regarding non-compliance (with
applicable laws and regulations) that comes to the auditor’s attention.
 Fees: Of course, every client is interested in how much fees they are paying and what
services they receive. Typically discussed in the long-form report are an overview of the
budget and actual audit costs, costs for related engagements, and service delivery issues.
Service delivery issues would include staffing, important changes, quality survey and follow-
up.
 Reportable Conditions: major internal control problems (reportable conditions) should be
reported to management, and where necessary, the board of directors. In deciding whether a
matter is a reportable condition, the auditor considers factors such as the size of the company
and its ownership characteristics, the organizational structure, and the complexity and
diversity of company activities.
 Optional Topics: There may be topics not typically addressed that the auditor may feel
warrants discussion because of the circumstances of the company, the economy or the audit.
These topics may include tax pension, treasury function, and audit related requirements.

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 ii. Short form Audit Report: this form of report is commonly issued to non –
administrative stockholders, creditors, analysts etc. The short form of audit report will be
discussed latter in this chapter.

6.2. Types of Audit Opinions

Based on the findings of an audit, auditors may issue a report containing, basically, four types of
opinions. These types of opinions are: Unqualified Opinion; Qualified Opinion; Adverse
Opinion, and Disclaimer Opinion.

6.2.1. Unqualified Opinion

What impression do you get from the phrase "unqualified opinion" (positive or negative) on the
fairness of financial statements?

As you can understand from the definitions of words given earlier, unqualified opinion conveys
a positive sense as to the financial statements. Unqualified opinion, also called the standard
unqualified opinion is provided when all of the following conditions are fulfilled.

 All necessary statements are included,

 The three general standards of GAAS and three field work standards have been followed
 The statements are found to be prepared according to IFRS, and include all the necessary
disclosures (including foot notes)
 There are no reasons to qualify the report
You should remember that an unqualified opinion may also be provided in an audit report with
explanations added on. Such type of opinion is known as unqualified opinion with explanations.
On what circumstances is this type of opinion provided? To answer this question, please study
the following.
Unqualified opinion with explanations: a report containing this opinion is issued by an auditor
if the auditor feels the financial statements are fairly presented, but she/he thinks there is some
matter which requires further explanation (or comment).

Another question can be asked at this point. "What are the reasons for explanation?"

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There are five causes of explanation on unqualified opinion. These are lack of consistent
application of IFRS, substantial doubt about going concern, the auditor agrees with promulgated
departure from IFRS, emphasis of a matter, repots involving other auditors. Let you study each
cause.

i. Lack of consistent application of IFRS: Accounting principles should be followed

consistently. However, a client might be found inconsistently following IFRS. The client
may include this change in a foot note. In such cases if the auditor agrees with the
change, she/he should explain it in her/his report. But if she/he doesn’t agree to the
change, she/he has to qualify her/his opinion.
ii. Substantial doubt about going concern: the going concern principle states that a
business entity is expected to continue operating at a profit for an indefinite period of
time. However, the auditor may doubt a clients going concern. In this case, she/he should
state it in her/his report. In what conditions does an auditor doubt going concern
(substantially)? Here are some examples to doubt going concern of a client's business:
 If the auditor feels the company doesn’t have enough cash to meet its obligations
 If the client's single warehouse is burned by fire etc

Here should note that the auditor should state doubt about going concern even though the
financial statement are fairly presented.

iii. The auditor agrees with promulgated departure from IFRS: under this reason, the
client is found to depart from IFRS but the auditor agrees with the departure. The auditor
should, therefore, state adhering to the principle would have been misleading and why.
iv. Emphasis of a matter: this includes anything that the auditor felt the users of the
statements need to know that doesn’t fit the other three situations. It requires, more than
others, the auditor's professional judgment. Let me give you an example.
 Related party transactions: the fact that the company audited is a subsidiary of a larger
entity
 Events that occurred subsequent to the balance sheet date

In both cases emphasis is required.

v. Reports involving other auditors: sometimes an audit work may be performed by two
auditors. For example if a client had a branch in distant areas, where the cost of travel is
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 very high, an auditor in the nearby area may perform the audit work of the branch. In
such cases, the two audit firms first determine which of them a primary auditor is. Once
determined, the primary auditor will decide if the other auditor's work is material. If it is
found to be immaterial, the primary auditor makes no mentions of the other auditor's
work in the report.

However, if the other auditor's work is found to be material, the primary auditor needs to decide
whether to take responsibility for the other auditor's work. This decision requires considerations
on the competence and reputation of the other auditor, personal visits and/or reviewing the other
auditor's audit programs and working papers. Therefore, dear learner! The primary auditor has
two options – to take the responsibility for the work of the other or not to take.

If the primary auditor takes the responsibility for the work of the other, an unqualified
opinion with explanation is provided. Hence, the other auditor's work (but not name) is
mentioned in each of the three paragraphs of the standard unqualified report.

If the primary auditor, however, doesn’t want to take any responsibility for the work of the other
auditor, she/he would qualify her/his report.

6.2.2. Qualified Opinion

The second type of opinion is qualified opinion. Issuing a qualified opinion is serious (harm full
to the client). For example if the client applied to get a loan from a bank, the bank may deny to
provide the loan to the client whose financial statements contain audit report with qualified
opinion.

Here you may ask an important question. "On what circumstances does an auditor issue a report
with qualified opinion?

Basically, there are two reasons that lead to give a qualified opinion. These are scope restriction,
and a departure from IFRS. Let me explain each one.

i. Scope Restriction: is first reason that leads to qualification of opinion. An audit is said to
have scope restriction if the auditor couldn’t accumulate sufficient evidence to form an
opinion. Scope restriction can be caused by two things. The first one if the client’s
management refuses to give the required information, known as client imposed
restriction. And the second one is scope restriction caused by circumstances.
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Which of the two restrictions do you think is more serious?

Good! A client imposed restriction is more serious than those caused by circumstances. Because
the auditor, generally, concludes that the client is trying to conceal fraud. An example of client
imposed restriction can be:

 Not allowing to examine marketable securities

 Not allowing to confirm certain receivables

Such restriction on scope of the audit calls for a qualified opinion.

Scope restriction imposed by circumstances also calls for qualification of opinions. Of course it
is less serious than client imposed restriction. Such restrictions are not necessarily caused by the
client. An example of this type of restriction can be:

 If an NGO (client) has a branch such as a clinic in a remote area where regular
commercial transportation doesn’t exist, the auditor may fail to examine the operations
of the clinic
 An audit that was engaged after the end of the fiscal period

In those circumstances the auditor should use alternative methods of examining accounts,
operations, etc in question. But if she/he is still unsatisfied, her/his opinion is qualified.

Note: scope restriction leads to qualification only if is not sever. A very sever scope restriction
results in a disclaimer opinion – to be discussed latter on.

ii. Departure from IFRS: it is the second reason that requires issuing a report containing a
qualified opinion. That means if the financial statements are not prepared in accordance
with IFRS. And the departure is material. For example,

 using the cash basis of accounting,

 not calculating depreciation
 Failing to disclose accounting methods used in a footnote etc.

Note: not all departures from IFRS require qualification of opinions. Qualification is necessary
only for material departures. However if the departure from IFRS is really bad, an adverse
opinion is issued. Adverse opinions will be discussed shortly.

6.2.3. Adverse Opinion

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The third type of opinion that an auditor may provide is an adverse opinion. Earlier I said a
qualified opinion is serious to the client. And an adverse opinion is even more serious than a
qualified one. An adverse opinion almost certainly would cause a bank to deny any loan
requested by the client.

On what circumstances is an adverse opinion provided?

Well! An adverse opinion is issued when the effect of a departure from IFRS is so material and
pervasive to the financial statements that the auditor concludes that a qualification of the report is
not adequate to disclose the misleading or incomplete nature of the financial statements. So, how
do we choose between a qualified and adverse opinion?

Good! Of course, deciding to issue an opinion other than the standard unqualified opinion as well
as choosing between the two is difficult. It requires determining the materiality of the matter.
However, the following should be considered in determining materiality:

i. The magnitude (dollar or Birr amount) of the item: a standard rule of thumb is
anything over 10% of net income (for income statement items) and over 10% of total
assets for balance sheet items is considered to be material
ii. The nature of the item: the following items generally, have a lower materiality
threshold (i.e. a lower misstatement is considered material):
 illegal or fraudulent transactions compared to honest mistakes
 a transaction that makes a difference between a small net income and small net loss
iii. The significance of the item to the client: some items are more important than other
items depending on situations. For example if a client wants to use receivables as
collateral, the materiality level for receivable can be 10% of total receivables. In this
case receivables are more important to the client so that lower materiality threshold is
set.
iv. The effect on financial statements as a whole: an item that has a significant effect
on the financial statements as a whole will have lower materiality threshold. In this
case, the auditor should read the statements as if she/he were a user. Items that have
significant influence of her/his decisions are considered to have higher effect on the
statements as a whole.

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Note: Generally, determining materiality for scope restriction qualification is more difficult than
qualification for departure from IFRS.

6.2.4. Disclaimer Opinion

Dear learner! The final type of opinion is a disclaimer opinion. An auditor’s report containing a
disclaimer opinion should be expressed when the auditor doesn’t know enough to give an
opinion. This opinion is less serious than adverse opinion but more serious than qualified
opinion.

What are the conditions that lead to issue a disclaimer opinion? Well! There are two conditions
that lead to disclaimer opinion. Those are scope restriction and auditor is not independent. Let
me explain each of them.

i. Scope restriction: the possible effect of a limitation on scope is so material and

pervasive that the auditor has not been able to obtain sufficient appropriate audit
evidence and therefore is unable to express an opinion on the financial statements.
ii. The auditor is not independent: if the auditor is not independent a report with a
disclaimer opinion is always issued.
6.3. Audit Opinions in audit Reports
Earlier you have seen that the standard unqualified opinion is the most favorable type of opinion
from the clients view point. This type of opinion is provided most of the time (about 90% of the
time).
An audit report with the standard unqualified opinion has the following eight parts (components).
1. Title: including the word independent
2. Addressee: an audit report is usually addressed to the company (client), its shareholders, or
its board of directors.
3. Opening or introductory paragraph: this paragraph states three basic things
a) states the auditor does an audit work (to distinguish it from a review of other type of
work)
b) it identifies the financial statements audited,
c) it distinguishes the responsibility of the entity’s management and the responsibility of
the auditor
4. Scope paragraph: it describes the nature of an audit, including
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 a) a reference to the GAAS or relevant national standards (practices) followed by the
auditor
b) a description of the work the auditor performed
5. Opinion paragraph: containing an expression of opinion on the financial statements. It is
the most important part of the report – opinion. This paragraph is worded in such a way to
indicate the auditor doesn’t have complete knowledge of the financial statements. This is
because, by definition, the auditor can't examine each and every aspect of the transactions
and/or statements.
6. Date of the report: The audit report is dated as the last date of field work rather than the
date of financial statements. The reason for this is that the auditor is responsible to look at
material events that occurred after the balance sheet date up to the last date of the field
work. For example if the client's warehouse is burnet after financial statements are issued
but before the field work is completed, this fact should be included in the audit report.
7. Auditor's Name and Address: The name of the audit (CPA) firm and its address should be
included in the audit report.
8. Auditor’s signature: Finally the auditor should put her/his signature of the audit report.

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 Auditor's report on financial statements of XYZ Corporation title

To the Board of directors of XYZ Corporation Address

Kebele 06, Asella, Ethiopia
We have audited the accompanying balance sheet of XYZ corporation as of
December 31, 2022 and the related profit and loss accounts and the statement of Introductory
cash flow as of the same date. The statements are the responsibilities of the paragraph
management of the corporation. Our responsibility express to our opinion of the
financial statements based on our audit.

We conducted our audit in accordance with international standards on auditing.

The standards require that we plan and perform our audit to obtain reasonable Scope
assurance that the financial statements are free from material misstatements. paragraph
Audit requires examination on test basis evidence supporting the amounts and
disclosures in the financial statements. It also includes assessing the
accounting principles (GAAP) used and significant estimates made by management
as well as evaluating the overall financial statement presentation. We believe
that our audit provide a reasonable basis for our opinion.

In our opinion, the financial statements present fairly the financial position of XYZ Opinion
Corporation as of December 31, 2011 and the results of operation as well as cash paragraph
Flows for the year then ended, in accordance with the international accounting
standards.
January 15, 2023 Date of the report

ABC auditors
04 kebelle, Asella, Ethiopia Auditors Name and Address
Signature _________________ Auditors Signature

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As stated earlier, this report contains standard unqualified opinion. Hear you may ask important
questions "are the ways unqualified opinion with explanation, qualified opinion, adverse opinion,
and disclaimer opinion differ in the way they are reported?" How are those opinion reported?

Well! The answer for the first question is yeas. Departures from the standard unqualified reports
are presented differently. And to answer the second one, please study the following:

i. Unqualified opinions with explanation: those opinions are reported in an audit report
by adding a fourth paragraph after the opinion paragraph. This fourth paragraph is used
to write further comments. But this comment doesn’t mean the opinion is qualified.
Unqualified opinion with explanation is reported in this way only if it is caused by the
first four causes of explanation. However, for the forth cause of explanation (reports
involving other auditors), no additional paragraph is added. The fact is stated on each of
the three paragraphs of the standard unqualified report.

For example, such opinion may read like this:

We believe the statements are ok. But we have something we want to say about them. …

ii. Qualified Opinions: A scope restriction results in a change in the scope paragraph, a
change in the opinion paragraph and needs an additional paragraph (explanatory
paragraph) between the scope and opinion paragraphs. It is stated as "except for …" and
refers to the potential effect of the particular area not adequately examined.

Example of opinion: I believe the statements are ok, except that we were not able to [count
inventories]

Material departure from IFRS requires no change in the scope paragraph. But an additional
paragraph (explanatory paragraph) between the scope and opinion paragraph is inserted. It
explains the departure and its effects on the financial statements. The opinion paragraph says,
"except for … " and refers to the explanatory paragraph.

Example of opinion: We believe the statements are ok, except that [fixed assets are not recorded
according to IFRS]
iii. Adverse Opinion: an adverse opinion is the worst of all opinions. Just like qualified due to
departure from IFRS, it is reported by adding a fourth paragraph. And the opinion states
that the statements don’t present fairly.
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Example of opinion: we believe the statements don’t present fairly the financial position and
results of operation of the company.
iv. Disclaimer Opinion: remember this opinion is issued if there was sever limitation of scope
and/ or if the auditor is not independent. In the case of disclaimer due to scope limitation,
the introductory paragraph is altered to read as "we were engaged to audit … and our
opinion is our responsibility". Besides, the scope paragraph is omitted from the report and
an explanatory paragraph is added in its place.
Example of an opinion: we don’t know, we didn’t see enough to form an opinion.
If disclaimer opinion is provided because the auditor is not independent, there will be no
introductory and no scope paragraph. A paragraph that states the disclaimer is used.
Example of an opinion: I will not express my opinion because I am not independent.

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