UNIT SIX

AUDIT REPORT
 Introduction
 The Auditor's report is a formal opinion, or disclaimer
thereof, issued by either an internal auditor or an
independent external auditor as a result of an internal or
external audit or evaluation performed on a legal entity or
subdivision thereof (called an “auditee”).

 Reports are essential to audit and assurance engagement,

because they communicate the auditor’s findings.

 The audit report is the final step in the entire audit process.
 Components of Audit Report
 An audit report has to contain a minimum of the
following seven parts.

1. Report title: - Auditing standard requires that the report be

titled and that the title include the word “independent”.
For example, appropriate title would be “independent auditors
report”,

2. Audit Report Address: - the report is usually addressed to the

company, its stockholders or board of directors.

3. Introductory Paragraph: - The first paragraph of the report

does three things:-
a. It makes a simple statement that CPA firm has
conducted an audit to distinguish it from review
or compilation.

b. It state financial statements that were audited

in the wordings given by management together
with exact dates or periods

c. It shows that the statements are the

responsibilities of managers, and the auditors
work is to give an opinion to indicate that the
selection of IFRS is up to managers.
4. Scope Paragraph:-The scope paragraph is a factual
statement about what the auditor did in the audit.

 This paragraph first states that the auditor followed ISAs.

 It states that the audit is designed to obtain reasonable

assurance about whether the statements are free of material
misstatement.

 It discusses the audit evidence accumulated and states that

the auditor believes that the evidence accumulated was
appropriate for the circumstance to express the opinion
presented.
5. Opinion Paragraph: The final paragraph in the standard
report states the auditors conclusions based on the results
of the audit.

 Its an opinion rather than as a statement of absolute

fact or a guarantee.

 Indicates that may be some information risk associated

with the financial statement, even though the statements
have been audited.

 The opinion paragraph is directly related to the ISA 700.

6. Name of CPA Firm:- the name identifies the CPA firm or
practitioner who performed the audit.

7. Audit Report Date:- The appropriate date for the report

is one on which the auditor has completed the most
important auditing procedures in the field.

 It indicates the last date of the auditor’s responsibility

for the review of significant events that occurred after
the date of financial statements.

 For example, if the balance sheet is dated December 31,

1998, and the audit report is dated March 6, 1999.
 Kinds of Audit Opinion
 There are five common types of auditor’s reports, each one
presenting a different situation encountered during the
auditor’s work.

1. Standard Unqualified Opinion Report

2. Unqualified opinion with explanatory paragraph or
modified wording
3. Qualified opinion Report
4. Adverse Opinion Report
5. Disclaimer of opinion Report
 1. Standard Unqualified Audit Report

 This type of report is issued by an auditor when the financial statements

presented are free from material misstatements and are presented fairly
in accordance with the ISAs.

 The company’s financial condition, position, and operations are fairly

presented in the financial statements.

 It is the best type of report an auditee may receive from an external

auditor.

 Sometimes called a clean opinion, because there are no circumstances

requiring a qualification or modification of the auditor’s opinion.

 The standard unqualified report is the most common audit opinion.

 The standard unqualified audit report is issued when
the following conditions have been met:

a. All statements- balance sheet, income statements or retained earnings and

statements of cash flow-are included in the financial statement.

b. ISAs have been followed in all respects on the engagement

c. Sufficient evidence has been accumulated, and the auditor has conducted
the engagement in a manner that enables him or her to conclude that the
standards of filed work have been met.

d. The financial statements are presented in accordance with ISAs. Indicates

adequate disclosures have been included in the footnotes and other parts
of the financial statements.

e. There are no circumstances requiring the additions of an explanatory

paragraph or modification of the wording of the report.
 The following is an example of a standard unqualified
auditor’s report on financial statements as it is used in most
countries, using the name ABC Company as an auditee’s
name:
Standard Unqualified Report.docx
 2. Unqualified Audit Report with Explanatory
Paragraph or Modified Wording
 In certain situation, an unqualified audit report is
issued, but the wording deviates from the standard
unqualified report.

 The unqualified audit report with explanatory

paragraph or modified wording meets the criteria of
a complete audit with satisfactory results and
financial statements that are fairly presented, but the
auditor believes it is important or is required to
provide additional information.
 The most important causes of the addition of an
explanatory paragraph or a modification in the
wording of the standard unqualified report.

1. Lack of consistent Application of IFRS

 Explanatory paragraph because of change in

accounting principles
Independent auditor’s opinion
(Same introductory, scope, and opinion paragraph as the standard report)

As discussed in the note to the financial statements, the company changed its method of
computing depreciation in 2009.
2. Consistency versus Comparability

 The auditor must be able to distinguish between changes that affect

consistency and those that may affect comparability but don’t affect
consistency.

 The following are examples of changes that affect consistency and

therefore require explanatory paragraph if they are material:

a. Change in accounting principles, such as change from FIFO to LIFO

inventory valuation

b. Changes in reporting entities, such as the inclusion of an additional

company in combined financial statements

c. Correction of errors involving principles, by changing from an

accounting principle that is not generally acceptable to one that is
generally acceptable, including correction of the resulting error
 Changes that affect comparability but not consistency and
therefore need not be included in the audit report include
the following:

a. Changes in estimates, such as a decrease in the life of an

asset for depreciation purposes

b. Error corrections not involving principles such as a

previous years mathematical error

c. Variation in format and presentation of finical information

d. Changes because of substantially different transactions or

events, such as new endeavors in research and
development or the sales of subsidiary.
3. Substantial Doubt about Going Concern

 Even though the purpose of an audit is not to evaluate the financial health
of the business, the auditor has a responsibility to evaluate whether the
company is likely to continue as a going concern.

 For example, the existence of one or more of the following factors causes
uncertainty about the ability of a company to continue as a going concern:

 Significant recurring operating losses or working capital deficiencies

 Inability of the company to pay its obligation as they come due

 Loss of major customers, the occurrence of uninsured catastrophes such

as an earthquake or flood, or unusual labor difficulties

 Legal proceedings, legislation, or similar matters that have occurred that

might jeopardize the entity’s ability to operate
 The following table provides an example in which
there is substantial doubt about going concern.

Independent auditor’s opinion

(Same introductory, scope, and opinion paragraph as the standard report)

The accompanying financial statements have been prepared assuming that ABC Company
continues as going concern. As the discussion in the note to the financial statements, ABC
Company has suffered recurring losses from operations and has a net capital deficiency that
raises substantial doubt about the company’s ability to continue as a going concern.
Managements plan in regard to these matters are also described in the note. The financial
statements don’t include any adjustments that might result from the outcomes of this uncertainty.
4. Auditors Agrees with a Departure from a
Promulgated Principle

 Sometimes the company’s departure from Generally Accepted

Principles is acceptable, if adhering to the principles would
have produced a misleading result.

 In this case, the auditor can issue Standard unqualified audit

report with additional explanation for the change.
5. Emphasis of Matter

 The auditor may want to emphasis specific matters regarding the

financial statements even though he or she intends to express an
unqualified opinion.

 Normally, such explanatory information should be included in a

separate paragraph in the report.
 Examples:

 Existence of significant related party transactions,

 Important events occurring subsequent to the balance sheet date,

 The description of accounting matters affecting the comparability of

the financial statements with those of the preceding year and
material uncertainties disclosed in the footnotes.
6. Reports involving Other Auditors

 When an auditor relies on different auditors to perform part of the audit,

which is common when the client has several widespread branches or
subdivisions, the principal audit firm has three alternatives.

 Only the second one is an unqualified report with modified wording

1. Make no reference in the audit report:

 When no reference is made to the other auditor, a standard unqualified

opinion is given unless other circumstances require a departure.

 This paragraph is typically followed when the other auditor audited an

immaterial portion of the statement, the other auditor is well known or
closely supervised by the principal auditor, or the principal auditor has
thoroughly reviewed the other auditor’s work.

 The other auditor is still responsible for his or her own report and work in the
2. Make reference in the report:

 This type of report is called a shared opinion or report.

 A shared unqualified report is appropriate when it is impractical to review

the work of the other auditor or when the portion of the financial
statements audited by the other CPA is material in relation to the whole.

3. Qualify the opinion:

 The principal auditor may conclude that a qualified opinion is required.

 A qualified opinion or disclaimer, depending on the materiality is required

if the principal auditor is not willing to assume any responsibility for the
work of the other auditor.

 The principal auditor may also decide that a qualification is required in the
overall report if the other auditor qualified his or her portion of the audit.
 3. Qualified Opinion Report
 A Qualified Opinion report is issued when the auditor
encountered one of the two types of situations which do
not comply with IFRS, however, the rest of the financial
statements are fairly presented.

 This type of opinion is very similar to an unqualified or

“clean opinion”, but the report states that the financial
statements are fairly presented with a certain exception
which is otherwise misstated.

 The two types of situations which would cause an

auditor to issue this opinion over the unqualified opinion
are:
1. Deviation from IFRS:

 This type of qualification occurs when one or more areas of the

financial statements do not conform with IFRS (e.g. are
misstated), but do not affect the rest of the financial statements
from being fairly presented when taken as a whole.

 Example:

A company dedicated to a retail business that did not correctly

calculate the depreciation expense of its building. Even if this
expense is considered material, since the rest of the financial
statements do conform with IFRS, then the auditor qualifies the
opinion by describing the depreciation misstatement in the report
and continues to issue a clean opinion on the rest of the financial
statements.
2. Limitation of Scope:

 This type of qualification occurs when the auditor could not

audit one or more areas of the financial statements, and
although they could not be verified, the rest of the financial
statements were audited and they conform with IFRS.

 Example

An auditor not being able to observe and test a company’s

inventory of goods. If the auditor audited the rest of the
financial statements and is reasonably sure that they conform
with IFRS, then the auditor simply states that the financial
statements are fairly presented, with the exception of the
inventory which could not be audited.
 The wording of the qualified report is very
similar to the unqualified opinion, but an
explanatory paragraph is added to explain the
reasons for the qualification after the scope
paragraph but before the opinion paragraph.

 The introductory paragraph is left exactly the

same as in the unqualified opinion, while the
scope and the opinion paragraphs receive a
slight modification in line with the
qualification in the explanatory paragraph.
 The scope paragraph is edited to include the following phrase
in the first sentence, so that the user may be immediately
aware of the qualification.

 This placement also informs the user that, except for the
qualification, the rest of the audit was performed without
qualifications:

“Except as discussed in the following paragraph, we conducted our audit...”

 For a qualification arising from a deviation from IFRS, the

following phrase is added to the opinion paragraph, using the
depreciation example mentioned above:
“In our opinion, except for the effects of the Company’s incorrect determination of
depreciation expense, the financial statement referred to in the first paragraph presents
fairly, in all material respects, the financial position of…”
 For a qualification arising from a scope limitation, the
following phrase is added to the opinion paragraph, using the
inventory example mentioned above:

“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 perform proper tests and procedures on
the Company’s inventory, the financial statement referred to in the first paragraph
presents fairly, in all material respects, the financial position of…”

 Due to the phrases added to the scope and opinion

paragraphs, many refer to this report as the Except-For
Opinion.
 4. Adverse Opinion Report
 An Adverse Opinion is issued when the auditor determines
that the financial statements of an auditee are materially
misstated and, when considered as a whole, do not conform
with IFRS.

 It is considered the opposite of an unqualified or clean

opinion, essentially stating that the information contained is
materially incorrect, unreliable, and inaccurate in order to
assess the auditee’s financial position and results of
operations.

 An adverse opinion is only given if the financial statement

pervasively differs from IFRS.
Example:
Failure of a company to consolidate a material subsidiary.

 The wording of the adverse report is similar to the qualified

report.

 The scope paragraph is modified accordingly and an

explanatory paragraph is added to explain the reason for the
adverse opinion after the scope paragraph but before the
opinion paragraph.

“In our opinion, because of the situations mentioned above (in the explanatory
paragraph), the financial statements referred to in the first paragraph do not present
fairly, in all material respects, the financial position of…”
 5. Disclaimer of Opinion Report
 Is issued when the auditor could not form, and
consequently refuses to present, an opinion on the
financial statements.

 This type of report is issued when the auditor tried to

audit an entity but could not complete the work due
to various reasons and does not issue an opinion.

 Auditing Standards provide certain situations where

a disclaimer of opinion may be appropriate:
 A lack of independence, or material conflict(s) of
interest, exist between the auditor and the auditee

 There are significant scope limitations, whether

intentional or not, which hinder the auditor’s work
in obtaining evidence and performing procedures

 There is a substantial doubt about the auditee’s

ability to continue as a going concern or, in other
words, continue operating

 There are significant uncertainties within the

auditee
 Although this type of opinion is rarely used, the most
common examples where disclaimers are issued
include audits where;

 The auditee willfully hides or refuses to provide

evidence and information to the auditor in significant
areas of the financial statements,

 The auditee is facing significant legal and litigation

issues in which the outcome is uncertain,

 The auditee has going concern issues (the auditee

may not continue operating in the near future).
 Since the audit was not completely and/or
adequately performed, the auditor refuses to accept
any responsibility by omitting the last sentence of the
paragraph.

 The scope paragraph is omitted in its entirety since,

effectively, no audit was performed.

 The following is a draft of the three main paragraphs

of a disclaimer of opinion because of inadequate
accounting records of an auditee, which is
considered a significant scope limitation:
We were engaged to audit the accompanying balance sheet of ABC Company, Inc. (the
“Company”) as of December 31, 2009 and the related statements of income and cash
flows for the year then ended. These financial statements are the responsibility of the
Company's management.

The Company does not maintain adequate accounting records to provide sufficient
information for the preparation of the basic financial statements. The Company’s
accounting records do not constitute a double-entry system which can produce financial
statements.

Because of the significance of the matters discussed in the preceding paragraphs, the
scope of our work was not sufficient to enable us to express, and we do not express, an
opinion of the financial statements referred to in the first paragraph.
 Materiality and Audit Report
 A misstatement in the financial statements can be considered
material if knowledge of the misstatement would affect a
decision of a reasonable user of the statements.

 Materiality is an essential consideration in determining the

appropriate types of report for a given set of circumstances.

 For example:

If a misstatement is immaterial relative to the financial

statements of the entity for the current period, it is appropriate
to issue an unqualified report.
A common instance is the immediate expensing of office
supplies rather than carrying the unused portion in inventory
because the amount is significant.

The situation is totally different when the amounts are of such

significant that the financial statements are materially affected
as a whole.

 Three levels of materiality are used for determining the type

of opinion to issue:

1. Amounts are Immaterial:

 When a misstatement in the financial statement exists but is

unlikely to affect the decision of a reasonable user, it is
considered to be immaterial.
 Unqualified opinion is therefore appropriate.

 For example:

Assume that management recorded unexpired insurance as an asset

in the previous year and decides to expense it in the current year to
reduce record keeping costs; management has failed to follow IFRS
but if the amounts are small, the misstatement would be immaterial
and standard unqualified audit report would be appropriate.

2. Amounts are material but don’t overshadow the financial

statements as a whole:

 Exists when a misstatement in the financial statement would

affect a user’s decision but the overall statements are still fairly
stated and therefore useful.
 For example:

 Knowledge of a large misstatement in fixed assets might affect a

user’s willingness to loan money to a company if the asset were the
collateral.

 When the auditor concludes that a misstatement is material but

doesn’t overshadow the financial statements as a whole, a qualified
opinion using except for is appropriate.

3. Amounts are so material or so pervasive that overall fairness of the

statements is in question:

 Exists when users are likely to make incorrect decisions if they rely
on the overall financial statements when the highest level of
materiality exists, the auditor must issue either a disclaimer of
opinion or an adverse opinion, depending on which conditions exist.
 The following table summarizes the relationship
between materiality and type of opinion issued:

Materiality level Significance in terms of reasonable user decision Type of opinion

Immaterial users decisions are unlikely to be affected Unqualified

User’s decisions are likely to be affected only if

the information in question is important to the
specific decisions being made. The overall
Material financial statement are presented fairly Qualified

Most or all users decision based on the financial Disclaimer or

Highly material statements are likely to be significantly affected Adverse