TYPES OF AUDIT'S REPORT MODIFICATIONS
These three modifications to the auditor’s report are used when there is either:
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a limitation on the scope of the auditor’s work or;
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disagreement with management regarding the acceptability of the accounting policies selected, the method of their application or the adequacy of financial statement disclosures.
The effect of these circumstances can be material or fundamental. The qualified report is used for material problems.
If a limitation on scope or a disagreement is so material and pervasive tat a simple qualification is not sufficient, one of the two stronger forms are used.
(a) A qualified opinion should be expressed when the auditor concludes that an unqualified opinion cannot be expressed but that the effect of any disagreement with management, or limitation on scope is not so material and pervasive as to require an adverse opinion or a disclaimer of opinion. A qualified opinion should be expressed to being ‘except for’ the effects of the matter to which the qualification relates.
(b) A disclaimer of opinion should be expressed when 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 accordingly is unable to express an opinion on the financial statements.
(c) An adverse opinion should be expressed whet the effect of a disagreement 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.
Whenever the auditor expresses an opinion that is other than unqualified, a clear description of all the substantive reasons should be included in the report and unless impracticable, a quantification of the possible effect(s) on the financial statements. Ordinarily, this information would be set out in a separate paragraph preceding the opinion or disclaimer or opinion and may include a reference to a more extensive discussion, if any, in a note to the financial statements.
Examples of modified reports
(a) Limitation on scope
(i) Limitation on scope – qualified person
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‘We have audited …(remaining words are the same as illustrated in the introductory paragraph of the unqualified above). Except as discussed in the following paragraph, we conducted our audit in accordance with ….(remaining words are the same as illustrated in the scope paragraph of the unqualified report above). |
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We did not observe the counting of the physical inventories as of December 31, 20x1, since that date was prior to the time we were initially engaged as auditors fir 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. |
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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 (remaining words are the same as illustrated in the opinion paragraph of the unqualified report above).’ |
(ii) Limitation on scope – disclaimer of opinion
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‘We are engaged to audit the accompanying balance sheet of the ABC Company as of December 31 20x1 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. (Omit the sentence stating the responsibility of the auditor). (The paragraph discussing the scope of the audit would either be omitted or amended according to the circumstances.) (Add a paragraph discussing the scope limitations 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. |
(b) Disagreement
(i) Disagreement on Accounting Policies- Inappropriate Accounting method – Qualified Opinion
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‘We have audited ….(remaining words are the same as illustrated in the introductory paragraph of the unqualified report above.) We conducted our audit in accordance with … (remaining words are the same as illustrated in the scope paragraph of the unqualified report above). As discussed in Note X to the financial statements, no depreciation has been provided in the financial statements which practice, in our opinion, isn’t in accordance with International Accounting Standards. The provision for the year ended December 31, 20x1 should be based on the straight line method of depreciation using annual rates of 5% for the building and 20% for the equipment. Accordingly the non current assets should be reduced by the accumulated depreciation of xxx and the loss for the year and accumulated deficit should be increased by xxx and xxx respectively. In our opinion, except for the effect on the financial statements of the matter referred to in the preceding paragraph, the financial statements give a true and …. (remaining words are the same as illustrated in the opinion paragraph of the unqualified report above). |
(ii) Disagreement on Accounting Policies – inadequate disclosure – qualified opinion
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‘We have audited … (remaining words are the same as illustrated in the introductory paragraph of the unqualified report above). We conducted our audit in accordance with.. (remaining words are the same as illustrated in the scope paragraph of the unqualified report above. |
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On January 15, 20x2, the company issued debentures in the amount of xx for the purpose of financing plant expansion. The debenture agreement restricts the payment of future cash dividends to earnings after December 31, 20x1. In our opinion, disclosure of this information is required by …. (insert reference to statutory or regulatory requirement). In our opinion, except for the omission of the information included in the preceding paragraph, the financial statements give a true and … (remaining words are the same as illustrated in the opinion paragraph of the unqualified report above). |
(iii) Disagreement on Accounting Policies – inadequate disclosure – adverse opinion
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We have audited … (remaining words are the same as illustrated in the introductory paragraph of the unqualified report above). We conducted our audit in accordance with.. (remaining words are the same as illustrated in the scope paragraph of the unqualified report above. 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 of ( or do not ‘present fairly’) the financial position of the company as at December 31, 20x1, and of result of its operations and its cash flows for the year then ended in accordance with (insert relevant IASs or national standards) .. and do not comply with …… (insert relevant statutes or law). |
The extent to which users understand the audit report
Users of accounts have information needs, and the auditor’s report as an independent attestation lends credibility to the accounting information. However there has been the tendency for users to place far more reliance on the audit report than its actual function merits.
Typical, and erroneous, beliefs of users, have included the following:
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Auditors are the persons responsible for ensuring the accounts show a true and fair view
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Auditors are responsible for preventing and/or detecting fraud.
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Auditors guarantee that the company is going concern.
How qualification may be avoided by negotiation with management
Before deciding on the nature of the audit opinion, the auditor should review the impact of the Summary of Audit Differences. A meeting between the auditor and the directors should be held to discuss the issues which may affect the opinion and review the audit differences. In practice, after negotiation, it is often the case that a compromise will be reached with the client such that some audit differences are adjusted whilst those that do not materially affect the view given by the financial statements are left as they are.
Management are generally keen to avoid qualifications in the audit report because:
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Adverse publicity may arise from the media
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If the qualification concerns a matter of statutory accounting policy, the powers of the courts may result in the preparation of revised accounts.
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Loan/debenture deed may refer to an audit qualification as giving rise to a breach of a covenant, thus giving loan note holders an immediate right to repayment or the right to appoint a receiver.
Therefore if the auditors have a contentious issue, the directors will often reconsider their decision on a particular policy provided that the auditors present the matter in an effective way with management. Thus can sometimes be a difficult and sensitive area because the auditor would normally want to avoid antagonizing or losing the client, although of courts, the need for ‘truth and fairness’ must prevail.
