Chapter 13 - Reporting Flashcards
What are the two primary reports issued by auditors at the conclusion of an audit engagement?
At the end of an audit engagement, auditors issue two main reports:
* the auditor’s report, which is directed to the shareholders
* management letter, formally known as a communication to those charged with governance.
What matters are to be included, if necessary, in a management letter and why?
A management letter, issued as part of an audit, may include various important matters that have come to the auditor’s attention. These are communicated to support oversight and improve governance. The letter may cover:
Absolutely! Here’s the expanded version of the answer with more detail for each bullet point:
- Significant findings from the audit: These are key issues that arose during the audit process and may impact the financial statements or the audit opinion. This could include unusual transactions, inconsistencies, or material misstatements.
- Issues relating to compliance with the UK Corporate Governance Code: If the entity falls under the scope of this code, any non-compliance or concerns regarding governance practices should be communicated to ensure that governance expectations are met.
- Written representations requested by the auditor: These are formal confirmations provided by management, often relating to the completeness and accuracy of information. The auditor will highlight what representations were requested and their importance.
- The auditor’s views on significant qualitative aspects of accounting practices: This includes commentary on the appropriateness of accounting policies, the reasonableness of accounting estimates, and the adequacy of financial statement disclosures. These insights help those charged with governance understand the judgmental areas of financial reporting.
- Significant difficulties encountered during the audit: If the auditor experienced issues such as delays in receiving information, uncooperative staff, or access limitations, these will be reported as they may indicate deeper issues within the organization.
- Significant matters discussed with management: Any critical audit-related issues that were brought to management’s attention—such as adjustments to the accounts, disagreements, or sensitive disclosures—are included to keep governance bodies fully informed.
- Other relevant issues significant to financial oversight: This includes any additional matters that, in the auditor’s professional judgment, are important to the oversight of the financial reporting process but don’t fall neatly into other categories.
- Deficiencies in internal controls: Any weaknesses in the entity’s internal control systems that could lead to material misstatements or inefficiencies are communicated. Addressing these deficiencies is crucial for strengthening the control environment and reducing risk.
When should an auditor communicate deficiencies in internal control, and what information must be included?
An auditor is required to communicate deficiencies in internal controls identified during the audit process. If the deficiencies are assessed as significant, they must be formally communicated in writing to those charged with governance. Other deficiencies that are not significant but still merit attention should be communicated to management.
The written communication must include:
* A clear and detailed description of the deficiency, outlining what the control weakness is and where it occurs in the system or process.
* An explanation of the potential effects of the deficiency, such as the risk of material misstatement, operational inefficiency, or exposure to fraud.
What factors should auditors evaluate to determine whether a deficiency in internal controls is considered significant?
To determine whether a deficiency is significant, the auditor considers the following factors:
* The likelihood of the deficiency leading to material misstatements: This assesses how probable it is that the weakness could cause errors or omissions in the financial statements that might mislead users.
- The susceptibility to loss or fraud: This examines whether the deficiency could allow for the misappropriation of assets or manipulation of financial records, particularly in high-risk areas.
- The volume of activity exposed to the deficiency: A control weakness affecting high-volume transactions (e.g., cash receipts or inventory processing) is more concerning due to the greater exposure and impact.
- The frequency of the deficiency: A recurring issue indicates a persistent control problem that may not be isolated or accidental, increasing its potential severity and significance.
What are the two types of opionions given in an audit report? Define each
-Unmodified Opinion (also known as an Unqualified Opinion):
This is issued when the auditor concludes that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. It reflects a clean bill of health, indicating that the financial statements give a true and fair view.
-Modified Opinion:
This is given when the auditor identifies material misstatements or is unable to obtain sufficient appropriate audit evidence, and these issues are significant enough to affect the overall fairness of the financial statements. There are three types of modified opinions.
What are the three types of modified opions? Define each
- Qualified Opinion: Issued when the misstatement or scope limitation is material but not pervasive.
- Adverse Opinion: Issued when misstatements are both material and pervasive, meaning the financial statements do not present a true and fair view.
- Disclaimer of Opinion: Issued when the auditor is unable to obtain sufficient audit evidence, and the possible effects are material and pervasive, preventing them from forming an opinion.
What are the main components of an auditor’s report?
The main components of an auditor’s report, include:
- Title: Clearly identifies the document as an independent auditor’s report.
- Addressee: Typically addressed to the shareholders or members of the company.
- Auditor’s Opinion: Presented first; states whether the financial statements give a true and fair view.
- Basis for Opinion: Explains the rationale behind the opinion and references compliance with ISAs.
- Conclusions Relating to Going Concern: Discusses the company’s ability to continue as a going concern and highlights any material uncertainties (per ISA 570).
- Emphasis of Matter (if applicable): Draws attention to disclosures in the financial statements that are of fundamental importance.
- Materiality: Explains the materiality threshold applied and judgments involved.
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Key Audit Matters (for listed entities): Highlights areas of significant risk or auditor judgment, including:
– High-risk areas of misstatement
– Significant auditor judgments (e.g., estimates)
– Impact of major events or transactions - Other Information: Addresses the auditor’s responsibilities regarding other content in the annual report, and notes inconsistencies if found.
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Opinion on Other Matters Required by the Companies Act:
– Confirms whether the Directors’ Report and Strategic Report are consistent with the financial statements and comply with legal requirements
– For listed entities, under the UK Corporate Governance Code, auditors are also required to review the corporate governance statement and state whether they have anything to report regarding the company’s compliance -
Matters Reported by Exception (as required by the Companies Act): Auditor must report if, for example:
– Adequate records weren’t kept
– Required audit information was not received
– Financial statements disagree with underlying records
– Disclosures like directors’ remuneration are missing - Responsibilities of Directors: Outlines management’s duty to prepare financial statements and assess going concern.
- Auditor’s Responsibilities: Describes the auditor’s objectives, including obtaining reasonable assurance and complying with ISAs.
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Risk Areas & Materiality (Expanded):
– Areas most at risk of material misstatement
– How materiality was determined and applied
– How the audit addressed risks - Other Required Disclosures: Any additional information required by laws or standards.
- Name & Signature: For listed entities, the name of the engagement partner and their signature. For unlisted entities, the name and signature of the firm.
- Auditor’s Address and Date of Report: Provides the location of the audit firm and the date the report is finalized.
What are the main differences between auditor reports for listed and unlisted companies?
Auditor reports for listed companies include additional elements that enhance transparency and accountability, such as:
- Key Audit Matters (KAMs): A section highlighting the most significant risks and how they were addressed during the audit.
- Review of Compliance with the UK Corporate Governance Code: The auditor must report on the company’s adherence to governance requirements.
- Engagement Partner Disclosure: The name and signature of the engagement partner must be included in the report.
Outline and explain the matrix to determine the type of modified auditors opinion to give
The matrix is used by auditors to decide which type of modified opinion to issue when they encounter problems during the audit. It considers two key factors:
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Nature of the issue:
- A misstatement, where the auditor disagrees with the accounting treatment, policies, or disclosures.
- An inability to obtain sufficient and appropriate evidence, such as when records are missing or access is restricted.
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Severity of the issue:
- Whether the issue is material but not pervasive (i.e., significant but isolated), or
- Material and pervasive (i.e., the issue has widespread impact on the financial statements).
Based on this assessment, the auditor will issue one of the following modified opinions:
- Qualified Opinion – Given when the issue is material but not pervasive, whether due to a misstatement or lack of evidence.
- Adverse Opinion – Given when a misstatement is material and pervasive, meaning the financial statements are fundamentally misleading.
- Disclaimer of Opinion – Given when the auditor cannot obtain sufficient evidence and the potential effects are material and pervasive, meaning they cannot form an opinion at all.
METHOD FOR ANSWERING AUDIT REPORT QUESTIONS
What is an Emphasis of Matter paragraph in an auditor’s report, and when is it used?
An Emphasis of Matter paragraph is included in the auditor’s report when the auditor considers it necessary to draw users’ attention to a matter that is appropriately presented or disclosed in the financial statements and is fundamental to understanding them.
- It does not modify the audit opinion — the financial statements must still give a true and fair view.
- It is typically used to highlight significant matters such as:
- A disclosure note indicating the company is not a going concern
- A note on unquantifiable litigation or legal uncertainty
The paragraph is placed immediately after the auditor’s opinion and begins with wording like:
“Without qualifying our opinion, we draw your attention to…“
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What is the auditor’s responsibility for information included in financial reports but not part of the audited financial statements?
The auditor is not responsible for auditing other information (e.g., financial summaries, Chairman’s report), and other matters (directors/strategic report) but they must read and consider it to ensure it is consistent with the audited financial statements.
If a material inconsistency or misstatement of fact is identified, the auditor must assess its impact and may need to act.
What ‘other information’ and ‘other matters’ will auditors look at?
Other Information
This refers to content included in the annual report that is not part of the audited financial statements but is still presented alongside them. The auditor is not required to audit this, but they must read it for consistency and identify any material misstatements.
Examples include:
- Chairman’s Report
- Financial summaries or highlights
- Employment data
- Financial ratios
- Corporate Social Responsibility (CSR) reports
- Planned capital expenditures
Other Matters
These refer to legal and regulatory responsibilities placed on auditors, particularly under the Companies Act or relevant standards. They usually relate to content the auditor is required to express an opinion on, even though it is not part of the financial statements.
Examples include:
- The Directors’ Report
- The Strategic Report
What is the auditor’s responsibility when reviewing ‘other information’ provided by the audited entity?
While auditors are not required to audit the other information included in the annual report (such as the Chairman’s report, financial highlights, or the Directors’ and Strategic Reports), they do have a duty to read and consider it.
Their role is to assess whether the other information is materially consistent with the audited financial statements and free from material misstatements of fact.
If the auditor identifies a material inconsistency or misstatement that remains uncorrected, they must:
- Evaluate its impact on the audit, and
- Include an “Other Information” paragraph in the auditor’s report describing the issue.
This ensures users of the financial report are alerted to any concerns regarding the reliability of other information presented alongside the financial statements.
What is the auditor’s responsibility when reviewing ‘other matters’ provided by the audited entity?
Auditors are not required to audit other matters such as the Directors’ Report and Strategic Report, but they must read and assess this information to ensure it is consistent with the audited financial statements and complies with applicable legal requirements.
If the auditor identifies a material inconsistency or misstatement of fact, they must evaluate its significance and take appropriate action.
These responsibilities are addressed in the auditor’s report under:
- “Opinion on Other Matters Prescribed by the Companies Act”, and
- “Matters on Which We Are Required to Report by Exception”.
This ensures stakeholders are informed if any legal or regulatory concerns arise regarding these reports.
