Unit 2a - The auditor's report

Question 1

What is the main important phrase in the auditor’s report?

What are the two important words?

What is the audit opinion based on?

Answer 1

The auditor’s report includes a clear expression of opinion on the financial statements as a whole.

Opinion - There is nothing absolute here. Different firms of auditors could quite legitimately come to different opinions.

Financial statements as a whole - We are not just looking at the statement of financial position in solation from the statement of profit or loss or the notes. What’s important is the impression given by the financial statements as a whole.

Audit opinion has to be based on evidence obtained in the course of the audit.

Question 2

What are the five financial statements?

Answer 2

Statement of Financial Position
Statement of profit/loss and OCI
Statement of changes in equity
Cash flow statement
Notes to the financial statements, including significant accounting policies.

Question 3

What is the independent auditor’s report titled?

Answer 3

Independent Auditor’s Report - It also states to whom it’s addressed, that’s the members (shareholders) of the company.

Question 4

Audit opinion and identification of what’s been audited

Answer 4

The opinion paragraph comes right at the top. It summarises the F/S that have been audited.

The report set out below includes an unmodified audit opinion, which states that the financial statements give a true and fair view (or present fairly, in all material respects), and have been prepared in accordance with IFRS’s.

As appropriate, depending on opinion type, it can be named opinion/qualified/adverse/disclaimer of opinion

Question 5

The basis for Opinion

Answer 5

Refers to compliance with the ISAs (complying with them is key to the basis of opinion) and will refer to the auditor’s responsibilities section of the report. It must include an assertion of the auditor’s independence and that other ethical matters have been complied with.

If the audit opinion has been modified, the explanation would be here too.

As appropriate, this paragraph would be called:
Basis for opinion/qualified/adverse/disclaimer of opinion

Question 6

Emphasis of matter paragraph

Answer 6

This paragraph is used to draw users’ attention to a matter already properly disclosed in the financial statements. For example, a note stating that ther ehad been a fire at the compan’y premises after the date of the SOFP.

An emphasis of matter paragraph is not a modification of the audit opinion and it will state that the audit opinion is not modified in this respect. If the auditor’s report also includes a key audit matters section, the emphasis of matter paragraph may follow that section, depending on their relative importance.

Question 7

Material uncertainty related to going concern (if one)

Answer 7

A separate paragraph is now required if there is a material uncertainty related to the going concern of the company.

Such a paragraph is not a modification of the audit opinion - provided the uncertainty has been adequately disclosed by the directors in the notes to the financial statements.

Question 8

Key audit matters

Answer 8

Those matters that were of most significance during the audit.
There is then a full description of these matters in accordance with ISA701.

Question 9

Other matter paragraph (if one)

Answer 9

Used if necessary to communicate a matter that is not required to be presented or disclosed in the F/S which is relevant to the user’s understanding of the audit, the auditor’s responsibilities or the auditor’s report.

Circumstances where it may be necessary
Where the auditor reports on two sets of F/S prepared under different general purpose frameworks (eg a national framework and IFRS)

Where the financial statements have been prepared for a specific purpose, to state that the auditor’s report is solely for the intended users.

In the rare circumstance where the auditor is unable to withdraw from an engagement even though a management-imposed limitation on the audit may be pervasive.

Question 10

Other information paragraph (if one)

Answer 10

For example, an audit covers the F/S but not the directors’ report. So what if the directors’ report contains something that conflicts with the financial statements? The audit opinion cannot be modified because it does not cover the director’s report, but perhaps the shareholders need to be alerted to this. This can be done in a paragraph, headed ‘Other information.’

This is not a modification of the audit opinion.

Question 11

Management’s responsibilities

Answer 11

Points out that it is management’s responsibility to prepare the F/S in accordance with the IFRS to maintain the system of I/C and to consider the going concern position of the company.

Question 12

Auditor’s responsibilities

Answer 12

To obtain reasonable assurance about whether the f/s as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes their opinion.

Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these F/S.

Question 13

Date, address and signature

Answer 13

Finally, the auditors must sign the report and must give their address and the date at which it is signed. The date of the report is very important because before that date the auditor has an active duty: the audit is not yet over. The auditor should still be investigating whether receivables are being paid and inventory is selling at above cost. After that date, the auditor has a passive duty only. This means that the auditor is not ‘on the lookout’ for events affecting the truth and fairness of the F/S but if any are brought to his attention then they might have to act.

Question 14

ISA701 Communicating Key Audit Matters in the Independent Auditor’s Report

Answer 14

The first thing to note is that the auditor only reports on key audit matters (“KAMs”) in respect of listed entities.
The auditor shall determine, from the matters communicated with those charged with governance, those matters that required significant auditor attention in performing the audit. In making this determination, the auditor shall take into account the following:
(1) Areas of higher assessed risk of material misstatement or significant risks
(2) Significant auditor judgements relating to areas in the financial statements that involved significant management judgement, including accounting estimates that have been identifies as having high estimation uncertainty.
(3) The effect on the audit of significant events or transactions that occurred during the period.

The auditor therefore selects only those matters that were of most significance in the audit of the F/S of the current period and therefore are the key audit matters.

Question 15

How are key audit matters identified?

Answer 15

Starting with all matters communicated with those charged with governance
Determining the matters that required significant auditor attention in performing the audit.
The most significant of these are the ‘key audit matters’

If the auditor disclaims an opinion on the financial statements (very rarely) there will be no KAMs section in the auditor’s report because the auditor has not obtained the evidence necessary to form an opinion.

Question 16

What is meant by true and fair?

Answer 16

‘True’ means that the info is factually correct and not materially misstated

Fair is more difficult. You can have information which is accurate but which is nevertheless presented in a way which is unfair, and which perhaps conceals or does not reflect the commercial substance of transactions. E.G. It wouldn’t be fair to present a bank loan as a NCL if in fact, it is repayable in the next 12 months. (ie a current liability) This would distort the financial position presented because the bank loan would not be included in assessing the company liquidity, as shown, for example, by the liquidity ratio.

Question 17

Materiality

Answer 17

A matter is material if its omission/misstatement would reasonably influence the economic decisions by a user of the auditor’s report
It is affected by the size and nature of the misstatement

The auditor’s judgement flows all the way through the audit process, from planning and deciding the amount of work that should be done, to deciding what action should be taken should errors be found in the accounts.

We are looking for material misstatements, and a material misstatement is defined through its effect on decisions made by a user of the report. For example, if a misstatement would cause an investor to keep those shares rather than selling those shares, there has been a real effect on that investor and the misstatement would be material.

If misstatements are so small that they don’t really spark any reaction in the members, then they are rather superficial. That’s not to say that auditors don’t want to get things right, but errors only really matter when they trigger incorrect action.

Materiality has to be decided for the f/s as a whole and it is the audit partner’s judgements about whether or not a misstatement is material.

Question 18

Guidance on materiality - rules of thumb

Answer 18

0.5% to 1% of revenue
1% to 2% of total assets
5% to 10% of profit

You should assume that the matter is material. These percentages should take into account the auditor’s knowledge if which items users will focus on, the nature of the entity, its ownership, structure and financing, volatility of the benchmark.

Additionally, a lesser amount should be set for materiality when designing and carrying out audit procedures to reduce the risk that misstatements in aggregate exceed F/S materiality, this is known as performance materiality: the materiality that is important in the performance of the audit work.

Question 19

More guidance on materiality

Answer 19

Errors which are less than the suggested guidelines could still be regarded as being material. An error that turns a small loss into a small profit could cause unfounded optimism in some situations, perhaps a feeling that the company has turned a corner, SO, although in absolute terms, the size of an error is relatively small, the way in which accounts are then interpreted could lead to unreasonable decisions being made. Therefore, you can talk about both quantitative and qualitative materiality.

Finally, there are some amounts in the F/S where no errors are tolerable. FOr example, there is often a statutory duty to disclose directors’ remuneration and that has to be stated with absolute accuracy.

All misstatements identified should be communicated to management who should be asked to correct them or to explain why not. The auditors must assess the materiality of uncorrected statements and obtain written representations from management that they believe uncorrected misstatements to be not material.

If management refuses to correct an error that the auditor thinks is material then the auditor will issue a modified (qualified) audit opinion.

Question 20

Other reporting responsibilities

Answer 20

An auditor’s report will explicitly state whether in the auditor’s opinion the accounts show a true and fair view. In some jurisdictions, the auditor may have additional responsibilities to report on matters such as the adequacy of accounting books and records. These may be included in the auditor’s report under a suitably headed section (e.g. Report on Other Legal and Regulatory Requirements)