Auditing – Study Notes Chapter Auditor’s Report & Types of Opinions CHAPTER FOUR AUDITOR’S REPORT & TYPES OF OPINIONS LO # LEARNING OBJCTIVE ICAP'S STUDY TEXT REFERENCE* PART A – AUDITOR’S REPORT LO ELEMENTS OF AUDITOR’S REPORT FORMAT OF AUDITOR’S REPORT (FORM 35A OF COMPANIES RULES 1985) PART B – AUDITOR’S OPINIONS ON FINANCIAL STATEMETNS LO 15.5.3 15.5.4 15.6.1 LO MATTERS TO BE EVALUATED BEFORE FORMING OPINION 15.5.2 LO WHAT IS MEANT BY MISSTATEMENTS AND SCOPE LIMITATIONS LO WHAT IS MEANT BY IMMATERIAL, MATERIAL AND PERVASIVE LO DECIDING TYPE OF OPINION ON FINANCIAL STATEMENTS 15.7.2 15.7.3 15.7.4 3.2.4 1.1.3 15.7.1 15.7.4 PART C – APPENDICES Appendix Appendix DIFFERENCE BETWEEN FORMATS OF AUDITOR’S REPORT (FORM 35A VS ISA) HOW TO ATTEMPT REPORTING CASE STUDY IN EXAM 15.6.4 15.7.2 15.7.3 *Explanation of Reference: First digit in Study Text’s Reference represents chapter number, second and third digits represents section and sub-section number Contents in brackets (if any) represent part of the sub-section which is covered by the learning objective By: Muhammad Asif, ACA Auditing – Study Notes Chapter Auditor’s Report & Types of Opinions PART A – AUDITOR’S REPORT LO 1: ELEMENTS OF AUDITOR’S REPORT: Auditor’s Report is always in written form with following elements/contents: Sr # Content Title Addressee Introductory Paragraph Management’s Responsibility Paragraph Auditor’s Responsibility Paragraph Basis for Modified Opinion Paragraph (if modified opinion is expressed) Auditor’s Opinion Paragraph Other Reporting Responsibilities (if any) Emphasis of Matter Paragraph or Other Matter Paragraph (if any) Brief Explanation Auditor’s report shall have a title clearly indicating that it is “auditor’s report” Title is necessary to differentiate auditor’s report from other type of reports included in annual report Addressee is the stakeholder to whom report is issued Report may be addressed to any appropriate addressee according to circumstances e.g “Members”, or “Board of Directors” This paragraph states: That an audit has been conducted Entity whose financial statements have been audited Description of financial statements that have been audited Period covered by each statement This paragraph describes responsibilities of management: for preparation of financial statements in accordance with AFRF for such internal controls as are necessary This paragraph describes 1.auditor’s responsibility to express an opinion on financial statements based on audit brief description of audit that his audit provides a reasonable basis for his opinion Whenever auditor modifies the opinion on financial statements, he includes an additional paragraph in auditor’s report that provides information of the matter giving rise to the modification This is called “Basis for Qualified/Adverse/ Disclaimer of Opinion Paragraph” This is most important paragraph in which auditor states: whether financial statements are prepared in accordance with AFRF and (Where IFRSs are not used as the FRF, auditor shall jurisdiction of FRF) whether financial statements present true and fair view (if fair presentation framework is used) If auditor is required by local laws and regulations to report on matters other than financial statements, such matter shall also be covered by auditor in his report Emphasis of Matter Paragraph is included if auditor considers it necessary to draw users’ attention to a disclosure in the financial statements that is fundamental to users’ understanding of the financial statements Other Matter Paragraph is included if auditor considers it necessary to communicate a matter which is not disclosed in the financial statements but is relevant to users’ understanding of the audit, auditor’s responsibilities or auditor’s report By: Muhammad Asif, ACA Auditing – Study Notes Chapter Auditor’s Report & Types of Opinions This section contains signature by auditor: in his personal name (if auditor is sole-proprietor) in the name of partnership firm (if auditor is partnership firm) Date indicates the date on which auditor signs auditor’s report after obtaining sufficient appropriate audit evidence This will not be 11 Date earlier than date of approval of F/S by directors/management Date also indicates that auditor has considered the effect of subsequent events on F/S and auditor’s report till that date 12 Auditor’s Address This is the name of city where auditor practices If local laws/regulations require different format/wording of auditor’s report, auditor shall refer to ISAs only when, at minimum, element # 1, 2, 3, 4, 5, 7, 10, 11 and 12 are included in auditor’s report 10 Signature LO 2: FORMAT OF AUDITOR’S REPORT (FORM 35A OF COMPANIES RULES 1985): Auditor’s Report to the Members We have audited the annexed balance sheet of Star Chemicals Limited (the Company) as at June 30, 2014 and the related profit and loss account, cash flow statement and statement of changes in equity together with the notes forming part thereof, for the year then ended and we state that we have obtained all the information and explanations which, to the best of our knowledge and belief, were necessary for the purposes of our audit It is the responsibility of the company’s management to establish and maintain a system of internal control, and prepare and present the above said statements in conformity with the approved accounting standards and the requirements of the Companies Ordinance, 1984 Our responsibility is to express an opinion on these statements based on our audit We conducted our audit in accordance with the auditing standards as applicable in Pakistan These standards require that we plan and perform the audit to obtain reasonable assurance about whether the above said statements are free of any material misstatement An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the above said statements An audit also includes assessing the accounting policies and significant estimates made by management, as well as, evaluating the overall presentation of the above said statements We believe that our audit provides a reasonable basis for our opinion and, after due verification, we report that: (a) in our opinion, proper books of accounts have been kept by the company as required by the Companies Ordinance, 1984; (b) in our opinion: (i) the balance sheet and profit and loss account together with the notes thereon have been drawn up in conformity with the Companies Ordinance, 1984, and are in agreement with the books of accounts and are further in accordance with accounting policies consistently applied, except for the changes as stated in note # xxx with which we concur; (ii) the expenditure incurred during the year was for the purpose of the company’s business; and (iii) the business conducted, investments made and the expenditure incurred during the year were in accordance with the objects of the company; By: Muhammad Asif, ACA Auditing – Study Notes (c) (d) Chapter Auditor’s Report & Types of Opinions in our opinion and to the best of our information and according to the explanations given to us, the balance sheet, profit and loss account, cash flow statement and statement of changes in equity together with the notes forming part thereof conform with approved accounting standards as applicable in Pakistan, and, give the information required by the Companies Ordinance, 1984, in the manner so required and respectively give a true and fair view of the state of the company’s affairs as at June 30, 2014 and of the profit (or loss), its cash flows and changes in equity for the year then ended; and in our opinion, Zakat deductible at source under the Zakat and Ushr Ordinance, 1980 (XVIII of 1980), was deducted by the company and deposited in the Central Zakat Fund established under section of that Ordinance(N–1) ABC & Co August 13, 2014 Lahore Engagement partner: XYZ N – 1: Where no Zakat is deductible, substitute “in our opinion, no Zakat was deductible at source under the Zakat and Ushr Ordinance, 1980” PART B – AUDITOR’S OPINIONS ON FINANCIAL STATEMETNS LO 3: MATTERS TO BE EVALUATED BEFORE EXPRESSING OPINION: Before forming an opinion, auditor shall conclude: 1) Whether there is a misstatement or scope limitation 2) Whether effect of misstatements or scope limitation is immaterial, material or pervasive Auditor shall also evaluate following: Whether AFRF is adequately described Whether accounting policies are selected, applied and disclosed in accordance with AFRF Whether accounting estimates are reasonable If an accounting policy is changed, auditor shall: a Obtain evidence that it has been changed, applied and disclosed in accordance with AFRF b Refer to the change in auditor’s report c State in auditor’s report whether he concurs with the change or not Financial statements provide adequate disclosures Financial statements present true and fair view (if fair presentation framework is used) LO 4: WHAT IS MEANT BY MISSTATEMENTS AND SCOPE LIMITATIONS: Types/Situations Accounting Policies are not appropriate Transactions/Events are not recorded in financial statements Examples Accounting Policy is not selected in accordance with AFRF Accounting policy is not applied correctly (errors in application) Accounting policy is not applied consistently and auditor does not concur with change Not recording depreciation on fixed assets Impairment loss not recorded on fixed assets Not recording inventory at lower of cost and NRV By: Muhammad Asif, ACA Auditing – Study Notes Disclosures are not appropriate in financial statements Chapter Auditor’s Report & Types of Opinions Not recording provision for bad debts on bankrupt debtor Not recording provision on legal cases filed against company Not recording liabilities (e.g gratuity, finance lease obligations) Non-disclosure of information (which is required by AFRF to be disclosed.) Wrong disclosure of information (i.e not in accordance with AFRF) Study Tip Disclosure of misstatement in financial statements is not a substitute for correct accounting treatment Types/Situations Limitations imposed by management/entity Limitations by circumstances beyond the control of entity Limitations by circumstances relating to the nature or timing of the auditor’s work a b c d a b a b Examples Management prevents auditor from requesting confirmation from debtors Management does not provide representation letter to auditor Management does not provide minutes of meetings of Shareholders/TCWG to auditor Management does not allow auditor to communicate with predecessor auditor Accounting records of entity have been destroyed due to fire, computer virus or other natural disaster Accounting records of entity have been seized by govt authorities Auditor is appointed after year-end and is unable to observe the inventory count For Consolidation, financial statements of subsidiary are not available Study Tip There will be no scope limitation if auditor is able to obtain evidence from alternative audit procedures in above cases Scope limitation (of any type) affects auditor’s report However if there is a scope limitation by management which is unreasonable, it also affects other aspects of audit LO 5: WHAT IS MEANT BY IMMATERIAL, MATERIAL AND PERVASIVE: Material and Pervasive are terms used to describe the effects of misstatement or scope limitation on financial statements and audit Material: Effects of misstatement/scope limitation are considered material if they, individually or in aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements By: Muhammad Asif, ACA Auditing – Study Notes Chapter Auditor’s Report & Types of Opinions Pervasive: Effects of misstatement/scope limitation are considered pervasive, if they: i Are not confined to specific accounts of the financial statements; ii If so confined, represent substantial proportion of the financial statements; or iii In relation to disclosures, are fundamental to users’ understanding of the financial statements (Pervasive effect is greater than Material effect and both depend on auditor’s judgment.) LO 6: DECIDING TYPE OF OPINION ON FINANCIAL STATEMENTS: Which opinion to express in what Circumstances: There are four types of audit opinions, expressed by an auditor Misstatement Scope Limitation Immaterial effect Unmodified Opinion Material effect Qualified Opinion Pervasive effect Adverse Opinion Disclaimer of Opinion When to express Unmodified Opinion: In compliance framework, when auditor has obtained sufficient appropriate evidence that financial statements have been prepared, in all material respects, in accordance with AFRF In fair presentation framework, when auditor has obtained sufficient appropriate evidence that financial statements given a true and fair view in accordance with AFRF When to express Modified Opinion: When auditor has obtained sufficient appropriate audit evidence that there are misstatements in financial statements whose effect is either Material or Pervasive When auditor is unable to obtain sufficient appropriate evidence on which to base the opinion and possible effect of undetected misstatements in financial statements is either Material or Pervasive When to express Qualified Opinion: When auditor has obtained sufficient appropriate evidence that there are misstatements in financial statements whose effect is material (but not pervasive) When auditor is unable to obtain sufficient appropriate evidence on which to base the opinion and possible effect of undetected misstatements in financial statements is material (but not pervasive) When to express Adverse Opinion: When auditor has obtained sufficient appropriate evidence that there are misstatements in financial statements whose effect is pervasive When to express Disclaimer of Opinion: When auditor is unable to obtain sufficient appropriate evidence on which to base the opinion and possible effect of undetected misstatements in financial statements is pervasive By: Muhammad Asif, ACA Auditing – Study Notes Chapter Auditor’s Report & Types of Opinions When there are multiple uncertainties and it is not possible to form an opinion due to these uncertainties Study Tips There will be only one opinion in an auditreport Qualified Opinion, Adverse Opinion and Disclaimer of Opinion are collectively called “Modified Opinions” The term “Modified Report” means report contains either: (a) Modified Opinion or (b) “Emphasis of Matter” or “Other Matter” PART C – APPENDICES APPENDIX 1: DIFFERENCE BETWEEN FORMATS OF AUDITOR’S REPORT (FORM 35A VS ISA): Use of Report Title Addressee Introductory Paragraph Management’s Responsibility for the Financial Statements Auditor’s Responsibility Form 35A Requirements ISA Requirements This report is used in Statutory This Report is used in non-statutory audits only e.g in Audits only audits of Sole-proprietor, Partnership, non-statutory audit of a company Title does not include the word Title is “Independent Auditor’s Report” “Independent” Report of statutory audit shall be Report may be addressed to any appropriate addressed to Members of the addressee according to circumstances e.g “Board of company Directors”, “Bankers” or “Prospective Investors” Introductory paragraph states No such statement is given whether auditor has obtained necessary information and explanations from management No heading prescribed A heading is required AFRF is “approved accounting Any framework may be used e.g IFRS or GAAP standards and the requirements of the Companies Ordinance 1984” No heading prescribed A heading is required Audit shall be conducted in Audit shall be conducted in accordance with accordance with “auditing “International Standards on Auditing” standards as applicable in Pakistan” Following statements are added in auditor’s responsibility paragraph: (i) Auditor complies with ethical requirements N/A (ii) Auditor’s procedures depend on auditor’s judgment and risk assessment, and auditor considers internal control for risk assessment By: Muhammad Asif, ACA Auditing – Study Notes Chapter Auditor’s Report & Types of Opinions No heading prescribed A heading is required Auditor’s opinion is under “Fair Auditor’s opinion could be under “Fair Presentation Presentation Framework” Framework” or “Compliance Framework” Auditor expresses opinion on Auditor expresses opinion on Financial Statements Financial Statements as well as only Auditor’s Opinion Five Additional Opinions *** Auditor’s opinion mentions Auditor’s opinion does not mention statement of complete set of financial changes in equity and notes to the accounts statements as mentioned in introductory paragraph No difference in requirements Signature could be in individual’s name (in case of soleproprietor) or in firm’s name (in case of partnership) Signature However, ICAP’s ATR – 19 requires that if signature is in firm’s name, Name of Engagement Partner shall also be mentioned *** Refer to Auditor’s Report (under Form 35A) for detail of such opinions APPENDIX 2: HOW TO ATTEMPT REPORTING CASE STUDY IN EXAM: Types of Question: In exam, usually three types of questions are set to test reporting skill of students i.e You will be given a short situation, and requirement will be to explain implication of situation on auditor’s opinion or auditor’s report You will be asked to draft whole or part of auditor’s report You will be asked to identify errors from whole or part of auditor’s report Exam Tips In the absence of information, assume that Auditor’s Report is to be drafted in accordance with “Form 35A of Companies Rules 1985” If you are required to identify errors, write errors alongwith correct treatment But, DO NOT redraft report; otherwise you will get zero marks Suggested Approach (when expressing effect on opinion/report): SUGGESTED APPROACH TO SOLVE REPORTING CASE STUDIES IN EXAM State the basis for your decisions i.e Whether it is case of misstatement or scope limitation (prove from facts given in case) Whether effect is Immaterial, Material or Pervasive (mention how you determined this) State your decision i.e If effect on Opinion is required: o State opinion on financial statements o State additional opinions (when relevant) If effect on Report is required, in addition to opinion, also include following: o Basis for qualified/adverse/disclaimer of opinion Paragraph (whichever is relevant) o Emphasis of Matter or Other Matter Paragraphs (when relevant) o Reference to change in accounting policy (when relevant) (You can get FULL marks in such questions if you follow this simple-systematic approach) By: Muhammad Asif, ACA Auditing – Study Notes Chapter Auditor’s Report & Types of Opinions Exam Tip: Is Effect Immaterial, Material or Pervasive Three situations are possible in exam in this regard: It will be clearly mentioned whether item is material or pervasive (words “significant” or “major” in question means “not immaterial”) If it is not clearly mentioned, use Financials (given in question) to determine materiality using Rule of Thumb: Materiality = 5% or more of Profit before tax Pervasive = 50% or more of Profit before tax If Financials are also not given, cover Both situations i.e if Material, if Pervasive HOW TO ATTEMPT REPORTING CASE STUDY IN EXAM – AN EXAMPLE Question: Below are two independent situations, you are required to state type of opinion you would express in each situation (a) Net realizable value of inventory is lower than cost of inventory but management has not written down inventory to net realizable value Effect of this event is material (b) Auditor was appointed after the year end date and the accounting records are not sufficiently reliable to ensure accuracy of the year-end inventory balances Solution: (a) ̶ This is a case of misstatement in financial statements IFRSs require to record inventory at lower of cost and NRV but management has not written down inventory to NRV ̶ Effect is Material (clearly mentioned in case) ̶ Auditor shall express Qualified Opinion (b) ̶ This is a case of scope limitation on audit Auditor is unable to obtain evidence on inventory balance Alternative procedures also, not provide sufficient appropriate audit evidence ̶ Effect could be Material or Pervasive ̶ If effect is material, auditor shall express Qualified Opinion If effect is pervasive, auditor shall express Disclaimer of Opinion By: Muhammad Asif, ACA ...Auditing – Study Notes Chapter Auditor’s Report & Types of Opinions PART A – AUDITOR’S REPORT LO 1: ELEMENTS OF AUDITOR’S REPORT: Auditor’s Report is always in written... or auditor’s report By: Muhammad Asif, ACA Auditing – Study Notes Chapter Auditor’s Report & Types of Opinions This section contains signature by auditor: in his personal name (if auditor is... Explanation Auditor’s report shall have a title clearly indicating that it is “auditor’s report Title is necessary to differentiate auditor’s report from other type of reports included in annual report