Audit Reports

Hi everyone,

There are many challenging F1 topics that you will need to understand in order to successfully pass your F1 Objective Test exam. 

Audit Reports is a subject which many students find difficult to grasp at first.

At Astranti we aim to make difficult subjects easy to understand. All of our materials are designed to ensure that our students are given in-depth knowledge of all the key subjects, but in a format allows learn easily and effectively.



As an example we'd like to share with you our new and updated section of the F1 Study Text which explains Audit Reports in a straight forward and clear way. 

Audit Reports 

We can determine the outcome of an audit report by referring to the flow chart below. But first, let's look at some key concepts behind the audit process.

Materiality

The measure of whether an issue is material is based on the extent to which its omission or misstatement would have an effect on the economic decisions taken by the users of the accounts. A matter that is not material would not affect the behaviour or decisions of users and would therefore not need to be mentioned in the audit report.

The materiality of an item is a question of judgement and although percentages of profit or turnover may be used as a guide to materiality (5% of turnover is a common figure used) they are only a rough guide that must be backed up by judgement of the case in question.

Example

So, we see that a small error or misstatement will be ignored by the auditor, but a major one will be followed up on. As an example, if the cash in the bank was $10m and the auditors found that the reported figure was just a few thousand pounds out, they would deem that this does not effect a reader significantly, and it would be waived through.

If, on the other hand, the balance was a million dollars out, that would be misleading, as decisions made by the reader (an investor, for instance) would be affected, and as such this would need to be corrected, or the auditors would report it.

Pervasiveness

Pervasiveness refers to the extent to which a matter affects elements of the financial statements.

A matter is pervasive when it affects many elements of the financial statements, and thus makes their overall reliability dubious.

A matter is not pervasive when it is localised to a specific area of the financial statements, and does not render the financial statements as a whole unreliable.

Pervasiveness is distinct to materiality, because a matter can be both material and pervasive, or material and not pervasive.

Example

Let's suppose that an auditor has doubts as to whether the company classifies as a going concern. This is a material matter, and will be disclosed in the audit report. In addition, this is also a pervasive matter, because it puts the reliability of the entire financial statements under question!

However, suppose that the auditor is unable to access relevant information regarding the dividend paid for the year. Now, clearly this is material, since the auditor has no recourse to check the documentation on the calculation of dividends, thus cannot form an opinion, but it is not pervasive, because it doesn't necessarily throw the entire set of financial statements into doubt; only the dividend.

Unqualified audit report

An unqualified audit report is the standard report issued when the auditor is satisfied with each of the elements on which they have to express an opinion. Although it sounds underwhelming, this is the result the company wants!

Where there is no qualification of the report, the auditor will state in their audit opinion that:

“The financial statements give a true and fair view of the company’s financial position at the end of the accounting period and its performance and cash flows during the accounting period ending on the relevant date.”

Emphasis of Matter

Certain issues may arise in the course of an audit that do not affect the opinion expressed in the audit report, but which the auditor would like to make note of. Such a statement is called an “emphasis of matter” statement.

This is an auditor's way of saying that everything checks out, but you might want to take a look at this one thing, if the mood should take you.

So, for example, an emphasis of matter may be required in the case of the early adoption of accounting standards.

In this case, the statements are in accordance with the accounting standards, thus there is no disagreement, but the changes in accounting treatment is so great, that, in the auditor’s judgement, if not disclosed, will cause users to misinterpret the financial statements.

The Modified Audit Report

Now, what if an auditor runs in to some real issues in their audit? In situations such as a problem with access to audit evidence or the use of inadequate accounting policies in the financial statements, the auditor would need to consider issuing a modified audit report.

There are 3 types of modified audit report:

• A qualified opinion,
• A disclaimer of opinion; or
• An adverse opinion.

Let's take a look at each in turn.

Qualified opinion

A qualified opinion can be given in the following situations:

• Accounting policies used by the client company are not in accordance with the relevant financial reporting standards.
• The auditor has been restricted from obtaining all the evidence required to form an opinion

A qualified opinion can be given if there is a disagreement between the auditors and management on how a matter should be treated, but this disagreement is not great enough to lead to a disclaimer or an adverse opinion by the auditors. This type of qualified opinion is normally expressed with the words “except for” followed by a description of the issue.

Regarding pervasiveness, qualified opinions are given in instances of a material but not pervasive matter, and thus will be along the lines of, “Most of this checks out, except for this, which is a material matter.”

Disclaimer of opinion

A disclaimer of opinion is given when a limitation is placed on the scope of the audit that is sufficiently material, and affects the auditor’s work in such a manner that the auditor cannot collect enough evidence to express an opinion.

In terms of pervasiveness, a disclaimer of opinion is given in instances where a matter is both material AND pervasive, because the auditor was unable to obtain sufficient audit evidence. The nature of the matter is that the auditor is being prevented from fully completing their work.

Adverse opinion

An adverse opinion in given in a situation where a disagreement between the auditor and the management is sufficiently material and affects the financial statements in such a way that a qualified report is not sufficient.

In other words, in these cases, a qualified report would not adequately cover the extent to which the financial statements are incomplete or misleading, so an adverse opinion must be expressed.

Once more, in terms of pervasiveness, adverse opinions are given in instances where a matter is both material and pervasive. However, the nature of the matter in this instance is a serious issue with the statements, rather than a limit on the ability of the auditor to perform their work.

Example

Just to make sure you have absorbed all of the admittedly dry information in this chapter, let's go through an example to recap how an audit is undertaken.

Let's say you work in the finance department of a medium sized company and an audit has recently been conducted on your department. Unfortunately for you and your colleagues, the auditor has issued a modified report.

Now, the auditor has said that the scope of the audit was significantly limited due to inaccessible documents. We know that it is the right of the auditor to request all and any relevant information, and to be refused is a big no-no.

The denial of access to certain documents has made the auditor suspicious, and he now wonders if there may be something else going on behind the scenes. However, we also know that this is not necessarily a responsibility of the auditor to seek out fraud.

So, he doesn't mention anything about fraud. After all, such a claim would potentially be libellous, and get the auditor into a lot of trouble if it can't be backed up. Not only that, but there is no way for the auditor to confirm or deny it, since he has restricted access. If fraud really is something that is an issue in this case, it will have to wait until a later stage. Thus, rather than mentioning anything about fraud, he will issue a...

Disclaimer of opinion!

It's a material limitation that seriously affects the auditor's work. However, since the auditor can't access all the information, he can't claim that the statements are untrue. Nor would the issue be adequately covered in an 'Except for' opinion, since the matter is material AND pervasive. Therefore, what we have is a disclaimer of opinion.

You may want to start looking for work elsewhere!

Astranti Financial Training.