Qualified audit reports
| by John Wyett
01 Nov 2000
|The purpose of this article is to explain the structure of the basic form of audit report and to describe the various forms of qualified audit reports and the situations which could lead to their use. Please note that for study purposes it is pointless trying to memorise the exact wording of these reports, instead concentrate upon the structure of the report and how this may change when a qualification is in prospect.
The elements of an audit report
These are as follows:
1 Title: the report is addressed to the members of the company, remember that the auditor is under a statutory duty to report to the members of the company.
2 Scope: The purpose of this paragraph is to ensure that the elements of the financial statements which are subject to audit are identified (by reference to the relevant page numbers in the annual report).This is important to avoid misunderstandings in relation to the auditor�s opinion. An element of the so-called �expectation gap� which is claimed to exist between users of financial statements and auditors is the perception on the part of some users that the entire contents of the annual report are subject to audit so identifying the scope of the audit is crucial.
The following financial statements are subject to audit.
Note that company law requires the first two of the above list to be audited whereas the auditor needs to audit the cash flow statement and STRGL because these have to be produced to comply with FRS1 and FRS3 respectively, and compliance with accounting standards is now an accepted part of achieving a �true and fair view.� In addition, the auditors should disclose the details of directors� remuneration and details of any transactions between a company and its directors or officers if the company has not given the required disclosures in the notes to its financial statements as required by company law.
Note that the auditor is also under a statutory duty to consider if:
Auditors use exception reporting in relation to the above duty, no reference to any of these matters in the audit report indicates that they have been considered and that the auditor is satisfied.
3 The basis of the opinion: The key point in this paragraph is that the audit is conducted in accordance with auditing standards, this gives a benchmark against which the quality of the audit may subsequently be judged in the event of any external scrutiny of the auditors� work. Therefore it is very important that auditors can demonstrate compliance with all relevant auditing standards in order to satisfy external scrutiny as a result of, for example, litigation against the auditor.
4 The opinion: The key parts of the opinion paragraph are that:
In the event that the opinion is qualified the heading to the opinion paragraph will state �qualified opinion . . . . �
5 Signature and date: The report must be signed by a registered auditor and dated. The date is significant because it specifies a key point in the post balance sheet events review period and it will usually be the same as the date of approval of the financial statements. The audit report cannot be dated before the date of approval because the financial statements do not legally exist until they have been approved by the directors.
Qualified audit reports
It is necessary to firstly identify the circumstances which can give rise to a qualification.
These are as follows:
Secondly, it is necessary to decide upon the effect of the circumstances discussed above.
These are classified as:
�Fundamental� means that the matter is such as to seriously distort or undermine the view which is given by the financial statements to the extent that they could mislead user groups.
The wording of the qualification can then be arrived at using one of the examples given in the appendix to SAS 600.
An �except for� qualification will be given when the matter is a material but not fundamental uncertainty or disagreement. An example of an uncertainty could be the destruction of a part of the clients� accounting records leading to a limitation of scope being imposed upon the auditors� work because audit evidence is then unavailable. An example of a disagreement under this heading could be a failure by a client to apply a reasonable depreciation policy to a particular class of fixed assets, however in both of these examples the effect is not pervasive to the view which the financial statements give as a whole.
An �adverse� opinion indicating that the financial statements do not give a true and fair view and/or do not comply with the Companies Act 1985 will be given when the matter concerned gives rise to a fundamental disagreement. An example of this could be that the client has failed to recognise a provision which would turn a reported profit into a loss and which would fundamentally change the net asset position if it were recognised. Such qualifications are relatively rare.
A �disclaimer� opinion will be given in the event of a fundamental uncertainty and the auditors� report will indicate that an opinion cannot be given. This a very unsatisfactory state of affairs for users and SAS 601 has been introduced to deal with the situation where the uncertainty arises because of an imposed limitation of scope by the directors. This is discussed later in the article.
Finally it is important to note that qualification only occurs in relation to material items.
Note that if there is an inherent uncertainty associated with the financial statements which the directors have disclosed to the best of their abilities in the notes to the accounts (and the auditors agree with the manner of disclosure) then an �explanatory paragraph� can be added to the �basis of opinion� section of the report to ensure that users� attention is drawn to the matter concerned. It is important to remember that this does not constitute an audit report qualification.
SAS 601, Imposed limitation of audit scope
This is a relatively recent standard which was designed to deal with the situation where the auditors� response to a fundamental imposed limitation of scope placed upon their work, by the directors� actions, is to simply issue a �disclaimer� type of report as described above.
In such situations the standard requires that:
Questions on audit reporting almost invariably involve a mini case study scenario where you are invited to comment upon the given circumstances and to discuss an appropriate type of auditors� response. Make sure you understand the different types of circumstances which can lead to an audit report qualification and that you appreciate that the gravity of each circumstance can also affect the opinion.
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