UNIT 6: AUDIT REPORT

Contents
6.0 Aims and Objectives
6.1 Introduction
6.2 Statutory Requirements
6.3 Auditors Report on Financial Statements
6.4 Qualifications in Audit Report
6.5 Summary
6.6 Answer to Check Your Progress Exercise

6.0 AIMS AND OBJECTIVES

After studying this unit, you should be able to:

- describe the standard audit report
- discuss how materiality affects the considerations of the type of audit report to be
issued
- explain the main elements of an audit report
- identify the circumstances that may result in qualified opinions, adverse opinions, and
disclaimers of opinion.

6.1 INTRODUCTION

The audit report is the means by which the auditors express their opinion on the truth and
fairness of a company's financial statement for the benefit principally of the shareholders, but
also for the users. Statue has consistently recognized its importance by requiring that certain
mandatory statements appear in the report.

You should learn what the auditor reports on explicitly and what the auditor reports on by
exception. You will not be required to reproduce a full audit report in the exam, however you
may be required to:

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 (a) describe how the audit report in a specific situation differs from an unqualified audit
report,
(b) describe to give extracts from an audit report dealing with uncertainties or
disagreements.

6.2 STATUTORY REQUIREMENTS

International Auditing Standards require the auditors to state explicitly whether in the
auditors' opinion the annual accounts have been properly prepared in accordance with the
GAAP and in particular whether a true and fair view is given.
- In the balance sheet, of the state of the company's affairs at the end of financial year.
- In the profit and loss account, of the company's profit or loss for the financial year;
and
- In the case of group accounts, of the state of affairs at the end of financial year and the
profit or loss for the year of undertakings including in the consolidation, so far as
concerns member of the company.

In addition, certain requirements are reported on by exception; the auditor only has to report if
they have not been met. The following are matters with which the auditors imply satisfaction
in an unqualified report.

- Proper accounting records have been kept and proper returns adequate for the audit
received from branches not visited.
- The accounts are in agreement with accounting records and returns.
- All information and explanations have been received as the auditors think necessary
and they have had access at all times to the company's book, accounts and vouchers.
- Details and directors' emoluments and other benefits, and particular of higher paid
employees have been correctly disclosed in the financial statements.
- Particulars of loans and other transactions in favor of directors and others have been
correctly disclosed in the financial statements.
- The information given in the directors' report is consistent with the accounts.

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Directors' Emoluments
The auditor should include in their report the required disclosure particulars of directors'
emoluments and transactions with directors, if these requirements have not been complied
with in the accounts. This means that the auditors carryout various procedures to ensure that
they are aware of all such emoluments and transactions by reference to directors' service
contracts, board minutes, cash book payments and so on. Benefits received in kind may be
particularly hard to identify.

6.3 AUDITORS' REPORT ON FINANCIAL STATEMENTS

Auditors' reports on financial statements should contain a clear expression of opinion based
on review and assessment of the conclusions drawn from evidence obtained in the course of
the audit.

6.3.1 Basic Elements of the Audit Report

Auditors' reports on financial statements should include the following matters.
a) A title identifying the person or person to whom the report is addressed.
b) An introductory paragraph identifying the financial statement audited.
c) Separate sections, appropriately headed, dealing with
- respective responsibilities of directors (or equivalent persons) and auditors
- the basis of the auditors' opinion
- the auditors' opinion on the financial statements
d) The manuscript or printed signature of the auditors and
e) The date of the auditors' report.

Unqualified Opinion
Example 1: Unqualified Opinion
Auditors' Report to the shareholders of XYZ PLC we have audited the financial statements on
pages __ to __ which have been prepared under the historical cost convention and the
accounting policies set on page ….

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Respective Responsibilities of directors and auditors
As described on page … the company's directors are responsible for the preparation of
financial statements. It is our responsibility to form an independent opinion, based on our
audit, on those statements and to report our opinion to you.

Basis of opinion
We conducted our audit in accordance with audit standards issued by the audit practices
board. An audit includes examination, on a test basis, of evidence relevant to the amounts and
disclosures in the financial statements. It also includes an assessment of the significant
estimates and judgments made by the directors in the preparation of the financial statements,
and of whether the accounting policies are appropriate to the company's circumstances,
consistently applied and adequately disclosed.

We planned and performed our audit so as to obtain all the information and explanations
which we considered necessary in order to provide us with sufficient evidence to give
reasonable assurance that the financial statements are free from material misstatement,
whether caused by fraud or other irregularity or error. In forming our opinion we also
evaluated the overall adequacy of the presentation of information in the financial statements.

Opinion
In our opinion the financial statements give a true and fair view of the state of the company's
affairs at 31 December 20__ and of its profit (loss) for the year then ended and have been
properly prepared in accordance with GAAP.

Registered Auditor
Date Address

The report recommends the use of standard format as an aid to the reader, including headings
for each section, for example 'Qualified Opinion'. The title and address and the introductory
paragraph are fairly self-explanatory.

Statements of Responsibility and Basic Opinion

a) Auditors should distinguish between their responsibilities and those of the directors by
including in their report.

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 i) a statement that the financial statements are the responsibility of the
reporting entity's directors
ii) a reference to a description of those responsibilities when set out elsewhere
in the financial statements or accompanying information: and
iii) a statement that the auditors' responsibility is to express an opinion on the
financial statements.
b) Where the financial statements or accompanying information (for example the
directors' report) do not include an adequate description of directors' relevant
responsibilities the auditor report should include a description of those responsiblities.

Example wording of a description of the directors' responsibilities for inclusion in a

company's financial statements.

A description of the directors' responsibilities can be produced by the directors or included by

the auditors in their report.

Company law requires the directory to prepare financial statements for each financial year
which give a true and fair view of the state of affairs of the company and of the profit or loss
of the company for the period. In preparing these financial statements the directors are
required to:
a) select suitable accounting policies and then apply them consistently
b) make judgments and estimates that are responsible and prudent:
c) state whether applicable accounting standards have been followed, subject to any
material departures disclosed and explained in the financial statements
d) prepare the financial statements on the going concern basis unless it is inappropriate to
presume that the company will continue in business (if not separate statement on going
concern is made by the directors).

The directors are responsible for keeping proper accounting records, which disclose with
reasonable accuracy at any time the financial position of the company and to enable them to
ensure that the financial statements comply with the companies Act 1985. They are also
responsible for safeguarding the assets of the company and hence for taking reasonable steps
for the prevention and detection of fraud and other irregularities.

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Explanation of Auditors' Opinion
Auditors should explain the basis of their opinion by including in their report:
a) a statement as to their compliance or otherwise with Auditing standards, together with
the reasons for any departure there from:
b) a statement that the audit process includes
i) examining, on a test basis, evidence relevant to the amount and disclosures
in the financial statements
ii) assessing the significant estimates and judgments made by the reporting
entity's directors in preparing the financial statements;
iii) considering whether the accounting policies are appropriate
To the reporting entity's, circumstances, consistently applied and adequately disclosed.

c) A statement that they planned and performed the audit so as to obtain reasonable
assurance that the financial statements are free from material misstatement, whether
caused by fraud or other irregularity or error, and that they have evaluated the overall
preparation of the financial statements.

In some exceptional circumstances, a departure from auditing standards may be appropriate to

fulfill the objective of a specific audit more effectively. If this is the case, the auditor should
explain the reason for that departure in their report. Other than in such exceptional and
justifiable circumstances, a departure from an auditing standard is a limitation on the scope of
work undertaken by the auditors.

Expression of Opinion
An auditors' report should contain a clear expression of opinion on the financial statements
and on any further matters required by statute or other requirements applicable to the
particular engagement.

An unqualified opinion on financial statement is expressed when in the auditors' judgment

they give a true and fair view (where relevant) and have been prepared in accordance with
relevant accounting or other requirements. This judgment entails concluding whether inter
alia.

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 a) The financial statements have been prepared using appropriate consistently applied
accounting policies
b) The financial statement have been prepared in accordance with relevant legislation,
regulations or applicable accounting standards (and that any departures are justified
and adequately explained in the financial statements); and
c) There is adequate disclosure of all information relevant to the proper understanding of
the financial statements.

Date and Signature of the Auditors' Report

a) Auditors should not express an opinion on financial statement until those statements
and all other financial information contained in a report of which the audited financial
statements form a part have been approved by the directors, and the auditors have
considered all necessary available evidence.
b) The date of an auditors' report on a reporting entity's financial statements is the date on
which the auditors signed their report expressing an opinion on those statements.

The date of the auditors' report is, therefore, the date on which, following;
a) receipt of financial statements and accompanying documents in the form approved by
the directors for release
b) review of all documents which they are required to consider in addition to the
financial statements (for example the directors' report, chairman's statement or other
review of an entity's affairs which will accompany the financial statements); and
c) completion of all procedures necessary to form an opinion on the financial statements
(and any other opinion required by law or regulation) including a review of post
balance sheet events.
The auditors sign their report expressing an opinion on the financial statements for
distribution with those statements.

If the date on which the auditor sign the report is later than that on which the directors
approve the financial statements, then the auditors must check that the post balance sheet
event review has been carried out up to the date they sign their report and that the directors
would also have approved the financial statement on that date.

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6.3.2 Forming an Opinion on the Financial Statement
The principal matters, which auditors consider in forming an opinion may be expressed in
three question.
a) Have they completed all procedures necessary to meet auditing standards and to obtain
all the information and explanations necessary for their audit?
b) Have the financial statements been prepared in accordance with the applicable
accounting requirements?
c) Do the financial statements, as prepared by the directors, give a true and fair view?

Note: requirements are referred to in terms of generally accepted accounting principles.

6.4 QUALIFICATIONS IN AUDIT REPORTS

Prior to the introduction of auditing standards, qualified audit reports were often criticized as
failing to convey the meaning intended.

The standard on audit reports aimed:

a) to outlaw the use of ambiguous ways of qualifying
b) to categorize the circumstances giving rise to qualification
c) to prescribe suggested wording and format for different categories of qualification
d) to introduce a distinction between material and fundamental problems
e) to promote better drafting by using non-technical language and clear presentation.

6.4.1 The Qualification 'Matrix'

Auditing standards give the circumstances in which each sort to qualification would be
appropriate where the auditors are unable to report affirmatively on the matters contained in
the paragraphs about which they are reservations, they should give:

a) a full explanation of the reasons for they qualification

b) whenever possible, a quantification of its effect on the financial statements. Where
appropriate, reference should be made to non-compliance with relevant legislation and
other requirements.

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The standard stresses the fact that a qualified audit report should leave the reader in no doubt
as to its meaning and its implication for an understanding of the financial statements. In order
to promote a more consistent understanding of qualified audit reports, Accounting Practices
Board (APB) recommends that the forms of qualification described in the standard should be
used unless, in the auditors' opinion, to do so would fail to convey clearly the intended
meaning.

The APB takes the view that the nature of the circumstances giving rise to a qualification of
the auditor's opinion will generally fall into one of two categories.
a) where there is a limitation in the scope of work which prevents the auditors from
forming an opinion on a matter (uncertainty).
b) where the auditors are able to form an opinion on a matter but this conflicts with the
view given by the financial statements (disagreement).

Either case, uncertainty or disagreement, may give rise to alternative forms of qualification.
This is because the uncertainty or disagreement can be:
a) material but not fundamental; or
b) of fundamental importance to the overall true and fair view.

The standard requires that the following forms of qualification should be used in the different
circumstances outlined below.
Qualification Matrix
Nature of circumstances Material but not fundamental Fundamental
Limitation in scope Except for … might Disclaimer Adverse
disagreement Except for …

- Except for …might: Auditors disclaim an opinion on a particular aspect of the

accounts, which is not considered fundamental.
- Disclaimer of opinion: Auditors state they are unable to form an opinion on truth and
fairness.
- Except for: Auditors express an adverse opinion on a particular aspect of the accounts,
which is not considered fundamental.
- Adverse opinion: Auditors state the accounts do not give a true and fair view.

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6.4.2 Limitations on the Scope of an Audit
One source of uncertainties is limitations in the scope of the audit. Scope limitations will arise
where the auditor is unable for any reason to obtain all the information and explanations,
which he considers necessary for the purpose of his audit, arising from:
a) absence of proper accounting records
b) inability to carryout audit procedures considered necessary as, for example, where the
auditor is unable to obtain satisfactory evidence of the existence or ownership of
material assets.

When there has a limitation on the scope of the auditors' work that prevents them from
obtaining sufficient evidence to express an unqualified opinion.

a) the auditors report should include a description of the factors leading to the limitation
in the opinion section of their report.
b) the auditors should issue a disclaimer of opinion when the possible effect of a
limitation on scope is so material or pervasive that they are unable to express an
opinion on the financial statements.
c) a qualified opinion should be issued when the effect of the limitation is not as material
or pervasive as to require a disclaimer, and the wording of the opinion should indicate
that it is qualified as to the possible adjustments to the financial statements that might
have been determined to be necessary had the limitation not existed.

When giving this type of qualified opinion, auditors should assess:

a) the quality and type of evidence which may reasonably be expected to be available to
support the figure or disclosure in the financial statements,
b) the possible effect on the financial statements of the matter for which insufficient
evidence is available.

Example 2: Qualified Opinion: Limitation on the auditor's work

(Basis of opinion: excerpt)
… or error. However, the evidence available to us was limited because Br. .. of the company's
recorded turnover comprises cash sales, over which there was no system of control on which
we could rely for the purposes of our audit. There were no other satisfactory audit procedures

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that we could adopt to confirm that cash sales were properly recorded. In forming our opinion
we also evaluated the overall adequacy of the presentation of information in the financial
statements.

Qualified opinion arising from limitation in audit scope

Except for adjustments that might have been found to be necessary had we been able to obtain
sufficient evidence concerning cash sales, in our opinion the financial statements give a true
and fair view of the state of the company's affairs as at 31 December 20.. and of its
profit(loss) for the year then ended and have been properly prepared in accordance with
generally accepted accounting principles. In respect alone of the limitation on our work
relating to cash sales:
a) we have not obtained all the information and explanations that we considered
necessary for the purpose of our audit, and
b) we were unable to determine whether proper accounting records had been maintained.

Example 3: Disclaimer of Opinion

Opinion: Disclaimer on view given by financial statements
Because of the possible effect of the limitation in evidence available to us, we are unable to
form opinion as to whether the financial statements give a true and fair view of the financial
affairs as at 31 December 20.. or of its profit(loss) for the year then ended. In all the respects,
in our opinion the financial statements have been prepared in accordance with GAAP. In
respect of the limitation on our work relating to stock and work in progress.

a) We have not obtained all the information and explanations that we considered
necessary for the purpose of our audit, and
b) We were unable to determine whether proper accounting records had been maintained.

6.4.3 Circumstances Giving Rise to Disagreements

The explanatory notes suggest that circumstances giving rise to disagreement include the
following.
a) Inappropriate accounting policies
b) Disagreement as to facts or amounts included in the financial statements.

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 c) Disagreement as to the manner or extent of disclosure of facts or amounts in the
financial statements.
d) Failure to comply with relevant legislation or other requirements

Where the auditors disagree with the accounting treatment or disclosure of a matter in the
financial statements, and in the auditors' opinion the effect of that disagreement is material to
the financial statements.
a) the auditors should include in the opinion section of their report
i) a description of all substantive factors giving rise to the disagreement
ii) their implications for the financial statements
iii) whenever practicable, a quantification of the effect on the financial statements.
b) when the auditors conclude that the effect of the matter giving rise to disagreement is
so material or persuasive that the financial statements are seriously misleading, they
should issue an adverse opinion:
c) in the case of other material disagreements, the auditors should issue a qualified
opinion indicating that it is expressed except for the effects of the matter giving rise to
the disagreement.

Check Your Progress Exercise

1. What are the basic elements of the auditors' report?
…………………………………………………………………………………………………
…………………………………………………………………………………………………
………………………………………………………………………………………………….
2. Write down a description of the directors' responsibilities, which should be
included in the financial statements?
…………………………………………………………………………………………………
…………………………………………………………………………………………………
………………………………………………………………………………………………….
3. What will the judgment of whether the financial statements show a true and
fair view entail?

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…………………………………………………………………………………………………
…………………………………………………………………………………………………
………………………………………………………………………………………………….
4. When will a qualified opinion be issued?
…………………………………………………………………………………………………
…………………………………………………………………………………………………
………………………………………………………………………………………………….
5. What is the effect of a limitation of scope on the audit report?
…………………………………………………………………………………………………
…………………………………………………………………………………………………
………………………………………………………………………………………………….
6. When should the auditors' report be dated?
…………………………………………………………………………………………………
…………………………………………………………………………………………………
………………………………………………………………………………………………….

6.6 SUMMARY

Generally Accepted Auditing standards require the auditor to state explicitly whether in the
auditors' opinion the annual financial statements have been properly prepared in accordance
with GAAP and in particular whether a true and fair view is given.

The main elements of an unqualified audit report are:

- a title identifying the addressee
- an introductory paragraph identifying the financial statements audited
- sections dealing with
o responsibilities of directors and auditors
o basis of auditors' opinion
o a clear statement of opinion

Auditors may qualify their audit opinion on the grounds of disagreement or limitation of
scope; these may be material or fundamental.

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6.6 ANSWER TO CHECK YOUR PROGRESS EXERCISE

7. Refer Section 6.3.1

8. Refer Section 6.3.1
9. Refer Section 6.3.1
10. Refer Section 6.4.1
11. Refer Section 6.4.2
12. Refer Section 6.3.1

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