ACCA Articles

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A Matter of Opinion

Students studying ACCA F8 (Audit and Assurance) and P7 (Advanced Audit and Assurance) must be familiar with the auditor’s report and the opinion contained therein as well as the circumstances in which the opinion is arrived at.

The objective of the audit is for the independent auditor to express an opinion as to whether the financial statements of an entity give a ‘true and fair view’ (or ‘present fairly, in all material respects’) in accordance with that particular financial reporting framework and comply with statutory requirements.

The auditor’s reports are dealt with in ISA 700 (revised) ‘The Independent Auditor’s Report on a Complete Set of General Purpose Financial Statements’.

This article looks at the different opinions an auditor may give on a set of financial statements and looks at some illustrative examples of when the opinions are appropriate.

In forming their opinion, an auditor must evaluate all the audit evidence collated by them during the course of the audit.  In evaluating this evidence, the auditor must decide whether they have obtained (as a result of that evidence), reasonable assurance that the financial statements of the reporting entity are free from material misstatement.  In addition, the auditor must also look at the effect of any identified misstatements within the financial statements and consider their effect also.

Composition of the Auditor’s Report

The following elements make up the auditor’s report on a set of general purpose financial statements:

• Title;
• Addressee;
• Introductory paragraph that identifies the financial statements audited;
• A description of management’s responsibility for the preparation of the financial statements;
• A description of the auditor’s responsibility to express an opinion on the financial statements which includes:
• reference to the International Standards on Auditing (ISAs); and
• a description of the work the auditor performs in an audit
• The opinion paragraph;
• Where relevant, an emphasis of matter paragraph;
• Date of the report;
• Auditor’s signature; and
• Auditor’s address

The opinions an auditor can express on a set of general purpose financial statements are:

• an unqualified opinion;
• a qualified opinion;
• an adverse opinion; and
• a disclaimer

The Unqualified Audit Opinion

An unqualified audit opinion is given when, in the opinion of the auditor, the financial statements give a true and fair view (or present fairly, in all material respects) and are prepared in accordance with the applicable financial reporting framework.

It is important to understand that an unqualified audit opinion does not guarantee that the financial statements are absolutely free from error.

During the course of the audit, the auditor may have identified some uncorrected misstatements which management have decided not to correct.  As long as these misstatements are immaterial, both individually and when aggregated, the auditor can still express an unqualified opinion.  Remember that ‘tolerable error’ (also referred to as the ‘materiality level’) is the error the auditor is willing to accept and still conclude the financial statements are free from material misstatement.

It is important that students understand the concept of ‘tolerable error’.  Consider the following example:

Illustration

Alicia Enterprises Inc has prepared their financial statements for the year ended 31 December 2008.  Revenue amounts to $2,500,000 and profit before tax amounts to $760,000.  Net assets amount to $4,500,000.  During the course of the audit the auditors discovered that a prepayment amounting to $1,500 had been omitted from the financial statements.  The directors do not wish to amend the financial statements as a result of the omission.

Solution

Clearly the omission is immaterial at less than 1% of profit before tax and even less in relation to net assets.  The auditor can still issue an unqualified opinion even though the directors do not wish to correct the misstatement. 

Qualified Opinion

A qualified opinion is given when the auditor concludes that an unqualified opinion is not appropriate in the circumstances but the effect of any disagreement with management, or scope limitation, is not so material and pervasive to warrant an adverse or disclaimer of opinion.

A qualified opinion is expressed as being ‘except for’ the effects of the matter(s) which the qualification relates.

Illustration

Alex Enterprises Inc has prepared their financial statements for the year ended 31 March 2009.  On 14 April 2009 your firm was appointed as their new auditors as their previous firm had to resign as they no longer had the resources available to deal with the audit efficiently. 

The financial statements of Alex Enterprises Inc shows closing inventory amounting to $17.5 million, which is highly material to the financial statements.  During the course of the audit, the auditor has gathered sufficient and appropriate audit evidence to support the opening balances of Alex Enterprises Inc as at 1 April 2008.  However, your firm were not appointed as auditors until 14 April 2009 (two weeks after the year end inventory count was performed).  The previous audit firm also did not attend the inventory count.

Solution

Where inventory is considered material to a set of general purpose financial statements, then the auditor is required to attend the inventory count to confirm the existence and condition of the inventory.  This test enables the auditor to inspect the inventory and to observe compliance with management’s procedures for recording and controlling the count and provides evidence as to the reliability of the management’s implemented procedures.

As the audit firm had not attended the inventory count they were unable to confirm the existence and condition of stock and to confirm that the procedures adopted by management had either been complied with or would have reduced the risk of material misstatement in relation to inventory.  A qualified opinion ‘except for’ should be given in these circumstances.

Adverse Opinion

An adverse opinion is when the effect of a disagreement is so material and pervasive to the financial statements that the auditor concludes a qualified opinion is not sufficient enough to disclose the matter(s) concerned.

Illustration

Lucas Enterprises Inc has prepared their financial statements for the year ended 31 December 2008.  Revenue amounts to $16 million, profit before taxation amounts to $1.3 million and net assets amount to $1.8 million. 

On 31 October 2008 a triennial valuation was undertaken by the Actuarial firm on Lucas Enterprises’ Defined Benefit Pension Scheme which showed a deficit on the Defined Benefit Pension Scheme amounting to $1.6 million.  The Directors of Lucas Enterprises have obtained a quotation from the Actuaries to provide the actuarial information required to bring the deficit onto the statement of financial position and to enable the relevant accounting input into the statement of comprehensive income as per the requirements in IAS 19 ‘Employee Benefits’.  The Directors are of the opinion that the fees to be levied by the actuaries for providing this information cannot be justified and have refused to obtain this information.

Solution

Clearly the Defined Benefit Pension Scheme needs to be included in the financial statements of Lucas Enterprises Inc.  However, without the actuarial information, the accounting input cannot be made into the financial statements.  The accounting input would clearly affect both the statement of financial position and the statement of comprehensive income.  In this situation, because of the material aspect of the issue, an adverse opinion should be given because the financial statements will not give a true and fair view (or present fairly, in all material respects).

Disclaimer

A disclaimer of opinion is given by the auditor when the possible effect of a scope limitation is so material and pervasive that the auditor has not been able to gather sufficient appropriate audit evidence and is therefore unable to express an opinion on the financial statements. By definition, a disclaimer is not an opinion.

Illustration

DodgyClients Inc have prepared their financial statements for the year ended 31 December 2008.  During the course of the audit the auditors failed to gather sufficient evidence to support the amounts disclosed in the financial statements.  The auditors had also concluded that during the year there had been a substantial failing in the internal control systems in that the systems did not prevent, detect or correct errors or misstatements.  The Directors said that there had been a flood in the year which resulted in a mass of information being destroyed.  The auditors had also discovered that material differences had been written off to the statement of comprehensive income with the narrative ‘correction to closing SoFP balance’ but with no supporting evidence
to substantiate the ‘correction’.  The Directors are of the opinion that the financial statements give a fair reflection of their expectations for the year despite the auditors not being able to generate the evidence to support the amounts and disclosures contained within them.

Solution

Clearly in this situation, the auditors cannot express an opinion on the financial statements and as such should issue a disclaimer

Emphasis of Matter Paragraphs
Finally we come to the emphasis of matter paragraph.  It is important that students understand that an emphasis of matter paragraph does not affect the auditors opinion.  An emphasis of matter paragraph is included after the opinion paragraph to highlight to the user of the financial statements, fundamental uncertainties that could affect the entity in future periods.

Illustration

Smyth Enterprises Inc is the defendant in a legal case relating to the infringement of copyright.  Smyth Enterprises has lodged a counter-claim and preliminary hearings are in the process of being heard.  The legal advisers have said that the outcome cannot be predicted and no provisions have been made in the financial statements as a result.  The case is considered to be significant.

Solution

An emphasis of matter paragraph should be made in the auditor’s report because of the significant uncertainty, though this paragraph will not affect the auditor’s opinion.  There has been no breach of accounting standard because IAS 37 ‘Provisions, Contingent Assets and Contingent Liabilities’ also prohibits providing for amounts in the financial statements when the outcome of such circumstances is uncertain.  Such a paragraph could be cross-referenced to the note in the financial statements in connection with contingent liabilities.

Conclusion

The report of the auditors is pivotal to the auditing profession.  Students must have an awareness of when an audit opinion is appropriate and in which circumstances.  The work of an auditor in real life is mainly judgement-based and professional judgement should be demonstrated in examinations as well.  When considering the potential qualification of an auditor’s opinion (or even adverse or disclaimer) bring in the provisions of ISA 260 (revised and redrafted) ‘Communication With Those Charged With Governance’ and what this standard says in relation to advising management as to problems encountered during the audit which would potentially give rise to a qualified, adverse or disclaimed audit opinion - this will demonstrating an element of ‘thinking outside the box’!

Steve Collings FMAAT ACCA DipIFRS is Audit and Technical Manager at Leavitt Walmsley Associates and a partner in AccountancyStudents.co.uk.  He is also the author of ‘A Summary of IFRS and IAS’ which can be purchased direct from http://www.accountancystudents.co.uk