Audit & Assurance

SBM 3306

Week 10, Lecture 9

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 Topic:
The auditor’s reporting obligations

Based on Chapter 12, Gay, G. and Simnett, R. (2015) Auditing and 2

Assurance Services in Australia 6E
 Learning objectives

At the end of this lecture, you should be able to:

Understand the nature and significance of the auditor’s reporting obligations.
Understand the structure and qualitative characteristics of the auditor’s report and
appreciate the recent changes to the report which are designed to enhance its
communication effectiveness.
Explain the differences between the concepts of ‘true and fair’ and ‘presents fairly
in accordance with’, and between a fair presentation framework and a
compliance framework.
Identify the different types of auditor’s reports—unmodified auditor’s report;
modifications to the auditor’s opinion (resulting in a qualified opinion, adverse
opinion or disclaimer of opinion); and auditor’s reports containing additional
communications (Emphasis of Matter or Other Matter paragraphs)—and describe
the circumstances under which an auditor would issue each type of report.
Identify the reasons for departures from a standard unmodified auditor’s report,
material misstatement and limitations imposed on the scope of the audit and
understand the factors giving rise to these reasons.
Describe communications other than the auditor’s report between the auditor and
shareholders, those charged with governance and management.

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 Obligations to report

ASA/ISA 200.11: the objective of an audit of the financial report

is to obtain reasonable assurance about whether the financial
report taken as a whole is free of material misstatement,
thereby enabling the auditor to express an opinion as to
whether the financial report is prepared, in all material
respects, in accordance with an applicable financial reporting
framework.

Audit is to be conducted in accordance with approved

auditing standards.

In Australia, the auditor has an obligation to form a conclusion

as to whether the financial report has been prepared using
Australian accounting standards issued by the AASB.

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 Obligations to report: s 307

The Corporations Act 2001, s 307, requires the

auditor to form an opinion as to:
(a) Whether the financial report is in accordance with
the Act, including:
(i) s 296 or 304 (compliance with accounting
standards), and
(ii) s 297 or 305 (true and fair view), and

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 Obligations to report: s 307 (continued)

s 307 continued:
(b) whether the auditor has been given all
information, explanation and assistance
necessary for the conduct of the audit, and
(c) whether the company, registered scheme
or disclosing entity has kept financial records
sufficient to enable a financial report to be
prepared and audited, and
(d) whether the company, registered scheme
or disclosing entity has kept other records and
registers as required by this Act.

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 Obligations to report: s 308

The Corporations Act 2001, s 308(1), also clearly

specifies that the auditor’s report shall state the
auditor’s opinion in relation to:
▪ subs (a)(i) of s 307(1)—compliance with
accounting standards
▪ subs (a)(ii) of s 307(1)—true and fair view.

Section 308(3)(b) states that auditor is required to

form an opinion on the matters noted in points (b) to
(d) on previous slide, but need only include these in
the auditor’s report if there is a deficiency, failure or
shortcoming in respect of any of those matters.

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 Who does the auditor have an
obligation to report to?

The engagement letter should clearly specify who the

auditor has an obligation to report to.

Auditor’s report is usually addressed to either the

governing body or members.

In addition to auditor’s report, auditors have reporting

responsibilities to:
▪ management and the board of directors on anything
prejudicial to the interests of shareholder
▪ ASIC where there are reasonable grounds to suspect a
significant contravention of the provisions of the
Corporations Act 2001 or other contraventions that will not
be adequately dealt with by comment in the auditor’s
report or by notifying directors.

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The auditor’s report and changes to improve its
communication effectiveness

There have been a number of improvements to the

standard auditor’s report over the past few years,
including clarification of the scope of the audit and
the respective responsibilities of management and
the auditor.

These improvements were primarily intended to

address the expectations gap (discussed in Chapter
1) and to promote international consistency in
auditor reporting.

Recognised that it is time for a more fundamental

change to auditor reporting.

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 Structure and qualitative characteristics of
the current auditor’s report

The standard-format auditor’s report, in use for the last 20

years, was designed to emphasise comparability and to
highlight departures from the standard form (such as a
qualified opinion) when they arose.

A suggested standard format covered both the structure

of the report and the wording.

This structure consisted of an introductory paragraph that

described the responsibility of those charged with
governance, a description of the auditor’s responsibility
and an opinion paragraph. It then included the auditor’s
opinion, and if the auditor’s opinion was modified, the
basis for the modification.

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 Reasons for enhancing the auditor’s
report

Identified issues.
▪ Other than communicating the auditor’s overall
conclusion, the content of the auditor’s report is not
viewed as being particularly useful or informative.
▪ The communication value of the auditor’s report could be
improved if changes were made to the structure and
wording of the auditor’s report.
▪ There is richer information available about the entity and its
financial report that is available to the auditor but is not
being communicated to the user.

Currently there is an ‘information gap’ between what users

believe is needed to make informed investment and fiduciary
decisions, and what is available to them through the entity’s
audited financial report or other publicly available information.
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 The enhanced auditor’s report

A number of options for enhancing auditor reporting

and narrowing the information gap were considered,
including:
changing the format and structure of the current
standard auditor’s report

expanding the auditor’s responsibilities for

consideration of other information presented with
audited financial reports

providing additional information about the entity

and the financial report.

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 The enhanced auditor’s report
(continued)

The major changes for improving the communicative

value of the auditor’s report are:
changing the location of the auditor’s opinion in the
financial report to the beginning of the report, to
give it greater emphasis

the auditor providing additional information about

the entity and the financial report (key audit
matters)

expanding the auditor’s responsibilities when

considering other information.

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Fair presentation and compliance frameworks

A financial reporting framework can either be a fair

presentation framework or a compliance
framework.

A fair presentation financial reporting framework

requires compliance with the requirements of the
framework and acknowledges that:
▪ to achieve fair presentation it may be necessary for
management to provide disclosures beyond the framework
▪ it may be necessary for management to depart from a
framework requirement to achieve fair presentation.

These disclosures or departures are commonly

referred to as true and fair overrides.
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 Fair presentation and compliance
frameworks

ASA/ISA 700.35 requires the auditor to express an

opinion as to whether the financial report ‘gives a
true and fair view’ or ‘presents fairly, in all material
respects’ in accordance with the applicable
financial reporting framework.

For the purposes of approved auditing standards,

the two phrases are equivalent.

A compliance framework is one that requires that

the framework be complied with and does not
contain the acknowledgments on the previous slide
(true and fair overrides).

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 Types of audit opinions

ASA/ISA 700 covers the auditor’s responsibility to form an

opinion on the financial report and the form and content
of unmodified auditor’s reports.

ASA/ISA 705 covers the types of modified opinions that

can be issued:
▪ qualified opinion
▪ disclaimer of opinion
▪ adverse opinion.

ASA/ISA 706 covers those situations where it is necessary

to draw users’ attention to an issue by an:
▪ Emphasis of Matter paragraph
▪ Other Matter paragraph.

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 Unmodified auditor’s report

This type of report is issued when the auditor is

satisfied in all material respects that the financial
report:
▪ has been prepared in accordance with the Corporations
Act 2001, including giving a true and fair view and
complying with Australian accounting standards and with
the Corporations Regulations 2001, and
▪ complies with IFRSs.

This form of opinion gives rise to the unmodified

opinion paragraph, as shown in Exhibit 12.1.

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 Unmodified auditor’s report (continued)

Issuing an unmodified auditor’s report means that the

auditor has determined that they have obtained
reasonable assurance that the financial report as a
whole is free from material misstatement, whether due to
fraud or error.

This means that the auditor has concluded that:

▪ sufficient appropriate audit evidence has been obtained (in
accordance with ASA/ISA 330)
▪ any uncorrected misstatements are immaterial, both
individually and in aggregate (in accordance with ASA/ISA
450)
▪ the financial report is prepared, in all material respects, in
accordance with the requirements of the applicable financial
reporting framework (ASA/ISA 700).

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 Modifications affecting the
auditor’s opinion

Nature of the matter giving rise to the modification and

pervasiveness of its effects on the financial report,
determine the type of opinion expressed.

Effects are considered to be pervasive if they:

▪ are not confined to specific elements, accounts or items of
the financial report
▪ if so confined, represent or could represent a substantial
proportion of the financial report, or
▪ in relation to disclosures, are fundamental to users’
understanding of the financial report (ASA/ISA 705.05).

For all the types of modified opinions, a basis for the

modification paragraph is inserted just before the opinion
paragraph.

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How different types of modifications
affect the auditor’s opinion

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 Qualified opinion

A qualified opinion is expressed when the auditor:

▪ concludes that misstatements are material but not
pervasive to the financial report
▪ is unable to obtain sufficient appropriate evidence on
which to base the opinion but concludes that the
possible effects on the financial report could be material
but not pervasive (ASA/ISA 705.07).

The most common types of qualified opinions issued

relate to material departures from a specific
accounting standard or material disagreements
over the carrying value of a specific asset or liability
and its potential effect on profit.

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Basis for qualified auditor’s opinion

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 Qualified auditor’s opinion

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 Adverse opinion

An adverse opinion should be expressed when the

effect of the misstatements, individually or in the
aggregate, are so material and pervasive that the
financial report taken as a whole is, in the auditor’s
opinion, misleading or of little use to the addressee
of the auditor’s report (ASA/ISA 705.08).

The most common situation in which adverse

opinions are issued is when the accounts are
prepared on a going concern basis and the auditor
concludes that it is highly improbable that the entity
will continue as a going concern (ASA/ISA 570.21).

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Basis for adverse auditor’s opinion

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 Adverse auditor’s opinion

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 Disclaimer of opinion

A disclaimer of opinion is expressed when the

auditor is unable to obtain sufficient appropriate
evidence to form an opinion, and concludes that
the possible effect of undetected misstatements on
the financial report could be both material and
pervasive (ASA/ISA 705.09–10).

In issuing a disclaimer of opinion the auditor is

communicating that there has been such a
limitation on the evidence-gathering procedures
that they are unsure whether the financial report is
reliable.

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 Basis for disclaimer of
auditor’s opinion

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Example of a disclaimer of auditor’s
opinion

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 Additional communications in the
auditor’s report: Emphasis of Matter

In certain limited circumstances it is appropriate for

the auditor to draw attention to or emphasise a
matter that is appropriately presented or disclosed
in the financial report and is considered relevant to
users of the auditor’s report, but which, because of
its nature, does not affect the auditor’s opinion.

The major examples would be when there is a

disclosure in the notes to the financial report that the
auditor considers to be complete and adequate,
but important enough to bring to users’ attention.

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 Circumstances giving rise to
Emphasis of Matter

ASA/ISA 706.A1 outlines circumstances in which Emphasis of

Matter (EoM) can be issued:
▪ uncertainty relating to the future outcome of exceptional
litigation or regulatory action
▪ early application of a new accounting standard that has a
pervasive effect on the financial report in advance of its
effective date
▪ a major catastrophe that has had, or continues to have, a
significant effect on the entity’s financial position.

Until 2014, approximately 90% of auditor’s reports in Australia

containing EoM paragraphs related to uncertainty regarding
going concern status, with going concern modifications now
classed as a separate category of modification.
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Types of auditor’s report issued in
Australia, 2005–10

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 Other Matter paragraph

The ability to include an Other Matter (OM)

paragraph in the auditor’s report allows auditor to
draw user’s attention to any other matters, not
presented or disclosed in the financial report, that
the auditor believes are sufficiently important to be
highlighted.

Circumstances giving rise to an OM paragraph are

those relevant to enhancing the user’s
understanding of the audit, the auditor’s
responsibilities or the auditor’s report.

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Circumstances giving rise to a modified opinion

The auditor’s opinion should be modified when:

the auditor concludes, based on the audit evidence
obtained, that the financial report is not free from material
misstatements, or

the auditor is unable to obtain sufficient appropriate

evidence to conclude that the financial report is free of
material misstatements (ASA/ISA 705.06).

Before issuing a modified opinion, the auditor should

take all reasonable steps to overcome the issues
giving rise to the material misstatement
(disagreements with management) or the issues
causing the auditor to be unable to obtain sufficient
appropriate evidence (limitations on scope).
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 Material Misstatement

ASA/ISA 450 defines a misstatement as the difference

between the amount, classification, presentation or
disclosure of an item reported by an entity in the financial
report and the way that item is required to be treated in
accordance with the applicable financial reporting
framework.

Therefore, a material misstatement in the financial report

may arise in relation to:
▪ the appropriateness of the accounting policies
selected
▪ the application of those accounting policies, or
▪ the appropriateness or adequacy of disclosures in the
financial report (ASA/ISA 705.A3).
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 An inability to obtain sufficient
appropriate audit evidence

An inability to obtain sufficient appropriate audit

evidence (scope limitation on the auditor’s work)
may arise for one of three reasons (ASA/ISA 705.A8):
▪ circumstances beyond the control of the entity
▪ circumstances related to the nature or timing of the
auditor’s work, or
▪ limitations imposed by the entity.

A limitation on the performance of a particular

procedure does not necessarily constitute a
limitation on the scope of the audit if the auditor is
able to obtain sufficient appropriate evidence by
performing alternative procedures.
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 The effect of materiality on the
audit qualification

The primary factor when considering whether to

modify the auditor’s opinion, or attempting to
determine what sort of modification to apply, is the
materiality of the subject matter giving rise to the
qualification.
One critical aspect is the dollar magnitude of the
effects of the matter on the financial report.
The auditor also needs to consider the nature of the
matter when making judgments regarding
materiality.

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Communications between auditor and other
parties

Shareholder communication
The primary means of communication with
shareholders is the auditor’s opinion on the financial
report included in the annual report.
A second major method of communicating with
shareholders is at the company’s annual general
meeting (AGM).
▪ However, the effectiveness of auditors’
attendance at AGMs as a communication
mechanism is limited, as only a small minority of
shareholders usually attend these meetings.

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 Communicating with management and
those charged with governance

ASA/ISA 260, supported by ASA/ISA 450, provides

guidance for the auditor in communicating with all
groups of directors and management.
If the matter concerns a significant deficiency in
internal control, the auditor should also, on a timely
basis, communicate in writing such deficiencies to
those charged with governance (ASA/ISA 265.9).
ASA/ISA 450.12 requires that the auditor
communicate with those charged with governance
any uncorrected misstatements and the effects that
they may have on the auditor’s report.

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 Communicating with management

Contacts between the auditor and management

are more extensive, more frequent and less formal
than those with shareholders, audit committees and
boards of directors.
The auditor should also communicate to the
appropriate level of management any significant
deficiencies in internal control that they have
communicated to those charged with governance,
as well as other deficiencies identified during the
audit that are deemed sufficiently important to merit
management’s attention (ASA/ISA 265.10).

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 The management letter and
discussions with management

The management letter is a written communication

between the auditor and management that is normally
issued at the conclusion of the audit engagement.

This letter summarises the auditor’s recommendations

resulting from their assessment of the entity’s business risk
and inherent risk, and any recommended improvements
in internal control.

The most critical discussions between the auditor and

management concerns the form and content of the
financial report. If accounting policies proposed by
management differ materially from those auditor
believes are appropriate, an alternative presentation
must be agreed or issue taken up with governing body.

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 Summary

The auditor’s report formally communicates the auditor’s

conclusion on the presentation of the financial report and
concisely states the basis for that conclusion.
Auditors have a reporting obligation with regard to general-
purpose financial reports.
There have been recent changes to the auditor’s report to
improve its communication effectiveness.
Auditors must determine the appropriate type of opinion to
issue.
Auditor has reporting obligations to other parties.

Gay, G. and Simnett, R. (2015) Auditing and Assurance Services in Australia 6E