CHAPTER SIX

AUDIT REPORT

Introduction
The Auditor's report is a formal opinion, or disclaimer thereof, issued by either an internal
auditor or an independent external auditor as a result of an internal or external audit or evaluation
performed on a legal entity or subdivision thereof (called an “auditee”). Reports are essential to
audit and assurance engagement, because they communicate the auditor’s findings. Users of
financial statement rely on the auditor’s report to provide assurance on the company’s financial
statement. The auditor is held responsible if an incorrect audit report is issued. The audit report is
the final step in the entire audit process.
6.1. Components of Audit Report
To enable users understand audit report, professional standards provide uniform wording for
auditor’s report. An audit report has to contain a minimum of the following seven parts.
1. Report title: - Auditing standard requires that the report be titled and that the title include the
word “independent”. For example, appropriate title would be “independent auditors report”,
“report of independent auditors”, or “independent accountant’s opinion”. The requirement that
the title includes the word independent is intended to convey to users that the audit was unbiased
in all aspects.
2. Audit Report Address: - the report is usually addressed to the company, its stockholders or
board of directors. In recent years, it has become customary to address the report to stockholders
to indicate that the auditor is independent of the company and the board of directors.
3. Introductory Paragraph: - The first paragraph of the report does three things:-
1. It makes a simple statement that CPA firm has conducted an audit to distinguish it from
review or compilation.
2. It state financial statements that were audited in the wordings given by management
together with exact dates or periods
3. It shows that the statements are the responsibilities of managers, and the auditors work is
to give an opinion to indicate that the selection of IFRS is up to managers.

1
4. Scope Paragraph: - The scope paragraph is a factual statement about what the auditor did
in the audit. This paragraph first states that the auditor followed generally accepted auditing
standards. The remainder briefly describes important aspects of an audit. The scope paragraph
states that the audit is designed to obtain reasonable assurance about whether the statements
are free of material misstatement. The inclusion of the word material conveys that the auditor is
responsible only to reach for significant misstatements not minor misstatements that do not
affect users’ decision. The use of the term reasonable assurance is intended to indicate that an
audit cannot be expected to completely eliminate the possibility that a material misstatement will
exist in the financial statement. In other words, an audit provides a high level of assurances, but
it is not a guarantee.
The remainder of the scope paragraph discusses the audit evidence accumulated and states
that the auditor believes that the evidence accumulated was appropriate for the circumstance
to express the opinion presented. The word test basis indicates that sampling is used rather than
an audit of every transaction and amount on the statement. The scope paragraph states that the
auditor evaluates the appropriateness of those accounting principles, estimates and financial
statements disclosures and presentations given.
5. Opinion Paragraph: The final paragraph in the standard report states the auditors
conclusions based on the results of the audit. This part of the report is so important that often the
entire audit report is referred to simply as the auditor’s opinion. The opinion paragraph is stated
as an opinion rather than as a statement of absolute fact or a guarantee. The intent is to
indicate that the conclusions are based on professional judgment. The phrase in our opinion
indicates that may be some information risk associated with the financial statement, even though
the statements have been audited.
The opinion paragraph is directly related to the first and the fourth generally accepted
auditing reporting standards. The auditor is required to state an opinion about financial
statement taken as a whole, including the conclusion about whether the company followed IFRS.
Financial statements are presented fairly when the statements are in accordance with IFRS but
that it is also necessary to examine the substance of transactions and balances for possible
misinformation.

2
6. Name of CPA Firm: the name identifies the CPA firm or practitioner who performed the
audit. Typically, the firm’s name is used because the entire CPA firm has the legal and
professional responsibility to ensure that the quality of the audit meets professional standards.
7. Audit Report Date: The appropriate date for the report is one on which the auditor has
completed the most important auditing procedures in the field. This date is important to users
because it indicates the last date of the auditor’s responsibility for the review of significant
events that occurred after the date of financial statements. For example, if the balance sheet is
dated December 31, 1998, and the audit report is dated March 6, 1999. This indicates that the
auditor has searched for material unrecorded transactions and events that occurred up to March
6, 1999. If the auditor searched only until the financial statement date, the audit report date
should be December 31, 1998.
6.2 Kinds of Audit Opinion
There are five common types of auditor’s reports, each one presenting a different situation
encountered during the auditor’s work.
1. Standard Unqualified Opinion Report
2. Unqualified opinion with explanatory paragraph or modified wording
3. Qualified opinion Report
4. Adverse Opinion Report
5. Disclaimer of opinion Report
These different types of audit reports will be discussed in detail in the following sub units
6.2.1 Standard Unqualified Audit Report
This type of report is issued by an auditor when the financial statements presented are free from
material misstatements and are presented fairly in accordance with the Generally Accepted
Accounting Principles (IFRS), which in other words means that the company’s financial
condition, position, and operations are fairly presented in the financial statements. It is the best
type of report an auditee may receive from an external auditor. The standard unqualified audit
report is sometimes called a clean opinion, because there are no circumstances requiring a
qualification or modification of the auditor’s opinion. The standard unqualified report is the most
common audit opinion. Sometimes, circumstances beyond the client auditor’s control prevent the
issuance of a clean opinion. However, in most cases, companies make the appropriate changes to

3
their accounting records to avoid a qualification or modification by the auditor. The standard
unqualified audit report is issued when the following conditions have been met:
1. All statements- balance sheet, income statements or retained earnings and statements of
cash flow-are included in the financial statement.
2. The three general standards have been followed in all respects on the engagement
3. Sufficient evidence has been accumulated, and the auditor has conducted the engagement
in a manner that enables him or her to conclude that the three standards of filed work
have been met.
4. The financial statements are presented in accordance with Generally Accepted
Accounting Principles. This also means that adequate disclosures have been included in
the footnotes and other parts of the financial statements.
5. There are no circumstances requiring the additions of an explanatory paragraph or
modification of the wording of the report.
If any of the five requirements for the standard unqualified audit report are not met, the standard
unqualified report cannot be issued.

The following is an example of a standard unqualified auditor’s report on financial statements as

it is used in most countries, using the name ABC Company as an auditee’s name:

INDEPENDENT AUDITOR’S REPORT

To: Stockholders
ABC Company, Inc.

We have audited the accompanying financial statement of ABC Company, Inc. as of December
31, 2009 and the related statements of income, retained earnings, Balance sheet and cash flows
for the year then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial statements based on
our audit.

We conducted our audit in accordance with auditing standards generally accepted in (the
country where the report is issued). Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free from material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting

4
principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a reasonable basis for our
opinion.

In our opinion, the financial statements referred to above presents fairly, in all material respects,
the financial position of the Company as of December 31, 2009, and the results of its operations
and its cash flows for the year then ended in accordance with accounting principles generally
accepted in (the country where the report is issued).

AUDITOR’S SIGNATURE
Auditor’s name and address

Date of completion of the major field work

6.2.2. Unqualified Audit Report with Explanatory Paragraph or Modified

Wording
In certain situation, an unqualified audit report is issued, but the wording deviates from the
standard unqualified report. The unqualified audit report with explanatory paragraph or modified
wording meets the criteria of a complete audit with satisfactory results and financial statements
that are fairly presented, but the auditor believes it is important or is required to provide
additional information. The followings are the most important causes of the addition of an
explanatory paragraph or a modification in the wording of the standard unqualified report.
1. Lack of consistent Application of IFRS
The second reporting standard requires the auditor to call attention to circumstances in which
accounting principles have not been consistently observed in the current period in relation to the
preceding period. Generally Accepted Accounting Principles/IFRS require that change in
accounting principles or their method of application is to a preferable principle that the nature
and impact of the change be adequately disclosed. When a material change occurs, the auditor
should modify the report by adding an explanatory paragraph after the opinion paragraph that
discusses the nature of the change and points the reader to the footnotes that discusses the
change. An explanatory paragraph is required for both voluntary changes and required changes
due to a new accounting pronouncement

5
Explanatory paragraph because of change in accounting principles
Independent auditor’s opinion
(Same introductory, scope, and opinion paragraph as the standard report)

As discussed in the note to the financial statements, the company changed its method of
computing depreciation in 2009.

It is implicit in the explanatory paragraph in the above table that, the auditor agrees with the
appropriateness of the change in accounting principles. If the auditor does not so agree, the
change is considered a violation of Generally Accepted Accounting and his or her opinion must
be different
2. Consistency versus Comparability
The auditor must be able to distinguish between changes that affect consistency and those that
may affect comparability but don’t affect consistency. The following are examples of changes
that affect consistency and therefore require explanatory paragraph if they are material
 Change in accounting principles, such as change from FIFO to LIFO inventory valuation
 Changes in reporting entities, such as the inclusion of an additional company in combined
financial statements
 Correction of errors involving principles, by changing from an accounting principle that
is not generally acceptable to one that is generally acceptable, including correction of the
resulting error
Changes that affect comparability but not consistency and therefore need not be included in the
audit report include the following
 Changes in estimates, such as a decrease in the life of an asset for depreciation purposes
 Error corrections not involving principles such as a previous years mathematical error
 Variation in format and presentation of finical information
 Changes because of substantially different transactions or events, such as new endeavors
in research and development or the sales of subsidiary.
Items that materially affect the comparability of financial statements generally require disclosure
in the footnotes. A qualified audit report for inadequate disclosure may be required if the client
refuses to properly disclose the items

6
3. Substantial Doubt about Going Concern
Even though the purpose of an audit is not to evaluate the financial health of the business, the
auditor has a responsibility to evaluate whether the company is likely to continue as a going
concern. For example, the existence of one or more of the following factors causes uncertainty
about the ability of a company to continue as a going concern:
 Significant recurring operating losses or working capital deficiencies
 Inability of the company to pay its obligation as they come due
 Loss of major customers, the occurrence of uninsured catastrophes such as an earthquake
or flood, or unusual labor difficulties
 Legal proceedings, legislation, or similar matters that have occurred that might jeopardize
the entity’s ability to operate
When the auditor concluded that there is substantial doubt about the entity’s ability to continue
as a going concern, unqualified opinion with an explanatory paragraph is required, regardless of
the disclosure in the financial statement. The following table provides an example in which there
is substantial doubt about going concern.
Independent auditor’s opinion
(Same introductory, scope, and opinion paragraph as the standard report)

The accompanying financial statements have been prepared assuming that ABC Company
continues as going concern. As the discussion in the note to the financial statements, ABC
Company has suffered recurring losses from operations and has a net capital deficiency that
raises substantial doubt about the company’s ability to continue as a going concern.
Managements plan in regard to these matters are also described in the note. The financial
statements don’t include any adjustments that might result from the outcomes of this uncertainty.
4. Auditors Agrees with a Departure from a Promulgated Principle
Sometimes the company’s departure from Generally Accepted Principles is acceptable, if
adhering to the principles would have produced a misleading result. In this case, the auditor can
issue Standard unqualified audit report with additional explanation for the change.
5. Emphasis of Matter
Under certain circumstance, the auditor may want to emphasis specific matters regarding the
financial statements even though he or she intends to express an unqualified opinion. Normally,
such explanatory information should be included in a separate paragraph in the report. The
followings are examples of explanatory information the auditor may think should be expressed:

7
existence of significant related party transactions, important events occurring subsequent to the
balance sheet date, the description of accounting matters affecting the comparability of the
financial statements with those of the preceding year and material uncertainties disclosed in the
footnotes.
6. Reports involving Other Auditors
When an auditor relies on different auditors to perform part of the audit, which is common when
the client has several widespread branches or subdivisions, the principal audit firm has three
alternatives. Only the second one is an unqualified report with modified wording
1. Make no reference in the audit report: when no reference is made to the other auditor,
a standard unqualified opinion is given unless other circumstances require a departure.
This paragraph is typically followed when the other auditor audited an immaterial portion
of the statement, the other auditor is well known or closely supervised by the principal
auditor, or the principal auditor has thoroughly reviewed the other auditor’s work. The
other auditor is still responsible for his or her own report and work in the event of
lawsuit.
2. Make reference in the report: This type of report is called a shared opinion or report. A
shared unqualified report is appropriate when it is impractical to review the work of the
other auditor or when the portion of the financial statements audited by the other CPA is
material in relation to the whole.
3. Qualify the opinion: the principal auditor may conclude that a qualified opinion is
required. A qualified opinion or disclaimer, depending on the materiality is required if
the principal auditor is not willing to assume any responsibility for the work of the other
auditor. The principal auditor may also decide that a qualification is required in the
overall report if the other auditor qualified his or her portion of the audit. Qualified
opinion and disclaimers are discussed in the next subunit.
6.2.3 Qualified, Adverse and Disclaimer Audit Reports
There are circumstances where the conditions of unqualified audit report are not satisfied. When
these conditions are not satisfied, the auditor issues an opinion other than unqualified audit
report. The three conditions requiring departure from unqualified audit report are

8
1. The scope of the audit has been restricted: when the auditor has not accumulated sufficient
evidence to conclude whether financial statements are stated in accordance with IFRS, scope
restriction exists. The scope restrictions can be caused by the client or circumstances beyond the
client or the auditor. An example of client restriction is management’s refusal to permit the
auditor to confirm material receivables or to physically examine inventory. An example of
restriction caused by circumstances is when the engagement is not agreed on until after the client
year end. It may not be possible to physically observe inventories, confirm receivables or
perform other important procedures after the balance sheet date
2. Financial statements have not been prepared in accordance with generally accepted
accounting principles. For example, if the client insists on using replacement costs for fixed or
value inventory at selling price rather than historical cost, departure form unqualified report is
required.
3. The auditor is not independent: when any of the rules of the code of professional conduct
related to independence you have discussed in unit two are violated, the auditor is said to be
dependent
When any of the three conditions requiring a departure from unqualified report exists and is
material, a report other than unqualified report must be issued. Three main types of audit reports
are issued under this condition:: Qualified, Adverse opinion, and Disclaimer of opinion.
1. Qualified Opinion Report
A Qualified Opinion report is issued when the auditor encountered one of the two types of
situations which do not comply with generally accepted accounting principles, however, the rest
of the financial statements are fairly presented. This type of opinion is very similar to an
unqualified or “clean opinion”, but the report states that the financial statements are fairly
presented with a certain exception which is otherwise misstated. The two types of situations
which would cause an auditor to issue this opinion over the unqualified opinion are:
 Deviation from IFRS – this type of qualification occurs when one or more areas of the
financial statements do not conform with IFRS (e.g. are misstated), but do not affect the
rest of the financial statements from being fairly presented when taken as a whole.
Examples of this include a company dedicated to a retail business that did not correctly
calculate the depreciation expense of its building. Even if this expense is considered
material, since the rest of the financial statements do conform with IFRS, then the auditor

9
 qualifies the opinion by describing the depreciation misstatement in the report and
continues to issue a clean opinion on the rest of the financial statements.
 Limitation of Scope - this type of qualification occurs when the auditor could not audit
one or more areas of the financial statements, and although they could not be verified, the
rest of the financial statements were audited and they conform with IFRS. Examples of
this include an auditor not being able to observe and test a company’s inventory of goods.
If the auditor audited the rest of the financial statements and is reasonably sure that they
conform with IFRS, then the auditor simply states that the financial statements are fairly
presented, with the exception of the inventory which could not be audited.
The wording of the qualified report is very similar to the unqualified opinion, but an explanatory
paragraph is added to explain the reasons for the qualification after the scope paragraph but
before the opinion paragraph. The introductory paragraph is left exactly the same as in the
unqualified opinion, while the scope and the opinion paragraphs receive a slight modification in
line with the qualification in the explanatory paragraph.
The scope paragraph is edited to include the following phrase in the first sentence, so that the
user may be immediately aware of the qualification. This placement also informs the user that,
except for the qualification, the rest of the audit was performed without qualifications:
“Except as discussed in the following paragraph, we conducted our audit...”
The opinion paragraph is also edited to include an additional phrase in the first sentence, so that
the user is reminded that the auditor’s opinion explicitly excludes the qualification expressed.
Depending on the type of qualification, the phrase is edited to either state the qualification and
the adjustments needed to correct it or state the scope limitation and that adjustment could have
but not necessarily been required in order to correct it.
For a qualification arising from a deviation from IFRS, the following phrase is added to the
opinion paragraph, using the depreciation example mentioned above:
“In our opinion, except for the effects of the Company’s incorrect determination of
depreciation expense, the financial statement referred to in the first paragraph presents
fairly, in all material respects, the financial position of…”
For a qualification arising from a scope limitation, the following phrase is added to the opinion
paragraph, using the inventory example mentioned above:

10
 “In our opinion, except for the effects of such adjustments, if any, as might have been
determined to be necessary had we been able to perform proper tests and procedures on
the Company’s inventory, the financial statement referred to in the first paragraph
presents fairly, in all material respects, the financial position of…”
Due to the phrases added to the scope and opinion paragraphs, many refer to this report as the
Except-For Opinion.
2. Adverse Opinion Report
An Adverse Opinion is issued when the auditor determines that the financial statements of an
auditee are materially misstated and, when considered as a whole, do not conform with IFRS. It
is considered the opposite of an unqualified or clean opinion, essentially stating that the
information contained is materially incorrect, unreliable, and inaccurate in order to assess the
auditee’s financial position and results of operations. Investors, lending institutions, and
governments very rarely accept an auditee’s financial statements if the auditor issued an adverse
opinion, and usually request the auditee to correct the financial statements and obtain another
audit report.
Generally, an adverse opinion is only given if the financial statement pervasively differs from
IFRS. An example of such a situation would be failure of a company to consolidate a material
subsidiary.
The wording of the adverse report is similar to the qualified report. The scope paragraph is
modified accordingly and an explanatory paragraph is added to explain the reason for the adverse
opinion after the scope paragraph but before the opinion paragraph. However, the most
significant change in the adverse report from the qualified report is in the opinion paragraph,
where the auditor clearly states that the financial statements are not in accordance with IFRS,
which means that they, as a whole, are unreliable, inaccurate, and do not present a fair view of
the auditee’s position and operations.
“In our opinion, because of the situations mentioned above (in the explanatory
paragraph), the financial statements referred to in the first paragraph do not present
fairly, in all material respects, the financial position of…”
3. Disclaimer of Opinion Report
A Disclaimer of Opinion, commonly referred to simply as a Disclaimer, is issued when the
auditor could not form, and consequently refuses to present, an opinion on the financial

11
statements. This type of report is issued when the auditor tried to audit an entity but could not
complete the work due to various reasons and does not issue an opinion.
Auditing Standards provide certain situations where a disclaimer of opinion may be appropriate:
 A lack of independence, or material conflict(s) of interest, exist between the auditor and
the auditee
 There are significant scope limitations, whether intentional or not, which hinder the
auditor’s work in obtaining evidence and performing procedures
 There is a substantial doubt about the auditee’s ability to continue as a going concern or,
in other words, continue operating
 There are significant uncertainties within the auditee
Although this type of opinion is rarely used, the most common examples where disclaimers are
issued include audits where the auditee willfully hides or refuses to provide evidence and
information to the auditor in significant areas of the financial statements, where the auditee is
facing significant legal and litigation issues in which the outcome is uncertain (usually
government investigations), and where the auditee has going concern issues (the auditee may not
continue operating in the near future). Investors, lending institutions, and governments typically
reject an auditee’s financial statements if the auditor disclaimed an opinion, and will request the
auditee to correct the situations the auditor mentioned and obtain another audit report.
A disclaimer of opinion differs substantially from the rest of the auditor’s report because it
provides very little information regarding the audit itself, and includes an explanatory paragraph
stating the reasons for the disclaimer. Although, the report still contains the letterhead, the
auditee’s name and address, the auditor’s signature and address, and the report’s issuance date,
every other paragraph is modified extensively, and the scope paragraph is entirely omitted since
the auditor is basically stating that an audit could not be realized.
In the introductory paragraph, the first phrase changes from “We have audited” to “We were
engaged to audit” in order to let the user know that the auditee commissioned an audit, but does
not mention that the auditor necessarily completed the audit. Additionally, since the audit was
not completely and/or adequately performed, the auditor refuses to accept any responsibility by
omitting the last sentence of the paragraph. The scope paragraph is omitted in its entirety since,
effectively, no audit was performed. Similar to the qualified and the adverse opinions, the auditor
must briefly discuss the situations for the disclaimer in an explanatory paragraph. Finally, the

12
opinion paragraph changes completely, stating that an opinion could not be formed and is not
expressed because of the situations mentioned in the previous paragraphs. The following is a
draft of the three main paragraphs of a disclaimer of opinion because of inadequate accounting
records of an auditee, which is considered a significant scope limitation:
We were engaged to audit the accompanying balance sheet of ABC Company, Inc. (the
“Company”) as of December 31, 2009 and the related statements of income and cash
flows for the year then ended. These financial statements are the responsibility of the
Company's management.

The Company does not maintain adequate accounting records to provide sufficient
information for the preparation of the basic financial statements. The Company’s
accounting records do not constitute a double-entry system which can produce financial
statements.

Because of the significance of the matters discussed in the preceding paragraphs, the
scope of our work was not sufficient to enable us to express, and we do not express, an
opinion of the financial statements referred to in the first paragraph.

5.3 Materiality and Audit Report

A misstatement in the financial statements can be considered material if knowledge of the
misstatement would affect a decision of a reasonable user of the statements. Materiality is an
essential consideration in determining the appropriate types of report for a given set of
circumstances. For example, if a misstatement is immaterial relative to the financial statements
of the entity for the current period, it is appropriate to issue an unqualified report. A common
instance is the immediate expensing of office supplies rather than carrying the unused portion in
inventory because the amount is significant. The situation is totally different when the amounts
are of such significant that the financial statements are materially affected as a whole. In these
circumstances, it is necessary to issue a disclaimer of opinion or an adverse opinion, depending
on the nature of the misstatement. In situation of lesser materiality a qualified opinion is
appropriate.
Three levels of materiality are used for determining the type of opinion to issue

13
 1. Amounts are Immaterial: When a misstatement in the financial statement exists but is
unlikely to affect the decision of a reasonable user, it is considered to be immaterial.
Unqualified opinion is therefore appropriate. For example, assume that management
recorded unexpired insurance as an asset in the previous year and decides to expense it in
the current year to reduce record keeping costs; management has failed to follow IFRS
but if the amounts are small, the misstatement would be immaterial and standard
unqualified audit report would be appropriate.
2. Amounts are material but don’t overshadow the financial statements as a whole:
The second level of materiality exists when a misstatement in the financial statement
would affect a user’s decision but the overall statements are still fairly stated and
therefore useful. For example, knowledge of a large misstatement in fixed assets might
affect a user’s willingness to loan money to a company if the asset were the collateral.
When the auditor concludes that a misstatement is material but doesn’t overshadow the
financial statements as a whole, a qualified opinion using except for is appropriate.
3. Amounts are so material or so pervasive that overall fairness of the statements is in
question. The highest level of materiality exists when users are likely to make incorrect
decisions if they rely on the overall financial statements when the highest level of
materiality exists, the auditor must issue either a disclaimer of opinion or an adverse
opinion, depending on which conditions exist.
The following table summarizes the relationship between materiality and type of opinion issued
Materiality level Significance in terms of reasonable user
decision Type of opinion
Immaterial users decisions are unlikely to be affected Unqualified
User’s decisions are likely to be affected only if
the information in question is important to the
specific decisions being made. The overall
Material financial statement are presented fairly Qualified
Most or all users decision based on the financial Disclaimer or
Highly material statements are likely to be significantly affected Adverse

14