CHAPTER SIX AFT 06102

AUDIT REPORT
6.1. Introduction
The auditor’s report is the means by which the external auditors express their opinion on the
truth and fairness of a company's financial statements. It is for the benefit principally of the
shareholders, but also for other users as the audit report is usually kept on public record with
the filed financial statements.
Many of the contents of the auditor's report are prescribed by statute. The report contains a
number of consistent elements so that users know the audit has been conducted according to
recognised standards. They are also subject to professional requirements in the form of ISA
700 Forming an opinion and reporting on financial statements.
ISA 700 establishes standards and provides guidance on the form and content of the auditor's
report issued as a result of an audit performed by an independent auditor on the financial
statements of an entity. It states that the auditor shall form an opinion on whether the financial
statements are prepared, in all material respects, in accordance with the applicable financial
reporting framework.

6.2. Matters to be considered in Audit Report

In order to form the opinion, the auditor needs to conclude as to whether reasonable assurance
has been obtained that the financial statements are free from material misstatement. The
auditor’s conclusion needs to consider the following.
❖ Whether sufficient appropriate audit evidence has been obtained (ISA 330)
❖ Whether uncorrected misstatements are material (ISA 450)
❖ Qualitative aspects of the entity’s accounting practices, including indicators of
possible bias in management’s judgments
❖ Whether the financial statements adequately disclose the significant accounting
policies selected and applied
❖ Whether the accounting policies selected and applied are consistent with the applicable
financial reporting framework and are appropriate
❖ Whether accounting estimates made by management are reasonable
❖ Whether the information in the financial statements is relevant, reliable, comparable
and understandable
❖ Whether the financial statements provide adequate disclosures to allow users to
understand the effect of material transactions and events on the information presented
in the financial statements
❖ Whether the terminology used in the financial statements is appropriate
❖ The overall presentation, structure and content of the financial statements
❖ Whether the financial statements represent the underlying transactions and events so as
to achieve fair presentation
❖ Whether the financial statements adequately refer to or describe the applicable
financial reporting framework
6.3. Basic Elements of the Auditor's Report
A measure of consistency in the form and content of the auditor's report is desirable because
it promotes credibility in the global marketplace and also helps to promote the reader's
understanding and to identify unusual circumstances when they occur.
The auditor's report must be in writing and includes the following basic elements, usually in
the following layout.

6.3.1. Title
The auditor’s report must have a title that clearly indicates that it is the report of the independent
auditor. This signifies that the auditor has met all the ethical requirements concerning
independence and therefore distinguishes the auditor’s report from other reports

6.3.2. Addressee
The addressee will be determined by law or regulation, but is likely to be the shareholders or
those charged with governance.

6.3.3. Introductory Paragraph

This shall identify the entity being audited, state that the financial statements have been audited,
identify the title of each statement that comprises the financial statements being audited, refer
to the summary of significant accounting policies and other explanatory notes, and specify the
date or period covered by each statement comprising the financial statements.

6.3.4. Management’s Responsibility for the Financial Statements

This part of the report describes the responsibilities of those who are responsible for the
preparation of the financial statements. The report shall include a section headed
‘Management’s responsibility for the financial statements’ and describe management’s
responsibility including the following:
▪ Management is responsible for the preparation of the financial statements in accordance
with the applicable financial reporting framework.
▪ Management is responsible for such internal control necessary to enable the preparation
of financial statements that are free from material misstatement, whether due to error
or fraud.
▪ Reference shall be made to ‘the preparation and fair presentation of these financial
statements’ (or’ the preparation of financial statements that give a true and fair view’)
where the financial statements are prepared in accordance with a fair presentation
framework.

6.3.5. Auditor’s Responsibility

The report shall include a section entitled ‘Auditor’s responsibility’. The report must state that
the auditor is responsible for expressing an opinion on the financial statements based on the
audit.
This section must also state that the audit was conducted in accordance with International
Standards on Auditing and ethical requirements and that the auditor planned and performed the
audit so as to obtain reasonable assurance that the financial statements are free from material
misstatement.
The report must describe an audit by stating that:
 ▪ An audit involves performing procedures to obtain audit evidence about the amounts
and disclosures in the financial statements.
▪ The procedures chosen depend on the auditor's judgment of risks of material
misstatements, and the auditor considers internal control relevant to the preparation of
the financial statements in order to design appropriate audit procedures (but not to
express an opinion on the effectiveness of internal control).
▪ An audit includes evaluation of the appropriateness of the accounting policies used, the
reasonableness of accounting estimates made by management, and the overall
presentation of the financial statements. This part of the report shall also state whether
the auditor believes that the audit evidence obtained is sufficient and appropriate to
provide a basis for the opinion

6.3.6. Opinion Paragraph

If the auditor expresses an unmodified opinion on financial statements prepared in accordance
with a fair presentation framework, the opinion shall use one of the following equivalent
phrases:
▪ The financial statements present fairly, in all material respects,…in accordance with
[the applicable financial reporting framework]; or
▪ The financial statements give a true and fair view of … in accordance with [the
applicable financial reporting framework

6.3.7. Other Reporting Responsibilities

If the auditor is required by law to report on any other matters, this must be done in an additional
paragraph below the opinion paragraph which is titled ‘Report on other legal and regulatory
requirements’ or otherwise as appropriate.

6.3.8. Auditor’s Signature

The report must contain the auditor’s signature, whether this is the auditor's own name or the
audit firm's name or both.
6.3.9. Date of the report
The report must be dated no earlier than the date on which the auditor has obtained sufficient
appropriate audit evidence on which to base the auditor’s opinion on the financial statements.

6.3.10. Auditor’s Address

The location where the auditor practises must be included

6.4. Types of Audit Report

6.4.3.1. Unmodified Auditor's Report

An unmodified opinion is the opinion expressed by the auditor when the auditor concludes
that the financial statements are prepared, in all material respects, in accordance with the
applicable financial reporting framework according to ISA 700
If the auditor concludes that the financial statements as a whole are not free from material
misstatement or cannot obtain sufficient appropriate audit evidence to make this conclusion,
the auditor must modify the opinion in accordance with ISA 705 Modifications to the opinion
in the independent auditor’s report

.
6.4.3.2. Modified Opinions
There are three types of modified opinion: a qualified opinion, an adverse opinion, and a
disclaimer of opinion.
ISA 705 Modifications to the opinion in the independent auditor's report sets out the different
types of modified opinions that can result. It identifies three possible types of modifications:
▪ A qualified opinion
▪ An adverse opinion
▪ A disclaimer of opinion

Types of modifications
Pervasiveness is a term used to describe the effects or possible effects on the financial
statements of misstatements or undetected misstatements (due to an inability to obtain
sufficient appropriate audit evidence). There are three types of pervasive effect:
• Those that are not confined to specific elements, accounts or items in the financial
statements
• Those that are confined to specific elements, accounts or items in the financial
statements and represent or could represent a substantial portion of the financial
statements
• Those that relate to disclosures which are fundamental to users’ understanding of the
financial statements

The type of modification issued depends on the following:

▪ The nature of the matter giving rise to the modifications (i.e. whether the financial
statements are materially misstated or whether they may be misstated when the
auditor cannot obtain sufficient appropriate audit evidence)
▪ The auditor’s judgement about the pervasiveness of the effects/possible effects of the
matter on the financial statements

A modified opinion is required when:

▪ The auditor concludes that the financial statements as a whole are not free from material
misstatements or
▪ The auditor cannot obtain sufficient appropriate audit evidence to conclude that the
financial statements as a whole are free from material misstatement

6.4.3.1.Qualified opinions
A qualified opinion must be expressed in the auditor’s report in the following two situations:
a) The auditor concludes that misstatements are material, but not pervasive, to the
financial statements.
Material misstatements could arise in respect of:
▪ The appropriateness of selected accounting policies
▪ The application of selected accounting policies
▪ The appropriateness or adequacy of disclosures in the financial statements
b) The auditor cannot obtain sufficient appropriate audit evidence on which to base
the opinion but concludes that the possible effects of undetected misstatements, if
any, could be material but not pervasive.
The auditor’s inability to obtain sufficient appropriate audit evidence is also referred to as a
limitation on the scope of the audit and could arise from:
▪ Circumstances beyond the entity’s control (e.g. accounting records destroyed)
 ▪ Circumstances relating to the nature or timing of the auditor’s work (e.g. the timing
of the auditor’s appointment prevents the observation of the physical inventory
count)
▪ Limitations imposed by management (e.g. management prevents the auditor from
requesting external confirmation of specific account balances)

6.4.3.2.Adverse opinions
An adverse opinion is expressed when the auditor, having obtained sufficient appropriate audit
evidence, concludes that misstatements are both material and pervasive to the financial
statements. For example, an adverse opinion might be issued if there is a material uncertainty
in respect of going concern which has not be adequately disclosed or use of the going concern
assumption is inappropriate

6.4.3.3.Disclaimers of opinion
An opinion must be disclaimed when the auditor cannot obtain sufficient appropriate audit
evidence on which to base the opinion and concludes that the possible effects on the financial
statements of undetected misstatements, if any, could be both material and pervasive.
The opinion must also be disclaimed in situations involving multiple uncertainties when the
auditor concludes that, despite having obtained sufficient appropriate audit evidence for the
individual uncertainties, it is not possible to form an opinion on the financial statements due to
the potential interaction of the uncertainties and their possible cumulative effect on the
financial statements.
An example of when a disclaimer of opinion is used could be in relation to going concern if
management is unwilling to make or extend its assessment

Impact on the auditor’s report

When the auditor has had to modify the auditor’s report, the report must include a paragraph
before the opinion paragraph, which provides a description of the matter giving rise to the
modification. This paragraph will be entitled ‘Basis for qualified opinion’ or ‘Basis for adverse
opinion’ or ‘Basis for disclaimer of opinion’ depending on the type of modification.

The section of the auditor’s report containing the opinion will be headed either ‘Qualified
opinion’, ‘Adverse opinion’ or ‘Disclaimer of opinion’, again depending on the type of
modification.
When the auditor expresses a qualified or adverse opinion, the section of the report on the
auditor’s responsibilities must be amended to state that the auditor believes that the audit
evidence obtained is sufficient and appropriate to provide a basis for the auditor’s modified
audit opinion.
When the auditor disclaims an opinion due to being unable to obtain sufficient appropriate
audit evidence, the section on the auditor’s responsibilities must be amended to include the
following: ‘Because of the matter(s) described in the Basis for Disclaimer of Opinion
paragraph, however, we were not able to obtain sufficient appropriate audit evidence to provide
a basis for an audit opinion’.

Summary of modifications and impact on the auditor’s report

The following table summarises the different types of modified opinion that can arise.

Nature of circumstances Material but not pervasive Material and pervasive

Financial statements are QUALIFIED OPINION ADVERSE OPINION
materially misstated

Auditor unable to obtain QUALIFIED OPINION DISCLAIMER OF

sufficient appropriate audit OPINION
evidence
REVIEW QUESTIONS
1. Why audit report is essential after completion of collection of evidence
2. Explain the basic elements of the audit report
3. List and explain four types of audit report
4. Explain matters to be considered when writing audit report
5. Explain how pervasiveness and misstatements affect the audit report
6. When field work was finished on December 31, 2015, the following standard
unqualified auditor’s report was given by Sam Associates, Auditing Firm, of Ilala,
Dar es Salaam Tanzania:
Auditor’s Report
We have audited the accompanying financial statements. In our opinion, the
financial statements correctly show the account balances and comply with the
Companies Acts no 12 of 2002.
Sam Associates, Auditing Firm
Required:
(a) List the basic elements that should appear in an unqualified auditor’s report
(b) List and explain the deficiencies and omissions in the Eldridge and Lloyd
auditor’s report.