Auditing – The Case Book Chapter 4: Auditor’s Report & Types of Opinions

CHAPTER 4
Assignment – Lecture 29
QUESTIONS

Q.1 You have completed the audit of financial statements of Pride Limited showing profit before tax and total assets of Rs. 74
million and Rs. 582 million respectively. Following issues are still unresolved:

(i) Subsequent to year end, an employee left the company without settling a loan of Rs. 0.5 million. Management has
refused to make provision but is ready to give a disclosure.
(ii) The revenue recognition policy is not consistent with the relevant International Accounting Standard (IAS). Had it
been in accordance with the IAS, the profit before tax would have been Rs. 79.2 million.
(iii) The contract with a major customer is about to expire after three years. Certain internal documents show that the
company might have to face a very difficult situation thereafter.
(iv) Personal files of many senior executives do not contain any documentary evidence of their qualification. Salaries paid
to such executives are Rs. 24 million.

Required:
Discuss the impact of each of the above matters on your audit report. (08)
(ICAP, CAF 09 Level – Spring 2008)

Q.2 Suggest how would you modify the audit report in the following situations:
(i) A client of your firm has a history of tax contingencies arising out of appeals pending at various levels. The company
has disclosed all such contingencies along with the estimated amounts in accordance with the accounting standards.
Assume that the aggregate sum of these contingencies is material.

(ii) You are appointed as the auditor of a company after the year-end i.e. June 30, 2005. Hence, you have not been able to
physically observe the counting of inventories at the year-end. Further, alternative audit procedures could not be
performed due to the nature of the company’s records. (05)
(ICAP, CAF 09 Level – Autumn 2005)

Q.3 You are the auditor of certain companies, audits of which have been finalized and audit opinions are expected to be
shortly issued. Significant issues concerning these audits are as follows:

Company A
Subsequent to the year end, a debtor from whom a significant balance is due initiated winding up proceedings. (04)

Company B
The company is a shipping line with more than 6 ships as its assets. Subsequent to the year-end, one of its high value ship,
carrying huge stock for other parties, sank in high seas. (04)

Company C
Audit of the year ended 31st December 2003, would need to be finalized by 4thJanuary 2004.
The credit period for trade receivables is 3 months. You noted that significant sales were made in late December 2003.
You have requested the company to provide the evidences for such sales, which request has been sent by them to its field
office. However, the company considers that these evidences may not be timely available by 4 January 2004 due to law
and order situation in the area where the field office is situated. (04)

As an audit engagement partner of above companies, what would be your suggestions to the companies management
regarding the above circumstances on the financial statements of the companies? Also explain the type of opinion you
would issue, if the companies management do not agree with your suggestions.
(ICAP, CAF 09 Level – Spring 2004)

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 Auditing – The Case Book Chapter 4: Auditor’s Report & Types of Opinions

Q.4 You are a partner in a firm of Chartered Accountants. Annual audits of various clients are at finalization stage and since
this is the first time that ISA related to Key Audit Matters is to be applied, several issues have been referred to you for
guidance. These include:
(a) An adverse report is being issued in the case of Muneer Limited. The draft report also contains certain matters as Key
Audit Matters. (02)
(b) A qualified report has been drafted by the audit manager of Nadir Limited as the company has failed to make adequate
provision of contingency. The details of qualification are mentioned in the Key Audit Matters section. (03)
(c) The Key Audit Matters section of audit report of Zia Limited includes details of Key Audit Matters of only the current
period. However, the opinion has been expressed on current as well as prior year. (03)
Required:
Advise the concerned partners/managers with respect to the above matters.
(ICAP, CFAP 06 Level – Winter 2016)

Q.5 Identify and explain the shortcomings in the following paragraph of the draft audit report of Javed Limited:
Emphasis of Matter:
We draw attention to the fact that the company has accumulated losses of Rs. 115,436,540 (2011: Rs. 85,365,479) and
certain payments against long term loans were overdue as at the reporting date. As at 30 September 2012, its total
liabilities exceeded its total assets by Rs. 15,450,300 (2011: Rs. 11,542,200). These conditions indicate the existence of a
material uncertainty that may cast significant doubt on the Company’s ability to continue as a going concern. (03)
(ICAP, CFAP 06 Level – Winter 2012)

Q.6 You are the senior responsible for the audit of Iqra Industries Limited (IIL). During the course of the audit you became
aware that a legal action has been instituted against IIL by some of its customers, on account of disputes related to
performance of its products. In response to your request for an opinion, the company’s lawyer has simply stated “We are
totally unable to give any estimate”.
No provision was made in the financial statements for the possible loss as a result of the claims (which are considered to
be material) or for the related legal expenses, although details of those legal claims were fully disclosed in the notes.

Required:
Comment on the implication of the above matter on the auditors’ report and the financial statements of IIL. (04)
(ICAP, CFAP 06 Level – Winter 2009)
(ICAP’s Official Question Bank for CAF 09 – Q. # 159)

Q.7 Your firm is the external auditor of Macho Ltd (Macho) for the year ended 31 December 2013. On 12 January 2014,
Macho’s warehouse was destroyed resulting in the loss of its entire inventory and an inability to fulfill customers’
outstanding orders for the foreseeable future. Your firm has concluded that the financial statements should be prepared
on a break-up basis.

State, with reasons, the implications for your firm’s audit report on Macho’s financial statements for the year ended 31
December 2013 if the directors of Macho:
(i) prepare the financial statements on a break-up basis and adequately disclose the basis of preparation in the notes to
the financial statements; or
(ii) prepare the financial statements on a going concern basis. (04)
(Institute of Chartered Accountants in England and Wales, Professional Level – 2014 March)

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 Auditing – The Case Book Chapter 4: Auditor’s Report & Types of Opinions

Q.8 You are planning the external audit of Steady Eddy Ltd (Steady Eddy) whose principal activity is the provision of road
haulage services. You have been provided with the following information in respect of the year ended 31 May 2007.

The company made a loss for the year to 31 May 2007. This is mainly due to the loss of a major customer to a competitor
and exceptional costs incurred in relocating to new premises. In previous years the company has been profitable but has
recently experienced reduced margins due to the high cost of fuel.

Despite its poor trading results, the company has managed to stay within its overdraft limit of £500,000. This was
achieved by the managing director temporarily lending the company £200,000 and delaying payments to creditors. The
overdraft facility is to be reviewed by the bank in September 2007 after the audited financial statements are available.
The company has a loan installment falling due in October 2007 which it plans to repay with the proceeds from the
recently vacated premises which are currently for sale.

The company has fallen behind with its payments to tax authorities, but the directors have successfully negotiated a
scheme for settling the arrears over a period of four months. A condition of this concession granted by tax authorities is
that the company pays all its future monthly tax liabilities on the due dates.

Requirements
(a) Explain what is meant by the going concern concept and why the auditor should consider whether a company is a
going concern. (05)
(b) Explain the circumstances particular to Steady Eddy which may indicate that it is not a going concern. (08)
(Institute of Chartered Accountants in England and Wales, Professional Level – 2007 June)

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 Auditing – The Case Book Chapter 4: Auditor’s Report & Types of Opinions

SUGGESTED SOLUTIONS

A.1 (i)
 This is a misstatement in F/S.
 Effect is immaterial, as Rs. 500,000 million < Rs. 3,700,000 (=74,000,000 * 5%).
 Auditor shall express unmodified opinion on F/S.
(ii)
 This is a misstatement in F/S.
 Effect is material, as Rs. 5,200,000 (79,200,000 – 74,000,000) > Rs. 3,700,000 (=74,000,000 * 5%).
 Auditor shall express Qualified opinion on F/S.

(iii)
 This is an event/condition which is indication of going concern problem.
 As difficult situation will arise after twelve month, there is no need to include “Going Concern relating to
Material Uncertainty” paragraph in audit report.

(iv)
 This is a weakness in internal control.
 It does not affect audit report.

A.2 (i)
 There is no misstatement in financial statements.
 Auditor shall express unmodified opinion.
 However, considering complexity and subjectivity involved in the matter, auditor may include it as a “Key Audit
Matter” in his report.
(Note for students: If there is a single major regulator action by tax authorities, ‘Emphasis of Matter’ will be given)

(ii)
 This is a scope limitation.
 Auditor shall express Qualified Opinion (if effect is material), or Disclaimer of Opinion (if effect is pervasive).
 Auditor shall include Other Matter Paragraph in his report to communicate that prior period were audited by
the predecessor auditor.

A.3 Company A:
Suggestion to Company:
This is an adjusting event. Management should record provision for bad debt in F/S.

Type of opinion if management does not agree with suggestion:

1. This will be a misstatement in F/S.
2. Auditor shall express qualified opinion on financial statements (if effect is material) or adverse opinion (if effect is
pervasive).

Company B:
Suggestion to Company:
This is a non-adjusting event requiring disclosure. Management should disclose it in F/S.

Type of opinion if management does not agree with suggestion:

1. This will be a misstatement in F/S.
2. Auditor shall express qualified opinion on financial statements (if effect is material) or adverse opinion (if effect is
pervasive).

Company C:
Suggestion to Company:
Management should be requested to provide details of sales either before 4th of January (data may also be provided
electronically) or date of audit report should be extended until details are received.

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 Auditing – The Case Book Chapter 4: Auditor’s Report & Types of Opinions

Type of opinion if management does not agree with suggestion:

1. This will be a scope limitation.
2. Auditor shall express qualified opinion on financial statements (if effect is material) or disclaimer of opinion (if effect
is pervasive).

A.4 (a) There is no issue in this situation. Key Audit Matters can be included in Audit Report, even if Adverse Opinion is
expressed.
However, in such case adverse opinion will be because of different matter and Key Audit Matter will be because of
different matter.

(b)
This treatment is incorrect. If a matter requires modification in opinion, then it should be discussed in basis for modified
opinion and not in key audit matter section.

(c)
There is no issue in this situation. Auditor is required to communicate only those matters as Key Audit Matters which
significantly affect current year’s financial statements. Therefore non-inclusion of Key Audit Matters of prior period is
appropriate.

A.5
1. This matter should be discussed in “Material Uncertainty relating to going concern” instead of “Emphasis of
Matter “paragraph.
2. A reference to the notes to the accounts should be given which fully describe this event.
3. Phrase “Our opinion is not modified in respect of this matter.” is missing.

A.6
 This is a case of exceptional litigation whose outcome cannot be measured reliably.
 It should be disclosed in financial statements (no provision is required).
 As matter is fully disclosed in financial statements, there is no misstatement. Auditor shall express unmodified
opinion on financial statements.
 Auditor shall also include emphasis of matter paragraph in his report to draw users’ attention to exceptional
litigation.

A.7 (i)
Auditor shall express unmodified opinion on financial statements because there is no misstatement or scope limitation on
financial statements. However, auditor shall include emphasis of matter paragraph in his report to draw users’ attention
to the basis of preparation and the note in the financial statements.

(ii)
There is a misstatement in financial statements. Effect is pervasive, as basis of preparation of financial statements is not
correct. Auditor shall express adverse opinion. Auditor shall explain nature of misstatement in basis for adverse opinion
section.

Examiners’ Comments:
Financial statements prepared on break-up basis with adequate disclosure
The majority of candidates correctly identified that the opinion should be unmodified. However, a small minority failed to
consider the use of an emphasis of matter paragraph to direct the users' attention to the note.
Financial statements prepared on going concern basis
The majority of candidates correctly identified that the circumstances warranted an adverse opinion. Weaker candidates
hedged their opinions, thereby demonstrating that they were unaware of the requirement in ISA 570 Going Concern to
provide an adverse opinion when financial statements have been prepared on an inappropriate basis. A minority of
candidates confused the purpose of an emphasis of matter paragraph (i.e. to draw users' attention to a note in the financial
statements) with the purpose of a basis for adverse opinion paragraph (i.e. an explanation for the modified opinion).

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 Auditing – The Case Book Chapter 4: Auditor’s Report & Types of Opinions

A.8 (a)
What is meant by the going concern concept:
Going concern means entity has an ability to continue its operations in foreseeable future (usually 12 months) and does
not have intention or necessity to liquidate its operations.

Why auditor should consider whether a company is a going concern:

ISA 570 requires auditor to obtain sufficient appropriate audit evidence about the appropriateness of management’s use
of the going concern assumption. ISA 570 also requires auditor to conclude whether there is a material uncertainty about
the entity’s ability to continue as a going concern

If going concern assumption is not appropriate, it may have implications on both financial statements and audit report e.g.
financial statements may have to be prepared on alternative basis (i.e. liquidation or break-up basis), and auditor should
emphasize this in his report.

If there is going concern uncertainty, financial statements should disclose it and auditor should also emphasize it in his
report.

(b)
Loss of major customer causing loss for the year:
Future revenue stream has been lost. This will have adverse impact on company’s ability to generate cash in future.

Increased competition:
Company is losing its revenue to competitors. A tough competition may further cause company to lose its customers and
revenue.

Reducing profit margins due to high cost of fuels:

Company’s profitability will further reduce in future.

Delaying payments to creditors:

Creditors may withdraw credit facilities and may change terms of transactions (e.g. from credit to cash).

Overdraft facility is subject to review in September 2007:

Bank may not approve overdraft facility for next term, and company may not have sufficient cash to pay it.

Loan installment falling due in October:

Lender may file petition to court to wind-up company.

Default in payment to tax authorities & Customs:

Tax authorities may file petition to court to wind-up company if obligations not met as agreed.

Examiners’ Comments:
(a)Almost all candidates were able to explain what is meant by the going concern concept. Although the majority of
candidates appreciated that the auditor had to consider the going concern because of the potential impact on the financial
statements, many failed to develop the point and did not describe what the impact would be i.e. the classification of items and
the amounts at which they would be stated. Furthermore, many failed to consider the disclosure implications for the financial
statements and the implications for the audit report.
(b)This part of the question was generally well answered with a number of candidates attaining maximum marks.
Candidates tended to be better at identifying the circumstances but not so good at explanations.

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