ACCA F8 (INT) Audit & Assurance - 2010 - Study text - Emile Woolf Publishing
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Paper F8 (INT)
Audit and assurance
CHAPTER
16
The external audit report
Contents
1 Purpose of the audit report
2 The unmodified audit report: ISA 700
3 The modified audit report: ISAs 705 and 706
4 The impact of going concern on the audit report:
ISA 570
5 Other information issued with the audited
financial statements: ISA 720
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Purpose of the audit report
Introduction
The audit report and your examination
The expectation gap
1 Purpose of the audit report
1.1 Introduction
The audit report is the end-product of the external audit process. It is the
document in which the auditor expresses his professional judgement on whether
the financial statements present a ‘true and fair view’.
The contents of the audit report are likely to be regulated by national legislation. In
addition, the external auditor is governed by:
ISA 700 Forming an opinion and reporting on financial statements, and
ISA 705 Modifications to the opinion in the independent auditor’s report
ISA 706 Emphasis of matter paragraphs and other matter paragraphs in the
independent auditor’s report.
1.2 The audit report and your examination
The examiner has stated that you will not be required to produce an audit report in
full in an examination answer. However, you may be expected to:
describe the appropriate type of audit report to be issued in a specific situation
supply appropriate wording for a modification to an audit report (for example,
drafting a modified “opinion” paragraph)
explain extracts from a given audit report (such as one with errors of wording in
it).
1.3 The expectation gap
The audit report is the only direct means of communication between the auditor
and the users of the financial statements (who are mainly, but not exclusively, the
shareholders). In recent years, auditing has suffered from an ‘expectation gap’ as the
role of the auditor in law does not match what the users of financial statements
expect from an auditor.
The term ‘expectation gap’ refers to the fact that the public perception of the role
and responsibilities of the external auditor is different from his statutory role and
responsibilities. The expectations of the public are often set at a level higher than
that at which the external auditor actually operates.
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Some examples of the misunderstandings inherent in the public’s expectations are
as follows:
The public believes that the audit opinion in the audit report amounts to a
‘certificate’ that the financial statements are correct and can be relied upon for all
decision-making purposes, including decisions about takeovers.
The public also believes that the auditor has a duty to prevent and detect fraud
and that this is one reason for an audit.
The public assumes that, in carrying out his audit work, the auditor tests 100% of
the transactions undertaken during the accounting period.
One consequence of these misunderstandings has been an increasing tendency in
some countries to undertake legal action against the auditors, sometimes on a
‘frivolous’ basis, in the belief that the auditor should have prevented misstatements
in the financial statements or should have prevented fraud.
Responses to the problem of the expectation gap have varied between countries. In
some countries, corporate governance codes have been changed to strengthen the
role and responsibilities of directors for good internal control and accounting
systems.
In addition, the standard format of the audit report has been expanded in recent
years in an attempt to clarify what is involved in an audit and the relative
responsibilities of the directors and the auditors.
Critics argue that these moves are not likely to be effective as those groups in society
who are promoting the expectation gap may not understand these attempts that
have been made to remedy the problem.
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The unmodified audit report: ISA 700
Definition of an unmodified audit report
Reaching the audit opinion
Basic elements of the audit report
Audit report prescribed by law or regulation
Audits conducted in accordance with both ISAs and local auditing standards
Unaudited supplementary information presented with the audited financial
statements
IAPS 1014: Reporting by auditors on compliance with International Financial
Reporting Standards
2 The unmodified audit report: ISA 700
2.1 Definition of an unmodified audit report
An unmodified audit report is an audit report containing an audit opinion not
modified in any way by a ‘qualified’ opinion, and containing no other
modifications or additional paragraphs such as might be added by an ‘emphasis of
matter’ paragraph. These are discussed in a later section.
ISA 700 requires the auditor to give an unmodified opinion when he concludes that
the financial statements have been prepared, in all material respects, in accordance
with the applicable financial reporting framework.
If that framework is a “fair presentation framework” then the report will give an
opinion stating whether or not the financial statements “give a true and fair view”
or “present fairly” the position and results of the entity.
An unmodified opinion provides a high level of assurance that a professional,
independent examination of the financial statements has not revealed any material
misstatements in those financial statements.
2.2 Reaching the audit opinion
In reaching his audit opinion, the auditor is required to evaluate whether:
he has obtained sufficient appropriate audit evidence as to whether the
financial statements are free from material misstatement
uncorrected misstatements are material, individually or in aggregate
the financial statements have been prepared in accordance with the
requirements of the applicable financial reporting framework (which for a
“fair presentation framework” will include evaluating whether the financial
statements give a true and fair view)
and, in particular, whether
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the financial statements adequately refer to or describe the applicable financial
reporting framework
the financial statements adequately disclose the entity’s significant accounting
policies
the significant accounting policies are appropriate and consistent with the
applicable financial reporting framework
accounting estimates are reasonable
the information in the financial statements is relevant, reliable, comparable and
understandable
the financial statements provide adequate disclosures
the terminology used in the financial statements is appropriate.
2.3 Basic elements of the audit report
The basic elements of an unmodified audit report, as given in ISA 700, are as
follows:
1 Title
2 Addressee
3 Introductory paragraph
4 Statement of management’s responsibility for the financial statements
5 Auditor’s responsibility
6 Auditor’s opinion
7 Other reporting responsibilities (possibly)
8 Auditor’s signature
9 Date of the audit report
10 Auditor’s address.
These elements are designed to achieve the objectives of ISA 700, which are for the
auditor to:
form an opinion on the financial statements, based on the conclusions drawn
from his audit evidence, and
express that opinion clearly through a written report that also describes the basis
for that opinion.
Title
The auditor’s report should have a title that clearly indicates that it is the report of
an independent auditor. This is to distinguish this type of auditor’s report from
other reports that might be issued by other auditors (who may not have to abide by
the same ethical requirements and requirement for independence as the
independent auditor - for example, internal auditors).
Addressee
The report should be appropriately addressed, as required by national law and the
circumstances of the engagement. The report is usually addressed to either:
the shareholders of the entity whose financial statements are being audited, or
the board of directors of the entity.
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Introductory paragraph
The introductory paragraph in the report should:
identify the entity whose financial statements have been audited
state that the financial statements have been audited
identify the title of each of statement that makes up the complete set of financial
statements (statement of comprehensive income, statement of financial position,
and so on)
refer to the summary of significant accounting policies and other explanatory
information
specify the date or period covered by each statement.
Management’s responsibility for the financial statements
This section of the report should describe the responsibilities of those responsible
for the preparation and presentation of the financial statements. It should include an
explanation that management is responsible for:
the preparation of the financial statements in accordance with the applicable
financial reporting framework, and
for such internal controls as deemed necessary to enable the preparation of
financial statements which are free from material misstatement.
Auditor’s responsibility
This section of the report states that:
the responsibility of the auditor is to express an opinion on the financial
statements based on his audit
the audit was conducted in accordance with ISAs, explaining that those
standards require the auditor to:
- comply with ethical requirements, and
- plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free from material misstatement.
The latter gives the reader of the report assurance that the audit has been carried
out in accordance with established standards and practices.
This section also describes the ‘scope’ of the audit. It refers to the auditor’s ability to
perform the audit procedures which he deemed necessary in the circumstances.
Any restriction on the scope of the audit can lead to a ‘modified’ audit report (which
is explained later).
This section also therefore describes 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 selected depend on the auditor’s judgement, including his
assessment of the risks of material misstatement of the financial statements. As
part of this assessment, the auditor considers relevant internal controls. He does
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not consider internal controls for the purpose of expressing an opinion on their
effectiveness
an audit also includes evaluating the appropriateness of the accounting policies
used, the reasonableness of accounting estimates made by management, and the
presentation of the overall financial statements.
This part of the (unmodified) report should end with a statement that the auditor
believes that the audit evidence he has obtained is sufficient and appropriate to
provide a basis for his opinion.
Auditor’s opinion
When the financial statements have been prepared in accordance with a “fair
presentation” framework an unmodified opinion should be expressed when the
auditor concludes that the financial statements give a true and fair view or are
presented fairly, in all material respects, in accordance with the applicable financial
reporting framework.
When the financial statements have been prepared in accordance with a
“compliance” framework an unmodified opinion should be expressed when the
auditor concludes that the financial statements have been prepared, in all material
respects, in accordance with the applicable financial reporting framework.
This can lead to a two-fold opinion. For example, in the UK, an opinion will be
expressed on whether the financial statements:
give a true and fair view (UK accounting standards) or present fairly (IFRSs), and
have been properly prepared in accordance with the Companies Act 2006.
Where IFRSs are not used as the financial reporting framework, the reference to the
financial reporting framework in the wording of the opinion should identify the
jurisdiction of the financial reporting framework.
Further guidance on this point is given by IAPS 1014 which is covered in a later
section.
Other reporting responsibilities
In some countries, the auditor may have additional reporting responsibilities. For
example, he may be required by local legislation to report certain matters if they
come to his attention during the course of the audit, or he may be required to report
on specific matters such as the adequacy of accounting records.
Such other reporting responsibilities should be addressed in a separate section of
the report, following the opinion paragraph, sub-titled “Report on Other Legal and
Regulatory Requirements.
Auditor’s signature
The report should be signed:
in the name of the audit firm, or
in the personal name of the auditor, or
both.
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The report is usually signed in the name of the firm because the firm assumes
responsibility for the audit. However, in the UK, the report has to be signed by the
“senior statutory auditor” (i.e. engagement partner) for and on behalf of the firm.
Date of the auditor’s report
The report should be dated no earlier than the date on which the auditor has
obtained sufficient appropriate evidence on which to base his opinion on the
financial statements.
This will not be earlier than the date on which the financial statements are signed or
approved by the directors/management of the client company.
The date of the report informs the reader that the auditor has considered the effect
on the financial statements (and on his audit report) of subsequent events which
occurred after the reporting period and up to that date.
Auditor’s address
The report should give a specific location for the auditor. This will usually be the
city where the office responsible for the audit is located.
Example
An example of an unmodified audit report is set out below.
INDEPENDENTAUDITOR’SREPORT
(Appropriateaddr essee)
Reportonthefinancialstatements
WehaveauditedtheaccompanyingfinancialstatementsofABCCompany,which
comprise the statement of financial position as at 31 December 20X1, and the
statement of comprehensive income, statement of changes in equity, and
statement of cash flows
for the year then ended, and a summary of significant
accountingpolicesandotherexplanatoryinformation.
Management’sresponsibilityforthefinancialstatements
Management is responsible for the preparation and fair presentation of these
financial statements in accordance with International Financial Reporting
Standards, and for such internal control as management determines
is necessary
to enable the preparation of financial statements that are free from material
misstatement,whetherduetofraudorerror.
Auditor’sresponsibility
Ourresponsibilityistoexpressanopiniononthesefinancialstatementsbasedon
ouraudit.We conductedourauditinaccordancewithInternationalStandardson
Auditing.Those
standardsrequirethatwecomplywithethicalrequirementsand
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plan and perform the audit to obtain reasonable assurance about whether the
financialstatementsarefreefrommaterialmisstatement.
An audit involves performing procedures to obtain audit evidence about the
amounts and disclosures in the financial statements. The procedures selected
depend on the auditor’s judgement, including the assessment of the
risks of
materialmisstatementof the financialstatements, whetherduetofraudorerror.
In makingthose risk assessments, the auditor considers internal control relevant
to the entity’s preparation and fair presentation of the financial statements in
order to design audit procedures that are appropriate in the circumstances, but
not for
the purpose of expressing an opinion on the effectiveness of the entity’s
internal control. Anaudit also includes evaluating the appropriateness of
accountingpoliciesusedandthereasonablenessofaccountingestimatesmadeby
management, as well as evaluating the overall presentation of the financial
statements.
We believe that the audit
evidence that we have obtained is sufficient and
appropriatetoprovideabasisforourauditopinion.
Opinion
Inouropinion,thefinancialstatementsgiveatrueandfairview(orpresentfairly,
in all material respects,) of the financial position of ABC Company as at 31
December 20X1, and
of its financial performance and its cash flows for the year
thenendedinaccordancewithInternationalFinancialReportingStandards.
(Auditor’ssign ature)
(Dateof thereport)
(Auditor’saddress)
2.4 Audit report prescribed by law or regulation
If the auditor is required by law or regulation (eg a national auditing standard) to
use a specific layout or wording of the audit report, rather than the wording in ISA
700, then the audit report may only refer to ISAs if it includes, as a minimum, the
following elements:
Title
Addressee
An introductory paragraph identifying 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 and the scope of the audit: this should include a reference to
ISAs and local auditing standards and a description of an audit in accordance
with those standards
An opinion paragraph containing an expression of opinion on the financial
statements, and a reference to the applicable financial reporting framework used
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Auditor’s signature
Date of the report
Auditor’s address.
These headings correspond with those specified by ISA 700 as headings to be
included in an unmodified audit report.
2.5 Audits conducted in accordance with both ISAs and local auditing
standards
An auditor may be required to conduct an audit in accordance with particular
national auditing standards (e.g. in the UK, with ISAs (UK and Ireland)) but in
doing so may have also complied with “pure” ISAs. This will be the case in the UK,
where, ISAs (UK and Ireland) are based on the “pure” ISAs.
In this case the audit report may refer to ISAs in addition to the national auditing
standards but only where:
there is no conflict between the national auditing standards and ISAs which
would have led the auditor to form a different opinion or not to include an
emphasis of matter paragraph (see later) that would have been required by ISAs,
and
if the report follows the wording of national auditing standards, it includes, as a
minimum, the elements as specified above.
When the report refers to both national auditing standards and ISAs it should
clearly identify the jurisdiction of origin of the national standards.
2.6 Unaudited supplementary information presented with the audited
financial statements
The report and accounts issued by a company often contain supplementary
information that is not covered by the auditor’s opinion, such as a chairman’s
statement, employment report or business review.
The auditor should be satisfied that any unaudited supplementary information that
is presented together with the audited financial statements is clearly differentiated
from the audited financial statements. This is because unaudited items are not
covered by the auditor’s opinion.
If the auditor concludes that the unaudited information is not clearly differentiated,
then he should ask management to change how that information is presented. If
management refuse to do so then the auditor should explain in his report that the
supplementary information has not been audited.
The auditor’s responsibilities in respect of unaudited supplementary information
are covered by ISA 720 (which is covered in a later section of this chapter).