AUDITORS’ REPORT (iSA 700) NOTES

SUBSTANTIVE TESTING Notes Part 2

THE AUDITOR AND THE COMPANIES ACT-Principles of Good Corporate Governance

INTRODUCTION

Once the auditor has gathered sufficient appropriate audit evidence on which to base his opinion, he is expected to put his findings on the true and fairness of the financial statements in a report. This report is referred to as the auditors report. The report is primarily meant for the Shareholders but can be of benefit to other users of the financial statements as well for example the banks. The wording and the format of the report is guided by law.

The Companies act cap 486 requires that the auditor of a limited liability company to report to the members whether the financial statements laid before the AGM show true and fair view of the state of affairs of the company and comply with the requirements of the companies act. The audit report is therefore the means by which the auditor reports his opinions as to whether the financial statements show a true and fair view of the state of affairs. The report is addressed to shareholders.

DEFINITION OF KEY TERMS

Qualified audit reports

When the auditor has reservation on any matter that is considered material to the financial statements, he may introduce qualifying remarks in the audit report.

Going Concern

This concept states that the transactions and the financial statements have to be recognized and prepared in such a way that the entity shall continue with operations for the foreseeable future period and shall not cease to be in existence, stop or curtail is present production either currently or in the near future.

INDUSTRY CONTEXT

The main purpose of any audit is to form an opinion on the financial statements, this opinion is expressed in a report. This area is therefore important in any auditors work.

The requirements of Companies Act regarding auditors report

Section 162(1) of the Companies act stipulates the statements that should be expressly stated in the auditor’s report. These are;

Whether the auditor has obtained all the information and explanation which to the best of his knowledge and belief were necessary for audit proposes.
Whether in his opinion, proper books of accounts have been kept by the company, so far as it appears from the examination of those books and proper returns adequate for the purposes of the audit from branches not visited by him.
Whether the company’s balanced sheet and profit and loss accounts dealt by the report are in agreement with the books of the accounts and returns.
Whether in his opinion and to the best of his information and according to the explanations given to him, the financial statements give the information required by the Companies act in the manner so required and give at rue and fair view.
in the case of the balance sheet, of the state of affairs of the company as at the end of the accounting period.
In the case of the profit and loss account, of the state of profit or loss of the company in the financial year.
In the case of a holding company submitting group financial statements whether in his opinion, the group financial statements have been prepared in accordance with the provisions of the Companies act so as to give a true and fair view of the state of affairs and profit or loss of the company.

Basic Elements of Auditors Report

The Companies act does not stipulate the form the auditor’s report should take. The auditing standards seek to ensure that the auditor’s report is clear and unambiguous. To this end, it seeks to standardize the form of the auditor’s report. it does this by giving the basic elements of the auditor’s report.

Appropriate report title

Auditing standards require that the report be titled and that the title includes the word ‘independent’ e.g. independent auditors report’. The requirement that the title includes the word independent is intended to convey to users that the audit was unbiased in all aspects.

Address

The report is usually addressed to the company, its stockholders or the board of directors. For practical reasons, it limits the users of auditor’s report.

Introductory paragraph

The first paragraph has three purposes, fist, it makes a statement that the practice did an audit. Secondly, it lists all the financial statements that were audited including the balance sheet dates and accounting periods for the income statement and cash flow statement. The wording of the financial statements in the report should be identical to those used by management on the financial statements. Thirdly, the introductory paragraph states that the statements are the responsibility of management and that the auditor’s responsibility is to express an opinion on the statements based on the audit.

Scope paragraph

This paragraph is a factual statement about what the auditor did in the audit. This paragraph states how the audit was planned and performed in accordance with iSas and states that the audit is designed to obtain reasonable assurance whether the financial statements are free of material misstatements.

Opinion paragraph

This final paragraph states the auditors conclusions based on the results of the audit. This part of the report is so important that often the audit report is simply called the auditor’s opinion. The opinion paragraph is stated as an opinion rather than a statement of absolute fact or a guarantee.

Audit report date

The appropriate date for the report is the one on which the auditor has completed the most important audit procedures in the field. This date is important to users of financial statements as it indicates the last day of auditor’s responsibility for review of significant events that have occurred after date of financial statements.

Name of audit firm

The firm’s name is used because the entire firm has the legal responsibility to ensure that the quality of audit meets professional standards.

Types of Audit Opinions

Unqualified opinion.
1. Disclaimer opinion
1. Qualified opinion
1. adverse opinion

a) Unqualified opinion.

This is issued when the auditor is satisfied in all material aspects that enable him express the required opinion on financial statements without any reservation. This is sometimes called a clean opinion. It is expressed when the auditor concludes that the financial statements give a true and fair view in accordance with the relevant financial reporting standards.

Emphasis on matter report

There are occasions when the auditor has no reservation as to the financial statements but where they exists unusual events, conditions or accounting policies and he feels that unless the reader may not reach a proper understanding of the financial position and results. In such circumstances, the auditor should express an unqualified opinion including an extra paragraph called ‘emphasis of the matter paragraph’ to draw attention of the reader to the unusual matter.

The addition of such an emphasis of matter paragraph does not lead to a qualification of the audit opinion but is intended to enable the reader obtain a better understanding. To avoid this being understood as a qualification, the emphasis of the matter paragraph should contain the phrase ‘without qualifying our opinion’.

practical circumstances requiring emphasis of matter paragraph are:

Unusual condition would include destruction of assets after balance sheet date but the company remains a going concern.
The company being insolvent on the face of its own balance sheet but the auditor has letters of support which he is satisfied can be fulfilled by the other party thus he will accept appropriateness of the going concern assumption. Unusual events could also include changes in the legislation that could have a material impact on the entity’s business operations subsequent to the balance sheet date. Unusual accounting policies that may lead to emphasis of matter paragraph would involve those matters not covered by any accounting standard.

ii. inherent uncertainties that may call for emphasis of matter paragraph would include contingencies at the balance sheet date which have not been resolved at the date of signing the auditor’s report.

iv. Negotiations for financing which have not been financed by date of signing of the auditor’s report.

The format of the Unqualified audit report

Here is the illustrative unqualified report from ISA 700

Auditor’s Report

We have audited the accompanying balance sheet of the abC Company as of December 31, 2021, 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. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with international Standards on auditing (or refer to relevant national standards or practices). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of 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 account principles used in significant estimates made by the 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 give a true and view of (or ‘present fairly, in all material respects,’) the financial position of the Company as of December 31, 20×1 and of results of its operations and its cash flows for the year then ended in accordance with … (and comply with ….) Auditor Date address’ Footnotes: reference may be by page numbersindicate iaSs or relevant national standardsrefer to relevant statues or law

(Appropriate Addressee)

Qualifications of audit reports

When the auditor has reservation on any matter that is considered material to the financial statements, he may introduce qualifying remarks in the audit report. The auditor’s reservation could arise out of the following;

limitation on the scope of his work.
Disagreement with management.
Significant uncertainty affecting financial statements, the resolution of which is dependent upon future events.
Qualified audit opinion or except for opinion.

This is expressed when auditor concludes that unqualified opinion cannot be expressed but that the effect of any disagreement with management or limitation in scope is not so material and pervasive as to require an adverse opinion or disclaimed opinion. A qualified opinion implies that all aspects of the financial statements are okay expect for the effects of the matters which the qualifications relate.

Disclaimer of opinion.

This is issued when the possible effect of a limitation in scope or uncertainty is so material or pervasive that the auditor has not been able to obtain sufficient appropriate audit evidence, as a result he is unable to express an opinion on financial statements. A disclaimer of opinion implies that the auditor is unable to form an opinion because sufficient audit evidence could not be obtained.

Adverse opinion.

This is expressed when the effects of a disagreement is so material and pervasive to the financial statements that the auditor concludes that a qualification of the report is not adequate to disclose the misleading and incomplete nature of the financial statements. The auditor states that due to the nature of the disagreement in his opinion, the financial statements do not show true and fair view.

Limitation of scope

if for any reason the auditor is unable to receive all the information and explanations he deems necessary for the purposes of his audit, then there is a limitation in scope of his work. it means that the auditor to conclude his work objectively. This could arise due to the following reasons;

refusals by management to allow the auditor examine certain documents or records.
if the auditor is denied the opportunity to carry out an auditing procedure he considers important and he cannot conclude through alternative procedures, then there is limitation of scope in auditor’s work.
Destruction of accounting records or documents through fire of other disaster meaning that such documents or records are not available for examination by the auditor.
being appointed auditor after the year end with the result that certain evidence will not be collected.

Effects of Limitation in Scope on the Auditor’s opinion

if the possible effect of limitation in scope of an audit is material but not fundamental to the financial statements, the auditor issues a qualified opinion. (Except for opinion.)

if the possible effect of limitation in scope of an audit is of fundamental importance that the auditor is unable to express an opinion on the financial statements, the auditor issues a disclaimer of opinion as mentioned above.

When there is a limitation in scope of auditor’s work that requires the expression of a qualified opinion or a disclaimer of opinion, the auditor should describe the nature of the limitation in his report and indicate the possible adjustments to the financial statements that might have been determined to be necessary, had the limitation not existed.

Examples of modified reports

(a) Limitation on scope

Limitation on scope – qualified person

‘We have audited … (remaining words are the same as illustrated in the introductory paragraph of the unqualified above). Except as discussed in the following paragraph, we conducted our audit in accordance with ….(remaining words are the same as illustrated in the scope paragraph of the unqualified report above).

We did not observe the counting of the physical inventories as of December 31, 20×1, since that date was prior to the time we were initially engaged as auditors fir the company. Owing to the nature of the company’s records, we were unable to satisfy ourselves as to inventory quantities by other audit procedures.

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 satisfy ourselves as to physical inventory quantities, the financial statements give a true and (remaining words are the same as illustrated in the opinion paragraph of the unqualified report above).’

Limitation on scope – disclaimer of opinion

‘We are engaged to audit the accompanying balance sheet of the abC Company as of December 31 20×1 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. (omit the sentence stating the responsibility of the auditor).

(The paragraph discussing the scope of the audit would either be omitted or amended according to the circumstances.)

(add a paragraph discussing the scope limitations as follows:)

We were not able to observe all physical inventories and confirm accounts receivable due to limitations placed on the scope of our work by the company.

Because of the significance of the matters discussed in the preceding paragraph we do not express an opinion on the financial statements.

Inherent uncertainties

inherent uncertainties result from circumstances in which it is impossible for the auditor to reach any objective conclusion as to the outcome of a situation due to the circumstances themselves rather than a limitation of scope of the audit. Such uncertainties are only resolved through the passage of time e.g. to wait for the outcome of a litigation. however, time is a great constraint and financial statements must be prepared within the required time. The auditor should form an opinion on the adequacy of the accounting treatment of such uncertainties. This will involve consideration of:

The appropriateness of any accounting policies adopted by the management in treating the effect of such uncertainties.
The reasonableness of the estimates included in the financial statements.
The adequacy of disclosure of the uncertainties.

Some inherent uncertainties are fundamental. These are uncertainties where the degree of uncertainty and its potential impact on the view given by the financial statements may very great. in determining whether an uncertainty is fundamental, the auditor considers the following:

The risk of the estimate included in the balance sheet being subject to change.
The range of possible outcomes.
The consequences of those outcomes on the view given by the financial statements. Inherent uncertainties are considered fundamental when they involve a significant level of concern about the validity of the going concern assumption or other matters whose potential effect on the financial statements is usually great.

Disagreement

Under disagreement, the auditor is able to conclude objectively that he has received all the information and explanations he considers necessary for the purpose of the audit. but his conclusion is at variance with the position adopted by the management or the view given by the financial statements. Circumstances giving rise to disagreements include;

application of inappropriate records by the management.
Some facts or amounts included in the financial statements e.g. the auditor may feel that the amount provided for as a contingent loss arising from a lawsuit against the company is too low.
interpretation of accounting policies or legislation.
Manner, mode or extent of disclosure of facts or amounts in the financial statements. Whether the auditor agrees with the accounting treatment or disclosure of a matter in the financial statements and in the auditor’s opinion, the effect of that disagreement is material to the financial statements, the auditor should;
include in his report a description of all the factors giving rise to the disagreement.
The implications of such factors on the financial statements.
A quantification of the effect on the financial statements.

Examples

Disagreement on Accounting Policies- Inappropriate Accounting method – Qualified opinion

‘We have audited ….(remaining words are the same as illustrated in the introductory paragraph of the unqualified report above.) We conducted our audit in accordance with … (remaining words are the same as illustrated in the scope paragraph of the unqualified report above). As discussed in Note X to the financial statements, no depreciation has been provided in the financial statements which practice, in our opinion, isn’t in accordance with International accounting Standards. The provision for the year ended December 31, 2021 should be based on the straight line method of depreciation using annual rates of 5% for the building and 20% for the equipment. accordingly the non current assets should be reduced by the accumulated depreciation of xxx and the loss for the year and accumulated deficit should be increased by xxx and xxx respectively. In our opinion, except for the effect on the financial statements of the matter referred to in the preceding paragraph, the financial statements give a true and …. (remaining words are the same as illustrated in the opinion paragraph of the unqualified report above).

Disagreement on Accounting Policies – inadequate disclosure – qualified opinion

‘We have audited … (remaining words are the same as illustrated in the introductory paragraph of the unqualified report above). We conducted our audit in accordance with.. (remaining words are the same as illustrated in the scope paragraph of the unqualified report above.

On January 15, 2O17, the company issued debentures in the amount of xx for the purpose of financing plant expansion. The debenture agreement restricts the payment of future cash dividends to earnings after December 31, 2021. in our opinion, disclosure of this information is required by …. (insert reference to statutory or regulatory requirement). In our opinion, except for the omission of the information included in the preceding paragraph, the financial statements give a true and … (remaining words are the same as illustrated in the opinion paragraph of the unqualified report above).

Disagreement on accounting policies – inadequate disclosure – adverse opinion

We have audited … (remaining words are the same as illustrated in the introductory paragraph of the unqualified report above).

We conducted our audit in accordance with.. (remaining words are the same as illustrated in the scope paragraph of the unqualified report above.

in our opinion, because of the effects of the matters discussed in the preceding paragraph(s), the financial statements do not give a true and fair of (or do not ‘present fairly’) the financial position of the company as at December 31, 20×1, and of result of its operations and its cash flows for the year then ended in accordance with (insert relevant IASs or national standards) .. and do not comply with …… (insert relevant statutes or law).

Effects of disagreements on auditor’s opinion

When the auditor concludes that the effect of the matter giving rise to disagreement is so fundamental that the financial statements are misleading, the auditor should issue an adverse opinion.

if the nature of the disagreement is material but not fundamental, the auditor should issue a qualified opinion indicating that all other aspects of the financial statements are okay except for the matter giving rise to the disagreement.

Material but not pervasive

The auditor may not include qualifying remarks in his audit report unless the matter is material. material but not pervasive means that the reservation the auditor has is material in the context of a segment of the financial statements but not to the financial statements taken as a whole.

Material and pervasive

A matter becomes material and pervasive when it is material in the context of the financial statements taken as a whole. a limitation of scope becomes pervasive when it makes the financial statements misleading for decision making purposes or of little value for decision making purposes. A disagreement becomes pervasive when it makes the financial statements taken as a whole to be totally misleading.

Qualification matrix

nature of circumstance	Material but not significant	Fundamental
limitation of scope or uncertainty	Qualified opinion (except for opinion)	Disclaimer of opinion
Disagreement	Qualified opinion (except for opinion)	adverse opinion

Going Concern (iSA 570)

The going concern concept is a fundamental concept of iaS 1 (disclosure of accounting policies) which governs the preparation and presentation of financial statements. This concept states that the transactions and the financial statements have to be recognized and prepared in such a way that the entity shall continue with operations for the foreseeable future period and shall not cease to be in existence, stop or curtail is present production either currently or in the near future.

The auditor when reporting on the financial statements is categorically concerned of the going concern concept because;

It affects true and fair view of the financial statements
It facilitates qualification of audit reports.
It confirms compliance of financial statements with the generally accepted accounting principles and policies.
The auditor’s main interest will be that all material matters affecting the financial statements have been disclosed.

If fundamental accounting principles governing the financial statements have been properly observed in all material aspects, the financial statements presented show a true and fair view.

Appropriateness of Going Concern Assumption

The auditor should consider the risk that the going concern assumption may no longer be appropriate. indications of the risk that the continuance as a going concern may be questionable could come from the financial statements or from other sources. Examples of such indications are as follows:

Financial indicators.
1. Changes of the financial position of the company drastically within a short period of time especially from bad to worse.
1. Financial difficulties affecting the company’s production process and sales.
1. Changes of credit policies especially from credit to cash on delivery.
1. Difficulties in paying salaries and wages of employees.
1. Increased financial borrowing.
Non financial indicators.
1. High staff turnover in key accounting and managerial officials and finance personnel especially without replacement.
1. Unfriendly environment between management and management and employees
1. Unusual pressure within the entity for no apparent reason.
1. Circumstances of labour disputes e.g. strikes by employees leading to demonstrations ad protests.
1. Where the entity relies heavily on a customer for sale of its products or for marketing its output.
1. pending legal proceedings against the entity that may, if successful, result in judgements that could not be met.
1. non compliance with capital and other statutory requirements.

The significance of such indications can often be mitigated by other factors. For example, the effect of an entity being unable to make its normal debt repayments may be counterbalanced y management’s plans to maintain adequate cash flows by alternative means, such as by disposal of assets, rescheduling of loan repayments, or obtaining additional capital. Similarly, the loss of a principal supplier may be mitigated by the availability of a suitable alternative source of supply .

SUMMARY

Unqualified opinion

When the auditor is satisfied in all material respects that enables him to express the required opinion on the financial statements without any reservations. This is sometimes called a clean opinion. This is expressed when the auditor concludes that the financial statements give a true and fair view in accordance with the relevant financial reporting framework.

Qualified audit opinion (except for opinion)

This is expressed when the auditor concludes that an unqualified opinion cannot be expressed but that the effect of any disagreement with management or limitation on scope is not so material and pervasive as to require an adverse opinion or disclaimer of opinion. A qualified report implies that all other aspects of the financial statements are okay except for the effects of the matter to which the qualification relates.

Disclaimer of opinion

This is issued when the possible effect of a limitation on scope or uncertainty is so material and pervasive that the auditor has not been able to obtain sufficient appropriate audit evidence and as a result he is unable to express an opinion on the financial statements. A disclaimer of opinion implies that the auditor is unable to form an opinion because sufficient audit evidence could not be obtained.

Adverse opinion

This is expressed when the effects of a disagreement is so material and pervasive to the financial statements that the auditor concludes that a qualification of the report is not adequate to disclose the misleading or incomplete nature of the financial statements. The auditor states that due to the nature of the disagreement in his opinion the financial statements do not show a true and fair view.

Limitation of scope

if for any reason the auditor is unable to receive all the information and explanation he deems necessary for the purposes of his audit then there has been a limitation in the scope of his work. it means that the auditor is unable to conclude objectively.