Question 5 - Notes

Audit Report and Opinion

The Auditor’s Report

The purpose of an audit, according to ISA (NZ) 200.4, is to enhance confidence in the integrity of corporate reporting for stakeholders. This is achieved through the auditor's independent and objective opinion on whether the financial statements are presented fairly and give a true and fair view in accordance with the applicable financial reporting framework.

The auditor’s primary reporting obligation is typically to the governing body or members of the client's entity, as defined in the engagement letter. For companies under the Companies Act 1993, the main reporting obligation is to the company’s shareholders.

A typical auditor’s report includes the content/paragraphs (or has the structure) outlined in Fig. 11.1. ISA (NZ) 700 sets out the minimum requirements for what should be included in the auditor's report.

ISA (NZ) 700 (paragraphs 20 to 49) states that the auditor’s report should include:

• A title that clearly indicates it is the report of an independent auditor.
• Addressee, as per the engagement circumstances.
• An auditor’s opinion section, which should:
  • Identify the entity whose financial statements have been audited.
  • State that the financial statements have been audited.
  • Identify the title of each statement comprising the financial statements.
  • Refer to the notes, including the summary of significant accounting policies.
  • Specify the date of, or period covered by, each financial statement.
• A basis for opinion section, directly following the auditor’s opinion section, stating:
  • That the audit was conducted in accordance with International Standards on Auditing (New Zealand).
  • Reference to the section of the auditor’s report that describes the auditor’s responsibilities under the ISAs (NZ).
  • A statement that the auditor is independent of the entity in accordance with the relevant ethical requirements and has fulfilled other ethical responsibilities. The statement should identify the jurisdiction of origin of the ethical requirements or refer to the IESBA Code.
  • A statement of whether the auditor believes the audit evidence obtained is sufficient and appropriate to provide a basis for the auditor’s opinion (ISA [NZ] 700.8).
• Going concern considerations, where applicable.
• Key Audit Matters (KAMs): those matters that, in the auditor’s judgment, were of most importance in the audit of the relevant financial period.
• Other information, where applicable.
• Responsibilities for the financial statements, which are usually those charged with governance (as in New Zealand) or management (in some other jurisdictions).
• An auditor’s responsibilities for the audit of the financial statements section, stating the objectives of the audit and that reasonable assurance is a high level of assurance.
• An other reporting responsibilities section, where applicable.
• Name of the engagement partner.
• Signature of the auditor.
• Auditor’s address.
• Date of the auditor’s report.

Types of Auditor’s Opinions

Auditors can choose from four types of auditor opinion reports:

• The standard unmodified opinion: issued when the auditor is able to conclude that the financial statements are free from material misstatement.
• If the auditor believes that it is inappropriate to express an unmodified/clean opinion, ISA (NZ) 705.2 states that the auditor should issue one of the following modified opinions:
  • The qualified opinion: issued when the auditor concludes that misstatements, individually or in the aggregate, are material but not pervasive to the financial statements; or the auditor is unable to obtain sufficient appropriate audit evidence but believes that the probable impact of undetected misstatements, if any, would be material but not pervasive.
  • The adverse opinion: issued when the auditor, having acquired sufficient appropriate audit evidence, determines that misstatements, individually or in the aggregate, are both material and pervasive to the financial report.
  • The disclaimer of opinion: when the auditor decides to disclaim an opinion due to being unable to obtain sufficient appropriate evidence, and the auditor believes that the potential impact of undetected misstatements, if any, could be both material and pervasive.

The decision regarding which type of modified opinion is appropriate depends upon:

• The nature of the matter giving rise to the modification (whether the financial statements are materially misstated or, in the case of an inability to obtain sufficient appropriate audit evidence, may be materially misstated).
• The auditor’s judgement about the pervasiveness of the effects or possible effects of the matter on the financial statements.

Table 11.1 illustrates how the auditor’s judgement about the nature of the matter giving rise to the modification and the pervasiveness of its effects or possible effects on the financial statements affect the type of opinion to be expressed.

Types of Potential Misstatement

Auditors identify risk factors and then connect those to assertions that are likely to be misstated. Some potential misstatements are more significant than others in terms of the implications on the financial report and the auditor’s report. To determine the magnitude of potential misstatements, the auditor considers whether the effect of undetected and/or uncorrected misstatements is:

• material but not pervasive
• pervasive but not material
• both material and pervasive

ISA (NZ) 450.6 defines a misstatement as “a difference between the reported amount, classification, presentation, or disclosure of a financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be in accordance with the applicable financial reporting framework”.

According to ISA (NZ) 705, a material misstatement of the financial statements may arise in relation to:

• the appropriateness of the selected accounting policies
• the application of the selected accounting policies
• the appropriateness or adequacy of disclosures in the financial statements

ISA (NZ) 450.A1 describes how misstatements may result from:

• an inaccuracy in gathering or processing data from which the financial statements are prepared
• an omission of an amount or disclosure, including inadequate or incomplete disclosures, and those disclosures required to meet disclosure objectives of certain financial reporting frameworks, as applicable
• an incorrect accounting estimate arising from overlooking or clear misinterpretation of facts
• judgements of management concerning accounting estimates that the auditor considers unreasonable or the selection and application of accounting policies that the auditor considers inappropriate
• an inappropriate classification, aggregation or disaggregation of information

Misstatements can arise from error or fraud. ISA (NZ) 450 requires the auditor to communicate all misstatements identified during the audit with the client’s appropriate level of management and request them to address those misstatements. If management refuses or fails to correct some or all of the misstatements communicated by the auditor, the auditor should discuss with management the reasons for not making the corrections.

The auditor should then consider that discussion and his or her understanding of the implications of the uncorrected misstatements, individually or in the aggregate, when evaluating whether the financial statements as a whole are free from material misstatement (that is, when evaluating the magnitude of misstatements).

Materiality and Pervasiveness

The dividing line between material and immaterial information is usually referred to as the materiality threshold. Materiality is information that, if omitted, misstated, or not disclosed separately, has the potential to adversely affect decisions about the allocation of scarce resources made by users of the financial report. A transaction, event, or misstatement is material if it, individually or in the aggregate, will have a major impact on the financial, reputational, going concern, and/or economic and legal aspects of an entity. A misstatement is material if it may cause users of accounting information to reach wrong conclusions based on such misstated information.

Pervasive is a concept used in the context of misstatement to describe the scope of the effect of a misstatement. According to ISA (NZ) 705.5, “pervasive effects on the financial statements are those that, in the auditor’s judgement:

• are not confined to specific elements, accounts, or items of the financial statements
• if so confined, represent or could represent a substantial proportion of the financial statements
• in relation to disclosures, are fundamental to users’ understanding of the financial statements.”

How Different Types of Misstatements Affect the Auditor’s Opinion

An audit is the examination of accounting information conducted to express an independent audit opinion on whether the information presented, taken as a whole, reflects the financial position of the entity at a given date. The audit opinion is the output of the audit process and is presented in the audit report.

Auditors can choose among the following four different types of auditor opinion reports:

• The standard unmodified opinion, which is issued when the auditor can satisfactorily conclude that the financial statements are free from material misstatement. The form and content of the unmodified opinion are outlined in ISA (NZ) 700.
• If the auditor believes that it is inappropriate to express an unmodified/clean opinion, ISA (NZ) 705.2 states that the auditor should issue one of three types of modified opinions: a qualified opinion, an adverse opinion, and a disclaimer of opinion.

The decision regarding which type of modified opinion is appropriate depends upon:

• The nature of the matter giving rise to the modification, that is, whether the financial statements are materially misstated or, in the case of an inability to obtain sufficient appropriate audit evidence, may be materially misstated.
• The auditor’s judgement about the pervasiveness of the effects or possible effects of the matter on the financial statements.

The three modified opinions:

• The qualified opinion is issued when the auditor concludes, based on audit evidence, that misstatements, individually or in the aggregate, are material but not pervasive to the financial statements; or the auditor is unable to obtain sufficient appropriate audit evidence but believes that the probable impact on the financial statements of undetected misstatements, if any, would be material but not pervasive.
• The adverse opinion is issued when the auditor, having acquired sufficient appropriate audit evidence, determines that misstatements, individually or in the aggregate, are both material and pervasive to the financial report.
• The disclaimer of opinion is when the auditor decides to disclaim an opinion due to being unable to obtain sufficient appropriate evidence on which to base the opinion, and the auditor believes that the potential impact on the financial report of undetected misstatements, if any, could be both material and pervasive.

Table 7.1 illustrates how the auditor’s judgement about the nature of the matter giving rise to the modification and the pervasiveness of its effects or possible effects on the financial statements affects the type of opinion to be expressed.