chapter 12 audit reports and communication · 2018-09-22 · chapter 12 –audit reports and...

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Hayes, Gortemaker and Wallage, Principles of Auditing PowerPoints on the Web, 3rd edition © Pearson Education Limited 2014

Principles of Auditing: An Introduction to

International Standards on Auditing

Chapter 12 – Audit Reports and

Communication

Rick Hayes, Hans Gortemaker

and Philip Wallage

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Management responsibility for audit report – SOX

SOX Requires that the principal executive officer or officers and the principal financial officer or officers, certify in each report filed with the SEC the following:

the signing officer has reviewed the report;

the report does not contain any untrue statement of a material

fact or omit to state a material fact;

the financial statements, and other financial information, fairly

present in all material respects the financial condition of the

company;

the signing officers:

• are responsible for establishing and maintaining internal controls;

• have evaluated the effectiveness of the company’s internal controls;

• have presented in the report their conclusions about the

effectiveness of their internal controls based on their evaluation.

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Requires that the principal executive officer or officers and the principal financial officer or officers, certify in each report filed with the SEC the following:

the signing officers have disclosed to the company’s auditors and the audit committee of the board of directors:

• all significant deficiencies in the design or operation of internal controls which could adversely affect the company’s ability to record, process, summarise and report financial data and have identified for the company’s auditors any material weaknesses in internal controls;

• any fraud, whether or not material, that involves management or other employees who have a significant role in the company’s internal controls.

Management responsibility for audit report under

SOX (Continued)

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Old style audit report (3 paragraph)

Sample Wording – Auditor’s Unqualified Report17

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Contents of the PCAOB combined financial

statement and internal control auditor’s report

• Title

• Addressee (not required PCAOB AS 5)

• Opening or introductory paragraph

• Scope paragraph (describing the nature of an

audit)

• Definition paragraph

• Limitations paragraph

• Opinion paragraph containing an expression of

opinion on the financial statements

• The date of the report, the auditor’s address and

auditor’s signature

US classes

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Example PCAOB sample combined

financial statement and internal control

audit report from Audit Standard No. 5

Next slides

US classes

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Report of independent registered public accounting firm

[Introductory paragraph]We have audited the accompanying balance sheets of W Company as of December 31, 20X8 and 20X7, and the related statements of income,Stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 20X8. We also have audited management’s assessment, included in the accompanying [title of management’s report], that W Company maintained effective internal control over financial reporting as of December 31, 20X8, based on [Identify control criteria, for example, ‘criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)’.]. W Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the company’s internal control over financial reporting based on our audits.

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[Scope paragraph]

We conducted our audits in accordance with the standards of the Public

Company Accounting Oversight Board (United States). Those standards

require that we plan and perform the audits to obtain reasonable assurance

about whether the financial statements are free of material misstatement and

whether effective internal control over financial reporting was maintained in all

material respects. Our audits of the financial statements included examining,

on a test basis, evidence supporting the amounts and disclosures in the

financial statements, assessing the accounting principles used and significant

estimates made by management, and evaluating the overall financial

statement presentation. Our audit of internal control over financial reporting

included obtaining an understanding of internal control over financial

reporting, assessing the risk that a material weakness exists, testing and

evaluating the design and operating effectiveness of internal control based on

the assessed risk, and performing such other procedures as we considered

necessary in the circumstances. We believe that our audits provide a

reasonable basis for our opinions.

US classes

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[Definition paragraph]

A company’s internal control over financial reporting is a process designed

to provide reasonable assurance regarding the reliability of financial

reporting and the preparation of financial statements for external purposes

in accordance with generally accepted accounting principles. A company’s

internal control over financial reporting includes those policies and

procedures that (1) pertain to the maintenance of records that, in

reasonable detail, accurately and fairly reflect the transactions and

dispositions of the assets of the company; (2) provide reasonable

assurance that transactions are recorded as necessary to permit

preparation of financial statements in accordance with generally accepted

accounting principles, and that receipts and expenditures of the company

are being made only in accordance with authorisations of management and

directors of the company; and (3) provide reasonable assurance regarding

prevention or timely detection of unauthorised acquisition, use or

disposition of the company’s assets that could have a material effect on the

financial statements.

US classes

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[Inherent limitations paragraph]

Because of its inherent limitations, internal control over financial reporting may

not prevent or detect misstatements. Also, projections of any evaluation of

effectiveness to future periods are subject to the risk that controls may become

inadequate because of changes in conditions, or that the degree of compliance

with the policies or procedures may deteriorate.

[Opinion paragraph]

In our opinion, the financial statements referred to above present fairly, in all

material respects, the financial position of W Company as of December 31, 20X8

and 20X7, and the results of its operations and its cash flows for each of the

years in the three-year period ended December 31, 20X8 in conformity with

accounting principles generally accepted in the United States of America. Also in

our opinion, W Company maintained, in all material respects, effective internal

control over financial reporting as of December 31, 20X8, based on [Identify

control criteria, for example, ‘criteria established in Internal Control – Integrated

Framework issued by the Committee of Sponsoring Organizations of the

Treadway Commission (COSO)’.].

[Signature]

[City and State or Country]

[Date]US classes

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ISA 700 auditors opinion on F/S

• Title: ‘Independent Auditor’s Report’

• [Appropriate Addressee]

• Introductory Paragraph (Report on Financial Statements)

• Management’s Responsibility for the Financial Statements

• Auditor’s Responsibility

• Opinion

• Report on Other Legal and Regulatory Requirements

[Form and content of this section of the auditor’s report will

vary depending on the nature of the auditor’s other reporting

responsibilities.]

• [Auditor’s signature]

• [Date of the auditor’s report]

• [Auditor’s address]

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Included in the audit report

• A title, e.g. ‘Independent Auditor’s Report’

• An addressee, as required by the circumstances

of the engagement, e.g. ‘Shareholders of ABC

company’

• An introductory paragraph that identifies the

financial statements audited.

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ISA 700 sample financial statement

audit report

Independent Auditor’s Report

[Appropriate Addressee]

Report on the Financial Statements

We have audited the accompanying financial

statements of ABC Company, which comprise the

statement of financial position as at December 31,

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 accounting policies and other

explanatory information.

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• A description of the responsibility of management

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, that includes:

• A reference to International Standards on Auditing

and the law or regulation

• A description of an audit in accordance with those

standards.

The audit report management responsibility

and auditor responsibility

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Management’s Responsibility for the Financial Statements

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, whether due to fraud or error.

Auditor’s Responsibility

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. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.

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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 material misstatement of the financial statements, whether due to fraud or error. In making those 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. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

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• An opinion paragraph containing an expression of

opinion on the financial statements and a reference

to the applicable financial reporting framework used

to prepare the financial statements (including

identifying the jurisdiction of origin of the financial

reporting framework that is not International Financial

Reporting Standards or International Public Sector

Accounting Standards.

• The auditor’s signature.

• The date of the auditor’s report.

• The auditor’s address.

Included in the audit report opinion

and signatures

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Opinion

In our opinion, the financial statements present fairly, in all

material respects, (or give a true and fair view of) the financial

position of ABC Company as at December 31, 20X1, and (of)

its financial performance and its cash flows for the year then

ended in accordance with International Financial Reporting

Standards.

Report on Other Legal and Regulatory Requirements

[Form and content of this section of the auditor’s report will

vary depending on the nature of the auditor’s other reporting

responsibilities.]

[Auditor’s signature]

[Date of the auditor’s report]

[Auditor’s address]

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The report must be dated

The auditor shall date the report 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

including evidence that: (a) all the statements that

comprise the financial statements, including the

related notes, have been prepared; and (b) those

with recognised authority have asserted that they

have taken responsibility for those financial

statements.

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The opinion expressed in the auditor’s report

may be one of four types:

Q U A D

Unmodified

(unqualified), Three Modified Opinions:

qualified,

adverse or

disclaimer of

opinion

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Unqualified audit opinion – also called

unmodified opinion

• Unmodified (unqualified) opinion – 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.

• Most common type of audit report.

• Called ‘clean opinion’.

• Used for more than 90 per cent of all audit reports.

• Other audit reports are referred to as ‘modified opinion (adverse opinion, disclaimer of opinion and qualified opinion).

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Evaluation of the compliance to the reporting

framework include consideration of these

qualitative aspects

• Whether the financial statements adequately disclose the significant

accounting policies selected and they are consistent and appropriate.

• Accounting estimates made by management are reasonable.

• Information presented in the financial statements is relevant,

reliable, comparable and understandable.

• Disclosures to enable the intended users to understand the effect

of material transactions and events on the information conveyed in

the financial statements.

• Terminology used in the financial statements, including the

title of each financial statement, is appropriate.

• Whether the financial statements achieve fair presentation.

If they are prepared in accordance with a fair presentation

framework.

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Auditor’s qualified opinion

The auditor will express a qualified opinion when:

• having obtained sufficient appropriate audit

evidence, he 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 on which to base the opinion, but

the auditor concludes that the possible effects on

the financial statements of undetected

misstatements, if any, could be material but not

pervasive.

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Auditors responsibility …We believe that the audit evidence we have obtained

is sufficient and appropriate to provide a basis for our qualified audit opinion.

Basis for qualified opinion

ABC Company’s investment in XYZ Company, a foreign associate acquired

during the year and accounted for by the equity method, is carried at xxx on the

statement of financial position as at December 31, 20X1, and ABC’s share of

XYZ’s net income of xxx is included in ABC’s income for the year then ended.

We were unable to obtain sufficient appropriate audit evidence about the carrying

amount of ABC’s investment in XYZ as at December 31, 20X1 and ABC’s share

of XYZ’s net income for the year because we were denied access to the financial

information, management and the auditors of XYZ. Consequently, we were

unable to determine whether any adjustments to these amounts were necessary.

Qualified opinion

In our opinion, except for the possible effects of the matter described in the

Basis for Qualified Opinion paragraph, the financial statements present fairly,

in all material respects, (or give a true and fair view of) the financial position of

ABC Company as at December 31, 20X1, and (of) its financial performance and

its cash flows for the year then ended in accordance with International Financial

Reporting Standards.

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Auditor’s adverse opinion ( ISA 705)

The auditor shall express an adverse opinion

when the auditor, having obtained sufficient

appropriate audit evidence, concludes that

misstatements, individually or in the aggregate,

are both material and pervasive to the financial

statements.

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Auditor’s disclaimer of opinion (ISA 705)

The auditor shall disclaim an opinion when the

auditor is unable to obtain sufficient appropriate

audit evidence on which to base the opinion,

and the auditor concludes that the possible

effects on the financial statements of undetected

misstatements, if any, could be both material

and pervasive.

or interaction of multiple

uncertainties on F/S

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Basis for modification paragraph

When the auditor modifies the opinion on the

financial statements, the auditor shall, in addition to

the specific elements required by ISA 700, include

a paragraph in the auditor’s report that provides a

description of the matter giving rise to the

modification. The auditor shall place this paragraph

immediately before the opinion paragraph in the

auditor’s report and use the heading ‘Basis for

Qualified Opinion’, ‘Basis for Adverse Opinion’ or

‘Basis for Disclaimer of Opinion’, as appropriate.

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When the auditor includes an Emphasis

of Matter paragraph in the auditor’s report,

the auditor shall:

a. include it immediately after the Opinion paragraph

in the auditor’s report;

b. use the heading ‘Emphasis of Matter’;

c. include in the paragraph a clear reference to the

matter being emphasised and to where relevant

disclosures that fully describe the matter can be

found in the financial statements;

d. indicate that the auditor’s opinion is not modified

in respect of the matter emphasised.

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An auditor might write an emphasis of a

matter paragraph:

• If there is a significant uncertainty which may affect the financial statements, the resolution of which is dependent upon future events.

• Examples of uncertainties that might be emphasised include:

• the existence of related party transactions;

• important accounting matters occurring subsequent to the

balance sheet date;

• matters affecting the comparability of financial statements with

those of previous years (e.g. change in accounting methods);

• litigation, long-term contracts, recoverability of asset values,

losses on discontinued operations.

• To highlight a material matter regarding a going concern problem.

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The going concern disclosure

should:

• describe the principal conditions that raise doubt;

• state that there are doubts about going concern,

therefore the entity may be unable to realise its

assets and discharge its liabilities in the normal

course of business;

• state that the financial statements do not include

any adjustments relating to the recoverability and

classification of recorded asset amounts or to

amounts and classification of liabilities that may be

necessary should the entity be unable to continue

as a going concern.

ISA 570

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1. A limitation in scope

2. The auditor’s judgement about the pervasiveness of the

effects or possible effects of the matter on the financial

statements.

The circumstances described in 1 – scope limitation –

could lead to a modified opinion or a disclaimer of

opinion. The circumstances described in 2 –

disagreement with management – could lead to a

modified opinion or an adverse opinion.

Circumstances that may result in other than

an unmodified opinion

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Limitation on scope

• Scope limitations arise when the auditors are

unable for any reason to obtain the information

and explanations considered necessary for the

audit

– limited by the inability to carry out a procedure

the auditors consider necessary

– the absence of proper accounting records

• The audit report should describe the limitation.

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Modification of opinion results from

disagreement with management on

• the acceptability of the accounting policies

selected;

• the method of policy application, including the

adequacy of valuations and disclosures in the

financial statements; or

• the compliance of the financial statements with

relevant regulations and statutory requirements.

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Uncertainties leading to qualification

of opinions

Certain uncertainties may lead to an auditor’s

report containing a qualification of opinion in

many countries.

These uncertainties include:

• material uncertainties;

• lack of consistency;

• independence of auditor;

• reports in reference to an expert;

• fraud.

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Materiality, lack of consistency, independence

• If the amounts of a misstatement in the financial

statements are so significant that the financial statements

are materially affected as a whole, it is necessary to issue

either a qualified or an adverse opinion.

• Lack of consistency in the application of accounting

principles in the current period in relation to the preceding

period may require a modification to an unmodified

opinion based on standards in many countries.

• ISA auditing standards do not require a modified opinion

or a disclaimer of opinion if the auditor is not independent,

although this is the case in several countries (including

US).

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Reports involving other auditors

and experts

ISA 620 suggests that when expressing an unmodified

(unqualified) opinion the auditor should not refer to the

work of an expert in her report as such a reference might

be misunderstood to be a qualification of the auditor’s

opinion or a division of responsibility. If the auditor

references the work of an expert in the auditor’s report

because it is relevant to a modification to the auditor’s

opinion, the auditor shall indicate this does not reduce

the auditor’s responsibility for that opinion.

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Auditor communications to governance entity

Audit matters of governance interest to be communicated by the auditor to the board or audit committee ordinarily include:

• Material deficiencies in internal control

• Non-compliance with laws and regulations

• Fraud involving management

• Questions regarding management integrity

• The general approach and overall scope of the audit

• The selection of, or changes in, significant accounting policies and practices that have a material effect on the financial statements.

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Communications of deficiencies in internal control

The auditor must communicate to management in

writing significant deficiencies in internal control that

are of sufficient importance to merit management’s

attention. The communication should include:

A description of the deficiencies and an explanation

of their potential effects

Sufficient information to enable those charged with

governance and management to understand the

context of the communication.

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Governance structures

• The structures of governance vary from country to

country reflecting cultural and legal backgrounds.

• In some countries, the supervision function, and

the management function are legally separated

into different bodies, such as a supervisory

(wholly or mainly non-executive) board and a

management (executive) board.

• In other countries, like the US, both functions are

the legal responsibility of a single, unitary board.

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Reporting fraud and error

• When the auditor encounters circumstances that may

indicate that there is a material misstatement in the

financial statements resulting from fraud or error,

the auditor should perform procedures to determine

whether the financial statements are materially

misstated.

• The auditor’s duty of confidentiality would ordinarily

preclude reporting fraud or error to a third party.

However, in certain circumstances, statute or law

overrides this duty.

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Long-form audit report

• In many countries it is customary for the auditor to prepare a ‘long-form’ report to the Audit Committee of an entity’s board of directors in addition to the publicly published ‘short-form’ report discussed in this chapter.

• A long- form report ordinarily includes:

• Overview of the Audit Engagement

• Analysis of Financial Statements

• Risk Management and Internal Control

• Optional Topics

• Auditor independence and quality control

• Fees.

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Management letter

The management letter identifies issues not

required to be disclosed in the Annual Financial

Report but represent the auditors concerns and

suggestions noted during the audit. An evaluation

is made of the present system, pointing out

problem areas. Recommendations for

improvement are cited. Also included is a

discussion of any problem which may require

immediate action to correct.

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Thank you for your attention

Any Questions?

chapter 12 audit reports and communication · 2018-09-22 · chapter 12 –audit reports and...

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