Application and Other Explanatory Material
The table below 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 report, affects the type of opinion to be expressed.
|Nature of Matter Giving Rise to the Modification||Auditor’s Judgement about the Pervasiveness of the Effects or Possible Effects on the Financial Report|
|Material but Not Pervasive||Material and Pervasive|
|The financial report is materially misstated||Qualified opinion||Adverse opinion|
|Inability to obtain sufficient appropriate audit evidence||Qualified opinion||Disclaimer of opinion|
Circumstances When a Modification to the Auditor’s Opinion is Required
Nature of Material Misstatements (Ref: Para. 6(a))
ASA 700 requires the auditor, in order to form an opinion on the financial report, to conclude as to whether reasonable assurance has been obtained about whether the financial report as a whole is free from material misstatement. This conclusion takes into account the auditor’s evaluation of uncorrected misstatements, if any, on the financial report in accordance with ASA 450.
ASA 450 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. Accordingly, a material misstatement of the financial report may arise in relation to:
- The appropriateness of the selected accounting policies;
- The application of the selected accounting policies; or
- The appropriateness or adequacy of disclosures in the financial report.
Appropriateness of the Selected Accounting Policies
In relation to the appropriateness of the accounting policies management has selected, material misstatements of the financial report may arise, for example, when:
- The selected accounting policies are not consistent with the applicable financial reporting framework;
- The financial report does not correctly describe an accounting policy relating to a significant item in the statement of financial position, the statement of comprehensive income, the statement of changes in equity or the statement of cash flows; or
- The financial report does not represent or disclose the underlying transactions and events in a manner that achieves fair presentation.
Financial reporting frameworks often contain requirements for the accounting for, and disclosure of, changes in accounting policies. Where the entity has changed its selection of significant accounting policies, a material misstatement of the financial report may arise when the entity has not complied with these requirements.
Application of the Selected Accounting Policies
In relation to the application of the selected accounting policies, material misstatements of the financial report may arise:
- When management has not applied the selected accounting policies consistently with the financial reporting framework, including when management has not applied the selected accounting policies consistently between periods or to similar transactions and events (consistency in application); or
- Due to the method of application of the selected accounting policies (such as an unintentional error in application).
Appropriateness or Adequacy of Disclosures in the Financial Report
In relation to the appropriateness or adequacy of disclosures in the financial report, material misstatements of the financial report may arise when:
- The financial report does not include all of the disclosures required by the applicable financial reporting framework;
- The disclosures in the financial report are not presented in accordance with the applicable financial reporting framework; or
- The financial report does not provide the additional disclosures necessary to achieve fair presentation beyond disclosures specifically required by the applicable financial reporting framework.
Paragraph A14 of ASA 450 provides further examples of material misstatements in qualitative disclosures that may arise.
The auditor’s inability to obtain sufficient appropriate audit evidence (also referred to as a limitation on the scope of the audit) may arise from:
- Circumstances beyond the control of the entity;
- Circumstances relating to the nature or timing of the auditor’s work; or
- Limitations imposed by management
An inability to perform a specific procedure does not constitute a limitation on the scope of the audit if the auditor is able to obtain sufficient appropriate audit evidence by performing alternative procedures. If this is not possible, the requirements of paragraphs 7(b) and 9–10 apply as appropriate. Limitations imposed by management may have other implications for the audit, such as for the auditor’s assessment of fraud risks and consideration of engagement continuance.
Examples of circumstances beyond the control of the entity include when:
- The entity’s accounting records have been destroyed.
- The accounting records of a significant component have been seized indefinitely by governmental authorities.
Examples of circumstances relating to the nature or timing of the auditor’s work include when:
- The entity is required to use the equity method of accounting for an associated entity, and the auditor is unable to obtain sufficient appropriate audit evidence about the latter’s financial information to evaluate whether the equity method has been appropriately applied.
- The timing of the auditor’s appointment is such that the auditor is unable to observe the counting of the physical inventories.
- The auditor determines that performing substantive procedures alone is not sufficient, but the entity’s controls are not effective.
Examples of an inability to obtain sufficient appropriate audit evidence arising from a limitation on the scope of the audit imposed by management include when:
- Management prevents the auditor from observing the counting of the physical inventory.
- Management prevents the auditor from requesting external confirmation of specific account balances.
An inability to obtain sufficient appropriate audit evidence due to a management imposed limitation may be a matter that the auditor is required to report to the Australian Securities and Investments Commission (ASIC) under sections 311, 601HG or 990K of the Corporations Act 2001 (the Act). Particular attention should be given to section 312 of the Act which deals with assisting an auditor.
Determining the Type of Modification to the Auditor’s Opinion
Consequence of an Inability to Obtain Sufficient Appropriate Audit Evidence Due to a Management-Imposed Limitation after the Auditor Has Accepted the Engagement (Ref: Para. 13(b)(i)–14)
The practicality of withdrawing from the audit may depend on the stage of completion of the engagement at the time that management imposes the scope limitation. If the auditor has substantially completed the audit, the auditor may decide to complete the audit to the extent possible, disclaim an opinion and explain the scope limitation within the Basis for Disclaimer of Opinion section prior to withdrawing.
In certain circumstances, withdrawal from the audit may not be possible if the auditor is required by law or regulation to continue the audit engagement. This may be the case for an auditor that is appointed to audit the financial report of public sector entities. It may also be the case in jurisdictions where the auditor is appointed to audit the financial report covering a specific period, or appointed for a specific period and is prohibited from withdrawing before the completion of the audit of those the financial report or before the end of that period, respectively. The auditor may also consider it necessary to include an Other Matter paragraph in the auditor’s report.
When the auditor concludes that withdrawal from the audit is necessary because of a scope limitation, there may be a professional, legal or regulatory requirement for the auditor to communicate matters relating to the withdrawal from the engagement to regulators or the entity’s owners.
Under the Corporations Act 2001, the removal and resignation of auditors is covered by sections 329 and 331AC.
The following are examples of reporting circumstances that would not contradict the auditor’s adverse opinion or disclaimer of opinion:
- The expression of an unmodified opinion on the financial report prepared under a given financial reporting framework and, within the same report, the expression of an adverse opinion on the same financial report under a different financial reporting framework.
- The expression of a disclaimer of opinion regarding the results of operations, and cash flows, where relevant, and an unmodified opinion regarding the financial position (see ASA 510). In this case, the auditor has not expressed a disclaimer of opinion on the financial report as a whole.
Form and Content of the Auditor’s Report When the Opinion is Modified
Illustrative Auditor’s Reports (Ref: Para. 16)
[Aus] Illustrations 1A and 2A in the Appendix contain auditor’s reports with qualified and adverse opinions, respectively, as the financial reports are materially misstated.
[Aus] Illustration 3A in the Appendix contains an auditor’s report with a qualified opinion as the auditor is unable to obtain sufficient appropriate audit evidence. Illustration 4 contains a disclaimer of opinion due to an inability to obtain sufficient appropriate audit evidence about a single element of the financial report. Illustration 5 contains a disclaimer of opinion due to an inability to obtain sufficient appropriate audit evidence about multiple elements of the financial report. In each of the latter two cases, the possible effects on the financial report of the inability are both material and pervasive. The Appendices to other Australian Auditing Standards that include reporting requirements, including ASA 570, also include illustrations of auditor’s reports with modified opinions.
Amending this heading makes it clear to the user that the auditor’s opinion is modified and indicates the type of modification.
When the auditor expresses a qualified opinion, it would not be appropriate to use phrases such as “with the foregoing explanation” or “subject to” in the Opinion section as these are not sufficiently clear or forceful.
Consistency in the auditor’s report helps to promote users’ understanding and to identify unusual circumstances when they occur. Accordingly, although uniformity in the wording of a modified opinion and in the description of the reasons for the modification may not be possible, consistency in both the form and content of the auditor’s report is desirable.
An example of the financial effects of material misstatements that the auditor may describe within the Basis for Opinion section in the auditor’s report is the quantification of the effects on income tax, income before taxes, net income and equity if inventory is overstated.
Disclosing the omitted information within the Basis for Opinion section would not be practicable if:
- The disclosures have not been prepared by management or the disclosures are otherwise not readily available to the auditor; or
- In the auditor’s judgement, the disclosures would be unduly voluminous in relation to the auditor’s report.
Where an audit is conducted under the Corporations Act 2001 (the Act) and there is a material misstatement of the financial report that relates to the non-disclosure of required information, the auditor needs to consider reporting obligations under the Act, for example under sections 311, 601HG or 990K of the Act.
An adverse opinion or a disclaimer of opinion relating to a specific matter described within the Basis for Opinion section does not justify the omission of a description of other identified matters that would have otherwise required a modification of the auditor’s opinion. In such cases, the disclosure of such other matters of which the auditor is aware may be relevant to users of the financial report.
Description of Auditor’s Responsibilities for the Audit of the Financial Report When the Auditor Disclaims an Opinion on the Financial Report (Ref: Para. 28)
When the auditor disclaims an opinion on the financial report, the following statements are better positioned within the Auditor’s Responsibilities for the Audit of the Financial Report section of the auditor’s report, as illustrated in Illustrations 4–5 of the Appendix.
- The statement required by paragraph 28(a) of ASA 700, amended to state that the auditor’s responsibility is to conduct an audit of the entity’s financial report in accordance with Australian Auditing Standards; and
- The statement required by paragraph Aus 28(c) of ASA 700 about independence and other ethical responsibilities.
Providing the reasons for the auditor’s inability to obtain sufficient appropriate audit evidence within the Basis for Disclaimer of Opinion section of the auditor’s report provides useful information to users in understanding why the auditor has disclaimed an opinion on the financial report and may further guard against inappropriate reliance on them. However, communication of any key audit matters other than the matter(s) giving rise to the disclaimer of opinion may suggest that the financial report as a whole are more credible in relation to those matters than would be appropriate in the circumstances, and would be inconsistent with the disclaimer of opinion on the financial report as a whole. Similarly, it would not be appropriate to include an Other Information section in accordance with ASA 720 addressing the auditor’s consideration of the consistency of the other information with the financial report. Accordingly, paragraph 29 prohibits a Key Audit Matters section or an Other Information section from being included in the auditor’s report when the auditor disclaims an opinion on the financial report, unless the auditor is otherwise required by law or regulation to communicate key audit matters or to report on other information.
Communicating with those charged with governance the circumstances that lead to an expected modification to the auditor’s opinion and the wording of the modification enables:
- The auditor to give notice to those charged with governance of the intended modification(s) and the reasons (or circumstances) for the modification(s);
- The auditor to seek the concurrence of those charged with governance regarding the facts of the matter(s) giving rise to the expected modification(s), or to confirm matters of disagreement with management as such; and
- Those charged with governance to have an opportunity, where appropriate, to provide the auditor with further information and explanations in respect of the matter(s) giving rise to the expected modification(s).
See ASA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report, paragraph A10.