Audit Opinions: Unmodified/Modified

1 Unmodified opinion

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Now we are going to look at the different forms of audit opinion and how other matters relevant to understanding the financial statements are drawn to users' attention.

First and simplest is the unmodified audit opinion. This is the audit opinion that you will see in most auditor's reports. It simply states that the financial statements "present fairly". There are no "ifs" or "buts".

An auditor's report with an unmodified opinion may, however, include any (or all) of the following additional sections:

• "Emphasis of matter" paragraph;
  

• "Material uncertainty related to going concern" section;
  

• "Other matter" paragraph.
  

These matters do NOT affect the audit opinion.

2 Emphasis of matter and other matters

An emphasis of matter is where there is a paragraph in the auditor’s report which draws attention to some matter already properly disclosed within the financial statements. Such a paragraph does not affect the audit opinion: it is simply drawing attention to an important note in the financial statements that shareholders ought to be aware of to properly appreciate the financial statements.

Here is an example:

Note that the financial statements do contain a note explaining the effects of the fire. The financial statements are therefore as comprehensive and as open as they can be. But obviously, the fire has operational and financial implications and to understand the company's position (e.g. its ability to pay dividends next year), the users of the financial statements need to be aware of this.

Therefore the auditor uses the auditor’s report to emphasise this matter (and remember many readers don’t get far past the auditor’s report and very few study the notes) and to draw users’ attention to it.

An "other matters" paragraph refers to something which is NOT in the financial statements, nor should be. The commonest example is when something in the directors’ report contradicts what is in the financial statements and the auditor should point out the discrepancy in case users are misled by the directors’ claims. Therefore an other matters paragraph is added to explain the contradiction.

The emphasis of matter paragraph generally comes directly after the basis of opinion paragraph. It stresses that this does not mean that the financial statements are ‘qualified’, wrong or in any way criticised.

The other matter paragraph comes directly after the Key Audit Matters paragraph (where applicable).

3 Going concern

We have already noted (in Chapter 5), that one of the auditor's responsibilities is to conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the company’s ability to continue as a going concern.

Definition: Audit evidence – information used by the auditor in arriving at the conclusions on which the audit opinion is based. It includes information contained in the accounting records underlying the financial statements and information from other sources.

If a material uncertainty exists which is adequately disclosed in the financial statements, the auditor is required to draw attention to the related disclosure in a separate section of the auditor's report headed “Material Uncertainty Related to Going Concern”.

For example:

Generally if the directors or the auditors think the company might not survive into the foreseeable future there is a going concern problem. ‘Foreseeable future’ is not defined but under IFRS it should not be less than 12 months from the end of the accounting period.

Remember: It is for management to make an assessment of an entity’s ability to continue as a going concern. The auditor’s responsibilities are to obtain sufficient appropriate audit evidence, conclude and report.

Evidence can consist of:

• Evaluating management’s plans for future actions in relation to its going concern and whether the outcome of these plans is feasible and likely to improve the situation.
  

• Where the entity has prepared a cash flow forecast:
  

  • Evaluating the reliability of the underlying data generated to prepare the forecast; and
    

  • Determining whether there is adequate support for the assumptions underlying the forecast.
    

• Considering whether any additional facts or information have become available since the date on which management made its assessment.
  

• Requesting written representations from management and, where appropriate, TCWG, regarding their plans for future actions and the feasibility of these plans.
  

If there is no realistic prospect of the company surviving then the financial statements should be drawn up on a break-up basis. Then all sorts of issues are going to arise over valuation of assets and the payment of a certain statutory liabilities to employees.

Signs that the company may have going concern difficulties include the following:

• Negative operating cash flows.
  

• An inability to pay suppliers when due (and auditors are usually rather sensitive if they see that the company is borrowing more from its suppliers).
  

• Operating losses. These do not mean that the company is going to fail immediately; going concern tends to be rather more concerned with cash. An operating loss can be sustained for a number of years provided that cash doesn’t run out. In the longer term, losses usually result in cash flow problems.
  

• If the borrowing facilities are coming to an end and the new ones haven’t been agreed, what’s the company going to do to repay the loan, when no cash is available?
  

• The loss of key staff or key customers can mean the company is unable to trade or unable to sell its products.
  

• Technology changes can render the company’s purpose and main product redundant. Legislative changes may mean that the company’s operations become illegal or the company has to go through some sort of regulatory requirements before it can continue trading and that this is going to be difficult for it.
  

• Non-compliance with regulations may mean a business loses its right or license to trade and in such a case the company may simply have to be wound up. Non-compliance can also result in crippling penalties and harmful damage to the organisation’s reputation.

4 Effect of going concern problems on the auditor’s report

So what are the effects of going concern issues on the auditor’s report? If the worries are fully disclosed in a note to the financial statements, a "Material Uncertainty Related to Going Concern" section should be included in the auditor's report to make sure that users do not overlook this important piece of information.

If the going concern worries are not ADEQUATELY disclosed then the financial statements cannot "present fairly" (in all material respects) and they are effectively concealing something which is important for the proper understanding of them. In such a case, the audit opinion MUST be modified. (In this case, there will NOT be a "Material Uncertainty Related to Going Concern" section.)

A modified opinion would also be appropriate if the auditor felt that it was wrong to prepare the financial statements on a going concern basis. That would happen if the company was in such a precarious position that it had no realistic chance of survival. In this case the opinion would be adverse as explained in the section that follows.

5 Modified audit opinions

With respect to modified opinions there are two potential reasons for modification:

• The financial statements include one or more material misstatements; or
  

• The auditor has been unable to obtain sufficient appropriate audit evidence.
  

There are two degrees of seriousness for each of these problems.

First let’s look at material misstatement. This is where the auditor disagrees with the figure in the financial statements. It could be the figure itself or the way the figure is presented or the disclosures which must be made to comply with IFRS. First of all, if the misstatement is not material the audit opinion would not be modified, so the first hurdle is that disagreement must be for a material amount. In such a case the auditor would put a paragraph in the report saying that except for certain items, in other respects the financial statements are presented fairly (i.e. the opinion has been qualified).

If however misstatements are so significant that it renders the financial statements as a whole useless, the auditor would issue an adverse opinion stating that the financial statements are not presented fairly.

The other reason for a modified opinion is where the auditor has been unable to obtain sufficient appropriate audit evidence.

For some reason the auditor has not been able to get all the information required to draw conclusions. If the matter about where there is missing information is material then the auditor will qualify his opinion using an except for paragraph. For example, except that we could not verify the adequacy of the trade receivables allowance (i.e. for irrecoverable balances), the financial statements are presented fairly. If, however, the missing information is so significant that the auditor is unable to form any opinion, the auditor gives a disclaimer of opinion.

The choices can be described in a matrix. Think of ‘pervasive’ as misstatements or lack of evidence that affect the financial statements as a whole:

6 Example of insufficient appropriate audit evidence

Here is an example of a qualification due to insufficient appropriate audit evidence. Here the problem is material, but does not affect the financial statements as a whole and the report says the auditors are unable to determine the inventory quantities and then says in their opinion, except for the effects of such adjustments for inventory, if any, the financial statements are presented fairly.

7 Example of disclaimer of opinion

Here is a modified opinion arising from a lack of sufficient appropriate audit evidence but which is leading to disclaimer of opinion because multiple elements of the financial statements are affected.

8 Material misstatement /‘except for’

Here is an example of a qualified opinion arising from a material misstatement about something in the financial statements. Here the problem is that no depreciation has been provided when it should have been. Note, where there is a material misstatement auditors will normally be able to quantify its extent and the effect on the profits and this is useful information for the primary users of the financial statements. Here the amount of depreciation in dispute is material, but the financial statements as a whole are presented fairly.

9 Material misstatement/‘adverse opinion’

Finally, a modified opinion when one or more material misstatements are so significant that the auditor concludes that the financial statements are not presented fairly. Here the matter in dispute is the basis of accounting used in the preparation of the financial statements which is clearly pervasive.