The Auditor’s Report 1: Overall Structure

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1 Introduction

Now we begin to look at the auditor's report. For many people, this is the only purpose of an audit and it’s one of the few parts of an annual report that they really look at.

The auditor’s report includes a clear expression of opinion on the financial statements as a whole.

The two important phrases are:

• ‘Opinion’: there is nothing absolute here. Different firms of auditors could quite legitimately come to different opinions.
  

• ‘Financial statements as a whole’. We are not just looking at the statement of financial position in isolation from the statement of profit or loss or the notes. What’s important is the impression given by the financial statements as a whole.
  

The audit opinion has to be based on evidence obtained in the course of the audit. Indeed if you had to sum up the audit process in just a couple of words it the phrase would be ‘evidence gathering’. Auditors need to collect evidence that will support their opinion on the financial statements.

2 Financial statements

The auditor’s report refers to financial statements and you need to know what these are. They consist of the following:

• The statement of financial position (or balance sheet).
  

• The statement of profit or loss and other comprehensive income.
  

• The statement of changes in equity.
  

• The cash flow statement.
  

• The notes to the financial statements including significant accounting policies.
  

A director’s report and chairman’s statement included in an annual report are not part of the financial statements. However, the auditor may have reporting responsibilities for such 'other information’.

3 The parts of an auditor’s report

Now we are going to look at some of the key parts of an auditor’s report.

3.1 The title and addressees: Independent Auditor’s Report

First of all, it is clearly titled ‘Independent Auditor’s Report'. That should mean that no one has any doubt about what this document is. It next states to whom the report is addressed and that’s the members (i.e. shareholders) of the company.

3.2 The audit opinion and identification of what’s been audited

The opinion paragraph comes right at the top of the report.

An unmodified opinion will state that the financial statements give a true and fair view (or present fairly, in all material respects), and have been prepared in accordance with International Financial Reporting Standards (IFRSs). (The example of the report shown later in this chapter includes an unmodified audit opinion. We will see later the various modified opinions that may be expressed if the auditors are unable to say without reservation that the financial statements give a true and fair view.)

As appropriate, depending on the type of opinion given, this paragraph can be named:

• Opinion
  

• Qualified opinion
  

• Adverse opinion
  

• Disclaimer of opinion
  

The opinion paragraph must:

• Identify the entity whose financial statements have been audited.
  

• State that the financial statements have been audited.
  

• Identify the title of each element of the financial statements and the period audited.
  

3.3 The Basis for Opinion

This will refer to compliance with the ISAs (complying with ISAs is key to the basis of opinion) and will refer to the auditor’s responsibilities section of the report. It must include an assertion of the auditor’s independence and that other ethical matters have been complied with.

If the audit opinion has been modified, the explanation would be here too.

As appropriate, this paragraph would be called:

• Basis for opinion
  

• Basis for qualified opinion
  

• Basis for adverse opinion
  

• Basis for disclaimer of opinion
  

3.4 Material uncertainty related to going concern (if one)

A separate paragraph is required if there is a material uncertainty related to the going concern of the company. The need for such a paragraph is covered more fully in the following chapter.

This paragraph is not a modification of the audit opinion – provided the uncertainty has been adequately disclosed by the directors in the notes to the financial statements.

3.5 Key audit matters

Key audit matters are those matters that were of most significance during the audit.

There is then a full description of these matters in accordance with ISA 701. This is covered in more detail below.

3.6 Emphasis of matter paragraph (if one)

This paragraph is used to draw users’ attention to a matter already properly disclosed in the financial statements. For example, a note stating that there had been a fire at the company’s premises after the date of the statement of financial position.

An emphasis of matter paragraph is not a modification of the audit opinion and It will state that the audit opinion is not modified in this respect. If the auditor's report also includes a key audit matters section, the emphasis of matter paragraph may be presented before that section, depending on their relative importance.

3.7 Other matter paragraph (if one)

This paragraph is used, if necessary, to communicate a matter that is not presented or disclosed in the financial statements which is relevant to the user's understanding of the audit, the auditor's responsibilities or the auditor's report.

Circumstances in which an other matter paragraph may be necessary:

• Where the auditor reports on two sets of financial statements prepared under different general purpose frameworks (e.g. a national framework and IFRS).
  

• Where the financial statements have been prepared for a specific purpose, to state that the auditor's report is solely for the intended users.
  

• In the rare circumstance where the auditor is unable to withdraw from an engagement even though a management-imposed limitation on the audit may be pervasive.
  

3.8 Other information paragraph (if one)

For example, an audit covers the financial statements but does not cover the directors’ report. So what if the directors’ report contains something that conflicts with the financial statements? The audit opinion cannot be modified because it does not cover the directors’ report, but perhaps the shareholders need to be alerted to this. This can be done in a paragraph headed ‘Other Information’.

This is not a modification of the audit opinion.

Note that the interactions between the going concern section, key audit matters section and emphasis of matter/other matters paragraph are covered in detail in the following chapter.

3.9 Responsibilities of management and those charged with governance for the financial statements

This section is very important and points out that it is management’s responsibility to prepare the financial statements in accordance with the International Financial Reporting Standards to maintain the system of internal control and to consider the going concern position of the company.

3.10 Auditor’s responsibilities for the audit of the financial statements

The auditors’ responsibilities are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes their opinion.

Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements.

Read carefully in the Illustrative Example (later in this chapter) the details of the auditor's responsibilities, which can be located in an appendix to the auditor's report.

3.11 Name of the engagement partner, address of the auditing firm, date the auditor’s report was signed and the auditor’s signature

Finally, the auditors must sign the report and must give their address and the date on which it is signed. The date of the report is very important because before that date the auditor has an active duty: the audit is not yet over. The auditor should still be investigating whether receivables are being paid and inventory is selling at above cost etc. After that date the auditor has a passive duty only. This means that the auditor is not ‘on the lookout’ for events affecting the truth and fairness of the financial statements, but if any are brought to his attention he might have to act.

4 ISA 701 Communicating Key Audit Matters in the Independent Auditor's Report

The first thing to note is that the auditor only reports on key audit matters (‘KAMs’) in respect of listed entities.

The auditor shall determine, from the matters communicated with those charged with governance, those matters that required significant auditor attention in performing the audit. In making this determination, the auditor shall take into account the following:

1. Areas of higher assessed risk of material misstatement or significant risks (see Chapter 10).
   

2. Significant auditor judgments relating to areas in the financial statements that involved significant management judgment, including accounting estimates that have been identified as having high estimation uncertainty.
   

3. The effect on the audit of significant events or transactions that occurred during the period.
   

The auditor therefore selects only those matters that were of most significance in the audit of the financial statements of the current period and therefore are the key audit matters.

Key audit matters are therefore identified by:

• Starting with all matters communicated with those charged with governance
  

• Determining the matters that required significant auditor attention in performing the audit.
  

• The most significant of these are the KAMs.
  

If the auditor disclaims an opinion on the financial statements (i.e. very rarely), there will be no KAMs section in the auditor's report because the auditor has not obtained the evidence necessary to form an opinion.

5 Illustrative example (from ISA 700 (revised))

6 What is meant by ‘true and fair’?

'True and fair' is a widely used descriptor of financial reporting (e.g. in UK company legislation since 1948). As near as probably matters, the word ‘true’ means that the information is factually correct and not materially misstated.

‘Fair’ is a more difficult concept. You can have information which is accurate but which is nevertheless presented in a way which is unfair, and which perhaps conceals or does not reflect the commercial substance of transactions. For example, it would not be fair to present a bank loan as a non-current liability if, in fact, it is repayable in the next 12 months (i.e. a current liability). This would distort the financial position presented because the bank loan would not be included in assessing the company's liquidity as shown, for example, by the current ratio.

The IAASB prefers the phrase 'present fairly, in all material respect', which is deemed to be equivalent in ISAs.

As corporate accounting increasingly involves the use of estimates and judgments, it is one of the recommendations for audit reform in the UK (Brydon Report, December 2019) that 'true and fair' be replaced with 'present fairly, in all material respects' in the Companies Act.

7 Other reporting responsibilities

An auditor’s report will explicitly include an audit opinion on the financial statements. In some jurisdictions, the auditor may have additional responsibilities to report on matters such as the adequacy of accounting books and records. These may be included in the auditor's report under a suitably headed section (e.g. ‘Report on Other Legal and Regulatory Requirements’).