Types of modified opinions in audit reports

 

A modified opinion is a qualified opinion, an adverse opinion, or a disclaimer of opinion on financial statements.

The auditor shall modify the opinion in the auditor’s report when:

·        The auditor concludes that the financial statements as a whole are not free from material misstatement; or

·        The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement.

 

Nature of matter giving rise to the modification	Auditor’s judgment about the pervasiveness of the effects or possible effects on the financial statements
	material but not pervasive	material and pervasive
Financial statements are materially misstated	Qualified opinion	Adverse opinion
Inability to obtain sufficient appropriate audit evidence	Qualified opinion	Disclaimer of opinion

 Pervasive effects on the financial statements are those that, in the auditor’s judgment:

(i)        Are not confined to specific elements, accounts, or items of the financial statements.

(ii)       If so confined, represent or could represent a substantial proportion of the financial statements; or

(iii)      In relation to disclosures, are fundamental to users’ understanding of financial statements.

The nature of material misstatements when the auditor concludes that the financial statements as a whole are not free from material misstatement.

A material misstatement of the financial statements may arise in relation to:

(a)    The appropriateness of the selected accounting policies. It takes place when:

·   The selected accounting policies are not consistent with the applicable financial reporting framework.

·  The financial statements do not correctly describe an accounting policy relating to a significant item in the financial statements.

·  The financial statements do not represent or disclose the underlying transactions and events to achieve fair presentation.

 (b) The application of the selected accounting policies.

In this case material misstatements of the financial statements may arise when management has not applied the selected accounting policies consistently with the financial reporting framework or between periods or to similar transactions and events (consistency in application).

 (c)   The appropriateness or adequacy of disclosures in financial statements.

 In relation to the appropriateness or adequacy of disclosures in the financial statements, material misstatements of the financial statements may arise when:

·  The financial statements do not include all the disclosures required by the applicable financial reporting framework.

·  The disclosures in the financial statements are not presented in accordance with the applicable financial reporting framework.

·    The financial statements do not provide the additional disclosures necessary to achieve fair presentation beyond disclosures specifically required by the applicable financial reporting framework.

 The Nature of an Inability to Obtain Sufficient Appropriate Audit Evidence

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:

(a)    Circumstances beyond the control of the entity.

Examples of circumstances beyond the control of the entity include the following:

·     The entity’s accounting records have been destroyed.

·   The accounting records of a significant component have been seized indefinitely by governmental authorities.

(b)   Circumstances relating to the nature or timing of the auditor’s work.

Examples of circumstances relating to the nature or timing of the auditor’s work comprise:

·      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.

            (c)  Limitations imposed by management.

  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.

Qualified opinion in an audit report

The auditor shall express a qualified opinion when:

(a) The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are material, but not pervasive, to the financial statements; or

(b) 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.

If an auditor expresses a qualified opinion, the following headings should be used in audit report:

1.   The heading “Qualified Opinion.’ This section is used to express the audit opinion on financial statements.

2.   The heading “Basis for Qualified Opinion.” This section includes a description of the issue that caused the modification to the opinion in the independent audit report.

An example of a qualified audit opinion is presented below.

“Qualified Opinion

….

In our opinion, except for the effects of the matter described in the Basis for Qualified Opinion section of our report, the  accompanying financial statements present fairly, in all material respects the financial position of the Company as of December 31, 20X1, and (of) its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards (IFRSs).

 Basis for Qualified Opinion

 The Company’s inventories are carried in the statement of financial position at xxx. Management has not stated the inventories at the lower of cost and net realizable value but has stated them solely at cost, which constitutes a departure from IFRSs. The Company’s records indicate that, had management stated the inventories at the lower of cost and net realizable value, an amount of xxx would have been required to write the inventories down to their net realizable value. Accordingly, cost of sales would have been increased by xxx, and income tax, net income and shareholders’ equity would have been reduced by xxx, xxx and xxx, respectively.”

 Adverse opinion in an audit report

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.

If an auditor expresses an adverse opinion, the following headings should be used in audit report:

1.  The heading “Adverse Opinion.” This section of an audit report is used to express the audit opinion on financial statements.

2.  The heading “Basis for Adverse Opinion.” This section includes a description of the issue that caused the modification to the opinion in the independent audit report.

An example of an adverse opinion is presented below.

“Adverse Opinion

…

In our opinion, because of the significance of the matter discussed in the Basis for Adverse Opinion section of our report, the accompanying consolidated financial statements do not present fairly the consolidated financial position of the Group as at December 31, 20X1, and its consolidated financial performance and its consolidated cash flows for the year then ended in accordance with International Financial Reporting Standards (IFRSs).

Basis for Adverse Opinion

As explained in Note X, the Group has not consolidated subsidiary XYZ Company that the Group acquired during 20X1 because it has not yet been able to determine the fair values of certain of the subsidiary’s material assets and liabilities at the acquisition date. This investment is therefore accounted for on a cost basis. Under IFRSs, the Company should have consolidated this subsidiary and accounted for the acquisition based on provisional amounts. Had XYZ Company been consolidated, many elements in the accompanying consolidated financial statements would have been materially affected. The effects on the consolidated financial statements of the failure to consolidate have not been determined.”

 Disclaimer of opinion in an audit report

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.

The opinion must also be disclaimed in situations involving multiple uncertainties when the auditor concludes that, despite having obtained sufficient appropriate audit evidence for the individual uncertainties, it is not possible to form an opinion on the financial statements due to the potential interaction of the uncertainties and their possible cumulative effect on the financial statements.

If an auditor disclaims an opinion the following headings should be used in audit report:

1.      The heading “Disclaimer of Opinion,”

2.      The heading “Basis for Disclaimer of Opinion

An example of a disclaimer of opinion is presented below.

“Disclaimer of Opinion

….

We do not express an opinion on the accompanying consolidated financial statements of the Group. Because of the significance of the matter described in the Basis for Disclaimer of Opinion section of our report, we have not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion on these consolidated financial statements.

Basis for Disclaimer of Opinion

The Group’s investment in its joint venture XYZ Company is carried at xxx on the Group’s consolidated statement of financial position, which represents over 90% of the Group’s net assets as at December 31, 20X1. We were not allowed access to the management and the auditors of XYZ Company, including XYZ Company’s auditors’ audit documentation. As a result, we were unable to determine whether any adjustments were necessary in respect of the Group’s proportional share of XYZ Company’s assets that it controls jointly, its proportional share of XYZ Company’s liabilities for which it is jointly responsible, its proportional share of XYZ’s income and expenses for the year, and the elements making up the consolidated statement of changes in equity and the consolidated cash flow statement.”