SA 700, SA 705, SA 706 & SA 720

CA Sunil S Kothari 23rd June 2012

Audit Conclusions and Reporting

1

SA 700, Forming an Opinion and Reporting on Financial

Statements

AAS 28 v SA 700(R)AAS 28 SA 700 (R)

Auditor’s reports on all FS Only general purpose FS (SA 800 – special purpose FS)

All kinds of opinions – clean, modified, emphasis of matter

Only clean opinion(SA 705 – modified, SA 706 – Emphasis & Other Matter)

Deals with how to report on FS

Deals with how to - -form an opinion-report on FS (clean report)

FrameworksGeneral purpose FS       

 General purpose

framework 

                    

 Fair

presentation framework

 Compliance framework

         

 Compliance with framework + true and fair opinion

 

No true and fair opinion, only

compliance with framework

       

Conclude on whether sufficient appropriate audit evidence as per SA 330 was obtained

Conclude on whether uncorrected misstatements, individually or in aggregate, are material as per SA 450

Evaluate whether FS are prepared, in all material respects, as per applicable financial reporting framework, including its qualitative aspects and freedom from judgment bias

Evaluate whether accounting policies are appropriately disclosed, consistently applied and are appropriate

Forming an opinion - requisites

Evaluate whether estimates are reasonable Evaluate whether information presented is

relevant, reliable, comparable and understandable

Evaluate whether terminology used is appropriate Evaluate whether disclosures are adequate to

enable users to clearly understand material transactions and events

If reporting under a fair presentation framework, also evaluate whether FS achieve a fair presentation based on overall presentation, structure and contents; and whether they represent underlying transactions/ events befittingly

Forming an opinion - requisites

Ensure that the financial reporting framework is adequately referred to

Based on all above conclusions/ evaluations, auditor finally concludes whether the FS, as a whole, are free from material misstatement due to fraud or error

Forming an opinion - requisites

AAS 28 v SA 700(R)AAS 28 SA 700 (R)

Paragraphs do not have heading

Each paragraph has distinctive heading

Responsibility statement is brief

Management’s responsibility and auditor’s responsibility are two separate paragraphs

All reporting is mixed up Report under statute/ regulation follows true and fair/ compliance opinion report in separate section

AAS 28 v SA 700(R)AAS 28 SA 700 (R)

Reference to auditing standards made even if law/ regulation prescribes format that does not meet structural requirements of standard

Reference to auditing standards cannot be made unless basic structure of report meets requirements of revised standard

The reporting under Indian SAs and ISAs simultaneously was not envisaged in existing standard

Reporting simultaneously under Indian SAs and ISAs is permitted in single report

AAS 28 v SA 700(R)AAS 28 SA 700 (R)

Auditor’s responsibility when entity presents supplementary info along with FS is not addressed in this

Standard lays down auditor’s responsibility when entity presents supplementary info along with FS

Title: Auditor’s report Independent auditor’s report

No separate management’s responsibility paragraph

Separate and more elaborate management’s responsibility paragraph

AAS 28 v SA 700(R)AAS 28 SA 700 (R)

No separate auditor’s responsibility paragraph

Separate and more elaborate auditor’s responsibility paragraph

Scope paragraph No separate scope paragraph; but contents are generally covered in separate auditor’s responsibility paragraph

Firstly, talks about Financial Statements (FS)audit Then refers to CARO reporting (regulatory

requirement, not part of true and fair opinion reporting)

Then goes to specific matters required to be reported under Companies Act – e.g., books of account, qualifications of directors u/s 274(1)(g), etc. (regulatory requirement, not part of true and fair opinion reporting)

Then reverts back to true and fair opinion on FS audit

Appears to users as if regulatory compliance is part of true and fair opinion on FS

Existing report - structure

From start of report to opinion paragraph, the structure is strictly restricted to the audit of the FS as performed under either a fair presentation framework or a compliance framework

All other matters that law / regulation requires to be part of auditor’s report are put in a separate section of report below the opinion paragraph

New report - structure

The logic is that the true and fair part of the report is governed by procedures performed by the auditor as per auditing standards insofar as they pertain to audits of general purpose financial statements

For instance, those audit procedures are designed to evaluate whether the FS are prepared in accordance with the stated financial reporting framework and are not materially misstated due to fraud or error

What is the logic?

When we report on CARO, for example, we are responding to specific queries under the said Order.

CARO report is a report on specific financial

information that may or may not be contained in the financial statements and should, therefore, not be intermingled with the Opinion on the financial statements because completely different audit procedures are applied to provide a CARO report as versus the procedures used to give a report on the financial statements

What is the logic?

Likewise, when we report on books of account, or agreement of financial statements with books of account, or on qualification of directors, we are reporting on matters that are not really covered by our Opinion on the financial statements

What is the logic?

The existing standard says: ◦ “A statute governing the entity or a regulator

may require the auditor to include certain matters in the audit report or prescribe the form in which the auditor should issue his report. In such a case, the auditor should incorporate in his audit report, the matters specified by the statute or regulator and/or report in the form prescribed by them in addition to the requirements of this AAS.”

Format prescribed by law/ regulation

SA 700 says that unless auditor’s report contains, at a minimum, the basic elements of an auditor’s report as per the auditing standards, it would cease to be credible, lack consistency and could mislead the user into making inappropriate business decisions – thereby exposing the auditor to significant risk

SA 210 mandates that if the auditor does not have the ability to include relevant elements, such as the management’s responsibility paragraph, the auditor’s responsibility paragraph, etc., he may not refer to the audit having been done in accordance with the SAs or auditing standards generally applicable in India

Format prescribed by law/ regulation

SA 705, Modifications to the Opinion in the Independent

Auditor’s Report

Sufficient appropriate audit evidence obtained

Sufficient appropriate audit evidence not obtained

Auditor concludesthat FS as a whole are not

free from material misstatement

Auditor is unable to conclude whether FS as a whole are

free from material misstatement

Qualifiedopinion

Adverseopinion

Disclaimerof opinion

Depends on auditor’s judgement of

Whether FS are materially misstated

In absence of evidencewhether FS may be materially misstated

Whether misstatementis or is likely to be

pervasive

What isPERVASIVE?

Misstatements Possible misstatements

That are not confined to specific components

accounts or items

If so confined, represent a

substantial portion

Where pertaining to disclosures, are

fundamental to users’ understanding of FS

After obtainingsufficient

appropriate audit

evidence

Auditorconcludes

that

Individualmisstatements

Aggregate of misstatements

Are MATERIAL

but notPERVASIVE

OR

Auditor cannotobtain

sufficientappropriate

auditevidence

Auditorconcludes

that

Possible effects of

undetectedmisstatements

Are MATERIAL

but notPERVASIVE

QUALIFIEDOPINION

After obtainingsufficient

appropriate audit

evidence

Auditorconcludes

that

Individualmisstatements

OR

Aggregate of misstatements

Are MATERIAL

ANDPERVASIVE

ADVERSEOPINION

Auditor cannotobtain

sufficientappropriate

auditevidence

Auditorconcludes

that

Possible effects of

undetectedmisstatements

Are MATERIAL

ANDPERVASIVE

DISCLAIMER OF

OPINION

MultipleUncertainties

Auditorconcludes

that

Even after auditor hasobtained audit

evidence

He cannot form an opinion on FSdue to potential

interaction of the uncertainties and

their possible cumulative effect

After acceptingengagement,management

imposes a scope

limitation

Auditor assessesthat this may

result in aqualified opinion

or disclaimer

Auditor requests management to

remove the scopelimitation

Management doesnot

remove it

Auditor communicatesthis to Those charged with

governance (TCWG)

Considers alternative procedures

If he cannot obtain sufficient appropriate audit evidence, and

concludes thateffect of undetected

misstatements is

Material but not pervasive

Material and pervasive

QUALIFY

RESIGN, if allowed to

GIVE DISCLAIMER

Summary of modification of opinion

Nature of matter giving rise to the

modification

Auditor’s judgment about the pervasiveness of the

effects or possible effects on FS

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

When expressing adverse opinion or disclaiming an opinion on the FS as a whole the auditor cannot also express an unmodified opinion on one or more specific elements, accounts or items in the FS with respect to the same financial reporting framework

Can auditor give unmodified opinion on a component while giving adverse/ disclaimer of opinion on the FS?

Report to contain all elements per SA 700

+Basis for modification paragraph

Just abovethe Opinionparagraph

Describingmatter of

modification

Basis for QualifiedOpinion

Basis forAdverse Opinion

Basis for Disclaimerof Opinion

Heading to be

Describe and quantifyeffect of misstatement

Say so if quantificationis impracticable

Explain how disclosures

are misstated

Explain reason whysufficient appropriate

audit evidence was unavailable

Non-disclosureDiscuss withTCWG

Describe omitted

informationIf permittedprovide the

non-disclosed information,if practical

and if sufficient

appropriateaudit evidence

is obtained

Adverse or disclaimer of opinion expressed

But there are other mattersthat would

have requiredmodification

Reasons and effectsof such other matters

to be given in Basisof Modification paragraph

BASIS OF MODIFICATION

PARAGRAPH

Heading◦ “Qualified Opinion”, “Adverse Opinion” or

“Disclaimer of Opinion” Qualified opinion due to material

misstatement◦ In our opinion, except for the effects of matters

described in the Basis for Qualified Opinion paragraph The FS give true and fair view in accordance… The FS have been prepared, in all material respects, in

accordance with…

If qualified for inability to obtain sufficient appropriate audit evidence◦ ….except for the possible effects of the matters…

Opinion paragraph

Requirements when the auditor expresses a Qualified Opinion

o the auditor should state in the opinion paragraph that, in the auditor’s opinion, except for the effects of the matter(s) described in the Basis for Qualified Opinion paragraph, the financial statements give a true and fair view (or “present fairly, in all material respects”) in accordance with the applicable financial reporting framework

oWhen the modification arises from an inability to obtain sufficient appropriate audit evidence, the auditor should use the corresponding phrase “except for the possible effects of the matter(s) ...” for the modified opinion

Requirements when the auditor expresses an Adverse Opinion

o the auditor should state in the opinion paragraph that, in the auditor’s opinion, because of the significance of the matter(s) described in the Basis for Adverse Opinion paragraph, the financial statements do not give a true and fair view (or “do not present fairly”) in accordance with the applicable financial reporting framework

Requirements when the auditor disclaims an opinion

oWhen the auditor disclaims an opinion due to an inability to obtain sufficient appropriate audit evidence, the auditor should state in the opinion paragraph that, because of the significance of the matter(s) described in the Basis for Disclaimer of Opinion paragraph, the auditor has not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion and, accordingly, the auditor does not express an opinion on the financial statements

When the auditor expresses a qualified or adverse opiniono Requires to state that the audit evidence obtained

is sufficient and appropriate to provide a basis for the auditor’s modified audit opinion

When the auditor disclaims an opiniono Need to state that they were unable to obtain

sufficient appropriate audit evidence to provide a basis for an audit opinion

Auditor’s responsibility

The auditors need to communicate to those charged with governance, the reasons and circumstances that led to the expected modifications as well as the proposed wording of the modification

Communication with those charged with governance

SA 706, Emphasis of Matter Paragraphs and Other Matter(s) Paragraphs in the Independent

Auditor’s Report

◦ The Modified Opinion section of AAS 28 refers to matters that affect the auditor's opinion and matters that don't

◦ Matters that don't, are reported in an Emphasis of Matter paragraph (EMP)

◦ EMP amounts to a modification of the auditor's report, but does not affect the opinion

◦ EMP is placed in the report preceding the opinion paragraph

Comparison with AAS 28

◦ EMP is to be given where a going concern question is not resolved and adequate disclosure is made

◦ EMP is to be given where there is a significant uncertainty (other than going concern), whose resolution depends on future events and which may affect the FS – e.g. a lawsuit

◦ EMP is considered adequate in dealing with the above except in extreme cases (e.g. situations involving multiple uncertainties) where a disclaimer should be given

Comparison with AAS 28

Draw users’ attention to matters presented/ disclosed in FS that are

fundamental to users’ understanding of FS

Draw users’ attention to matters not presented/ disclosed in FS that

are relevant to users’ understanding of the audit, auditor’s responsibilities or

auditor’s report

Emphasis of Matter

paragraph (EMP)

Other Matter Paragraph

(OMP)

EMP OMP

Matters presented/ disclosed in FS

Matters NOT presented/ disclosed in FS

Fundamental to users’ understanding

Relevant to users’ understanding

Understanding of FS Understanding of the audit, auditor’s responsibilities or auditor’s report

Has to be fundamental to users’ understanding

Auditor has obtained sufficient appropriate audit evidence that matter is not materially misstated in the FS

Matter referred to must be presented/ disclosed in FS

EMP: requirements

EMP: requirements

EMP is included immediately AFTER opinion paragraph

Heading “Emphasis of Matter” is given

Reference to where matter emphasised can be found in FS is given

Indicate that auditor’s opinion is NOT MODIFIED in respect of matter emphasised

◦ Uncertainty relating to future outcome of exceptional litigation or regulatory action

◦ Early adoption and application of an accounting standard that has pervasive effect on the FS

◦ Major catastrophe that has/ had/ continues to have significant effect on the FS

EMP: examples

◦ Use of EMP should not be widespread and should not include more information than what is presented/ disclosed elsewhere in FS

◦ EMP is not a substitute for

A modified opinion (qualified/ adverse/ disclaimer)

Disclosures that management should make

EMP: other considerations

OMP: requirements

Matter has to be relevant to users’ understanding

Heading “Other Matter(s)” is given

Such reporting is not prohibited by law or regulation

Is placed after opinion para and any EMP in report on FS, but may be placed in Other Reporting Responsibilities section if its contents relate to such responsibilities

Given only for users’ understanding of matters related to the audit, auditor’s responsibilities and auditor’s report

• Users' understanding of audit• Auditor appointed by law is unable to resign when

management imposes a pervasive scope limitation

• Users' understanding of auditor's responsibility or auditor's report• Law requires auditor to elaborate on matters that

provide further explanation of his responsibilities in the audit or the auditor's report

Examples of circumstances necessitating OMP

• Reporting on > 1 set of FS• If auditor is engaged to issue a report under Indian

GAAP as well as under IFRS, he may use OMP in each report to inform users that he has also reported under another framework

◦ Restriction on distribution or use of report• If special purpose FS are prepared in accordance with

a general purpose framework because such a framework meets users' needs, auditor may use OMP to say that his report is intended solely for the intended users and should not be distributed/ used by others

Examples of circumstances necessitating OMP

What is the type of opinion in the following cases?

Case - 1

Inventories are misstated. Say it is 15 % of the profits for the year. The misstatement is deemed to be material but not pervasive to the financial statements.

Case – 2

The auditor was unable to obtain sufficient appropriate audit evidence about multiple elements of the financial statements. That is, say, the auditor was unable to obtain audit evidence about the entity’s inventories and accounts receivable. The possible effects of this inability to obtain sufficient appropriate audit evidence are deemed to be both material and pervasive to the financial statements.

Case Studies

◦ Qualified

The Company’s inventories are carried in the Balance Sheet at Rs. XXX. Management has not stated the inventories at the lower of cost and net realisable value but has stated them solely at cost, which constitutes a departure from the Accounting Standards referred to in sub-section (3C) of section 211 of the Act. The Company’s records indicate that had management stated the inventories at the lower of cost and net realisable value, an amount of Rs. XXX would have been required to write the inventories down to their net realisable value. Accordingly, cost of sales would have been increased by Rs. XXX, and income tax, net profit and shareholders’ funds would have been reduced by Rs. XXX, Rs. XXX and Rs. XXX, respectively.

Qualified Opinion

In our opinion and to the best of our information and according to the explanations given to us, except for the effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements give the information required by the Act in the manner so required and give a true and fair view in conformity with the accounting principles generally accepted in India:

Solution1

48

Disclaimer of opinionWe were appointed as auditors of the Company after March 31, 20XX and thus could not observe the counting of physical inventories at the beginning and end of the year. Accordingly, we were unable to satisfy ourselves by alternative means concerning the inventory quantities held at December 31, 20X0 and March 31, 20X1 which are stated in the Balance Sheet at Rs. XXX and Rs. XXX, respectively. In addition, the introduction of a new computerized accounts receivable system in September 20X1 resulted in numerous errors in accounts receivable. As of the date of our audit report, management was still in the process of rectifying the system deficiencies and correcting the errors. We were unable to confirm or verify by alternative means accounts receivable included in the Balance Sheet at a total amount of Rs. XXX as at March 31, 20X1. As a result of these matters, we were unable to determine whether any adjustments might have been found necessary in respect of recorded or unrecorded inventories and accounts receivable, and the elements making up the Statement of Profit and Loss and Cash Flow Statement.

Disclaimer of Opinion

Because of the significance of the matters described in the Basis for Disclaimer of Opinion paragraph, we have not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion. Accordingly, we do not express an opinion on the financial statements.

Solution 2

49

Case 3

The auditor of ABC Ltd. was unable to obtain sufficient appropriate audit evidence regarding existence of investments in XYZ Ltd in a foreign branch. The possible effects of the inability to obtain sufficient appropriate audit evidence are deemed to be material but not pervasive to the financial statement.

Case 4

You are the auditor of XYZ Ltd. There is uncertainty relating to a pending exceptional litigation Matter – say there is a law suit filed against the company for tax or some other matter. You cannot conclude that it should be provided for.

Case Studies

◦ Qualified

ABC Company Limited’s investment in XYZ Company, a foreign company acquired during the year and accounted as Held to maturity investment in Balance sheet of ABC company’ Ltd. We were unable to obtain sufficient appropriate audit evidence about the existence of ABC Company Limited’s investment in XYZ Company as at March 31, 20XX because we were denied access to the financial information relating to the same, management, Consequently, we were unable to determine whether any adjustments to these amounts were necessary.

Qualified Opinion

In our opinion and to the best of our information and according to the explanations given to us, except for the possible effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements give the information required by the Act in the manner so required and give a true and fair view in conformity with the accounting principles generally accepted in India:

Solution 3

51

◦ Emphasis of Matter paragraph

after opinion paragraph following shall be added:

“We draw attention to Note X to the financial statements which describes the uncertainty related to the outcome of the lawsuit filed against the Company by XYZ Company. Our opinion is not qualified in respect of this matter

Solution 4

52

Case 5

In case of auditor of Consolidated Financial Statement, there are certain subsidiaries which were not audited by him but which form part of the consolidated financial statements under report. Also the amounts involved are not insignificant.

Case Studies

◦ Other Matter paragraph

Other Matter“We did not audit the financial statements of certain subsidiaries, whose financial statements reflect total assets (net) of Rs. XXXX as at March 31, 20XX, total revenues of Rs. XXXX and net cash outflows amounting to Rs. XXXX for the year then ended. These financial statements have been audited by other auditors whose reports have been furnished to us by the Management, and our opinion is based solely on the reports of the other auditors. Our opinion is not qualified in respect of this matter.”

Solution 5

54

SA – 720The Auditor’s Responsibility in

relation to Other Information in Documents Containing

Audited Financial Statements

This SA deals with Auditor’s responsibility in relation to Other Information* presented in documents (annual reports or similar document) containing audited Financial Statements and the auditor’s report thereon.

*Other information may comprise for example:A report by Management or those charged with governance on operations.Financial Summaries or highlights.Planned Capital expenditures.Financial ratios.

The objective of the auditor is to respond appropriately when documents containing audited financial statements and the auditor’s report thereon include other information that could undermine the credibility of those financial statements and the auditor’s report.

SA 720 - Scope & Objective

Requirements of SA 720

Reading Other Information

The Auditor shall make an appropriate arrangements with Management or Those Charged with Governance, to provide such other information, prior to the date of auditor’s report to the auditor.

Read such other information to identify Material Inconsistencies or Material Misstatement of facts , if any with audited financial statements.

MI observed in Other Information Prior to Auditor’s Report Date

MI observed in Other Information Subsequent to Auditor’s Report Date

- When revision of audited Financial Statements is necessary & management refuses, modify opinion in accordance with SA-705.

-When revision of such Other Information is necessary and management refuses, communicate to TCWG and:a) Include such matter in Emphasis of Matter Para as per SA-706; ORb) If possible, withdraw from engagement.

- When revision of audited Financial Statements is necessary, follow requirements of SA-560 Subsequent Events.

-When revision of such Other Information is necessary and management makes such changes, ensure steps taken by the management.

-When management refuses to make changes to other information, notify to TCWG & seek legal opinion.

Material Inconsistencies (MI)

On observing the Material Misstatement, following actions can be taken by an auditor:

a) Discuss the matter with management to evaluate the validity of the management’s disclosures and after discussion with management, auditor may conclude that valid differences of judgment or opinion exists;

b) Request Management to consult qualified third party, such as legal entity’s counsel and auditor shall consider such advice received;

c) If auditor feels that such misstatement needs correction and management refuses for the same then auditor shall notify such facts to TCWG and seek legal opinion from his own legal counsel.

Effective Date: This standard is effective from 1st April 2010

Material Misstatements of Facts

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