The Auditorâ€™s Reporting Obligations - Landing

The Auditor’sReporting Obligations

LEARNING OBJECTIVESAfter studying this chapter you should be able to:

13C H A P T E R

understand the nature and significance of theauditor’s reporting obligations;

appreciate the concepts of ‘true and fair’ and‘presents fairly in accordance with ...’;

understand the structure and qualitativecharacteristics of the audit report;

identify the different types of opinions—unmodifiedaudit opinions, modifications to the audit report thatdo not affect the auditor’s opinion (emphasis ofmatter) and matters that do affect the auditor’sopinion (resulting in a qualified opinion, adverseopinion or disclaimer of opinion)—and describe thecircumstances in which the auditor would issue eachtype of report;

identify the possible reasons for departure from astandard report, a limitation on the scope of theaudit, a disagreement with those charged withgovernance regarding the financial report, and aconflict between applicable financial reportingframeworks;

describe the auditor’s responsibility for reporting oncomparative financial reports and understand theauditor’s responsibility with respect to otherinformation in an annual report; and

describe communications other than an audit reportbetween the auditor and shareholders, those chargedwith governance, and management.

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PART FOUR Complet ion and communicat ion602

C h a p t e r o u t l i n eThe entire audit process is geared toward the expressionof an opinion on the financial report. All of the auditor’splanning decisions and evidence collection proceduresare aimed at placing the auditor in the position wherethey can issue their audit report. As such, it is importantthat the audit report be an effective means of commu-nication. This chapter explains how the auditor decides

upon the type of report that is appropriate and thevarious modifications of the standard unqualifiedopinion that may be appropriate in particular circum-stances. This chapter also describes the auditor’scommunications with corporate clients, including com-munications with shareholders, boards of directors,audit committees and senior management.

R e l e v a n t g u i d a n c eAustralian International

ASA 260 Communication of Audit Matters with those ISA 260 Communications of Audit Matters with those Charged with Governance charged with Governance

ASA 570 Going Concern ISA 570 Going ConcernASA 700 The Auditor’s Report on a General Purpose ISA 700 The Auditor’s Report on Financial Statements

Financial ReportASA 701 Modifications to the Auditor’s Report ISA 701 Modifications to the Auditor’s ReportASA 710 Comparatives ISA 710 Comparatives ASA 720 Other Information in Documents Containing ISA 720 Other Information in Documents Containing

Audited Financial Reports Audited Financial StatementsAGS 1028 Uncertainty — AGS 1046 Responding to Questions at an Annual —

General Meeting AGS 1050 Audit Issues Relating to the Electronic —

Presentation of Financial Reports Audit and Assurance Alert No. 2: Auditors’ Responsibilities —in Relation to the Adequacy of Financial Records and Internal Controls throughout the Year Audit and Assurance Alert No. 4: Auditor Association — with Electronic Financial Reporting Audit and Assurance Alert No. 6: Auditors’ Responsibilities —in Relation to Reporting Contraventions of the Corporations Law Audit and Assurance Alert No. 11: Communicating with —Entities in Relation to Auditor IndependencePractice Note 34 Auditors’ Obligations: Reporting to ASIC —

OBLIGATIONS TO REPORTASA 200.05 (ISA 200.02) states that the objective of an audit of the financial report is to enable the

auditor to express an opinion whether the financial report is prepared, in all material respects, in

accordance with an applicable financial reporting framework. Auditors are required to conduct

an audit in accordance with Australian auditing standards. The auditing standards apply to audits

and reviews undertaken to meet the requirements of the Corporations Act 2001 (ASA 100.5). They

also apply, as appropriate, to the audit of other financial information (ASA 100.06/International

Preface, para. 04). The standards numbered 700–799 cover what may be regarded as the final stage

of the financial report audit process, the audit conclusions and reporting stages concerning

general purpose financial reports. In Australia there are currently four audit conclusions and

reporting standards (some of the equivalent international standards are noted at the beginning of

this chapter):

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CHAPTER 13 The auditor ’s report ing obl igat ions 603

1 ASA 700 The Auditor’s Report on a General Purpose Financial Report

2 ASA 701 Modifications to the Auditor’s Report

3 ASA 710 Comparatives

4 ASA 720 Other Information in Documents Containing Audited Financial Reports

As well as meeting the requirement to conduct an audit in accordance with Australian

auditing standards, the auditor also has an obligation to form a conclusion as to whether the

financial reports have been prepared using Australian accounting standards issued by the AASB.

It should be remembered that an auditor’s professional obligations should be exercised for all

types of entities, not just companies. This distinguishes them from the statutory responsibilities

that occur as a result of the Australian Accounting Standards Board (AASB) standards, which

apply only to companies, registered schemes and disclosing entities covered by the

Corporations Act 2001.

In many engagements the auditor’s reporting responsibilities are governed by the statute

under which the auditor is appointed. Often, compliance with statutory reporting responsibilities

also satisfies the professional reporting requirements outlined above. However, some

engagements undertaken under statute require a different form of reporting and/or additional

information in the audit report (e.g. engagements to audit banks and superannuation funds,

which will be discussed in more detail in Chapter 14).

One of the significant areas of reporting which is governed by statute is an audit undertaken in

accordance with the requirements of the Corporations Act 2001. This section will deal with those

requirements and the specific reporting obligations of the auditor. These obligations are found in

s. 307 of the Corporations Act 2001 and require the auditor to form an opinion as to:

(a) whether the financial report is in accordance with the Act, including:

(i) section 296 or 304 (compliance with accounting standards); and

(ii) section 297 or 305 (true and fair view); and

(aa) if the financial report includes additional information . . . (to give a true and fair view

of the financial position and performance)—whether the inclusion of that information

was necessary to give the true and fair view required by section 297 or 305; and

(b) whether the auditor has been given all information, explanation and assistance

necessary for the conduct of the audit; and

(c) whether the company, registered scheme or disclosing entity has kept financial records

sufficient to enable a financial report to be prepared and audited; and

(d) whether the company, registered scheme or disclosing entity has kept other records and

registers as required by this Act.

The Corporations Act 2001 also clearly specifies that the audit report shall state the

auditor’s opinion in relation to point (a) (i) and (ii) above (s. 308(1)). If for any reason the

auditor is not satisfied about any of these matters, the audit report must state why not. If in

the auditor’s opinion the financial report is not drawn up in accordance with a particular

applicable accounting standard, the audit report must show the quantified financial effect on

the financial report of failing to draw them up in accordance with that accounting standard

(s. 308(2)).

While the auditor is required to form an opinion on the matters noted in points (b) to (d)

above, under the exception basis of reporting the auditor need only report particulars of any

deficiency, failure or shortcoming in respect of any of those matters (s. 308(3)(b)). The exception

reporting basis was introduced as a response to concerns about the expectation gap, and has

resulted in a simplified and more concise form of audit report that it is believed is more effective

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in communicating its primary message. The advantage of reporting on these items only when the

requirements have not been met is that it draws the attention of the reader of an audit report

more directly to inadequacies in the financial report. This enhances the effectiveness of the

reporting process by highlighting and explaining exceptions when they occur. With regard to (c)

and (d) just quoted, Audit and Assurance Alert No. 2 points out that the auditor is required to form

an opinion as to whether the financial records have been kept satisfactorily throughout the

relevant period, not only at the end of the period.

The audit report must also describe any defect or irregularity in the financial report (s. 308(3)(a)).

Further professional considerations for the reporting of fraud are contained in ASA 240 (ISA 240),

which is discussed in Chapter 4.

There is also a responsibility for the entity to comply with applicable accounting standards

under s. 296 of the Corporations Act 2001. Applicable accounting standards are those prepared by

the AASB. It is possible that particular accounting standards may not be appropriate, and relief

may be granted by the Australian Securities and Investments Commission (ASIC) from

compliance with such standards under s. 340 of the Corporations Act 2001. Essentially, the auditor

is required to consider two sets of accounting standards:

1 AASB standards which must be complied with in the preparation of accounting reports of

companies unless relief is provided under s. 340 of the Corporations Act 2001; and

2 AAS standards which must be complied with in preparing general purpose financial reports for

all entities, in both the private and public sectors.

Under s. 308(3A) the auditor’s report must include any statements or disclosures required by

the auditing standards. If the financial report includes additional information to give a true and

fair view of financial position and performance, the auditor’s report must also include a statement

of the auditor’s opinion on whether the inclusion of that additional information was necessary to

give the true and fair view required by s. 297 (s. 308(3B)). The auditor’s report must also specify the

date on which the statement is made (s. 308(4)).

Who the auditor has an obligation to report toThe governing body and membersThe engagement letter (discussed in Chapter 6) should clearly spell out who the auditor has an

obligation to report to. As outlined in ASA 700.25 (ISA 700.07), the audit report should be

addressed as required by the terms of the engagement, normally to either the governing body or

the members of the entity.

Under the Corporations Act 2001, the auditor’s primary reporting responsibility is a report to

the company’s members (see s. 308(1)). This has been supported by common law. For example, in

the Pacific Acceptance Corporation case, Moffit J stated that one of the primary duties of the

auditor was to report to the members (refer to Chapter 4).

Management and the board of directorsJustice Moffit also said that the auditor’s reporting responsibilities extended beyond the audit

report. The auditor also had a responsibility to report to management anything that was

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prejudicial to the interests of shareholders (for further discussion, refer to Chapter 4). What

constitutes adequate reporting to management was discussed in the AWA case. In this case it

was stated that the auditor had a responsibility to bring a material weakness in internal control

to the attention of the full board of directors, and that reporting the weakness only to the

managing director was insufficient. This will be considered in more detail under learning

objective 7 of this chapter.

Australian Securities and Investments Commission (ASIC)Section 311 of the Corporations Act 2001 states that if the auditor of a company has reasonable

grounds to suspect that there has been a contravention of, or failure to comply with, any of the

provisions of the Corporations Act 2001 and believes that the matter will not be adequately dealt

with by comment in the audit report or notifying the directors, then the auditor must immediately

inform ASIC in writing. Failure to report such a breach is a criminal offence, subject to strict

liability (meaning that intention is not relevant).

As a result of initial concerns about the breadth of auditors’ obligations, ASIC issued Practice

Note 34 ‘Auditors’ Obligations’ (reissued 2004). The auditor’s reporting obligations with regard to

infringements of corporations legislation have been increased as a result of ASIC’s interpretation,

contained in Practice Note 34, of the requirements of the CLERP 9 Act. Under the amended

provisions an auditor is obliged to report a ‘significant’ contravention of the Act directly to ASIC.

Types of suspected contraventions that could be considered to be significant by an auditor

include:

■ insolvent trading by a company;

■ a breach of accounting standards or the true and fair view requirement; and

■ suspected dishonest or misleading and deceptive conduct.

An auditor is required to notify ASIC if the auditor has ‘reasonable grounds to suspect’ there

has been a significant contravention of the Act. This test is satisfied by circumstances that

would create in the mind of a reasonable auditor an actual apprehension or fear that a

contravention has occurred. The suspicion has to be honest and reasonable, and based upon

facts that would create suspicion in the mind of a reasonable auditor (refer George v. Rockett

(2003) 93 ALR 483).

Q u i c k r e v i e w

The auditor is required to express an opinion as to whether the financial report isprepared, in all material respects, in accordance with an applicable financial reportingframework.Legislative reporting obligations are contained in the statutes that govern the audit.Audits undertaken in accordance with the requirements of the Corporations Act 2001should form a conclusion that accounting standards prepared by the AASB (AASBstandards) were followed.Compliance with statutory reporting responsibilities usually satisfies professionalreporting requirements.The auditor’s primary reporting responsibility is normally to the governing body ormembers of the entity as outlined in the engagement letter. For audits of companies

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under the Corporations Act 2001, the primary responsibility is to the company’sshareholders.The auditor has a duty to report to management and the board of directors certain issueswhich may be judged as being prejudicial to the interests of shareholders.The auditor has a duty to report to ASIC when they have reasonable grounds to suspecta contravention of the Corporations Act 2001 that could not be adequately dealt with inthe audit report or by notifying the board of directors.

TRUE AND FAIR VIEWOne of the major differences between the form of audit opinion recommended by ASA 700 (ISA

700) and that required by legislation such as the Corporations Act 2001 is the terminology used

in expressing that opinion. ASA 700.08 (ISA 700.02–.04) requires the auditor to express an

opinion as to whether the financial report ‘gives a true and fair view’ or ‘presents fairly, in all

material respects’ in accordance with the applicable financial reporting framework. For the

purposes of approved auditing standards, the phrases ‘gives a true and fair view’ and ‘presents

fairly, in all material respects’ are equivalent (ASA 700.10/ISA 700.06). Section 297 of the

Corporations Act 2001 requires the auditor to give an opinion as to whether the accounts are

drawn up so as to give a true and fair view. Unless the phrase ‘a true and fair view’ is required by

legislation, the auditor’s opinion on a general purpose financial report ordinarily uses the

phrase ‘presents fairly, in all material respects’. The ‘true and fair’ form of opinion has been

used in companies legislation in Australia since 1955 and is taken from UK statutes. It has been

formalised as a legal obligation for both directors and auditors. However, it is not defined in the

initiating legislation or by court cases in which this reporting requirement has been called into

question. The interpretation and application of the term by auditors over time has generated

much debate.

Two major interpretations have been given to the words ‘true and fair’: a technical

interpretation and a literal interpretation. The technical interpretation is that a true and fair view

will be provided if the financial report is prepared in accordance with generally accepted

accounting principles (accounting standards, other authoritative pronouncements of the AASB,

and UIG interpretations). While there are a number of definitions of the literal interpretation, a

commonly accepted one is that the view presented by the financial information as a whole is

consistent with the auditor’s knowledge of the business and situation of the entity. Thus a

distinction may arise between the technical and literal approach where, if the generally accepted

accounting principles are followed, the view presented by the financial information is not

consistent with the auditor’s knowledge.

Section 297 of the Corporations Act 2001, the section requiring a true and fair view, states that

this section does not affect the obligation under s. 296 for a financial report to comply with

accounting standards. Therefore, it can be argued that the standard setters have currently adopted

a technical interpretation of a true and fair view. The arguments are that, in all but rare and

exceptional cases, following accounting standards should lead to a view of the company that is

consistent with its financial position and performance. Emphasising a literal interpretation would

have given management much more discretion in selecting ‘appropriate’ accounting policies.

Corporate accounting must now comply with accounting standards without exception. While

under the Corporations Act 2001 directors must add such information as is necessary to give a true

and fair view (s. 297), this additional information is de-emphasised by being disclosed only in the

notes to the financial report.

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In accordance with ASA 700.18 (ISA 700.14), when forming an opinion as to whether the financial statements give a true and fair view, or are presented fairly, the auditor:

■ evaluates the fair presentation of the report;

■ considers whether the financial report is consistent with the auditor’s understanding of the

entity and its environment;

■ considers the overall presentation, structure and content of the report; and

■ considers whether the financial report faithfully represents the underlying transactions and

events.


ASA 700 (ISA 700) requires the auditor to state whether the financial report ‘gives a trueand fair view’ or ‘presents fairly, in all material respects’ in accordance with the applicablefinancial reporting framework.For the purposes of approved auditing standards, the phrases ‘gives a true and fair view’and ‘presents fairly, in all material respects’ are equivalent.The Corporations Act 2001 requires the auditor to use the phrase ‘true and fair view’.Historically, there are two interpretations of the phrase ‘true’ and ‘fair’— a technical oneand a literal one. It is the technical interpretation which is currectly emphasised inreporting responsibilities.

STRUCTURE AND QUALITATIVECHARACTERISTICS OF THE AUDIT REPORT

Current structureAn example of an unqualified audit report is contained in Exhibit 13.1 (overleaf). This standard

form unmodified audit report has been adapted from the reports that were issued for reporting

periods ending 30 June 2006 and we will observe these audit reports in practice starting with

reporting periods ending 30 June 2007.

The report has a number of basic elements and key words and phrases that concisely express

the responsibility assumed by the auditor in issuing the report.

ASA 700.23 (ISA 700.06) requires that the title of the audit report should clearly indicate that

it is the work of an independent auditor. This is to assist users in identifying the audit report

and to clearly distinguish it from other reports. An audit report is normally addressed to

the person or group who engaged the auditor. In the case of a company, the auditor is engaged

to report to the shareholders (members), and they therefore become the addressees

(ASA 700.25–.26/ISA 700.06).We may usefully refer to Exhibit 13.1 to identify the elements of the audit report explained in

the list that follows:

■ The introductory paragraph, containing the words ‘The financial report which comprises …’

The auditor clearly identifies the components that comprise the financial report, which will be

covered by the audit. These are the balance sheet, the income statement, the statement of

changes in equity and the cash flow statement, the accompanying notes to the financial

statements and the directors’ declaration. This is important in an annual report, which

contains other information that has not been subject to audit (although it is considered by the

auditor, as outlined under learning objective 6 of this chapter).

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• 13.1 EX

HI

BI

T

INDEPENDENT AUDITOR’S REPORT

To the members of [name of entity]

Report on the Financial Report1

We have audited the accompanying financial report of [name of entity], which comprisesthe balance sheet as at 30 June 20XX, and the income statement, statement of changes inequity and cash flow statement for the year ended on that date, a summary of significantaccounting policies, other explanatory notes and the directors’ declaration.

Directors’ Responsibility for the Financial Report The directors of the [company/registered scheme/disclosing entity] are responsible for thepreparation and fair presentation of the financial report in accordance with AustralianAccounting Standards (including the Australian Accounting Interpretations) and theCorporations Act 2001 (Cwlth). This responsibility includes designing, implementing andmaintaining internal control relevant to the preparation and fair presentation of thefinancial report that is free from material misstatement, whether due to fraud or error;selecting and applying appropriate accounting policies; and making accounting estimatesthat are reasonable in the circumstances.

Auditor’s Responsibility Our responsibility is to express an opinion on the financial report based on our audit. Weconducted our audit in accordance with Australian Auditing Standards. These AuditingStandards require that we comply with relevant ethical requirements relating to auditengagements and plan and perform the audit to obtain reasonable assurance whetherthe financial report is free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amountsand disclosures in the financial report. The procedures selected depend on the auditor’sjudgement, including the assessment of the risks of material misstatement of the financialreport, whether due to fraud or error. In making those risk assessments, the auditorconsiders internal control relevant to the entity’s preparation and fair presentation of thefinancial report in order to design audit procedures that are appropriate in thecircumstances, but not for the purpose of expressing an opinion on the effectiveness ofthe entity’s internal control. An audit also includes evaluating the appropriateness ofaccounting policies used and the reasonableness of accounting estimates made by thedirectors, as well as evaluating the overall presentation of the financial report.

We believe that the audit evidence we have obtained is sufficient and appropriate toprovide a basis for our audit opinion.

IndependenceIn conducting our audit, we have complied with the independence requirements of theCorporations Act 2001 (Cwlth). We confirm that the independence declaration required bythe Corporations Act 2001 (Cwlth), provided to the directors of [name of entity] on [date],would be in the same terms if provided to the directors as at the date of this auditor’sreport.

Auditor’s Opinion In our opinion the financial report of [name of entity] is in accordance with theCorporations Act 2001 (Cwlth), including:

1 The Subheading ‘Report on the Financial Report’ is unnecessary in circumsatances when the second subheading‘Report on Other Legal and Regulatory Requirements’ is not applicable.

Example of anunmodified

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■ Paragraph outlining the responsibility of those charged with governance for the financial

report (ASA 700.33/ISA 700.28). ‘The directors of the company are responsible for the

preparation and fair presentation of the financial report in accordance with Australian

Accounting Standards (including the Australian Accounting Interpretations) and the

Corporations Act 2001…’ This directs attention to the fact that the financial report is the

representation of the governing body of the entity being audited, not the auditor. Management

and the governing body are responsible for the adequacy and accuracy of the financial report.

■ Paragraph outlining the auditor’s responsibility (ASA 700.37/ISA 700.32). ‘Our responsibility is

to express an opinion on the financial report based on our audit.’ This explains the role of the

auditor and, in conjunction with the preceding reference, distinguishes the responsibilities of

the governing body and the auditor. The auditor is conducting the audit to add credibility to

the representations in the financial report prepared by the governing body by expressing the

auditor’s independent opinion on the financial report to the report addressee.

■ ‘We conducted our audit in accordance with Australian Auditing Standards ...’ The audit

report indicates the auditing standards followed in conducting the audit. The auditor

indicates that an audit adequate to support an opinion on the financial report was

performed with professional competence by properly trained persons. This provides the

report user with an assurance that the audit has been carried out in accordance with

established standards.

■ ‘To obtain reasonable assurance whether the financial report is free from material

misstatement ...’ This sentence attempts to correct any misperception that the auditor’s

opinion is a guarantee of the accuracy of the financial report. It points out that the audit

opinion provides only reasonable—not absolute—assurance that the financial report, within

the context of materiality, does not contain misstatements.

■ ‘An audit involves performing audit procedures to obtain audit evidence about the amounts

and disclosures in the financial report. The procedures selected depend on the auditor’s

judgment, including the assessment of the risks of material misstatement of the financial

report, whether due to fraud or error.’ This emphasises the important concepts of auditor

judgment and risk assessment. In addition, the fact that the auditor assesses the

appropriateness of the accounting policies and disclosures used and significant accounting

estimates made by management indicates that the financial report includes a number of

estimates and approximations, for example provisions for depreciation and doubtful debts.

Overall, it attempts to convey that the precision of an audit, and the financial report being

audited, cannot be absolute.

■ ‘In making these risk assessments, the auditor considers internal control relevant to the entity’s

preparation and fair presentation of the financial report in order to design audit procedures


(a) giving a true and fair view of the [company/registered scheme/disclosing entity]’sfinancial position as at 30 June 20XX and of its performance for the year ended onthat date; and

(b) complying with Australian Accounting Standards (including the AustralianAccounting Interpretations) and the Corporations Regulations 2001.

Source: Auditing Standard ASA 700 ‘The Auditor’s Report on a General Purpose Financial Report’,Example 1: Unmodified auditor’s report prepared under the Corporations Act 2001 (Cwlth)—singlecorporate entity.

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that are appropriate in the circumstances, but not for the purpose of expressing an opinion

on the effectiveness of the entity’s internal control,’ is aimed specifically at addressing the

expectation that the auditor is providing assurance on the company’s internal controls.

This section of the audit report establishes why it would be illogical for the auditor to

issue something stronger than an opinion. As the financial report includes estimates and

approximations, and the audit process is based on test checks tailored to the circumstances of a

particular engagement, the audit report cannot be more than a statement of belief. This belief is

based on a series of judgments made after an expert examination of available evidence.

The independence section is newly added and allows the auditor to be assessed not only on

their expertise but on their independence. It conveys that the auditors have met the independence

requirements of the Corporations Act 2001 (discussed in Chapter 3).

The opinion paragraph completes the audit report. Again, refer to Exhibit 13.1.

■ ‘In our opinion …’ An auditor’s opinion is an expression of informed judgment. Auditors

are experts in the fields of accounting and auditing and therefore their opinions carry

substantial weight. Nevertheless, they cannot ensure or warrant the accuracy of the financial

report.

■ ‘the financial report ... is in accordance with the Corporations Act 2001, including (a) giving

a true and fair view ... and (b) complying with Australian Accounting Standards and the

Corporations Regulations 2001.’ This presents the auditor’s overall opinion.

There are some instances in which the auditor may be required to report on other matters that

are additional to their responsibility to express an opinion on the financial report. For example,

under certain legislation the auditor may have to report whether certain registers are properly

maintained. These other reporting responsibilities are included in a separate section of the

auditor’s report that follows the opinion paragraph. By including these specific reporting

responsibilities in a separate section of the audit report, the comparability of the audit report as it

relates to the financial report is enhanced. Guidance on these other reporting responsibilities is

contained in ASA 700.50–.52 (ISA 700.46–.49).

The audit report is signed in the name of the appointed auditor. If this is an audit firm, the

signing partner signs their own name as well as the name of the partnership. The report also

shows their location, usually the city in which the auditor’s office is located. This advises the

report user of the person and firm responsible for the report, and their location if contact is

necessary.

The audit report is dated as of the date the auditor signs that report. This informs the reader

that the auditor considered the effect on the financial report of events and transactions which had

occurred up to that date and about which the auditor had become aware. Auditors’ responsibilities

for events before and after this date are discussed in Chapter 12 under subsequent events.

Revision to structureIt should be noted that there are to be amendments to the structure of the audit report for general

purpose financial reports from 30 June 2007. The scope section will be replaced by three paragraphs.

The introductory paragraph will identify the entity whose financial report has been audited.


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Qualitative criteriaThe audit report should also meet a number of qualitative criteria. These are that:

■ the information in the audit report should be relevant to the needs of those to whom it is

addressed;

■ the report’s reliability depends upon the sufficiency and appropriateness of the audit evidence

and the degree of correspondence between that evidence and the type of audit opinion

expressed;

■ any explanatory information included in a qualification section or an ‘emphasis of matter’section (see p. 616) should satisfy the test of materiality;

■ the report should be timely, in that the auditor should not unreasonably defer issuing a report

in the hope of obtaining further evidence to resolve a possible situation that may result in a

modified audit report; and

■ there should be a measure of consistency in the form and content of the audit report so that

the message is communicated by different auditors in a comparable manner, to promote

understandability and to highlight unusual circumstances when they are reported (ASA 700.21/

ISA 700.16).

ASA 700 and 701 (ISA 700) promote consistency by describing the elements of the audit report

and including as appendices examples of audit reports containing unqualified and modified audit

reports. In practice, these examples provide standard forms of audit reports that are very rarely

departed from.


Australia has recently revised its standard form unqualified audit report to includeadditional information on the directors’ responsibilities, the audit approach and adescription of the auditors’ independence. These are attempts to improvecommunication between auditors and shareholders.The standard form unqualified audit report is a very standardised form of reporting,consisting of an introductory paragraph, a paragraph that describes the responsibility ofthose charged with governance, a description of the auditor’s responsibility and anopinion paragraph. Standardised wording is used in the report to convey the differentparties’ responsibilities and the work that has been undertaken by the auditor inpreparing the report. Even though the wording contained in the auditing standardsor other guidance material are only suggestions, they are very rarely departed from inpractice.Standard form audit reports are encouraged to produce comparability, to promoteunderstandability and to highlight unusual circumstances when they are reported.The audit report should have the following qualitative characteristics:• relevance;• reliability;• additional explanatory information if material;• timeliness;• consistency to aid comparability; and• understandability.

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TYPES OF AUDIT OPINIONSASA 700 (ISA 700) covers unmodified opinions. These are standard unqualified opinions,

containing no additional explanatory information. These are the opinions that have been

discussed up to now, and are used for approximately 80 per cent of Australian companies listed on

the Australian Stock Exchange. ASA 701 (ISA 701) covers modifications to the audit report. These

are either matters that do not affect the auditor’s opinion:

■ emphasis of matter situations; or

matters that do affect the auditor’s opinion:

■ qualified opinion;

■ disclaimer of opinion; or

■ adverse opinion (ASA 701.05/ISA 701.02).

The use of standard form opinions helps to highlight any modification to the audit report through

the use of appropriate subheadings and additional text. Real-life examples of modifications that

do affect the auditor’s opinion are contained in Exhibits 13.2–13.4.

Unqualified opinionAn unqualified opinion is expressed when the auditor is satisfied in all material respects that the

financial report is presented fairly in accordance with:

1 accounting standards and Australian accounting interpretations; and

2 relevant statutory and other requirements

so as to present a view which is consistent with the auditor’s understanding of the entity’s financial

position, the results of its operations and its cash flows (ASA 700.44/ISA 700.27).

Modifications affecting the auditor’s opinionQualified opinion (previously ‘except for’ opinion)A qualified opinion is expressed when the auditor concludes that an unqualified opinion is

inappropriate. This may be because of a disagreement with those charged with governance, a

conflict between applicable financial reporting frameworks or a scope limitation, the effects or

possible effects of which are not of such a magnitude or so pervasive as to require the expression

of an adverse opinion or a disclaimer of opinion (ASA 701.22/ISA 701.12). An example of a

qualification paragraph and a qualified audit opinion paragraph (which are included as an

additional paragraph after the scope paragraph) is contained in Exhibit 13.2 (overleaf). By far the

most common types of qualified opinions today are for material departures from a specific AASB

or other Australian accounting standard, or material disagreements over the carrying value of a

specific asset or liability and its potential effect on profit.

In issuing this type of opinion the auditor is communicating that, in their opinion, except for

the reservations outlined, the remainder of the financial report can be relied upon. The auditor

attempts to quantify their reservations so that the user can appropriately adjust the information

contained in the financial report if desired.

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Why are modifications to the audit report back in vogue?

In the previous edition of this book we asked where have all the qualifications gone? Itnow looks like they have reappeared. In recent research by Carson, Ferguson and

Simnett (2006) examining the frequency with which different types of audit opinionswere issued over the period 1996 to 2003, the authors found that the range of modifiedaudit reports identified over the period increased from 12 per cent in 1996–2000 to about20 per cent for 2001–2003. This is due mainly to an increase in one type of modifiedreport, that containing an emphasis of matter paragraph relating to significantuncertainty about a going concern issue. The qualification rate over this period is around4 per cent, significantly lower than the rate of qualifications issued in prior years.Significant divergences were found between the frequency and types of qualificationsissued by the various audit firms, with the rate of modifications for individual firmsranging from less than 10 per cent to over 30 per cent during the period of the study.Finally, significant divergences were also found between the frequency and types ofqualifications issued to clients in the various industry sectors.

What would explain this increase?

2001 was a year of some disastrous events for the auditing profession, including Enron inthe US and HIH in Australia. The increase is due to an increase in one type of opinion,emphasis of matter opinions relating to going concern. It may be that the companypopulation has become more risky, and a factor that supports this contention is that therecent economic boom has resulted in the listing of many speculative mining companies.It may also be that auditors have become more conservative in their reporting of thesetypes of modifications, with the recent disastrous events increasing auditors’ risk profileand encouraging them to issue such opinions. You may be able to think of other reasonsfor this increase.

AUDITING IN THE NEWS

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Adverse opinionAn adverse opinion should be expressed when the effect of disagreement with management or a

conflict between applicable financial reporting frameworks is extreme and therefore so material

and pervasive that the financial report taken as a whole is, in the auditor’s opinion, misleading or

of little use to the addressee of the audit report (ASA 701.24/ISA 701.14). An example of the

qualification and qualified audit opinion paragraphs for an adverse opinion is contained in Exhibit

13.3. These types of opinions are very rare in practice. The most common use is where there are

going concern considerations—where the accounts are prepared on a going concern basis and the

Ch 13 18/10/06 2:36 PM Page 613


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Example of thequalification

and qualifiedaudit opinion

paragraphs foran except

for opinion

Intermoco Ltd—Independent Audit Report—2004

QualificationAs a result of the acquisition of Intermoco Solutions Pty Ltd (formerly AustralonEnterprises Australia Pty Ltd), intangible assets representing intellectual property of $18 000 000 and goodwill of $48 330 204 were recognised. The valuation of the intellectualproperty is based on an independent valuation. The valuation takes into account theestimated future value of cash flows from the sale of products utilising the intellectualproperty. As at 30 June 2004, the written-down values of the intellectual property andgoodwill were $5 503 562 and $26 720 645 respectively.

The ability of Intermoco Limited to recover the carrying amounts of the intellectualproperty and goodwill is dependent on the generation of sufficient future cash flowsfrom the sale of products utilising the intellectual property. We have been unable toobtain sufficient reliable audit evidence to support the expected future profits andother cash flows associated with the intellectual property and goodwill, and thereforewe are unable to conclude whether these assets are carried at amounts above theirrecoverable amounts in accordance with AASB 1010 ‘Recoverable Amount of Non-Current Assets’.

Qualified audit opinionIn our opinion, except for the effects on the financial report of such adjustments, if any,as might have been determined to be necessary had the limitation of scope referred to inthe qualification paragraphs not existed, the financial report of Intermoco Limited is inaccordance with:

(a) the Corporations Act 2001, including:(i) giving a true and fair view of the financial position of Intermoco Limited and the

consolidated entity at 30 June 2004 and of their performance for the year endedon that date; and

(ii) complying with Accounting Standards in Australia and the CorporationsRegulations 2001; and

(b) other mandatory financial reporting requirements in Australia…

Ernst & YoungR.C. PiltzPartner

Melbourne30 September 2004

Source: Intermoco Ltd Annual Report 2004.

Ch 13 18/10/06 2:36 PM Page 614


QualificationNote 1 discusses a number of matters that may affect the ability of the entity tocontinue as a going concern. In that Note, the directors state their opinion that thegoing concern basis used in the preparation of the financial report is appropriate. Inour opinion however, it is highly improbable that the company will be able to continueas a going concern and therefore, we believe the going concern basis should not beused.

Had the going concern basis not been used, adjustments would need to be made relating to the recoverability and classification of recorded asset amounts, or tothe amounts and classification of liabilities, to reflect the fact that the company may be required to realise its assets and extinguish its liabilities other than in thenormal course of business, and at amounts different from those stated in the financialreport.

Qualified audit opinionIn our opinion, because of the matter referred to in the qualification paragraph, thefinancial report of Bestway Pacific Limited is not in accordance with:

(a) the Corporations Law, including:(i) giving a true and fair view of the Company’s and consolidated entity’s financial

position as at 30 June 1999 and of their performance for the year ended on thatdate; and

(ii) complying with Accounting Standards and the Corporations Regulations; and

(b) other mandatory professional reporting requirements.

KPMGChartered Accountants

P G SteerPartner

Gold Coast30 September 1999

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Example of thequalificationand qualifiedaudit opinionparagraphs foran adverseopinion

Source: Bestway Pacific Limited Annual Report, 30 June 1999.

auditor concludes that it is highly improbable that the entity will continue as a going concern (refer

ASA 570, Appendix 1). A recent one that has been issued for a listed company in Australia is

reproduced in Exhibit 13.3.

Disclaimer of opinion (also inability to form an opinion)A disclaimer of opinion, which is also referred to as an inability to form an opinion, is expressed

when a scope limitation (an unacceptable restriction to the extent of the auditor’s investigations)

exists and:

■ sufficient appropriate audit evidence to resolve the uncertainty resulting from the limitation

cannot reasonably be obtained; and

Ch 13 18/10/06 2:36 PM Page 615

Thus, the auditor is communicating that there has been such a limitation on the evidence-

gathering procedures that they are unsure whether the financial report is reliable or not. The

adverse opinion and the disclaimer of opinion can be distinguished as follows: for the adverse

opinion, the auditor knows that the financial report, taken as a whole, is of little use, whereas for

the disclaimer of opinion, the auditor has been unable to collect sufficient appropriate audit

evidence and is thus unable to form an opinion regarding the financial report. Again, these reports

are rarely issued in practice.

Modifications not affecting the auditor’sopinion: ‘emphasis of matter’ sectionIn certain limited circumstances it is appropriate for the auditor to draw attention to or emphasise

a matter that is relevant to the users of the audit report, but which, because of its nature, does not


■ the possible effects of the adjustments that might have been required had the uncertainty been

resolved are extreme, and therefore so material and pervasive that the auditor is unable to

express an opinion on the financial report taken as a whole (ASA 701.23/ISA 701.13).

However, it should be recognised that the auditor has a duty to form an opinion. Where there

is significant uncertainty the auditor should first exhaust all effective alternative means of

obtaining sufficient appropriate audit evidence before issuing an inability to form an opinion. An

example of the qualification and qualified audit paragraphs for an inability to form an opinion is

contained in Exhibit 13.4. These audit qualifications are very rare in practice, with less than

1 per cent of listed companies receiving such qualifications (Carson et al., 2006).

Bougainville Copper Limited—Independent Audit Report—2003Qualified Audit OpinionBecause of the existence of the limitation in the scope of our work and the fundamentaluncertainties, including the matters described in the qualification paragraphs below, andthe effects of such adjustments, if any, as might have been determined to be necessaryhad the uncertainties not existed:

(a) we have not obtained all the information and explanations that we have required, and(b) we are unable to, and do not express, an opinion as to whether the financial report of

Bougainville Copper Limited:(i) gives a true and fair view of the financial position of Bougainville Copper Limited

as at 31 December 2003 and its performance for the year then ended; and(ii) is presented in accordance with the Companies Act 1997, International Financial

Reporting Standards and other generally accepted accounting practice in PapuaNew Guinea.

In our opinion proper accounting records have been kept by the company as far asappears from our examination of those records.

This opinion must be read in conjunction with the qualification paragraphs below andthe rest of our audit report.

PricewaterhouseCoopersby J.C. Seeto26 February 2004

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Example ofqualified audit

opinionparagraph for a

statement ofinability to

form anopinion

Source: Bougainville Copper Limited, Independent Audit Report, 31 December 2003.

Ch 13 18/10/06 2:36 PM Page 616

affect the audit opinion. The auditor has to be careful that use of an ‘emphasis of matter’ does not

make the audit report too difficult to understand. Except for the circumstances listed below for

which an emphasis of matter is appropriate and allowed, the audit report should not draw

attention to or emphasise any matter which the auditor is satisfied has been adequately dealt with

in the financial report.

An ‘emphasis of matter’ section can accompany either an unqualified or a qualified audit

opinion. It should be suitably headed and is preferably placed immediately after the audit opinion

section (ASA 701.08/ISA 701.05). An ‘emphasis of matter’ is not a qualification, and care needs to

be taken to make this clear to the user of the audit report when describing the matter. It can be

introduced by use of words such as ‘Without qualification to the opinion expressed above,

attention is drawn to ...’ or, when the audit opinion has been qualified, ‘Without further

qualification to the opinion expressed above, attention is drawn to ...’.

The ‘emphasis of matter’ section included after the audit opinion should be used to draw the

users’ attention to the following circumstances as outlined by ASA 701.08–.20 (in ISA 701.05–.10

the circumstances are limited to highlighting matters regarding a going concern problem, and

issues of significant uncertainty, the resolution of which is dependent upon future events and

which may affect the financial statements):

1 SSiiggnniiffiiccaanntt uunncceerrttaaiinnttyy——ggooiinngg ccoonncceerrnn

When there is a significant uncertainty regarding a going concern problem, and the auditor believes

that it is adequately disclosed in the financial report, the auditor’s report should include an

‘emphasis of matter’ paragraph (ASA 701.09–.10/ ISA 701.06). Further guidance on this type of

‘emphasis of matter’ paragraph is provided in ASA 570 (ISA 570) ‘Going Concern’, in particular ASA

570.39 (ISA 570.33), which states that when the going concern uncertainty is adequately disclosed

in the financial report, an ‘emphasis of matter’ section is to be included in the audit report. The

‘emphasis of matter’ should clearly state that there is significant uncertainty as to whether the entity

will continue as a going concern and, therefore, as to whether it will realise its assets and extinguish

its liabilities in the normal course of business and at the amounts stated in the financial report. It

should also refer to the note to the financial report that has been determined to adequately describe

the principal conditions that raise doubt about the entity’s ability to continue as a going concern,

and the extent to which the financial report includes appropriate adjustments that might be

necessary if the entity does not continue as a going concern.

In evaluating the adequacy of the financial report disclosure, the auditor needs to consider

whether the information explicitly draws the reader’s attention to the possibility that the entity

may be unable to continue realising its assets and discharging its liabilities in the normal

course of business.

An example of an ‘emphasis of matter’ paragraph related to significant uncertainty—goingconcern is contained in Exhibit 13.5. It should be noted that as a result of the recent changes to ASA

701 (ISA 701), changes would now be required to this ‘emphasis of matter’, including that it would

have to be made clear that the ‘emphasis of matter’ regards going concern, and the incorporation

of a heading such as ‘Material uncertainty regarding continuation as a going concern’.

This category of ‘emphasis of matter’ is the most commonly observed, accounting for

approximately 80 per cent of auditors’ reports containing ‘emphasis of matter’ paragraphs

issued for publicly listed companies in Australia. There has recently been a large increase in the

number of such opinions issued. For 1997–2000, this type of ‘emphasis of matter’ paragraph is

contained in about 8 per cent of the audit reports for listed companies in Australia, while for

2002–2003 it is contained in approximately 14 per cent of such audit reports (refer to Snippet

13.1, discussed earlier in this chapter, and Carson et al., 2006).


Ch 13 18/10/06 2:36 PM Page 617

2 SSiiggnniiffiiccaanntt uunncceerrttaaiinnttyy——ootthheerr

When there is a significant uncertainty other than regarding going concern, the resolution of

which is dependent upon future events and which may materially affect the financial report,

and the auditor believes that it is adequately disclosed in the financial report, the auditor’s

report should include an ‘emphasis of matter’ section (ASA 701.11). In ISA 701.07 the auditor is

required to consider the addition of such a paragraph in these circumstances. Guidance on the

decision-making process for the auditor where there is an uncertainty is contained in AGS 1028

Uncertainty. This points out that in certain instances the outcome of a matter is contingent

upon future events, and its effect cannot be reasonably measured at the date of the audit report

on account of the nature of the matter, the facts of the particular situation or a lack of objective

evidence. When its potential to affect the financial report is not so remote as to make its

disclosure irrelevant, such a matter should be disclosed in a note to the financial report and be

included in an ‘emphasis of matter’ in the audit report.

This category of ‘emphasis of matter’ is the second-most commonly observed, accounting

for roughly the remainder (the other 20 per cent) of auditors’ reports containing ‘emphasis of

matter’ paragraphs issued for publicly listed companies in Australia. The issuing of such

opinions was reasonably stable between 1996 and 2003 (Carson et al., 2006).

3 AAddddiittiioonnaall ddiisscclloossuurree

When the auditor concurs that the financial report has been prepared in accordance with

approved accounting standards, but that a departure from such standards is appropriate and

that the impact of the departure is properly detailed in a note to the accounts, the auditor

issues an ‘emphasis of matter’.

In this ‘emphasis of matter’ section, the auditor:

(a) draws attention to the note containing the additional disclosures;

(b) states that in the auditor’s opinion application of the particular accounting standard

has, in this instance, resulted in the financial report being potentially misleading;

(b) states the specific reasons why the auditor believes the additional disclosures are

necessary to ensure the financial report as a whole is not misleading; and


(The following appears after the audit opinion paragraph.)

Inherent uncertainty regarding valuation of mining tenements

Without qualification to the opinion expressed above, attention is drawn to the followingmatters.

As disclosed in Note 12 of the financial report, exploration and evaluation expenditureon mining tenements is included in the Consolidated Entity and Company at $1 941 693 inrespect of areas of interest in exploration and evaluation Phases. The ultimate recovery ofthe Consolidated Entity’s and Company’s capitalised exploration expenditure is dependentupon the discovery, exploration and development of commercially viable mineral deposits,the generation of sufficient future income values therefrom and/or sale of the interests atan amount at least equal to the carrying values of the interests in mining tenements.

PKFD.J. GarveyPartner

29 September 2004

Source: Yamarna Goldfields Limited Annual Report 2004—Independent Audit Report.

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‘Emphasis ofmatter’

paragraphrelating to significant

uncertainty–going concern

Ch 13 18/10/06 2:36 PM Page 618

(d) states that, in the auditor’s opinion, the additional disclosures are relevant and

reliable in meeting the objectives of the financial report (ASA 701.15).

No ISA explicitly raises this as an issue in respect of which an ‘emphasis of matter’ would be

issued.

These additional disclosure ‘emphasis of matter’ reports are extremely rare for publicly

listed companies in Australia. In fact, Carson et al. (2006) identified no instances of such an

opinion for the period 1999–2003.

4 IInnccoonnssiisstteenntt ootthheerr iinnffoorrmmaattiioonn

When information in a document containing the audited financial report (for example, the

annual report) is materially inconsistent with that financial report and it is the other

information which is incorrect, the auditor’s report should include an ‘emphasis of matter’

section describing the material inconsistency (ASA 701.17). Thus, for example, if the directors

refer to a significant profit in their directors’ report, but this profit is before a large

extraordinary loss, which results in an overall loss, a reference to a profit may be inconsistent

and misleading. If not corrected by management, such an inconsistency needs to be clarified

(usually once such misstatements or inconsistencies are pointed out to management they will

rectify them). This is achieved by inclusion of an ‘emphasis of matter’ paragraph in the

auditor’s report. The auditor’s responsibility for identifying material inconsistencies and

reporting on them is contained in ASA 720 (ISA 720), discussed later in this chapter.

Such ‘emphasis of matter’ sections are very rare in practice for publicly listed Australian

companies. In fact, Carson et al. (2006) identified no instances of such opinions for the period

1997–2003.

5 SSuubbsseeqquueenntt eevveennttss rreessuullttiinngg iinn aa nneeww aauuddiittoorr’’ss rreeppoorrtt oonn aa rreevviisseedd ffiinnaanncciiaall rreeppoorrtt

When management finds it necessary to issue a revised financial report as a result of the

discovery of a material event after the financial report and auditor’s report have been issued,

the auditor’s report accompanying the revised financial report should include an ‘emphasis of

matter’ section (ASA 701.19). In practice in Australia, the revision of a previously issued

financial report is rare, and hence the issuing of such ‘emphasis of matter’ opinions is also rare.

Carson et al. (2006) identified no instances of such an opinion for the entire period of their

study, 1996–2003.


(The following appears after the audit opinion paragraph.)

Emphasis of MatterWithout qualification to the opinion expressed above, attention is drawn to the followingmatters.

As stated in Note 1 to the financial statements, the consolidated economic entitycomparative figures, being the figures for the year ended 31 December 1999, have beenrestated by the directors due to the discovery of material errors contained in thepreviously issued figures for that year.

The financial report has been revised subsequent to the issue of our audit report on5 April 2001. Note 1(p) to the financial statements sets out the reason for the issue of therevised financial report.

In our opinion, the additional disclosures are relevant for a proper understanding ofthe financial report.

SOMES & COOKEChartered Accountants

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Example of arevisedfinancial reportemphasis ofmatter

Source: United Overseas Australia Annual Report, 31 December 2000.

Ch 13 18/10/06 2:36 PM Page 619


HIH qualification, 2002 accounts

Apoint that seems to have been missed by many commentators is that the audit reporton the HIH accounts for 2000 does not contain a clean opinion.

The auditors draw attention to Notes 1 and 13 of the accounts and the uncertaintysurrounding ‘whole of account reinsurance’, which totals $1 819.9million.

This reporting of uncertainties is unlikely to have been welcomed by the managersand, consequently, is an expression of the independence of the auditor.

Of course, if investors fail to react to this and other warnings about HIH, it is hardlythe fault of the auditors …

The 2000 accounts of HIH contain the following emphasis of matter section in theaudit report:

Whole of Account ReinsuranceWithout qualification to the opinion expressed above, attention is drawn to thefollowing matter. As indicated in Note 7(t) to the financial statements, the consolidatedentity enters into whole of account reinsurance contracts to protect its underwritingportfolio. The realisation of benefits arising from a contract entered into during thefinancial year are dependent on factors described in Note 13.

Do you think the emphasis of matter was sufficient to alert the investors to the situation inHIH?

Is this an issue that the judiciary should have paid attention to in determining the liabilityof the auditors in the HIH case?

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The audit report will provide either an unmodified opinion (an unqualified opinionwhich also contains no additional explanatory information) or a modified opinion.Guidance on unmodified opinions is contained in ASA 700 (ISA 700).ASA 701 (ISA 701) covers modifications to the audit report. These are either matters thatdo not affect the auditor’s opinion:• ‘emphasis of matter’ situations; or matters that do affect the auditor’s opinion:• qualified opinion, where the auditor has a reservation that is not so material as to

preclude an expression of opinion on the financial report taken as a whole (i.e. with theexception of the stated reservation, the rest of the financial report is fairly presented);

• adverse opinion, where the financial report taken as a whole is misleading; and• disclaimer of opinion, where due to some limitation on scope the auditor was not able

to form an opinion on the financial report.An ‘emphasis of matter’ section is included in the audit report to draw attention tocertain matters which are considered relevant but do not affect the audit opinion andhave been adequately disclosed in the financial report.‘Emphasis of matter’ opinions are given on five grounds:(i) significant uncertainty (going concern);(ii) significant uncertainty (other);(iii) additional disclosure;(iv) inconsistent other information;(v) subsequent events resulting in a new auditor’s report on a revised financial report.

5

4

3

2

1

Source: A. Craswell,(2001), ‘US Audit

Rules Debated’,Australian Financial

Review, 14 June, p. 60.

HIH InsuranceLimited Annual

Report 2000.

AUDITING IN THE NEWS

Ch 13 18/10/06 2:36 PM Page 620


CIRCUMSTANCES GIVING RISE TO AQUALIFICATIONA qualified opinion should be expressed when any of the following are likely, in the auditor’s

opinion, to result in material effects:

■ a limitation on the scope of the audit (ASA 701.21/ISA 701.11).

■ a disagreement with those charged with governance regarding the financial report; and

■ a conflict between applicable financial reporting frameworks.

However, the auditor should take all reasonable steps to express an unqualified opinion

before expressing a qualified one. These will include attempts to overcome the limitations

on the scope or discussions with management to attempt to resolve the disagreement

satisfactorily.

Scope limitationA limitation on the scope of the auditor’s work exists when sufficient appropriate audit evidence

on which to base an unqualified opinion does or did exist, or could reasonably be expected to have

existed, but is not available to the auditor. It may sometimes be imposed by the entity (for

example, when management requests the auditor not to undertake a specific procedure) or by

circumstances (for example, the timing of the auditor’s appointment is such that they are unable

to observe the counting of inventory) (ASA 701.29–.31/ISA 701.16–.18).

When a limitation in the terms of an engagement is imposed by the entity and is such that

the auditor is unable to form an opinion, the limited engagement should not be accepted or

continued past the current period as an audit engagement. An auditor should not accept an audit

engagement when a known limitation infringes on the auditor’s legal duties or ethical or other

professional responsibilities (ASA 701.29/ISA 701.16).

When a scope limitation exists, the wording of the auditor’s opinion should describe the

limitation and indicate that it is qualified as to the effects on the financial report of such adjustments,

if any, as might have been required had the limitation not existed (ASA 701.31/ISA 701.18).

Disagreement with those charged withgovernanceIn practice, disagreements with those charged with governance of the entity are the most common

cause of qualification. Those charged with governance and the auditor may disagree over the

appropriateness of accounting policies selected, the method of their application, including the

appropriateness of accounting estimates, and the adequacy of disclosures in the financial report.

Accounting policies and disclosures are determined by accounting standards, UIG Interpretations

and other statutory and regulatory requirements. A qualified opinion is expressed when there is a

material departure from an accounting standard and/or an accounting interpretation. The audit

report cites the specific standard and/or accounting interpretation subject to departure or

disagreement (ASA 701.32–.34/ISA 701.20–.21).

As outlined earlier in this chapter when discussing the ‘emphasis of matter’ section, when

accounting standards and accounting interpretations have been adhered to but are subject to

additional disclosures which imply that the application of an accounting standard and/or

interpretation could be misleading, a qualified opinion is expressed in relation to such additional

disclosures, unless, in rare circumstances, the auditor is of the opinion that:

learningobjective 5

Ch 13 18/10/06 2:36 PM Page 621

■ it is likely, in the absence of the additional disclosures, that users would be misled when using

the information; and

■ the additional disclosures contain all, and only, relevant and reliable information, and are pre-

sented in such a manner as to ensure the financial report as a whole is comparable and under-

standable in meeting the objectives of a general purpose financial report.

The auditor must form an opinion on compliance with statutory and other requirements that

affect the form and content of the financial report. Compliance with these requirements may be

imposed by an Act of Parliament, including regulations, rules and directives. Most frequently such

requirements are aimed at separate disclosures, for example the separate disclosure of directors’

and audit fees. These items are usually considered material because of their nature, rather than

their amount, and a failure to meet such requirements will normally result in a qualified audit

opinion.

Conflict between applicable financialreporting frameworksSometimes the accounting policies adopted by management, although required or allowed by

statute or other requirements, do not result in fair presentation in accordance with accounting

standards and/or accounting interpretations. In such cases an unqualified opinion is expressed

on the presentation in accordance with the statute or other requirements and a qualified opinion

is expressed with respect to the presentation in accordance with accounting standards and

accounting interpretations. If, however, the accounting policies adopted are contrary to those

required by statute or other requirements, the auditor qualifies with respect to presentation in

accordance with those other requirements (ASA 701.35–.36; no equivalent section in ISA).

Qualifications on this basis are rarely seen in practice.

The effect of materiality on the auditqualificationAs is evident from Exhibit 13.7 (overleaf ), the primary factor when considering whether to

qualify an audit opinion, or attempting to determine what sort of qualification to apply, is the

degree of materiality of the subject matter giving rise to the qualification. One critical aspect is

the dollar magnitude of the effects, or potential effects, of the matter on the financial report.

However, as discussed in Chapters 7 and 12, materiality does not depend entirely on dollar

magnitude. The auditor also needs to consider the nature of the matter when making

judgments regarding materiality. A departure from an accounting standard need not be noted

in the audit report where it relates to an item of financial information that is not material.

However, qualifications may arise if there is a legal requirement to disclose specific items

irrespective of their dollar magnitude. As outlined earlier, these include for listed companies

the requirement to disclose specified directors’ and executive fees, and audit fees through

AASB 1046 and AASB 101 respectively. If not disclosed, such items will normally give rise to a

qualified opinion. For a matter to be considered extreme, it must be of such a magnitude, or be

so pervasive or fundamental, as to affect the overall usefulness of the financial report taken as

a whole.

Every modified audit report should contain a clear description of all material matters about

which the auditor has reservations. Each and every material reservation should be reported by the


Ch 13 18/10/06 2:36 PM Page 622


auditor, even if it leads to more than one qualification in the audit report. The auditor needs to

consider the requirements of law and the audit mandate in relation to the reported reservation

to ensure that reporting of the reservation complies with all necessary requirements.

COMPARATIVE AMOUNTS AND OTHERINFORMATION IN THE ANNUAL REPORT

The audit of comparative amountsMost entities disclose information from previous periods for comparison purposes. Such

comparative amounts are an integral part of the current period’s financial report, but they are

intended to be read only in relation to the amounts and other disclosures relating to the current

period. Unless otherwise stated, the financial report users are entitled to expect the comparative

amounts to have the same level of audit assurance as the disclosures relating to the current period.

The auditor’s responsibilities in the audit of comparative amounts are contained in ASA 710

FactsDuring the attendance at the annual stocktake and while undertaking follow-up procedures, theauditor identifies a range of obsolete stock. Subsequent work by the client reveals that under thelower of cost and net realisable value rule inventory is overstated by $10 million, but the clientdecides not to adjust the value because the reports are close to being issued. Testing of thesubsequent work of the client shows that the auditor is 95 per cent confident that the overstatementis in the range of $5–15 million. The inventory balance is $380 million and profit after tax but beforeextraordinary items is $693 million.

RequiredAssuming that the auditor is satisfied in all other respects, what type of audit opinion would theauditor issue?

SolutionThe adjusting entry required would be to debit the expense account ‘inventory write-down’ andto credit the asset account inventory, for $10 million. As the required adjustment is less than 5 percent of the inventory balance as well as the appropriate profit balance, the auditor wouldconclude that the concern over inventory valuation is immaterial and they would issue anunqualified opinion.

EXAMPLE 13.1 Consideration of materiality in issuing opinion


Qualifications may arise due to:• scope limitations;• disagreements with those charged with governance; and/or • conflict between applicable financial reporting frameworks.

Materiality is an important consideration in determining whether a qualification isnecessary, and, if so, the type of qualification. Consideration has to be given to bothquantitative and qualitative factors in this regard.

2

1

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(ISA 710), which requires that the auditor obtain sufficient appropriate audit evidence that the

comparative amounts are not materially misstated. The assessment of risk of material

misstatement includes these considerations:

■ The accounting policies used for the comparative amounts should be in accordance with the

financial reporting framework and consistent with those of the current period. If they

are not, the auditor must consider whether appropriate adjustments and disclosures have

been made.

■ The comparative amounts and other disclosures required should agree with those

presented in the previous period’s financial report. If they do not, the auditor must consider

the need for appropriate adjustments and/or disclosures to explain the variations that have

been made.

■ The comparative amounts should be free of material misstatement.

It is expected that, for continuing audits, the extent of audit procedures performed with

respect to comparatives will be significantly less than for the audit of the current period’s financial

information. If the financial report of the previous period was audited by another auditor, the

Source: Adapted and reproduced with the permission of the AUASB.

Circumstances Type of modification

Material but not Extreme casesextreme

Scope limitation Qualified Disclaimer(ASA 701.29–.31) (ASA 701.22) (ASA 701. 23)

Disagreement with those charged with Qualified Adversegovernance (ASA 701.32–.34) (ASA 701. 22) (ASA 701.24)

Conflict between applicable financial reporting Qualified Adverseframeworks (ASA 701.35–.36) (ASA 701.22) (ASA 701.24)

Significant uncertainty—Going concern Emphasis of matter (ASA 701.09–.10) (ASA 701.08)

Significant uncertainty—Other Emphasis of matter (ASA 701.11) (ASA 701.08)

Additional disclosures with which the Emphasis of matter auditor concurs (ASA 701.15–.16) (ASA 701.08)

Inconsistent other information Emphasis of matter (ASA 701.17–.18) (ASA.701.08)

Subsequent event resulting in a new auditor’s Emphasis of matter report on a revised financial report (ASA.701.08)(ASA 701.19)

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ASA 701,Appendix 1

‘Circumstancesthat result in amodified audit

report’

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incoming auditor may rely on the work of the previous auditor or may gain knowledge during

the audit as to whether the opening balances were materially misstated. The auditor who plans to

rely on the work of a predecessor should also consider the principles stated in ASA 600/ISA 600

‘Using the Work of Another Auditor’ (discussed in Chapter 5).

Except in the rare circumstances where the audit mandate requires a specific reference to the

comparative amounts, a reference in the audit report is required only in the following situations

(ASA 710.13–.26/ISA 710.12–.17):

1 The audit report on the previous period was qualified. In these circumstances, the current

audit report should be qualified when the matter which gave rise to the qualification either:

• results in a qualification of the audit report on the current period’s financial information

also, or

• is unresolved, but does not result in a qualification based on the current period’s

information, although it is material in relation to the current period’s financial information.

2 The auditor’s current opinion on the financial report of the previous period is different from

the original opinion, due to the discovery of a ‘subsequent event’.

3 The financial report of the previous period was audited by another auditor, and the incoming

auditor was unable to obtain sufficient appropriate evidence regarding the comparative amounts.

If the previous period’s financial report has not been audited, and the auditor is unable to

obtain sufficient appropriate audit evidence regarding the comparative amounts, the auditor

qualifies the audit report on the basis that the comparative amounts are unaudited and that no

opinion on them is expressed, and encourages clear disclosure in the financial report that the

comparative amounts are unaudited.

Auditor’s responsibilities for otherinformation in an annual reportMost annual reports include a deal of information, much of which contains or refers to financial

information, that is not part of the basic comparative financial report. For example, there may be

summaries of five or 10 years’ operating results, highlights of key figures from the financial report,

as well as analyses of financial data in the chairperson’s or directors’ reports. For companies listed

on the Australian Stock Exchange, other disclosures, such as the top 20 shareholders, are required.

In many cases this other information in an annual report is based on or related to material

contained in the audited financial report.

Thus the auditor should read the entire annual report and consider whether the other

information is consistent with the audited financial report. The auditor has no responsibility to

apply additional audit procedures to the other information to corroborate it unless this has been

specified as part of the engagement. However, where it is not so specified, it is prudent for the

auditor to read it and compare it with audited data. This is important since the credibility of the

audited financial report may be undermined by inconsistencies between it and accompanying

other information. The auditor’s responsibilities in relation to such information presented with

audited financial reports are dealt with in ASA 720 (ISA 720).

Since much of the other information is derived from the financial report, the auditor has a

basis for recognising material inconsistencies and material misstatements of fact. For example,

the directors’ report might mention an increase in net profit but omit the fact that it occurs

because of a material profit from discontinued operations, thus misleading investors. An

inconsistency is material when it contradicts information contained in the financial report and


Ch 13 18/10/06 2:36 PM Page 625


COMMUNICATIONS BETWEEN AUDITOR ANDOTHER PARTIESThe relationship between an auditor and client has many dimensions. One factor that has a

significant effect on the relationship is the form in which the client is organised—company,

partnership or sole trader. This section focuses on the corporate client whose shares are traded on

the stock exchange.

Communicating with shareholders through theannual reportThe primary communication between a company and its shareholders is the annual report. The

financial report included in the annual report should contain a balance sheet, income statement,

statement of changes in equity and cash flow statement, with accompanying explanatory notes.

Beyond the inclusion of the financial report, the form and content of annual reports vary

may therefore raise doubts about the material in the financial report and the auditor’s

conclusion and report. An auditor who concludes that the other information causes a material

inconsistency should ask the client to revise it. If the client will not, the auditor has the following

options:

1 revise the audit report in accordance with ASA 701 (ISA 701), and consider including in the

audit report an ‘emphasis of matter’ section describing the material inconsistency;

2 withhold the use of the audit report in the annual report; or

3 withdraw from the engagement.

The appropriate action depends on the significance of the inconsistency, and why the

inconsistency has arisen. In practice, management is usually happy to correct any material

inconsistencies or misstatements of fact brought to their attention. If they do not, option 1 above

is the most likely course of action, with options 2 and 3 being quite extreme. Note that the

inclusion of an ‘emphasis of matter’ section in the audit report is not an audit qualification,

because the deficiency is not in the audited financial report. If the other information is correct and

it is the financial report which requires revision, and the client refuses, the auditor issues an

‘except for’ or adverse opinion, depending on the circumstances.

For audits conducted under the provisions of the Corporations Act 2001, a material

inconsistency is most likely to be a breach of the Act by the directors. Thus, it is likely that on being

brought to the attention of directors, the inconsistency will be rectified. If it is not rectified, the

auditor should consider bringing the matter to the attention of ASIC.

The auditor should obtain sufficient appropriate audit evidence that comparativefinancial information is not materially misstated.The auditor should review the other information in documents containing auditedfinancial reports for any material inconsistencies or material misstatements of fact.The auditor should encourage management to correct any material inconsistencies ormaterial misstatements of fact. If management does not, the auditor’s most likely courseof action is to issue an ‘emphasis of matter’ opinion.

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Ch 13 18/10/06 2:36 PM Page 626

substantially. Some companies issue elaborate reports with pictures of physical facilities and

personnel, graphs and charts of operating data and supplementary financial information. Other

companies send shareholders only the basic financial report and statutory reports with a covering

letter. Regardless of the form or content of the annual report, the auditor’s opinion on the financial

report included in the annual report is the principal means of communication between the

auditor and shareholders. Thus, it is important that the audit report, discussed in this chapter in

detail, be an effective communication device.

Communicating with shareholders at annualgeneral meetingsA second major method of communicating with shareholders is at the company’s annual general

meeting (AGM). However, only a small minority of shareholders normally attend these meetings.

Over the last five years in Australia, attendance at AGMs has been increasing. However, many of the

companies listed on the Australian Stock Exchange will have attendances of less than 50, with over

200 usually only occurring for the largest public companies, or if there are contentious issues on the

agenda. It is now more common that there be shareholder representatives in attendance, through

associations such as the Australian Shareholders’ Association. Section 250T of the Corporations Act

2001 states that members must be allowed a reasonable opportunity to ask the auditor questions

relevant to the conduct of the audit, the preparation and content of the audit report, the accounting

policies adopted by the company and the independence of the auditor. Auditors have a legal

obligation to attend the company’s annual general meeting at which the audit report is considered

(Corporations Act, s. 250RA).

AGS 1046 ‘Responding to Questions at an Annual General Meeting’ provides auditors with

guidance on this issue. It emphasises the educational opportunity of putting specific issues raised

by shareholders into the broader context of the audit. Responses to questions relating to specific

issues or procedures should be addressed by reference to the fact that the audit report relates to

the financial report as a whole, after taking into account the auditor’s assessment of risk and

materiality. Questions about the issuing of modified or qualified opinions should be answered by

reference to the audit report. If the report is an effective communication device it should contain

sufficient explanation to ensure it answers all reasonable questions.

Communicating with those charged withgovernanceASA 260 (ISA 260) provides guidance for the auditor in communicating with all groups of directors

and management. The standard distinguishes between ‘those charged with governance’, being the

governing body (the board of directors for a listed company) and other persons having responsibility

for planning and directing the activities of an entity, and ‘management’, being those with

responsibility for supervision of the day to day activities of the entity. It does require the auditor to

report matters of governance interest identified as a result of audit procedures performed to the

governing body on a timely basis. In assessing the significance of each matter identified, the auditor

should consider the nature of the matter, the relevant characteristics of the entity and the potential for

the matter to materially affect the financial report. All such matters should be reported on a timely

basis, and oral reports regarding significant matters should be documented. The auditor should also

review matters raised in previous reports and the subsequent actions taken by the governing body.

The auditor uses different means to communicate with various groups. The discussion below

reviews communication first with management, then with those charged with governance,


Ch 13 18/10/06 2:36 PM Page 627

including the audit committee and the board of directors. The roles of these various groups were

discussed in the corporate governance section of Chapter 3.

Communicating with managementMuch of the communication between the auditor and the client is with the company’s

management. Contacts between the auditor and management are more extensive, more frequent

and more informal than those with shareholders, audit committees and boards of directors. At the

planning stage, management provides much of the information that is needed to plan the audit,

including news of major changes in the entity, both strategic and operational. During the

audit, management provides the auditor with information and explanations as required. This

includes the organisation and preparation of many schedules. It is management that undertakes

the preparation of the financial report, and it is with management that the auditor first negotiates

appropriate adjustments to the financial report as detected by the audit.

The management letter, or report to managementThe principal written communication between the auditor and management is the managementletter that normally is issued at the conclusion of every audit engagement. This letter summarises

the auditor’s recommendations resulting from their assessment of the entity’s business risk and

inherent risk, and any recommended improvements in internal control.

In Australia there is no recommended standard form for the management letter. As the auditor

attempts to add value with the business risk audit methodology, they may wish to communicate

to management, for each key business process:

■ the risks identified which would threaten the organisation’s objectives;

■ the critical success factors identified;

■ the key performance indicators linked to the critical success factors; and

■ performance improvement opportunities.

With regard to internal control, the report should include the following main points:

■ The purpose of the study and evaluation of internal control is to establish a basis for reliance

on controls in determining the nature, timing and extent of other audit procedures.

■ The objective of internal control is to provide reasonable, but not absolute, assurance, and

costs must be balanced against benefits by management.

■ Any internal control has inherent limitations and an evaluation cannot be projected to future

periods.

■ The auditor’s study and evaluation does not necessarily disclose all weaknesses.

■ The study and evaluation disclosed certain material weaknesses, which are enumerated, and

other audit tests were modified accordingly.

Although the management letter will be reviewed by executive management, which is

expected to respond to items contained in it, the audit committee and the full board of directors

are required to be informed of the contents of this letter and review the response (refer to the AWA

decision in Chapter 4).

Discussions with managementThe most critical communication between the auditor and management concerns the form and

content of the financial report. If the accounting policies or disclosures proposed by management

differ materially from those which the auditor believes are appropriate, either an alternative

presentation must be agreed on or the auditor takes up the issue with the governing body.


Ch 13 18/10/06 2:36 PM Page 628

If the auditor can convince management that a particular presentation is superior,

management may be persuaded to change the financial report. The auditor attempts to

demonstrate that the proposed presentation might be misleading or that it clearly departs from

authoritative pronouncements or substantially favoured practice. In some cases management is

unfamiliar with accounting or auditing requirements of the accounting profession and the stock

exchanges, or with statutory disclosure requirements.

Sometimes questions concerning the appropriate application of generally accepted

accounting principles or the adequacy of informative disclosures fall in a grey area. In this case,

extensive discussion with management is usually necessary. Resolution of differences depends on

the attitudes and personalities of management and the auditor and the working relationship that

has developed between them.

Communicating with the audit committee or boards of directorsThere is an increased emphasis on a company having an effective audit committee. The broad

objectives of an audit committee are discussed in Chapter 3. The AUASB, in conjunction with the

Institute of Company Directors and Institute of Internal Auditors, recently revised their best practice

guide for audit committees. If best practices are adopted, it can reasonably be expected that the

following communications between the external auditor and the audit committee will occur:

1 The auditor is able to contact the chair of the audit committee at any time to arrange meetings

or to discuss issues.

2 The auditor is informed of the proposed meeting dates of the audit committee.

3 The auditor meets with the audit committee at least twice: at the planning stage and at the

completion of the audit. Other meetings while the audit is being undertaken may also be

required to help resolve difficulties that may have arisen during the evidence collection stage.

Effective audit committees could also be expected to inquire of their auditor the extent to which

executive management has been aggressive in their choice of accounting policies, and the auditor

is independent of management. For example, they may ask the auditor to inform them of any

circumstances that may affect their independence, such as the provision by the audit firm of non-

audit services for that client. AAA 11 outlines suggested wording for a ‘declaration of independence’

by the auditor to the audit committee and/or board of directors, which helps ensure that issues that

may affect auditor independence are brought to their attention. For listed companies in Australia,

this is a discussion of the issues associated with auditor independence with the audit committee

and/or the board of directors. This was discussed in Chapter 3.

At the planning stage the audit committee should acquaint the auditor with the company’s

general disclosure policies and directions, including disclosure of the company’s corporate gover-

nance practices. It should also review and consider the scope of the external audit, particularly in

the identified risk areas.

At the conclusion of the audit the committee should ask the auditor about any significant

disagreements with management and whether or not they have been satisfactorily resolved. The

auditor may also provide an independent judgment about the appropriateness, not just the

acceptability, of the accounting principles and the clarity of the financial disclosure practices used

or proposed to be adopted by the company, as put forward by management. The audit committee

should also review the management letter which the auditor has provided and management’s

response to it.

As the audit committee is a subcommittee of the full board of directors, its meetings are

minuted for the consideration of the full board. The auditor should review these minutes.

At present in Australia, auditors do not have the right to attend meetings of the board of


Ch 13 18/10/06 2:36 PM Page 629

directors, but they may be invited to attend to discuss accounting or auditing matters. Sometimes

the auditor asks to be present at a meeting of the board, with attendance of the auditor at at least

one full board meeting becoming more and more common.

One of the results that has been observed since the introduction of the business risk audit

methodology is that boards generally now see auditors as more relevant with regard to their

deliberations. Also, matters that cannot be satisfactorily resolved with the executive management

must be discussed with the board. In addition, certain other matters, such as material weaknesses

in internal control, should be brought to the board’s attention because of its responsibility to the

shareholders. Unnecessary conflict with the executive management can usually be avoided by

allowing it to make a preliminary review of matters to be presented to the board, but the auditor

cannot subordinate professional judgment concerning which matters should be reported directly

to the board.

Communicating through electronicpresentation of financial reportsAudit and Assurance Alert No. 4 and the follow-up, AGS 1050, alert the auditor and provide

guidance for the circumstances where the entity decides to publish its audited financial report on

its web site. The major risks are whether the financial report on the web site is in accordance with

the published financial report, and whether it is possible that the audit report may be construed

as providing assurance on other information on the web site that was unaudited. For most entities

which place their financial report on the web site, there is a separate link in the web site to the

financial report and it is clear that the audit report is attached to and intended to be read with the

financial report. The auditor should review the web site to make sure the audit report cannot be

attached to or be seen as covering any information for which this was not the intention.

If in the auditor’s opinion the audit report may be construed to cover information that was

unaudited, they should bring this to management’s attention. In certain circumstances the auditor

may provide a separate audit report for electronic dissemination. This audit report may be

expanded to include specific references to the audited statements by name, advice to readers that

the audit report refers only to statements named in the report, and advice to readers that they

consider reference to the hard copy of the entity’s financial report.



The auditor’s principal means of communication with shareholders is through the auditreport on the financial report. A secondary means of communication is through theirattendance at the annual general meeting.Auditors have a responsibility to communicate to those charged with governance matterswhich they believe are prejudicial to the interests of shareholders. These includesignificant business risks and material weaknesses in internal control. Usually the auditorlists the weaknesses and recommendations for improvement in the management letter.Auditors should ensure that the full board of directors is informed of the contents of themanagement letter.There is an increased emphasis in the current environment on the auditor’scommunication with the audit committee. Communications may include such items as adiscussion of an assessment of aggressiveness of executive management’s accountingpolicy choice, as well as ensuring that the auditor is independent of management.Auditors should ensure that electronic presentations of the audit report provideassurance on the statements for which it was intended.

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S u m m a r yAn audit report formally communicates the auditor’sconclusion on the presentation of the financial reportand concisely states the basis for that conclusion. It isimportant that this audit report is an effective com-munication device, as it is the principal means ofcommunication between the auditor and the financial

report user. This chapter has considered howauditors’ reporting obligations for general purposefinancial reports arise and how auditors determinethe type of report that is appropriate. The auditors’reporting obligations to other parties have also beenconsidered.

K e y t e r m sAdverse opinion 613 Other information in an annual report 625Attendance at annual general meeting (AGM) 627 Other reporting reponsibilities 610Audit committee 629 ‘Presents fairly’ 606Comparative amounts 623 Qualified opinion 612Disclaimer of opinion 615 Significant uncertainty—going concern 617‘Emphasis of matter’ section 611 Those charged with governance 627Inability to form an opinion 615 ‘True and fair’ 606Independence section 610 Unmodified opinions 612Management letter 628 Unqualified opinion 612Opinion paragraph 610

R e f e r e n c e sAitken, M. and Simnett, R. (1991) ‘Australian audit reports:

1980–89’, Australian Accounting Review, Vol. 1, No. 1, 12–19.

Australian Accounting Research Foundation, Institute of InternalAuditors—Australia, Australian Institute of CompanyDirectors (2001) Audit committees: Best practice guide, revised,Australian Accounting Research Foundation, Melbourne.

Carson, E. (1996) ‘Corporate governance disclosure inAustralia: The state of play’, Australian Accounting Review,Vol. 6, No. 2, 3–11.

Carson, E., Ferguson, A. and Simnett, R. (2006) Australian AuditReports: 1996–2003, Australian Accounting Review,forthcoming.

Craswell, A. (1986–1996) Who Audits Australia, University ofSydney.

Deegan, C., Kent, P. and Lin, C.-J. (1994) ‘The true and fairview: A study of Australian auditors’ application of theconcept’, Australian Accounting Review, Vol. 4, No. 1, 2–12.

DeZoort, F.T. and Salterio, S. (2001) ‘The effects of corporategovernance experience and financial-reporting and auditknowledge on audit committee members’ judgments’,Auditing: A Journal of Practice & Theory, Vol. 20, No. 2, 31–48.

Gay, G., and Schelluch, P. (1993) ‘The effect of the longformaudit report on users’ perceptions of the auditor’s role’,Australian Accounting Review, Vol. 3, No. 2, 2–11.

Green, W. (1994) ‘Going concern qualifications and auditswitching’, Accounting Research Journal, Vol. 7, No. 2, 4–10.

Humphries, K., Craswell, A. and Simnett, R. (1999) ‘Assessingauditors’ uncertainty resolution strategies’, University ofNew South Wales Working Paper, Sydney.

Monroe, G.S. and Teh, S.T. (1993) ‘Predicting uncertainty: Auditqualifications in Australia using publicly availableinformation’, Accounting and Finance, Vol. 33, No. 2,November, 79–106.

National Companies and Securities Commission (1984) A Trueand Fair View and the Reporting Obligations of Directorsand Auditors, National Companies and SecuritiesCommission, Sydney.

Nugent, M. (1997) ‘Uncertain about what type of audit reportto issue?’, Charter, August, 84–5.

Psaros, J. and Wei, Z.M. (1994) ‘The going concern auditopinion: Australian evidence’, Perspectives on ContemporaryAuditing, Vol. 1, 39–46.

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13.1 Select the best response to the following questions.(a) When restrictions are imposed by the client which significantly limit the auditor’s

ability to audit fixed assets (a material part of the balance sheet), the auditor generallyshould issue which of the following opinions?A unqualified with an emphasis of matterB qualifiedC disclaimerD adverse

(b) Shaun Insurance Ltd is trading profitably at 30 June 20X0 as reflected in its financialreport. On 24 July 20X0 there is a hailstorm in Sydney which creates unprecedenteddamage. Although Shaun had undertaken all the normal reinsurance processes, it isunlikely that they will be able to pay all claims and there is a high probability that thecompany will have to be wound up. The auditor believes that the financial report as at30 June 20X0 is true and fair, and that this natural disaster is adequately disclosed. Theauditor should issue:A a disclaimer of opinionB an unqualified opinion with an ‘emphasis of matter’C an adverse opinionD a qualified opinion

(c) Your client, Blunt Ltd, is being sued by one of its competitors for $20 000 000 for analleged patent infringement. Your client has assets of $40 000 000 and a reported profitof $10 000 000. The client has disclosed the lawsuit in a note to the accounts along witha statement indicating that they intend to vigorously defend the suit and are confidentof winning the suit. Your independent legal advice supports this view. What type ofopinion should you express on the financial report of Blunt Ltd?A an unqualified opinion with an ‘emphasis of matter’B a disclaimer of opinionC an unqualified opinionD a qualified opinion or adverse opinion

(d) Morris Ltd has reported losses two years in a row and has a debt to total assets ratio of0.90. In addition, a $5 000 000 debenture is maturing next year and the company hasnot set aside a sinking fund to repay the debt. The parent entity of Morris Ltd hasdecided to repay the debenture when it matures and provide sufficient funding tocover any additional losses that Morris Ltd might incur. Morris Ltd has not disclosedthese arrangements in its financial report and the auditor is adamant that it should bebrought to the shareholders’ attention. What type of opinion should the auditorexpress on the financial report of Morris Ltd?A disclaimer of opinionB unqualified opinion with an ‘emphasis of matter’C unqualified opinionD qualified opinion or adverse opinion

(e) Your client has followed approved accounting standards but a note to the financialreport indicates that the application of certain standards results in the financial report

A s s i g n m e n t s

R E V I E W Q U E S T I O N S

MAXIMISE YOURMARKS! There

are approximately30 interactive

questions on theauditor’s

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Ch 13 18/10/06 2:36 PM Page 632

being materially misstated. The note details the reasons for this view. You do notconcur with this view. What type of opinion should you issue?A an unqualified opinion with an ‘emphasis of matter’B a disclaimer of opinionC an unqualified opinionD a qualified opinion or adverse opinion

(f ) Taylor Ltd has disclosed the fact that they are being sued for $1 000 000. Taylor Ltdreported a profit for the year of $10 000 000 and has total assets of $15 000 000. Youconclude that disclosure of the litigation is adequate. What type of opinion should youexpress on the financial report of Taylor Ltd?A disclaimer of opinionB unqualified opinion with an ‘emphasis of matter’C unqualified opinionD qualified opinion or adverse opinion

(g) Jodie Ltd, a listed company, refuses to separately disclose directors’ fees of $2.5 millionon the basis that they are immaterial. Profit for the last year was $980 million. The auditorshould issue a(n):A adverse opinionB qualified opinionC unqualified opinion with an ‘emphasis of matter’D unqualified opinion

(h) Your client has followed approved accounting standards but a note to the financialreport indicates that the application of certain standards results in the financial reportbeing materially misstated. The note details the reasons for this view. You, as theauditor, concur that this additional note disclosure is necessary to give a true and fairvalue. What type of opinion should you issue?A an unqualified opinion with an ‘emphasis of matter’B a disclaimer of opinionC an unqualified opinionD a qualified opinion or adverse opinion

13.2 Select the best response to the following independent situations.(a) Roebuck Ltd has disclosed an uncertainty due to pending litigation. The auditor’s

decision to issue a qualified opinion would most likely be determined by the:A lack of insurance coverage for possible losses from such litigationB entity’s lack of experience with such litigationC inability to estimate the amount of lossD lack of sufficient evidence

(b) Morris Ltd changed from the straight-line method to the declining balance method ofdepreciation for all newly acquired assets. This change has no material effect on thecurrent year’s financial statements but is reasonably certain to have a substantialeffect in later years. If the change is disclosed in the notes to the financial statements,the auditor should issue a report with a(n):A consistency modificationB unqualified opinionC explanatory paragraphD qualified opinion

(c) Which of the following best describes the auditor’s responsibility for ‘other information’included in the annual report to stockholders that contains financial statements andthe auditor’s report?A The auditor must modify the auditor’s report to state that the other information ‘is

unaudited’ or ‘is not covered by the auditor’s report’


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B The auditor should extend the examination to the extent necessary to verify the‘other information’

C The auditor has no obligation to corroborate the ‘other information’ but shouldread the ‘other information’ to determine whether it is materially inconsistent withthe financial statements

D The auditor has no obligation to read the ‘other information’(d) King, CPA, was engaged to audit the financial statements of Newton Company after its

fiscal year had ended. King neither observed the inventory count nor confirmed thereceivables by direct communication with debtors but was satisfied concerning bothafter applying alternative procedures. King’s auditor’s report most likely contained a(n):A unqualified opinion with an explanatory paragraphB unqualified opinionC disclaimer of opinionD qualified opinion

(e) An auditor concludes that there is a material inconsistency in the ‘other information’in an annual report to shareholders containing an audited financial report. If theauditor concludes that the financial report does not require revision, and the clientrefuses to revise or eliminate the material inconsistency in the ‘other information’, theauditor may do the following:A disclaim an opinion on the financial report after explaining the material

inconsistency in a separate explanatory paragraphB revise the audit report to include an ‘emphasis of matter’ section describing the

material inconsistencyC consider the matter closed since the other information is not in the audited

financial reportD issue a qualified opinion after discussing the matter with the client’s board of

directors(f) Higgins Ltd is required to but does not wish to prepare and issue a statement of cash flows

as part of its financial report. In these circumstances, the audit report should include:A an adverse opinion stating that the financial report, taken as whole, is not fairly

presented because of the omission of the required statementB an unqualified opinion with a statement of cash flows prepared by the auditor

included as part of the audit reportC an unqualified opinion with an ‘emphasis of matter’ section explaining that the

company declined to present the required statementD a disclaimer of opinion with a separate explanatory paragraph stating why the

company declined to present the required statement(g) Which of the following will not result in modification of the audit report due to a scope

limitation?A Inability to obtain sufficient appropriate evidenceB Restrictions imposed by the clientC Reliance placed on the report of another auditorD Inadequacy in the accounting records

(h) A solicitor limits a response concerning a litigation claim because the solicitor isunable to determine the likelihood of an unfavourable outcome. Which type ofopinion should the auditor express if the litigation is adequately disclosed and therange of potential loss is material in relation to the client’s financial report consideredas a whole?A qualifiedB adverse

Ch 13 18/10/06 2:36 PM Page 634

C unqualified with an ‘emphasis of matter’D unqualified

(i) An auditor is confronted with an exception considered sufficiently material so as towarrant some deviation from the standard unqualified audit report. If the exceptionrelates to a departure from generally accepted accounting principles, the auditor mustdecide between expressing:A an adverse opinion and a qualified opinionB an adverse opinion and a disclaimer of opinionC a disclaimer of opinion and a qualified opinionD a qualified opinion and an unqualified opinion

13.3 Select the best response to the following independent situations.(a) An auditor concludes that there is substantial doubt about an entity’s ability to

continue as a going concern for a reasonable period of time. If the entity’s disclosuresconcerning this matter are adequate, the audit report may include:

Disclaimer Qualified of opinion opinion

A Yes No B No Yes C No NoD Yes Yes

(b) Under which of the following set of circumstances might an auditor disclaim anopinion?A There are significant uncertainties affecting the financial report.B There has been a material change between periods in the method of the

application of accounting principles.C The principal auditor decides to make reference to the report of another auditor

who disclaimed an opinion on the audit of a subsidiary. The subsidiarycontributed 6% of operating revenue and profit but very little in other aspects.

D The financial report contains a departure from generally accepted accountingprinciples, the effect of which is material.

(c) An auditor was unable to obtain an audited financial report or other evidencesupporting an entity’s investment in a foreign subsidiary considered material to thefinancial report. Between which of the following opinions should the entity’s auditorchoose?A Qualified and disclaimerB Qualified and adverseC Disclaimer and unqualified with an ‘emphasis of matter’D Adverse and unqualified with an ‘emphasis of matter’

(d) An auditor should normally disclose the substantive reasons for expressing an adverseopinion in an explanatory paragraph:A within the notes to the financial reportB following the opinion paragraphC preceding the paragraph determining responsibility of those charged with

governance for the annual reportD preceding the opinion paragraph

(e) An ‘emphasis of matter’ is:A information relating to the entity which requires a separate emphasis paragraph

but which is dealt with elsewhere in the financial report


Ch 13 18/10/06 2:36 PM Page 635

B information relating to the entity which requires emphasis in an audit opinionparagraph but which is dealt with elsewhere in the financial report

C information relating to the entity which requires emphasis in an audit opinionparagraph as it is not dealt with elsewhere in the financial report

D additional information in an audit opinion paragraph(f ) The auditor of Asia Business Opportunities Ltd determines that the accounting

treatment for a certain material item is not in conformity with accounting standards,although the departure is prominently disclosed in a footnote to the financial report.The auditor should issue:A an unqualified opinion because the departure from accounting standards was

disclosedB a qualified opinion because of the departure from accounting standardsC a disclaimer of opinionD express an unqualified opinion but insert a separate paragraph emphasising the

matter by reference to the footnote(g) Before providing an opinion on the financial report for the year ended 30 June 20X0,

the auditor must consider:A all matters relating to the client up to a point in time determined by the auditor as

reasonableB all matters relating to the client up to the date of the directors’ reportC all matters relating to the client up to the date of the audit reportD all matters relating to the client up to 30 June 20X0

(h) On 2 July 20X0 Pretty Paint Ltd received a notice from its primary suppliers that allwholesale prices would be increased by 10%, to be effective immediately. On the basisof the notice Pretty Paint Ltd revalued its 30 June 20X0 inventory to reflect the highercosts. The details of the adjustment were disclosed in the notes to the financial report.The inventory adjustment was material. The auditor of the 30 June 20X0 financialreport would issue:A an unqualified opinion with an ‘emphasis of matter’ of disclosureB a disclaimer of opinionC a qualified opinionD an unqualified opinion

(i) An audit report on comparative financial reports should be dated as of the date of the:A last subsequent event disclosed in the financial reportB latest financial report being reported onC completion of the auditor’s recent evidence collection proceduresD issuance of the report

(j) Due to time and staff restrictions the auditor was unable to attend the inventorystocktake at a remote branch location for Outback Ltd. The inventory at this siteaccounted for 30% of total assets. Alternative procedures were applied satisfactorily.The auditor should issue:A an unqualified opinionB an unqualified opinion with an ‘emphasis of matter’C a disclaimer of opinionD a qualified opinion


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Concept of ‘true and fair’

13.15 Basic You are the audit manager of a new client. Management of the new client hasprepared its accounts in accordance with generally accepted accounting principles but youbelieve that the overall view presented by this financial report is not true and fair.

RequiredOutline in a report to your partner the approach that should be taken in thesecircumstances.

Structure and qualitative characteristics of audit report

13.16 Moderate An audit report prepared for Buddy Plumbing for the year ended 30 June 2007is as follows:

Concept of ‘true and fair’

13.4 Are ‘gives a true and fair view’ and ‘presents fairly, in all material respects’ equivalent terms?13.5 What are the differences between the technical and the literal interpretations of true and

fair? Which view has been adopted in the Corporations Act 2001?

Structure and qualitative characteristics of audit report

13.6 Compare and contrast the advantages of standard form audit reports with a less structuredform of reporting by the auditor.

Types of audit opinions

13.7 Identify the three basic types of audit reports other than an unmodified opinion andexplain the circumstances in which each might be issued.

13.8 What are the five circumstances in which an unqualified opinion with an ‘emphasis ofmatter’ can be issued? How commonly are these circumstances observed to give rise tosuch an opinion in practice?

13.9 What differences have been observed in the proportion of modified opinions that havebeen issued for listed companies in Australia? Identify possible reasons for any changes.

Types of audit and standard reports

13.10 What are the basic reasons why the auditor may be unable to express an unqualifiedopinion?

13.11 What types of limitation of scope are there? What is the significance of the different types?

Auditor’s responsibility with ‘other information’ and reports

13.12 What are the auditor’s responsibilities for ‘other information’ in an annual report?

Communications other than audit report

13.13 What reporting communications could be expected between the auditor and the auditcommittee? To what extent would an auditor communicate with the board of directorswhen there is an effective audit committee?

13.14 What are the auditor’s responsibilities for reporting business risk factors and materialweaknesses in internal control?

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Audit ReportWe have audited the financial report of Buddy Plumbing for the year ended30 June 2007 as set out on pages 35 to 55. We have conducted an independentaudit of the financial report in order to express an opinion on it.

Our audit has been conducted to provide high assurance whether the financialreport is free of material misstatement. Our procedures included examination, ona test basis, of evidence supporting the amounts and other disclosures in thefinancial report, and the evaluation of accounting policies and significantaccounting estimates. These procedures have been undertaken to form anopinion whether, in all material respects, the financial report is presented fairly inaccordance with Accounting Standards and other mandatory professionalreporting requirements in Australia so as to present a view which is consistentwith our understanding of Buddy Plumbing’s financial position, the results of itsoperations# and its cash flows.

The audit opinion expressed in this report has been formed on the above basis.The financial report presents fairly in accordance with applicable Accounting

Standards and other mandatory professional reporting requirements in Australiathe financial position of Buddy Plumbing as at 30 June 2007 and the results of itsoperations and its cash flows for the year then ended.

Date Firm

Address Partner

RequiredIdentify five deficiencies in the audit report presented above.

13.17 Moderate Carey and Partners is a sole trader who provides plumbing services in regionalQueensland. They require an audit report and general purpose financial report in order tosatisfy the requirements of a bank lending agreement. During the audit you noted anumber of control weaknesses typical of small businesses, some of which had the potentialfor fraud. You discussed the problems with the manager of Carey and Partners, Peter Carey,who agreed to rectify many of the problems. Fortunately, substantive testing of Carey andPartners’ records provided sufficient appropriate evidence to support the balances anddisclosures contained in the financial report. You are now preparing the audit report forCarey and Partners and are unsure whether mention should be made of the controlweaknesses identified.

Required(a) Should mention be made in the audit report of the control weaknesses identified at

Carey and Partners? Provide reasons for your answer.(b) Draft an appropriate audit report for Carey and Partners. Note the audit report is a

report on a general purpose financial report requested by the owner of Carey andPartners and not a report prepared specifically at the request of the bank.

Different types of opinions

13.18 Basic The consolidated profit of Y Ltd and its subsidiaries for the year ended 30 June 20X0

is $490 000. During the audit of X Ltd, one of the subsidiaries, the auditor, CA, notices that

there is $5000 of intercompany profit in the inventory. The net profit of X Ltd for the year

ended 30 June 20X0 is $25 000. There was no adjustment on any of the entity’s financial

reports for this profit, and management refuses to allow any change in the reports.

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RequiredIndicate the opinions, with reasons, CA would issue on:

(a) X Ltd(b) Y Ltd and its subsidiaries

Source: CICA

13.19 Basic Lerna Corporation (whose financial year will end on 30 June 20X0) informs you on18 June 20X0 that it has a serious shortage of working capital because of heavy operatinglosses incurred since 1 April 20X0. Application has been made to a bank for a loan, and thebank’s loan officer has requested a financial report.

Indicate the type of report you would render under each of the following independentsets of circumstances. Give the reasons for your decision.(a) Lerna asks that you save time by auditing the financial report prepared by Lerna’s chief

accountant as of 31 March 20X0. The scope of your audit would not be limited byLerna in any way.

(b) Lerna asks that you conduct an audit as of 15 June 20X0. The scope of your auditwould not be limited by Lerna in any way.

(c) Lerna asks that you conduct an audit as of 15 June 20X0 and render a report by 16 July.To save time and reduce the cost of the audit, it is requested that your audit notinclude confirmation of accounts receivable or observation of the taking of inventory.

(d) Lerna asks that you prepare a financial report as of 15 June 20X0 from the booksand records of the company without audit. The report is to be submitted on plainpaper without your name being associated in any way with it. The reason Lerna asksyou to prepare the report is that you are familiar with the proper form for financialreports.

Source: AICPA adapted

13.20 Moderate The 30 June 20X0 audit of X Ltd (X) has now been completed. A number of

difficulties were experienced during the audit, including significant disagreements over

the valuation of X’s investment property holdings. The audit partner had suggested the

property value was overstated by $10 million, a figure which was twice the level of

materiality set for the audit. As a result of discussions with the audit committee, the CEO of

X agreed to revise the valuations downward by $8 million. All other issues were resolved to

the satisfaction of the audit partner, resulting in an overall misstatement of the accounts of

$2 million. The audit partner is now considering the effect of the misstatement on the audit

report.

RequiredDiscuss the effect of the misstatement on the audit report.

Reasons giving rise to qualifications

13.21 Basic One of your audit clients, Morris Pty Ltd, is having to prepare its accounts inaccordance with Australian Accounting Standards. During the audit, a number of concernshave been raised about the application of these standards. Many of these issues are smalland may not result in material misstatement, but when considered together the auditmanager believes the financial report will be materially misstated unless some adjustmentsare made. All of the issues have been discussed with the financial controller, but the auditmanager is unsure whether the financial controller has discussed the issues with the boardof directors. The audit manager is reluctant to issue a qualified audit opinion, and is unsurehow to resolve a number of the issues as this is the first engagement in which he has beenassigned full responsibility; he has asked the audit partner for guidance.



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RequiredAssume you are the audit partner. Advise the audit manager as to strategies he could use toassist in resolving the issues he has identified.

13.22 Moderate Hayes Ltd is a listed public company that manufactures highly sophisticatednavigation equipment for submarines, large ships and aircraft. The company has a 31 March20X0 year-end and the statutory financial report is due to be signed one week after thedirectors’ meeting on 5 June 20X0.

During the course of the audit you become aware that the government has reviewed itsbudget in an effort to reduce the growing deficit and as a result defence expenditure hassuffered major cuts.

One of the major projects to be scrapped as a result of these cuts is the planned 20X0upgrading of the navigation equipment for the current navy fleet. You are aware that thecompany’s 20X0 budget and projection of sales included a major subcontract to theDefence Department and RAN for this project.

The company has been experiencing cash flow difficulties and has recently applied fora significant increase to a borrowing facility that is already fully drawn. Management isadamant that the company will continue to be viable, and if necessary can resort tocutbacks in its future capital expenditure program and can seek additional off-balance-sheet financing and/or reschedule existing debt arrangements.

Required(a) Outline the reporting options open to an auditor when going concern issues arise.

Discuss the relevant circumstances under which each of these reporting optionsbecomes appropriate.

(b) Discuss the steps that you need to take to form a conclusion as to whether the goingconcern basis is appropriate in relation to Hayes Ltd. Your discussion should coverdetails of audit evidence to be obtained, where appropriate.

(c) Discuss the potential audit report options in relation to Hayes Ltd.

Source: This question was adapted from the Professional Year Programme of The Institute of CharteredAccountants—1996 Advanced Audit Module.

13.23 Moderate You are undertaking the audit of Harwell Ltd, a manufacturer and retailer ofplumbing fittings. As in the past the company has accounted for inventory on a last-in-first-out (LIFO) basis. In previous years the effect has not been material given the companyusage of a ‘just in time’ inventory management system. In the current year, however, thecompany has a large stockpile of inventory at year-end due to an unexpected cancellationof a major order en route to its destination. In order to cut freight costs, the companytemporarily stored the goods in Indonesia, hoping for an order from another South-EastAsian customer.

Unfortunately you were not told of this problem until after balance date and did notconduct a stocktake of the inventory. You have also been told some of the inventory hassince been shipped to a number of different customers to fill outstanding orders. Theavailable audit procedures have been unable to validate the existence of this inventory. Therelevant inventory is currently recorded at $2 000 000. Audit procedures have indicated thathad inventory been accounted for on a first-in-first-out (FIFO) basis it would have beenrecorded at $3 000 000. Materiality for the audit has been set at $1 000 000.

RequiredIndicate the most appropriate audit opinion for Harwell Ltd. Provide reasons for yourdecision.

13.24 Moderate You are currently involved in the 30 June 20X0 audit of Eastern Europe ImportsPty Ltd (E), a company incorporated in Australia to import products from EasternEuropean countries. A large portion (67%) of E’s assets, including warehouses and


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inventory, is located in Chechnia. In previous years an accountant in Chechnia hasinspected foreign warehouses and inventory on your behalf. Unfortunately, due to recenteconomic and social turmoil, you have been unable to obtain assistance from accountantsin Eastern Europe. In addition, you are unsure whether the company’s assets exist giventhat E has been unable to establish regular contact with its Chechnian office. The totalassets of E are $3 000 000, of which $2 000 000 is located in Chechnia; net assets are$1 000 000.

During discussions with the CEO of E you have been assured the company will be ableto continue as a going concern as the company is currently obtaining new suppliers, andthe company’s existing customers and creditors have expressed a desire to continue tradingwith E. Your audit procedures, however, have not revealed any firm commitments fromsuppliers, customers, creditors or financiers. Faced with this information, you believe thateither the financial statements should be prepared on a liquidation basis or significantdisclosures of E’s financial position should be made. The directors of E have agreed to makedisclosures indicating the extent of the problems they are facing. After reviewing theinformation you are satisfied the disclosures are adequate.

RequiredIndicate the most appropriate audit opinion for E. Provide reasons for your decision.

13.25 Moderate Consider each of the following independent and material situations. In eachcase, assume the client is a reporting entity and that a general purpose financial report hasbeen prepared and audited:(i) Part of Water Limited’s operations are in South America. Recent changes of

government have made it impossible for you to verify the key accounts of inventory,fixed assets and cash and the related income statement balances.

(ii) River Pty Ltd is a large proprietary company that your firm has audited for the last fiveyears. The directors refuse to include a cash flow statement in the financial report,stating that it is far too time consuming to obtain the necessary information, and thatthey do not believe a cash flow statement is necessary for a true and fair view.

(iii) Wave Limited’s annual report includes a detailed graph showing sales and profitfigures for the last 10 years. However, there are some inconsistencies between thegraph and the figures in the audited financial report. Management does not want tochange the graph because it would involve increased printing costs.

(iv) The management of Stream Limited has refused to disclose a few director-relatedtransactions on the grounds of commercial confidentiality. The Financial Controllerreminds you that no other errors have been found in the financial report and statesthat the transactions are immaterial and therefore irrelevant to the users of thefinancial report.

RequiredDetermine the type of audit report to be issued in each of the above situations, and givereasons for your answer.

Source: This question was adapted from the Professional Year Programme of The Institute of CharteredAccountants in Australia—1995 Accounting 2 Module.

13.26 Moderate For each of the following independent situations, indicate the reason for andthe type of audit report that you would issue. Assume that each item is significant.(a) Upon review of the recent history of the lives of their specialised automobiles, Toyota

Ltd changed the service lives for depreciation purposes on their autos from five yearsto three years. This change resulted in a material amount of additional depreciationexpense.

(b) During the 2007 audit of Chrysler Ltd, you found that a material amount of inventoryhad been excluded from the inventory amount shown in the 2006 financial


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statements. After discussing this problem with management, you become convincedthat it was an unintentional oversight.

(c) Holden Ltd is suing your client for royalties over patent infringement. Your client’soutside legal counsel assures you that Holden’s case is without merit.

(d) In previous years, your client, Ford Ltd, has consolidated its Zimbabwean subsidiary.Because of restrictions on repatriation of earnings placed on all foreign-ownedcorporations in Zimbabwe, Ford Ltd has decided to account for the subsidiary on theequity basis in the current year.

(e) Mercedes Ltd’s financial condition has been deteriorating for the last five years. Mostof their problems result from loans made to real estate developers in the Sydney area.Your review of the loan portfolio indicates that there should be a major increase in theloan-loss reserve. Based on your calculations, the proposed write-down of the loanswill put Mercedes into violation of the state’s capital requirements.

13.27 Moderate Consider each of the following independent and material circumstances:(a) Ling Ltd, a reporting entity, uses the LIFO basis in respect of valuation of closing

inventories, which is one of the most significant balance sheet accounts. Thedifference between FIFO and LIFO valuation has a material effect on the closinginventory balance.

(b) During the review of the final copy of Ablett Ltd’s annual report prior to signing theaudit report you identify the following information in the non-statutory Chairman’sReport:

The large increase in the profits of the company is attributable to increasedmarket share based on our successful marketing strategy, expansion ofoperations and product range. The increased profitability is expected to continuewith the signing of a $5 million contract on 31 March, for the purchase of a newplant facility in Brisbane.

Information in the statutory financial report is as follows:Net profit before tax: 2000, $3 500 000; 2001, $2 400 000Capital commitment for plant and equipment of $150 000 as at 31 March 20X1.

(c) King Ltd is a holding company with a number of wholly owned subsidiaries. One ofthese subsidiaries is a self-sustaining foreign subsidiary, FX Ltd, with manufacturingand distribution facilities throughout South-East Asia. The group financial report ofKing and its subsidiaries consists of the consolidated financial report of King and itssubsidiaries, excluding the financial report of FX, which is attached separately. Theconsolidated financial report includes a note stating that the directors believe that itis misleading to consolidate FX as its operations are very diverse from the rest of thegroup and carried out under substantially different conditions. The note includesdetails of intercompany balances and transactions.

(d) The audit of the statutory records of Mooney Ltd, a reporting entity, revealed thefollowing problems:• failure to update members’ register for changes in shareholders• failure to obtain written consent from directors to act• directors’ minutes not prepared in respect of current year• failure to hold the AGM in respect of the previous financial year.The company made no comment in respect of the failure to keep properly updatedstatutory registers or to hold the AGM.

RequiredDiscuss in relation to each of these circumstances the audit issues to be considered and


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their likely impact on the audit opinion to be issued. Justify your answers with reference tothe Australian auditing standards and the Corporations Act 2001, as appropriate.

Source: This question was adapted from the Professional Year Programme of The Institute of CharteredAccountants in Australia—1996 Advanced Audit Module.

13.28 Complex The following are independent situations relating to the year ended 30 June2008. Assume all entities are reporting entities and that all situations are material.(i) The depreciation rates used by Langer Ltd have not changed for the past three years.

Given recent technological changes in the industry in which Langer operates, you areconvinced the useful lives of Langer’s assets need to be adjusted downwards. Thedirectors refuse to make this change despite the fact that you have explained thisplaces them in breach of impairment tests contained in approved accountingstandards.

(ii) You are finalising the audit of Jones Limited, a large proprietary company whichexports grains and cereals to most regions of the world. Subsequent to balance date,regional tensions in the Middle East saw orders plummet by over 40 per cent. The fallin profit placed Jones in breach of the conditions of its bank loan. Not wishing to risklosing its money, the bank placed a freeze on Jones’ bank account and other assets,rendering Jones Ltd unable to trade. These circumstances are adequately disclosed ina note to the accounts.

(iii) The audit of Waugh Limited was extremely difficult this year as the client did not keepappropriate books and records. The accounting department was chronicallyunderstaffed, so transactions were not promptly entered and reconciliations notperformed. A temporary accountant was employed to help sort out the mess but wasunable even to reconcile the bank account at year-end. You are not satisfied that alltransactions that occurred during the year are reflected in the financial report.

(iv) You have received the draft annual report from Hayden Club Limited. On reading the‘Year in Review’ you note the club chairman states that revenues increased by 150%.On checking the accuracy of this information you note that revenues have actuallyfallen by 10%. The club refuses to change anything in the annual report for fear ofmissing printing deadlines.

Required(a) For each situation (i) to (iv) above, describe the additional audit procedures you would

perform prior to issuing your audit report.(b) Assuming the matters remain unresolved, discuss the audit opinion you intend to

issue for each of the above entities for the year ended 30 June 2008.


13.29 Complex You are an audit manager for REW Chartered Accountants and are currentlyfinalising your 30 June 20X0 audits.

Company ACompany A is a listed company with three subsidiaries, Company B, Company C andCompany D. Another firm (RST Chartered Accountants) act as the auditors of Company Dand have qualified their audit report on the basis that continued financial support fromCompany A is required for Company D to continue as a going concern.

In auditing Company A and the economic entity, you are satisfied that the goingconcern basis of preparing the financial report is appropriate. In addition, you are satisfiedthat the carrying value in Company A’s financial report of the investment in Company D of$200 is not stated above its recoverable amount. The company and the economic entitymade profits for the year.


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Company HThe audit of Company H was extremely difficult as the client did not maintain appropriatebooks and records during the year. Although the statutory registers were maintained, theaccounting records were not updated for the first 9 months of the year as the company waswithout an accountant during this period. An accountant was employed in April 20X0 andshe tried to reconstruct records from the details of receipts and payments available. Theaccountant has been unable to reconcile the bank account and you are not satisfied that alltransactions which occurred during the year are reflected in the financial report. Theoperating loss recorded by Company H in the current year is $22 190.

Company GCompany G, a property developer, holds freehold property purchased for development andresale which is classified as inventories. This property, as disclosed in the financial report atNote 10, has been valued at cost, which is $5 000 000. In your audit you found that in thecurrent market the net realisable value of the property is $3 500 000. Although material, theclient does not consider that the value of the property should be written down as futuredevelopment will result in the property being worth more than the current book value. Thewrite-down would have no tax effect. The financial report audited, including the Directors’Declaration, spans pages 5 to 38. The company made a profit for the year. Company G hasother assets of $25 000 000 and liabilities of $7 000 000.

RequiredDiscuss the type of audit opinion that you intend to issue for each of the above companiesfor the year ending 30 June 20X0.


Auditor’s responsibility with regard to other information and reports

13.30 Moderate The audit of the financial report of Neot Limited has now been completed andthe client is preparing the annual report. You have been given a first draft of the annualreport for review and have reviewed the financial report and are satisfied they areconsistent with the audited information. You are now reviewing the preliminaryinformation contained in the audit report. Within the chairperson’s address you note thefollowing statement:

The directors are of the opinion that the economic conditions currently facing NeotLimited will soon abate, and closure of additional manufacturing facilities will beunnecessary.

You are quite surprised, as your discussions with management have indicated that closureof two further factories is imminent. In addition, the financial report includes a largeprovision for redundancies together with disclosure of the nature of the item. You approachthe CEO with your concerns. The CEO replies: ‘Don’t worry, it’s only a first draft, and anywaythe auditors don’t report on that.’

Required(a) Discuss the auditor’s responsibility for information accompanying a financial report.(b) Assuming the chairperson’s address is not amended, identify the most appropriate

course of action for the auditor.

Communications other than audit report

13.31 Basic You are the audit partner of Josh Ltd, a listed company that specialises in the

manufacture and retail of shopping trolleys. At the end of the audit you issue an

unmodified opinion. The past three months have been busy and you would like to take a




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13.33 Complex This is a continuation of question 12.32. It may, however, be completedindependently.

Mitchell Pty Ltd (Mitchell) is a small manufacturer of chemical products. During thereview of subsequent events at Mitchell the auditors noted a large chemical spill whichoccurred at the company’s Victorian shipping point. To date, the client has been unable toestimate the total financial effect on the company or determine whether Mitchell will beconsidered the responsible party. Previous experiences with chemical spills suggest thefinancial effect can be significant and it may take some months to determine the totalimpact, given the possibility of fines and action by other parties occupying the harbour.

Discussions with the directors of Mitchell regarding disclosure of the spill in thefinancial report have been productive; however, the directors have refused to specificallyindicate that the spill may have the potential to bankrupt the company. The disclosurewhich has been agreed to date is as follows:

Note 20.During the financial year a vessel carrying chemicals used to supply Mitchell Pty Ltdwas involved in a spillage incident in southeastern Victoria while unloadingchemicals. The directors are unable to estimate the financial effect of this spillage onthe company at this time; however, we are of the opinion it is likely to be significant.

While the audit partner is satisfied this adequately discloses the nature of the incident,she believes the disclosure is not sufficient to alert users to the possibility of liquidation andhas suggested the following amendment:

holiday with your family, but you find that Josh Ltd’s annual general meeting will be held

during this time. You argue that you need not attend given that there are fewer than 10

shareholders who attend the AGM, no questions have been asked of the auditor in the past

and an unqualified audit report has been issued.

RequiredAre you, as audit partner, required to attend the AGM?

13.32 Moderate You are the audit manager assigned to the 31 December 20X0 audit of a newclient, Q Pty Ltd (Q), an importer of pharmaceutical products. In order to hedge its foreigncurrency transactions, Q entered into a number of forward rate agreements in March 20X0.Prior to this time Q had had little exposure to derivative instruments, but a series of badexperiences resulting from the Asian economic crisis has convinced the company that ahedging strategy was necessary. During planning for the audit of Q, the company’s hedgingarrangements were identified as inherently risky and a thorough review of controls wasrequested.

The audit of Q has now been completed. A number of small errors were noted inaccounting for hedge transactions, but there did not appear to be any material errors andas such no adjustments were made. A review of the audit file suggests that the errors notedwere a result of inexperience and poor controls in the area. While all of the errors werebrought to the attention of the treasurer, who is responsible for the company’s hedgingstrategy, no further action has been taken to date.

RequiredIdentify and discuss any further action which the audit manager and/or partner shouldtake in response to the errors and control weaknesses identified.

C O N T I N U O U S C A S E S T U D I E S

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In the event the financial effect of the spillage exceeds the net assets of the companythe company will be unable to continue as a going concern.

The directors have refused to make this amendment and the audit partner isconsidering qualifying the audit opinion.

RequiredDo you believe a qualification is necessary? If so, indicate the type of opinion which shouldbe included in the audit report of Mitchell Pty Ltd. Provide reasons for your decision.

13.34 Complex This is a continuation of question 12.33. It may, however, be completedindependently of that question.

The audit of HomeChef Pty Ltd is now complete and the audit report is being prepared.As part of completion procedures the audit manager has performed a final review of the fileto ensure all matters arising during the audit are noted for communication to the client.During this review the manager has noted the following matters:(i) A number of control deficiencies were noted in the purchases and payments area.

Internal audit is aware of these deficiencies and has recommended appropriateprocedures.

(ii) There were a number of immaterial errors made in recording fixed asset additions anddisposals. This appears to be a result of inexperience and a lack of supervision of anew fixed asset clerk.

(iii) The company’s stocktaking procedures were not followed in all stores. This appearedto be a result of a lack of understanding of procedures on the part of store managersand inappropriate planning and correspondence from head office.

In each of the above cases the audit team was able to obtain sufficient appropriateaudit evidence to ensure the financial report was not materially misstated.

RequiredFor each of the above matters, indicate the most appropriate means of communicationwith the client. Where you believe communication should be documented, draft one or twoparagraphs appropriate for inclusion in your correspondence with management.


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The Auditorâ€™s Reporting Obligations - Landing

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