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AUDITING
Week 5
7.11 Outline the contents of a general purpose financial report.
The disclosure and presentation requirements for such reports are generally determined by
accounting standards and statutory and other requirements. The Corporations Act 2001
outlines the contents of a financial report (s. 295), including:

the financial statements for the year required by accounting standards such as AASB
101, including:
an income statement (in Australian accounting standards, this is also known as a
statement of comprehensive income)
a balance sheet (known in Australian accounting standards as a statement of
financial position)
a cash flow statement (called a statement of cash flows in Australian accounting
standards)
a statement of changes in equity

notes to the financial statements, including:

disclosures required by regulations
notes required by accounting standards
any other information necessary to give a true and fair view (see s. 297)

the directors declaration that:

the financial statements and notes comply with accounting standards
the financial statements and notes give a true and fair view
in the directors opinion, there are reasonable grounds to believe that the company
will be able to pay its debts as and when they become due and payable
in the directors opinion, the financial statements and notes are in accordance with
the law.

7.12 What are the contents of an unmodified auditors report? Explain

each section.
The basic elements of an unqualified audit report are briefly summarised below:
Title. This identifies the audit report and distinguishes it from other reports issued by
management. The title includes the word independent to indicate the nature of the
audit.
Addressee. The report is normally addressed to those who requested the audit and
were ultimately responsible for the auditors appointment (for example, the
shareholders of a company or the members of a superannuation fund).
Scope. This identifies the financial report audited, the name of the entity and the
reporting period covered. It also restates the responsibilities of the governing body
(usually represented by the directors) and the auditor. In essence, it describes the
nature of the audit, stating that it was conducted in accordance with auditing
standards.

Audit opinion: An opinion is expressed that the financial statements are presented in
accordance with the Corporations Act 2001, giving a true and fair view and
complying with the Accounting Standards and the Corporations Regulations 2001.
Signature. The report is signed by the audit firm or the individual audit partner, as
appropriate.
Auditors address. A specific location where the auditor maintains an office.
Date the audit report is signed. The audit report is dated after the governing body has
signed the financial statements. This date is important because the auditor has
responsibility for subsequent events up to this date.
Note that an unqualified report may be modified by an emphasis of matter
statement by the auditor.
Also, the auditor makes an independence declaration in respect of the requirements of
the Corporations Act 2001 and any applicable code of professional conduct in relation
to the audit.

7.13 What are the different types of modified audit opinions? Explain
each type.
A modified auditors report is issued when the auditor concludes that, based on the audit
evidence obtained, the financial report as a whole is not free from material misstatement, or,
the auditor is unable to obtain sufficient appropriate audit evidence to conclude that the
financial report as a whole is free from material misstatement. Material misstatements may be
the result of a number of factors, including an inappropriate selection or application of
accounting policies that are required by the applicable financial reporting framework, or
inadequate disclosures of matters that are required or disagreement with management relating
to the financial statements ot conflict between applicable financial reporting frameworks.
Guidance is given in ASA 705 Modifications to the Opinion in the Independent
Auditors Report. When an audit report is other than unqualified, it is either qualified, a
disclaimer or an adverse opinion, as described in ASA 705.
Type of audit opinions:
Qualified opinion is expressed when the auditor, having obtained sufficient
appropriate audit evidence, concludes that misstatements, individually or in the
aggregate, are material, but not pervasive, to the financial report; or the auditor is
unable to obtain sufficient appropriate audit evidence on which to base the opinion,
but the possible effects on the financial report of undetected misstatements, if any,
could be material but not pervasive.

Adverse opinion is expressed when the auditor, having obtained sufficient appropriate
audit evidence, concludes that misstatements, individually or in the aggregate, are
both material and pervasive to the financial report.

Disclaimer of opinion is expressed when the auditor is unable to obtain sufficient

appropriate audit evidence on which to base the opinion, and the auditor concludes
that the possible effects on the financial report of undetected misstatements, if any,
could be both material or pervasive. In extreme cases, the auditor may conclude that,
even after having obtained sufficient appropriate audit evidence, it is not possible to
form an opinion on the financial report due to the potential interaction of multiple
uncertainties and their possible cumulative effect on the financial report.

7.14 Under what circumstances may the auditor decide to include an

emphasis of matter section in the auditors report?
The purpose of an emphasis of matter section is to draw the attention of users of the
auditors report to relevant information. Circumstances in which an emphasis of matter may
be necessary are:
An uncertainty relating to the future outcome of an exceptional litigation, or
regulatory action
An early application, where permitted, of a new accounting standard that has a
pervasive effect on the financial report in advance of its effective date
A major catastrophe that has had or continues to have, a significant effect on the
entitys financial position
7.15 What is the difference between an unmodified auditors opinion and
a modified auditors opinion?
An unmodified auditors opinion is an unqualified report which states that the financial report
present fairly, in all material respects, in accordance with the applicable financial reporting
framework; or the financial report gives a true and fair view of the financial position and the
results of operations and cash flows of the entity in accordance with the applicable financial
reporting framework. An audit report may have an unmodified opinion but include an
emphasis of matter or other matter paragraph.
A modified audit opinion encompasses other than unqualified audit reports that include
opinions in relation to material or pervasive limitations of scope or disagreements, these
opinions would be qualified, disclaimer or adverse as appropriate
7.17 What does each of the modified types of auditors opinions mean to
users wanting to rely on the financial report?
Qualified Opinion
The auditor shall express a qualified opinion when:
(a) The auditor, having obtained sufficient appropriate audit evidence, concludes that
misstatements, individually or in the aggregate, are material, but not pervasive, to the
financial report; or
(b) The auditor is unable to obtain sufficient appropriate audit evidence on which to base
the opinion, but the auditor concludes that the possible effects on the financial report
of undetected misstatements, if any, could be material but not pervasive.
Adverse Opinion
The auditor shall express an adverse opinion when the auditor, having obtained sufficient
appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are
both material and pervasive to the financial report.

Disclaimer of Opinion
(a) The auditor shall disclaim an opinion when the auditor is unable to obtain sufficient
appropriate audit evidence on which to base the opinion, and the auditor concludes

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that the possible effects on the financial report of undetected misstatements, if any,
could be both material and pervasive.
(b) The auditor shall disclaim an opinion when, in extremely rare circumstances involving
multiple uncertainties, the auditor concludes that, notwithstanding having obtained
sufficient appropriate audit evidence regarding each of the individual uncertainties, it
is not possible to form an opinion on the financial report due to the potential
interaction of the uncertainties and their possible cumulative effect on the financial
report.
When the auditor modifies the opinion on the financial report, the auditor shall, in addition to
the specific elements required by ASA 700, include a paragraph in the auditors report that
provides a description of the matter giving rise to the modification. The auditor shall place
this paragraph immediately before the opinion paragraph in the auditors report and use the
heading Basis for Qualified Opinion, Basis for Adverse Opinion, or Basis for
Disclaimer of Opinion, as appropriate. Auditor should include a clear description of all the
substantive reasons and unless impracticable, a quantification of the possible effect(s) on the
financial report.
If it is not practicable to quantify the financial effects, the auditor shall so state in the basis for
modification paragraph.
7.18 What circumstances may give rise to an adverse opinion and a
disclaimer of opinion?
Circumstances that give rise to an adverse opinion:

Disagreement with those charged with governance. The auditor may disagree
with the directors and/or management over the following matters:
appropriateness of accounting policies selected
method of application of accounting policies selected
adequacy of certain disclosures in the financial statements
compliance of the financial statements with relevant statutory and other
requirements.

Audit report
Material but not extreme: qualified
Extreme cases: adverse.

Conflict between applicable financial reporting frameworks. Application of

accounting policies in compliance with statutory and other requirements may not result in
fair presentation in accordance with accounting standards .

Audit report
Material but not extreme: qualified
Extreme cases: adverse.
Circumstances that give rise to disclaimer of opinion:
Scope limitation. When the auditor cannot perform the necessary procedures or the
procedures do not provide sufficient evidence, the auditor is said to have a scope
limitation.

Audit report
Material but not extreme: qualified
Extreme cases: disclaimer.

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7.19 When an auditor is faced with a disagreement, what factors should
be considered to determine whether a qualified or an adverse
opinion is appropriate?
A qualified opinion is expressed when the auditor, having obtained sufficient appropriate
audit evidence, concludes that misstatements, individually or in aggregate, are material, but
not pervasive, to the financial report; or the auditor is unable to obtain sufficient appropriate
evidence on which to base the opinion, but the possible effects on the financial report of
undetected misstatements, if any, could be material but not pervasive.
An adverse opinion is appropriate when, the auditor, having obtained sufficient appropriate
audit evidence, concludes that misstatements, individually or in the aggregate, are both
material and pervasive to the financial report.
7.20 What might constitute Other matters on which an auditor may be
required to report?
The circumstances in which an other matter paragraph may be necessary include:

Where the auditor is unable to withdraw from an engagement even though the
possible effect of an inability to obtain sufficient appropriate audit evidence, due to a
limitation on the scope of the audit as imposed by management, is pervasive. The
auditor would include another matter paragraph to explain why it is not possible to
withdraw from t he engagement.

The auditor is permitted to elaborate on matters that provide further

explanation of the auditors responsibilities or the auditors report, such as those that are
required by law, or regulation; or such other matters that the auditor has been asked to
perform and report on or express an opinion on, but are in addition to the auditors
responsibility under the Australian auditing standards.
7.21 Effect of circumstances on audit opinion
Assume you are an auditor and you are facing the following separate circumstances, the
effects of all the items below are material:
1. The provision for stock is inadequate.
2. A retailer values inventory at sales price less an allowance for sales margin.
3. A manufacturing company is currently negotiating with the bank an extension of a
loan facility that is due for repayment shortly after the AGM; without this refinancing
the business will not be able to continue operations.
4. A significant proportion of a retailers sales are on a cash basis and inadequate records
have been maintained; there are no audit tests that can be done to satisfy yourself that
the cash sales are accurate.
5. Management have excluded from the financial report the necessary disclosures in
relation to a contingent liability.
6. The company that runs a dairy farm has prepared the financial report on a going
concern basis; shortly after the year end the companys contract with a major
supermarket was cancelled. Without this customer you expect the business to cease
trading within six months and it is unlikely that the company will be able to secure
any new contracts in that time.
7. The directors of a construction company refuse to give you access to reports produced

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by an independent quantity surveyor in relation to the value of work done on some of
their construction projects.
8. A wholesaler has a policy of including all of its buildings in the balance sheet at cost
less depreciation. You establish that one of the warehouses included in the balance
sheet at a value of $20m has an actual market value of $23m.
Required
Indicate the effect of the above circumstances on your auditors report if
management were to refuse to make any changes you feel necessary in
order that the financial report gives a true and fair view.
1.
2.
3.

4.
5.
6.

7.
8.

This is a disagreement with management. The audit report would be qualified if the
issue is material but not extreme, or an adverse opinion in extreme cases.
This is an acceptable method of valuing inventory at cost and therefore an unmodified
opinion can be given.
If the matter of loan negotiations is not adequately disclosed, then this constitutes a
disagreement with management, and the report would be qualified or an adverse
opinion, depending on the circumstances. If the matter of the loan negotiations is
adequately disclosed, an emphasis of a matter is added.
This is a scope limitation. The audit report would be qualified or a disclaimer,
depending on the circumstances.
This is a disagreement with management and a qualified opinion is necessary, refer to
1 above.
It appears that it is highly likely that the business will not continue to trade and
therefore the financial report should not be prepared on a going concern basis; some
alternative such as a break-up basis would be appropriate. This gives rise to an
adverse audit opinion.
This is a scope limitation. Refer answer 4 above.
The policy is to include buildings at cost less depreciation and therefore the accounts
do not need to be changed to include the market value of the property. An unmodified
opinion is appropriate.

7.24 Going-concern issues, audit opinion

Temper Telecommunications Ltd is listed public company that manufactures communication
equipment. Last year the company engaged itself in a contract involving the engineering and
infrastructures for a highly complex broadband network in Adelaide. The company has a 30
June year-end, and the statutory accounts are due to be signed one week after the board of
directors meeting on 5 August 22011. During the course of the audit, you become aware that
due to the complex negotiations with the Australian Government on broadband networks, and
the likely change in government policies, the company was advised that the plan for the
broadband network engineering project may be suspended until further notice. Temper
Telecommunications had bought sophisticated equipment which was to be paid off through
the life of the project over 3 years. It also commenced the architectural planning, employing
two highly paid experts in broadband architecture. Temper Telecommunications is now
experiencing growing cash flow difficulties (the project was meant to be able to save its
business).It has recently applied for a significant increase to a borrowing facility that is
already fully drawn. Management is adamant that the company will continue to be viable. If
necessary, it claims it can resort to cutbacks in its other future capital expenditure program,
seek additional off-balance-sheet financing and/or reschedule existing debt arrangements.

Explain the concept of going concern. Discuss the reporting options open to an auditor
when going concern issues arise.
The going-concern concept means that it is assumed that the entity will realise its assets and
extinguish its liabilities in the normal course of business.
The auditors reporting options are:
Going concern basis considered appropriate
Auditor should issue an unmodified audit report.
Significant uncertainty about going concern
If the uncertainty is adequately disclosed in the financial statements, the audit report
should be qualified in accordance with ASA 700 (ISA 700).
If the financial statements do not adequately disclose the significant uncertainty, a
disclaimer of opinion should be expressed on the basis of a lack of disclosure in
accordance with ASA 700 (ISA 700).
Going-concern basis considered inappropriate
If the auditor is satisfied that it is highly improbable that the entity will continue as a
going concern for the relevant period, an adverse opinion should be expressed in
accordance with ASA 700 (ISA 700).
Discuss the potential auditor's report options in relation to Temper Telecommunications
Lid.
There are a number of matters that indicate potential going-concern reporting issues for
Temper Telecommunications Ltd (TT). These include:
Due to the complex negotiations with the Australian Government on broadband networks,
and the likely change in government policies, TT was advised that the plan for broadband
network engineering project may be suspended until further notice.
TT has been experiencing cash flow difficulties and the project was meant to be able to
save its business.
TTs borrowing facility is already fully drawn.
The auditor would need to perform a number of procedures to evaluate the appropriateness of
the going-concern basis.
In this case all of the above should be disclosed in a note to the accounts. If the auditor is
satisfied with the disclosure, he or she may issue an unqualified audit report with an
emphasis of matter paragraph. However, if the auditor is unsatisfied as to the ability of the
entity to continue as a going concern (which is difficult to tell from the information given in
this case), he or she should issue an adverse audit opinion.