Scope and objectives
The auditing standards that are being summarized here deals with the auditor’s responsibility to issue an appropriate report when the auditor concludes that a modification to the auditor’s opinion on the financial statements is necessary. In other words, this SA provides guidance on how an auditor should modify their report when they encounter significant issues or errors in the financial statements that require a modification to the opinion.
The SA 705 establishes three types of modified opinions: qualified opinion, adverse opinion, and disclaimer of opinion. A qualified opinion is issued when the financial statements are materially misstated, but the misstatement is not pervasive, which means it is confined to specific elements, accounts, or items of the financial statements and does not affect the financial statements as a whole. An adverse opinion is issued when the financial statements are materially misstated, and the misstatement is pervasive, which means it affects the financial statements as a whole. A disclaimer of opinion is issued when the auditor is unable to obtain sufficient appropriate audit evidence to form an opinion on the financial statements.
The decision on which type of modified opinion to issue depends on two factors: the nature of the matter giving rise to the modification and the auditor’s judgment about the pervasiveness of the effects or possible effects of the matter on the financial statements. The table in the SA705 helps illustrate how the auditor’s judgment about these factors affects the type of opinion to be expressed.
This SA 705 is effective for audits of financial statements for periods beginning on or after April 1, 2018. The objective of the auditor is to express clearly an appropriately modified opinion on the financial statements that is necessary when the financial statements are not free from material misstatement, or the auditor is unable to obtain sufficient appropriate audit evidence.
Finally, the SA 705 provides definitions for the terms “pervasive” and “modified opinion.” Pervasive effects on the financial statements are those that, in the auditor’s judgment, are not confined to specific elements, accounts, or items of the financial statements, represent or could represent a substantial proportion of the financial statements if so confined, or in relation to disclosures, are fundamental to users’ understanding of the financial statements. Modified opinion refers to a qualified opinion, an adverse opinion, or a disclaimer of opinion on the financial statements.
Circumstances When a Modification to the Auditor’s Opinion is Required
The auditor must modify the opinion in the auditor’s report if they conclude that, based on the audit evidence obtained, the financial statements as a whole are not free from material misstatement. In this case, the auditor should evaluate uncorrected misstatements on the financial statements in accordance with SA 450 to form an opinion on the financial statements.
SA 450 defines a misstatement as a difference between the amount, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure required for the item to be in accordance with the applicable financial reporting framework.
Material misstatements of the financial statements may arise in relation to the appropriateness of the selected accounting policies, the application of the selected accounting policies, or the appropriateness or adequacy of disclosures in the financial statements.
The inability to obtain sufficient appropriate audit evidence may arise from circumstances beyond the control of the entity, circumstances relating to the nature or timing of the auditor’s work, or limitations imposed by management. Inability to perform a specific procedure does not constitute a limitation on the scope of the audit if the auditor can obtain sufficient appropriate audit evidence by performing alternative procedures. However, limitations imposed by management may have other implications for the audit, such as for the auditor’s assessment of fraud risks and consideration of engagement continuance.
Examples of circumstances beyond the control of the entity include when the entity’s accounting records have been destroyed, or the accounting records of a significant component have been seized indefinitely by governmental authorities. Examples of circumstances relating to the nature or timing of the auditor’s work include when the auditor is unable to observe the counting of the physical inventories or when the auditor determines that performing substantive procedures alone is not sufficient, but the entity’s controls are not effective. Examples of limitations on the scope of the audit imposed by management include when management prevents the auditor from observing the counting of the physical inventory or requesting external confirmation of specific account balances.
Determining the Type of Modification to the Auditor’s Opinion
The different types of modifications that can be made to an auditor’s opinion when conducting an audit of an entity’s financial statements. These modifications are based on the level of materiality and pervasiveness of misstatements identified during the audit, as well as the level of appropriate audit evidence obtained.
If the auditor determines that misstatements in the financial statements are material but not pervasive, a qualified opinion is issued. If the misstatements are both material and pervasive, an adverse opinion is issued. If the auditor is unable to obtain sufficient appropriate audit evidence, a disclaimer of opinion is issued.
If the auditor becomes aware of a limitation on the scope of the audit imposed by management that may result in the need to modify the opinion, the auditor requests that management remove the limitation. If management refuses to remove the limitation, the auditor communicates the matter to those charged with governance and determines whether it is possible to perform alternative procedures to obtain sufficient appropriate audit evidence. If the auditor is unable to obtain sufficient appropriate audit evidence, the auditor may withdraw from the audit or issue a disclaimer of opinion, depending on the circumstances.
If the auditor withdraws from the audit due to a scope limitation, any matters regarding misstatements identified during the audit that would have given rise to a modification of the opinion must be communicated to those charged with governance. Additionally, there may be professional, legal or regulatory requirements for the auditor to communicate matters relating to the withdrawal from the engagement to regulators or the entity’s owners.
Other Considerations Relating to an Adverse Opinion
The auditor when expressing an adverse opinion or disclaimer of opinion on the financial statements as a whole. If the auditor decides to express an adverse opinion or disclaimer of opinion on the financial statements, the auditor’s report cannot include an unmodified opinion with respect to the same financial reporting framework on a single financial statement or one or more specific elements, accounts, or items of a financial statement. This is because including an unmodified opinion in the same report would contradict the auditor’s adverse opinion or disclaimer of opinion on the financial statements as a whole.
However, there are some exceptions where the auditor can express an unmodified opinion on financial statements prepared under a different financial reporting framework. Additionally, the auditor can express a disclaimer of opinion regarding the results of operations and cash flows, where relevant, and an unmodified opinion regarding the financial position. In this case, the auditor has not expressed a disclaimer of opinion on the financial statements as a whole.
Form and Content of the Auditor’s Report When the Opinion is Modified
The form and content requirements for an auditor’s report when their opinion has been modified. When an auditor modifies their opinion, they must use the appropriate heading for the opinion section of the report. The three possible headings are “Qualified Opinion,” “Adverse Opinion,” or “Disclaimer of Opinion,” depending on the circumstances.
The auditor’s reports with modified opinions in the certain objectives to help auditors understand how to apply these headings. The examples include reports with qualified and adverse opinions due to material misstatements in the financial statements. They also include a qualified opinion where the auditor was unable to obtain sufficient appropriate audit evidence, and disclaimers of opinion due to an inability to obtain sufficient appropriate audit evidence about a single element or multiple elements of the financial statements.
The effects of the inability to obtain sufficient appropriate audit evidence are both material and pervasive, meaning that they have a significant impact on the financial statements as a whole. The illustrations in the appendix provide a visual representation of how an auditor’s report should look when their opinion is modified, helping auditors to comply with the reporting requirements of auditing standards.
Finally, it including SA 570 (Revised), also include similar illustrations of auditor’s reports with modified opinions. This means that auditors can refer to those standards to find additional guidance on how to report when their opinion is modified.
Auditor’s Opinion
The requirements for an auditor’s opinion in an audit report, which is a formal statement of the auditor’s opinion on the financial statements of an entity. The text provides guidance on how an auditor should modify their opinion in the case of a qualified opinion, adverse opinion, or disclaimer of opinion.
A qualified opinion is issued when the auditor identifies a material misstatement in the financial statements but concludes that the overall financial statements are still fairly presented or comply with the applicable financial reporting framework, except for the effects of the matter(s) described in the Basis for Qualified Opinion section. The auditor must clearly state the nature of the modification and should not use phrases such as “with the foregoing explanation” or “subject to” in the Opinion section.
An adverse opinion is issued when the auditor concludes that the financial statements do not fairly present the financial position, results of operations, or cash flows of the entity, or do not comply with the applicable financial reporting framework. The auditor must clearly state the nature of the modification.
A disclaimer of opinion is issued when the auditor is unable to obtain sufficient appropriate audit evidence to form an opinion on the financial statements. In this case, the auditor must clearly state that no opinion is expressed and describe the reasons for the disclaimer of opinion. The auditor should also amend the statement required by SA 700 (Revised) to indicate that the financial statements were audited.
The Basis for Opinion section should include a description of the matter giving rise to the modification, including any material misstatements of the financial statements and the financial effects of those misstatements, unless it is impracticable to quantify the financial effects. If the misstatement relates to non-disclosure of required information, the auditor should discuss it with those charged with governance and, if practicable, include the omitted disclosures.
Consistency in the auditor’s report helps promote users’ understanding and identify unusual circumstances when they occur. Therefore, the auditor should aim for consistency in both the form and content of the report, even if uniformity in the wording of a modified opinion and in the description of the reasons for the modification may not be possible.
Considerations When the Auditor Disclaims an Opinion on the Financial Statements
The considerations that need to be taken into account when an auditor disclaims an opinion on the financial statements. If the auditor is unable to obtain sufficient appropriate audit evidence, they may disclaim an opinion, which means that they cannot express an opinion on the financial statements as a whole.
In such a situation, the auditor’s report should not include a Key Audit Matters section or an Other Information section, unless required by law or regulation. The auditor’s report should, however, provide the reasons for the disclaimer of opinion, which will help users of the financial statements understand why the auditor was unable to provide an opinion.
Including a Key Audit Matters section or an Other Information section would suggest that the financial statements are more credible in relation to those matters than is appropriate, which would be inconsistent with the disclaimer of opinion. Therefore, SA 705 prohibits the inclusion of such sections in the auditor’s report when an auditor disclaims an opinion on the financial statements, unless required by law or regulation.
Communication with Those Charged with Governance
The importance of communication between the auditor and those charged with governance (such as a company’s board of directors) when the auditor expects to modify their opinion in the audit report. The auditor is required to communicate the circumstances that led to the expected modification and the wording of the modification.
There are several reasons why this communication is important. First, it allows the auditor to give notice to those charged with governance of the intended modifications and the reasons for them. Second, it enables the auditor to seek the concurrence of those charged with governance regarding the facts of the matter(s) giving rise to the expected modifications or to confirm disagreements with management. Finally, it gives those charged with governance the opportunity to provide further information or explanations regarding the matter(s) giving rise to the expected modifications.
By communicating with those charged with governance, the auditor can ensure that all parties are on the same page regarding the expected modifications and can address any concerns or questions before the audit report is finalized.
Quiz: Modifications to the Opinion in the Independent Auditor’s Report
1. Which of the following is not a type of modified opinion that can be issued by an auditor?
a) Qualified opinion
b) Adverse opinion
c) Unmodified opinion
d) Disclaimer of opinion
Answer: c)
2. True or False: A qualified opinion is issued when the financial statements are materially misstated, but the misstatement is pervasive.
Answer: False
3. In which circumstances is an adverse opinion issued?
a) When the financial statements are materially misstated, and the misstatement is pervasive.
b) When the financial statements are materially misstated, but the misstatement is not pervasive.
c) When the auditor is unable to obtain sufficient appropriate audit evidence.
d) None of the above.
Answer: a)
4. True or False: A disclaimer of opinion is issued when the auditor is unable to obtain sufficient appropriate audit evidence to form an opinion on the financial statements.
Answer: True
5. What factors determine the type of modified opinion to be issued by the auditor?
a) The auditor’s judgment about the pervasiveness of the effects or possible effects of the matter on the financial statements.
b) The nature of the matter giving rise to the modification.
c) Both a) and b)
d) None of the above.
Answer: c)
6. True or False: Pervasive effects on the financial statements are limited to specific elements, accounts, or items of the financial statements.
Answer: False
7. What are examples of circumstances that may lead to the inability of the auditor to obtain sufficient appropriate audit evidence?
a) Destruction of the entity’s accounting records.
b) Limitations imposed by management.
c) Circumstances relating to the nature or timing of the auditor’s work.
d) All of the above.
Answer: d)
8. True or False: If there is a limitation on the scope of the audit imposed by management, the auditor must issue an adverse opinion.
Answer: False
9. Can an auditor express an unmodified opinion on specific elements of the financial statements if an adverse opinion or disclaimer of opinion is issued on the financial statements as a whole?
a) Yes, as long as the specific elements are not materially misstated.
b) No, it would contradict the adverse opinion or disclaimer of opinion.
c) Only if required by law or regulation.
d) None of the above.
Answer: b)
10. True or False: The auditor must clearly state the nature of the modification in the Basis for Opinion section of the auditor’s report.
Answer: True
Additional questions:
11. Which of the following is not a type of modified opinion that can be issued by an auditor?
a) Qualified opinion
b) Adverse opinion
c) Unmodified opinion
d) Disclaimer of opinion
Answer: c)
12. True or False: A qualified opinion is issued when the financial statements are materially
misstated, but the misstatement is not pervasive.
Answer: True
13. What is the purpose of SA 705 in the context of auditor’s reports?
a) To provide definitions for modified opinions.
b) To establish three types of modified opinions.
c) To guide auditors on how to modify their reports in case of significant issues or errors in financial statements.
d) None of the above.
Answer: c)
14. True or False: An adverse opinion is issued when the financial statements are materially misstated, and the misstatement is pervasive.
Answer: True
15. In what circumstances would an auditor issue a disclaimer of opinion?
a) When the financial statements are materially misstated, but the misstatement is not pervasive.
b) When the auditor is unable to obtain sufficient appropriate audit evidence.
c) When the misstatement affects specific elements, accounts, or items of the financial statements.
d) None of the above.
Answer: b)
16. True or False: The decision on which type of modified opinion to issue depends solely on the auditor’s judgment about the pervasiveness of the effects or possible effects of the matter on the financial statements.
Answer: False
17. What are examples of circumstances that may lead to the inability of the auditor to obtain sufficient appropriate audit evidence?
a) Destruction of the entity’s accounting records.
b) Limitations imposed by management.
c) Circumstances beyond the control of the entity.
d) All of the above.
Answer: d)
18. True or False: If there is a limitation on the scope of the audit imposed by management, the auditor must always issue a disclaimer of opinion.
Answer: False
19. Can an auditor express an unmodified opinion on specific elements of the financial statements if an adverse opinion or disclaimer of opinion is issued on the financial statements as a whole?
a) Yes, as long as the specific elements are not material.
b) No, it would contradict the adverse opinion or disclaimer of opinion.
c) Only if the specific elements are deemed pervasive.
d) None of the above.
Answer: b)
20. True or False: The Basis for Opinion section of the auditor’s report should include a description of the matter giving rise to the modification, including any material misstatements of the financial statements.
Answer:True
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