Auditor's reports: formula sheet

Key formulas

Misstatement, material not pervasive

Material misstatement + not pervasive → Qualified opinion ("except for")

Use wording such as "except for the effects of the matter described in the Basis for Qualified Opinion section".

Misstatement, material and pervasive

Material misstatement + pervasive → Adverse opinion

Say the financial statements do not give a true and fair view (or are not presented fairly, in all material respects).

Scope limitation, not pervasive

Unable to get evidence + possible effects material but not pervasive → Qualified opinion

Use "except for the possible effects of...".

Scope limitation, pervasive

Unable to get evidence + possible effects material and pervasive → Disclaimer of opinion

State that you do not express an opinion. Do not say the statements are right or wrong.

Disclaimer after accepting the engagement

Management imposes a limitation + auditor concludes a disclaimer is likely → request removal; if not removed, communicate with those charged with governance and consider withdrawal where practicable

If withdrawal is not possible, issue the disclaimer.

Report sections

Opinion section heading + Basis for [Qualified/Adverse/Disclaimer] section

The Basis section comes straight after the opinion and describes the matter and its effect.

Emphasis of Matter test

Matter already disclosed in the financial statements + fundamental to users' understanding → EoM paragraph

Both conditions must hold. The paragraph refers to the disclosure and states the opinion is not modified in respect of the matter.

Other Matter test

Matter not disclosed in the financial statements + relevant to understanding the audit, auditor's responsibilities or report → OM paragraph

Not for matters that law or regulation, or another ISA, requires to be dealt with elsewhere, such as management's disclosure.

Placement and heading

EoM: heading 'Emphasis of Matter' placed in a separate section; OM: heading 'Other Matter' placed in a separate section

Place the paragraph in a separate section with a suitable heading. Where it goes depends on how relevant it is to users. Use the heading and the wording to show the opinion is not modified in respect of the matter.

Effect on the opinion

EoM or OM paragraph → opinion unchanged

Missing or misstated disclosure → modified opinion under ISA 705, not an EoM.

Communication with TCWG

Expect to include an EoM or OM paragraph → tell those charged with governance before issuing the report

Give them a chance to understand the proposed wording and the reason for it.

KAM selection funnel

Matters communicated to TCWG → matters requiring significant auditor attention → matters of most significance = KAMs

Document the judgement. The number of KAMs is not fixed. Fewer, more significant matters are the aim.

Considerations in determining significant attention

Higher assessed risk or significant risks + significant auditor judgement in areas of significant management judgement + effect of significant events or transactions

These are the three ISA 701 considerations. Use them as headings in your answer.

Content required for each KAM

Why it was a KAM + how it was addressed + reference to related disclosure

Describe the matter without giving a separate opinion on it.

Scope of ISA 701

Listed entities; or where law requires; or where the auditor decides to communicate

For unlisted entities it is voluntary unless law requires it.

Matters not communicated as KAM

Matters giving rise to a modified opinion; material uncertainty related to going concern

These are reported under their own headings. They are by nature KAMs but must not be described in the KAM section.

Omitting a KAM

Omit only if law or regulation precludes disclosure, or in extremely rare cases where adverse consequences clearly outweigh public interest benefits

The second exception does not apply if the entity has already publicly disclosed the matter.

Basis appropriate, material uncertainty adequately disclosed

Unmodified opinion + separate section "Material Uncertainty Related to Going Concern"

Not a modification. The section must refer to the note and state that the opinion is not modified in respect of the matter.

Basis appropriate, material uncertainty inadequately disclosed

Qualified ("except for") or adverse opinion under ISA 705

Qualified if the effect is material but not pervasive. Adverse if it is material and pervasive. The basis for opinion section must state the uncertainty exists and the statements do not adequately disclose it.

Going concern basis inappropriate

Adverse opinion

Applies when the statements are prepared on the going concern basis but the basis is inappropriate. Disclosure does not cure it. The exception is an acceptable alternative basis with adequate disclosure.

Management unwilling to make or extend assessment

Consider qualified opinion or disclaimer (ISA 705)

The auditor asks management to extend its assessment period. If management refuses, this is a scope limitation.

Alternative basis used, adequately disclosed

Unmodified opinion; emphasis of matter only if the auditor considers it necessary to draw attention to the alternative basis

Only if the alternative basis is acceptable in the circumstances and the disclosures are adequate. If the going concern basis is still used, the adverse opinion applies instead.

Who to communicate with

TCWG = those overseeing strategy and accountability; management = those running operations

If all TCWG are involved in managing the entity and the matters have already been communicated to them in that management capacity, they need not be communicated again, provided the TCWG are adequately informed.

ISA 260 matters

Responsibilities + planned scope and timing + significant findings + independence (listed entities)

Use this as a checklist for any question asking what to communicate.

Significant findings

Accounting practices + difficulties + uncorrected misstatements + matters affecting the report + other relevant matters

Include qualitative views on policies, estimates and disclosures, not only numbers.

ISA 265 significant deficiencies

Significant deficiencies → written to TCWG, on a timely basis

Include a description of the deficiency and an explanation of its potential effects.

Other deficiencies

Other deficiencies → management on a timely basis, if of sufficient importance to merit its attention and not already communicated by other parties

Do not repeat points already communicated by others. Communicate only those you judge of sufficient importance to merit management's attention.

Management letter point layout

Deficiency → implication → recommendation

This three-part layout earns most marks in exam answers.

Quick revision

• A modified opinion arises from a material misstatement or an inability to obtain sufficient appropriate evidence.
• Material but not pervasive gives a qualified opinion; material and pervasive gives an adverse opinion or a disclaimer.
• A misstatement that is material and pervasive leads to an adverse opinion.
• If you cannot obtain evidence and the possible effects are material and pervasive, you disclaim an opinion.
• Emphasis of matter refers to a matter already properly disclosed that is fundamental to understanding; it does not modify the opinion.
• Other matter paragraphs deal with matters not presented or disclosed in the financial statements that are relevant to users' understanding of the audit or report.
• KAMs are matters of most significance in the audit, chosen from matters communicated to those charged with governance; ISA 701 applies to listed entity audits and where required or chosen.
• A KAM paragraph is not a substitute for a modified opinion.
• Material uncertainty over going concern with adequate disclosure gives an unmodified opinion with a separate section headed Material Uncertainty Related to Going Concern.
• If a material uncertainty is not adequately disclosed, give a qualified or adverse opinion.
• Under ISA 720, read other information and report if you find an uncorrected material misstatement of it.
• Communicate significant findings and deficiencies in internal control to those charged with governance on a timely basis.

Common mistakes

• Giving a disclaimer for a material misstatement or an adverse opinion for a scope limitation. Fix: Link adverse to misstatement and disclaimer to scope limitation. Qualified can arise from either.
• Treating material and pervasive as the same thing. Fix: Material means it matters to users. Pervasive means it spreads across the statements or is fundamental. Always assess both separately.
• Using an EoM to cover an inadequate or missing disclosure. Fix: An EoM only works if the disclosure is adequate. If it is not, the opinion is qualified or adverse under ISA 705.
• Treating an EoM as a KAM or a KAM as a replacement for an EoM. Fix: A KAM is a matter of most significance in the audit. An EoM is a disclosed matter fundamental to understanding. They have different purposes and can both appear.
• Treating KAMs as a modified opinion or a way to qualify the report. Fix: If the matter requires a modified opinion, use ISA 705. KAMs are about matters that were significant but where the opinion is unmodified.
• Reporting a material uncertainty on going concern as a KAM. Fix: Use the separate heading Material Uncertainty Related to Going Concern. The KAM section can refer to it but must not describe it.
• Calling the material uncertainty section a modification of the opinion. Fix: When the uncertainty is adequately disclosed the opinion stays unmodified. The separate section informs users and states that the opinion is not modified.
• Using an emphasis of matter paragraph for a material uncertainty. Fix: Under ISA 570 a material uncertainty needs its own section headed "Material Uncertainty Related to Going Concern". Emphasis of matter is for other matters already fairly presented.
• Treating TCWG and management as the same group. Fix: State who the TCWG are in the entity. Note that some matters, such as independence, go to TCWG even though management is also informed.
• Listing control weaknesses without implications or recommendations. Fix: Always use deficiency, implication, recommendation. Marks sit in the implication and the fix.

Exam tips

• Always state both tests, material and pervasive, in your answer. Markers award marks for each judgement.
• Use the scenario figures. Calculate the percentage of profit, revenue or total assets to justify your choice.
• When asked to draft, use the correct headings: the opinion heading and the matching Basis heading. Do not use "except for" outside a qualified opinion.
• Mention practical consequences such as discussing with management, informing those charged with governance, and the effect on key audit matters. This earns professional skills marks.
• Keep drafting short. Two clear paragraphs with the right wording beat a long copied report.
• Always test disclosure first. 'Disclosed and fundamental' means EoM. 'Not disclosed but relevant to the audit' means OM. Missing disclosure means modification.
• Write the key sentence that the opinion is not modified in respect of the matter. It is an easy mark.
• Show the contrast with KAMs and going concern sections when the scenario offers a choice.