CHAPTER 11

THE AUDITOR’S REPORT ON FINANCIAL STATEMENTS

PSA 700 requires the auditor’s report to contain a clear expression of the auditor’s opinion on the
financial statements.

When forming an opinion on the financial statements, the auditor evaluates whether sufficient
appropriate audit evidence has been obtained to provide reasonable assurance that the financial
statement taken as whole are free from material misstatement and evaluates whether the financial
statements conform to the applicable financial reporting framework.

Hence, the auditor must form a judgement as to whether

1. The accounting policies selected and applied are consistent with the financial reporting
framework and are appropriate in the circumstances;
2. The accounting estimates made by management are reasonable in the circumstances;
3. The information presented in the financial statements; including accounting policies, is
relevant6, comparable and understandable; and
4. The financial statements provide sufficient disclosures to enable users to understand the
effects of transactions and events conveyed in the financial statements.

The Unmodified Report

 The most common type of audit report contains a clean opinion or unmodified opinion.
 This type of opinion is issued when the auditor concludes, based on audit evidence
obtained, that the financial statements are presented fairy, in all material respects in
accordance with the applicable financial reporting framework.

Basic Elements of the Unmodified Report

1. Title

 Should clearly indicate that it is the report of an independent auditor.

 In order to emphasize the independence of the auditor with client being audited; and to
distinguish the auditor’s report from the reports that might be issued by others.

2. Addressee

 Should be addressed to those parties for whom the report is prepared.

 Shareholders, board of directors or a third party requesting the audit.
 Complete mailing address of the client (FS to be filed w/ the regulatory agencies)

3. Introductory paragraph

 Identify the name of the entity whose Financial Statements have been audited
 State that the financial statements have been audited
 Identify the title of each of the financial statements audited including the date and
period covered by the financial statements
 Refer to the summary of significant accounting policies and explanatory notes

4. Management’s Responsibility for the Financial Statements

 Responsibility for the preparation and fair presentation of the financial statements in
accordance with applicable financial reporting framework.
 Responsibility for the design, implementation and maintenance of such internal
control relevant to the preparation and fair presentation of financial statements that are
free from material misstatement, whether due to fraud or error.

5. Auditor’s responsibility

 State that the responsibility of the auditor is to express an opinion on the financial
statements based on the audit in order to contrast it to management’s responsibility for
the preparation of the financial statements.
 State that the audit was conducted in accordance with Philippine Standards on
Auditing (PSAs) to inform the users that the auditor has complied with the standard of
performance established by the profession.
 Give a general description of an audit.
 State that the auditor believes that the audit evidences obtained is sufficient and
appropriate to provide a basis for the auditor’s opinion.

6. Auditor’s opinion

 Section heading – “Opinion”

 State that the financial statements are presented fairly in all material respects in
accordance with the applicable financial reporting framework.

7. Other Reporting Responsibilities

 Report on other matters that are supplementary to the auditor’s responsibility under PSA
to report on the financial statements.
 Subtitle: “Report on the Financial Statements”

8. Auditor’s signature
  The report should be signed in the name of the audit firm and/or the personal name of
the auditor.
 Personal name of the partner (if FS are to be submitted to regulators)

9. Date of the report

 Dated as of the completion of all essential audit procedures, which in effect the last
day of field work.
 Should not be dated earlier than the date of approval of the financial statements.

10. Auditor’s address

 The location in the jurisdiction where the auditors maintain his office.

Modification to the Opinion

The unmodified opinion will be issued only the auditor is satisfied that

1. The auditor was conducted in accordance with PSA; and

2. The financial statements have been prepared in accordance with the applicable financial
reporting framework.

Failure to meet any of the above requirements will cause the auditor to modify his opinion on the
financial statement.

Material Misstatements

Any departure from the specific requirements of the applicable financial reporting framework
will cause the financial statements to contain material misstatements.

A material misstatement of the financial statement may arise form:

1. Inappropriate accounting policy selected;

2. Misapplication of selected accounting policy; or
3. Inappropriate or inadequate disclosure.

Scope limitation

Scope limitation arises when the auditor is unable to perform necessary audit procedures or
the auditor is unable to obtain sufficient appropriate evidence about an assertion.
A limitation on the scope of the auditor’s work may be imposed by the client or imposed by
circumstances:

1. Circumstances beyond the control of the entity such as inadequacy of accounting

records.
2. Circumstances relating to the nature or timing of the auditor’s work like the auditor
is engaged only after client’s fiscal year ends.
3. Limitations imposed by management like when management prevents the auditors
from requesting external confirmation of specific accounts.

Management Imposed Scope Limitation

 The auditor should request the management to remove the limitation.

 If the management refuses to remove the limitation, the auditor should communicate the
matter to those charge with governance.

The auditor may perform alternative procedure to obtain sufficient appropriate evidence.

Failure to perform alternative procedure the auditor may either express a

1. Qualified opinion – if the effect is material but not pervasive

2. Disclaimer an opinion/resign from the engagement – if the effect is both material and
pervasive.

Basis for Modification Paragraph

 Heading: “Basis for Qualified Opinion,” “Basis for Adverse Opinion,” or “Basis for
Disclaimer of Opinion.”

Material Misstatement

If there is a material misstatement that relates to specific amounts or disclosure in the

financial statements, the auditor should include in the basis for modification paragraph:

3. A description of the nature of misstatement or an explanation of how the disclosure is

misstated;
4. A quantification of the financial effects of the misstatement or a disclosure of omitted
information, if practicable.

Scope and Limitation

If the modification results from an inability to obtain sufficient appropriate audit evidence,
the basis for the modification paragraph shall only explain the reason for the inability.

Modification of the Auditor's Report

In addition to the Basis for the Modification paragraph, the following modification to the
Auditor's Report should be observed when issuing a report that contains a modified opinion:

Opinion Paragraph

1. The auditor's opinion paragraph should use the heading “Qualified Opinion.” Adverse
Opinion,” or “Disclaimer of Opinion” as appropriate.
2. When the auditor expresses a qualified opinion due to a material misstatement, the
auditor should use the phrase “except for the effects of the matter described in the Basis
for Qualified Opinion paragraph, the financial statements are fairly. . .”
3. When the auditor expresses a qualified opinion due to a scope limitation, the auditor
should use the phrase “except for the possible effects of the matter described in the
Basis for Qualified Opinion paragraph, the financial statements present fairly . . .”
4. When the auditor expresses an adverse opinion, the auditor should state that in the
auditors opinion, because of the significance of the matter described in the Basis for
Adverse Opinion paragraph, the financial statements do not present fairly. . .
5. When the auditor disclaims an opinion, the auditor should state that because of the
significance of the matter described in the Basis for Disclaimer of Opinion paragraph, the
auditor has not been able to obtain sufficient appropriate audit evidence to provide a
basis for an audit opinion; and, accordingly, the auditor does not express an opinion on
the financial statements.

Auditor's Responsibility paragraph

6. When qualified or adverse opinion is expressed the last sentence of the auditor's
responsibility paragraph should be modified to state that the auditor believes that the
audit evidence the auditor has obtained is sufficient and appropriate to provide a basis for
the auditor's qualified or adverse opinion.
7. When the auditor disclaims an opinion, the auditor should amend the description of the
auditor's responsibility such as this: “Our responsibility is to express an opinion on the
financial statements based on conducting the audit in accordance with the Philippine
Standards on Auditing. Because of the matter described in the Basis for Disclaimer of
Opinion paragraph, however, we were not able to obtain sufficient appropriate audit
evidence to provide a basis for an opinion.”
 In addition, the introductory paragraph of the report should also be modified to state that
the auditor was engaged to audit the financial statements.

Piecemeal Opinion

Piecemeal opinion is an unmodified opinion expressed on one or more components of the

financial statements while expressing an adverse or disclaimer of opinion o the financial
statements taken as a whole. PSA 705 does not allow this reporting practice because piecemeal
opinion tends to contradict or even overshadow the disclaimer or adverse opinion expressed on
the financial statements taken as a whole.

Emphasis of Matter and Other Matter Paragraphs

In certain instances, it may be appropriate for the auditor to include an additional paragraph in
the report to give emphasis on an important matter affecting the financial statement or the
auditor's report. The addition of these paragraphs does not negate the auditor's unmodified
opinion and is not construed as a modification to the opinion or a substitute for the modified
opinion. Instead, such paragraphs are presented in order to promote reader's understanding of the
financial statements or the auditor's responsibility.

Emphasis of Matter

An emphasis of matter paragraph is included in the report to draw the readers' attention to a
matter presented or disclosed in the financial statements that, in the auditor's judgment, is of
such importance that is fundamental to the readers' understanding, the auditor.

Below are examples of circumstances where the auditor may consider it necessary to include an
Emphasis of Matter paragraph:

1. An uncertainty.
2. A material going concern uncertainty.
3. Early application of new accounting standard in advance of its effective date.
4. A major catastrophe that has a significant effect on the entity's financial position.
5. A subsequent discovery of facts affecting the previously issued opinion.
6. Financial statements prepared using a special purpose framework.

Uncertainty
An uncertainty is a matter whose outcome depends on future actions or events not under the
direct control of an entity that may affect the financial statements. When there are significant
uncertainties that are adequately accounted for and disclosed in the notes to the financial
statements, the auditor should consider modifying the report by adding an emphasis of matter
paragraph to highlight the material uncertainty.

Going concern uncertainty

Continuation of the entity as a going concern is assumed in financial statements in the absence of
explicit information to the contrary. When planning and performing audit procedures, the auditor
should consider the appropriateness of management use of the going concern assumption in the
preparation of the financial statements and consider whether there are material uncertainties
about the entity's ability to continue as a going concern that need to be disclosed in the financial
statements.

Going Concern Appropriate – Material Uncertainty Exists

A material uncertainty exist when the impact of the going concern problem is significant such
that, in the auditor's judgment, clear disclosure of the nature and implications of the uncertainties
is necessary for the fair presentation of the financial statements. When going concern uncertainty
exist, PSA 570 requires that financial statements:

 Adequate describe the principal conditions and events that give rise to the significant
doubt including management plans to deal with these events or conditions.
 State clearly that there is a material uncertainty about the entity's ability to continue as a
going concern and that the entity may not be able to realize its assets or discharge its
liabilities in the normal course of business.

If the going concern uncertainty is adequately disclosed in the financial statements, the auditor
should express an unmodified opinion with emphasis of matter paragraph to highlight the
material uncertainties about the entity's continued existence and to draw that reader's attention to
the note to financial statements that discusses the matter in detail.

If the going concern uncertainty is not adequately disclosed, a qualified opinion or an adverse
opinion will be issued.

Going Concern Assumption Inappropriate

If the auditor believes that the entity will not be able to continue as a going concern, the financial
statements should not be prepared on a going concern basis. Instead, an alternative basis must
be used in presenting the financial statements. For this purpose, the Philippine Interpretation
Committee requires that assets and liabilities of an entity be measured in accordance with the
requirement of PFRS 5 – Noncurrent assets held for sale.

If the entity insist on using the going concern assumption in presenting financial statements
despite the fact that the entity will not be able to continue as a going concern, the financial
statements will be misleading. Consequently, the auditor must issue a report an adverse opinion.

Multiple uncertainties affecting the financial statements

Ordinarily, the addition of paragraph emphasizing a going concern problem or significant

uncertainty is adequate to meet the auditor's reporting responsibilities regarding such matters.
However, in extreme cases, such as situations involving multiple uncertainties that are
significant to the financial statements, the auditor may consider it appropriate to issue a
disclaimer of opinion instead of adding an emphasis of matter paragraph.

Early application of new accounting standard

Standard setting bodies sometimes allow or even encourage entities to apply a new accounting
standard prior to its mandatory effective date. If the application of this new standard has
pervasive effect on the financial statements of the entity, the auditor should include an Emphasis
of Matter paragraph to draw the readers' attention to the note to the financial statements that
discusses the matter.

Major catastrophe

Recent disaster brought about by calamities have brought major catastrophes to many
companies. A major catastrophe that has had, or continues to have, a significant effect on the
entity's financial position will have to be disclosed in the notes to the financial statements.
Besides the disclosure required by accounting standards, the auditor's report should include an
Emphasis of Matter paragraph to give emphasis on the note that discusses this event.

Subsequent discovery of facts that affect the auditor's opinion

As discussed in the preceding chapter, a entity may need to amend the previously issued
financial statements because of significant facts that come to light after the financial statements
are issued. When this happens, a new audit report on the amended financial statements is
required.