TANZANIA INSTITUTE OF ACCOUNTANCY

DAR ES SALAAM CAMPUS

LECTURE NOTES – 5

5. Audit Report
5.1. Definition
An audit report is a written opinion of anauditor regarding an entity's financial
statements. Thereport is written in a standard format, as mandated International
Standards on Auditing  (ISAs). ... A qualified opinion, if there were any scope
limitations that were imposed upon the auditor's work.
5.2. Basic elements of the auditor’s report
The auditor's report should include the following basic elements, normally in this
layout:
Title
Addressee
Introductory paragraph
Managements' responsibility for the financial statement
Auditor's responsibility
Auditor's opinion
Other reporting responsibilities
Auditor's signature
Date of the auditor's report
Auditor's address
5.3. Overview

Reports

Audit Reports Reports to Management Internal Audit Reports

Unmodified Audit Reports Modified Audit Reports

5.4. Audit Opinion

ISA 700 (revised): The Auditor’s Report on Financial Statements
The auditor's report should contain a clear written expression of opinion, in the
financial statements taken as a whole.
5.4.1. Types of Audit Reports/Opinion
There are four types of audit reports.
i) Unqualified Opinion
Often called a clean opinion, an unqualified opinion is an audit report
that is issued when an auditor determines that each of the financial
records provided by the business is free of any misrepresentations. In
addition, an unqualified opinion indicates that the financial records have
been maintained in accordance with the standards known as Generally
Accepted Accounting Principles (GAAP).

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Example 1
Unqualified Report
INDEPENDENT AUDITOR'S REPORT
(APPROPRIATE ADDRESSEE)
Report on the Financial Statements
We have audited the accompanying financial statements of ABC
Company, which comprise the balance sheet as at December 31, 20X1,
and the income statement, statement of changes in equity and cash flow
statement for the year then ended, and a summary of the significant
accounting policies and other explanatory notes.
Management's Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of
these financial statements in accordance with International Financial
Reporting Standards. This responsibility includes: designing,
implementing and maintaining internal control relevant to the
preparation and fair presentation of financial statements that are free
from material misstatement, whether due to fraud or error; selecting and
applying appropriate accounting policies; and making accounting
estimates that are reasonable in the circumstances.
Auditor's Responsibility
Our responsibility is to express an opinion on these financial statements
based on our audit. We conducted our audit in accordance with
International Standards on Auditing. Those Standards require that we
comply with ethical requirements and plan and perform the audit to
obtain reasonable assurance whether the financial statements are free
from material misstatement.
An audit involves performing procedures to obtain audit evidence about
the amounts and disclosures in the financial statements. The procedures
selected depend on the auditor's judgement, including the assessment of
the risk of material misstatement of the financial statements, whether
due to fraud or error. In making those risk assessments, the auditor
considers internal control relevant to the entity's preparation and fair
presentation of the financial statements in order to design audit
procedures that are appropriate in the circumstances, but not for the
purpose of expressing an opinion on the effectiveness of the entity's
internal control. An audit also includes evaluating the appropriateness of
accounting policies used and the reasonableness of accounting estimates
made by management, as well as evaluating the overall presentation of
the financial statements.
We believe that the audit evidence we have obtained is sufficient and
appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the financial statements give a true and fair view of ("or
present fairly, in all material respects,") the financial position of ABC
Company as of December 31, 20X1, and of its financial performance
and cash flows for the year then ended in accordance with International
Financial Reporting Standards.
Report on Other Legal and Regulatory Requirements
[Form and content of this section of the auditor's report will vary
depending on the nature of the auditor's other reporting
responsibilities.]
[Auditor's signature]
[Date of the auditor's report]
[Auditor's address]
Example 2
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 Unqualified opinion with emphasis of matter paragraph for a
significant uncertainty
“In our opinion…(remaining words are the same as illustrated in the
opinion paragraph – Example 1 above)
Without qualifying our opinion we draw attention to Note X to the
financial statements. The company is the defendant in lawsuit alleging
infringement of certain patent rights and claiming royalties and punitive
damages. The Company has filed a counter action, and preliminary
hearings and discovery proceedings on both actions are in progress. The
ultimate outcome of the matter cannot presently be determined, and no
provision for any liability that may result has been made in the financial
statements”.
ii) Qualified Opinion
In situations when a company’s financial records have not been
maintained in accordance with GAAP but no misrepresentations are
identified, an auditor will issue a qualified opinion. The writing of a
qualified opinion is extremely similar to that of an unqualified opinion. A
qualified opinion, however, will include an additional paragraph that
highlights the reason why the audit report is not unqualified.
Example 3
Qualified opinion: material limitation on scope
“We have audited…(remaining words are the same as illustrated
in the introductory paragraph – Example 1 above).
Management is responsible for …. (remaining words are the same
as illustrated in the management's responsibility paragraph –
Example 1 above).
Our responsibility is to express an opinion on these financial statements
based on our audit
Except as discussed in the following paragraph, we conducted our audit
in accordance with …. (remaining words are the same as illustrated in
the auditor's responsibility paragraphs – Example 1 above).
We did not observe the counting of the physical inventories as of
December 31, 20X1, since that date was prior to the time we were initially
engaged as auditors for the Company. Owing to the nature of the
Company’s records, we were unable to satisfy ourselves as to inventory
quantities by other audit procedures.
In our opinion, except for the effects of such adjustments, if any, as
might have been determined to be necessary had been able to satisfy
ourselves as to physical inventory quantities the financial statements
give a true and…(remaining words are the same as illustrated in the
opinion paragraph – Example 1 above).”
iii) Adverse Opinion
The worst type of financial report that can be issued to a business is an
adverse opinion. This indicates that the firm’s financial records do not
conform to GAAP. In addition, the financial records provided by the
business have been grossly misrepresented. Although this may occur by
error, it is often an indication of fraud. When this type of report is
issued, a company must correct its financial statement and have it re-
audited, as investors, lenders and other requesting parties will generally
not accept it.
Example 4
Adverse opinion
“We have audited…(remaining words are the same as illustrated
in the introductory paragraph – Example 1 above)
Management is responsible for …. (remaining words are the same
as illustrated in the management's responsibility paragraph –
Example 1 above).

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 Our responsibility is to …. (remaining words are the same
as illustrated in the management's responsibility paragraph
– Example 1 above).
(Paragraph(s) discussing the disagreement)
In our opinion, because of the effects of the matters discussed in the
preceding paragraph(s), the financial statements do not give a true and
fair view of (or do not ‘present fairly, in all material respects,') the
financial position of ABC Company as of December 31, 20X1, and of its
financial performance and its cash flows for the year then ended in
accordance with International Financial Reporting Standards.
iv) Disclaimer of Opinion
On some occasions, an auditor is unable to complete an accurate audit
report. This may occur for a variety of reasons, such as an absence of
appropriate financial records. When this happens, the auditor issues a
disclaimer of opinion, stating that an opinion of the firm’s financial
status could not be determined.
Example 4
Disclaimer of opinion: pervasive limitation on scope
“We were engaged to audit the accompanying balance sheet of the
ABC Company, which comprise the balance sheet as at December 31,
20X1, and the income statement, statement of changes in equity and
cash flow statement for the year then ended, and a summary of the
significant accounting policies and other explanatory notes.
Management is responsible for …. (remaining words are the same
as illustrated in the management's responsibility paragraph –
Example 1 above).
(Omit the sentence stating the responsibility of the auditor)
(The paragraph discussing the scope of the audit would either be
omitted or amended according to the circumstances).
(Add a paragraph discussing the scope of limitation as follows:
We were not able to observe all physical inventories and confirm account
receivable due to limitations placed on the scope of our work by the
Company.)
Because of the significance of the matters discussed in the preceding
paragraph, we do not express an opinion on the financial statements.
5.5. Reports to management
5.5.1. Communication on internal control
The auditor has no duty to report any weaknesses in control systems to the
shareholders but ISA 260 Communications of audit matters with those charged
with governance requires the external auditor to communicate ‘audit matters of
governance interest’ to those charged with governance of the entity.
The matters to be communicated include:
 Approach and scope of audit
 Selection of, or changes in, accounting policies
 Audit adjustments that could have a material effect on the entity's
financial statements
 Material uncertainties that may cast doubt on the entity's ability to
continue as a going concern
5.5.2. Material weakness in internal control
Questions regarding management integrity and fraud involving management.

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5.5.3. Procedures
Such communications should be on a sufficiently prompt basis to enable
those charged with governance to take appropriate action. All
communications will be before the financial statements are finalised.
 The form of communications and the addressee of
communications should be established at an early stage in the
audit process (ie. planning).
 with management. This gives management an opportunity to provide
further information or explanations.
 If possible, matters should be addressed to the audit committee,
or to the board if there is no audit committee.
5.5.4. Third parties interested in communications to those charged with
governance
Occasionally those charged with governance may wish to provide third parties,
for examples bankers or certain regulatory authorities, with copies of a written
communication from the auditors. It is appropriate to ensure that third parties
who see the communication understand that it was not prepared with third
parties in mind.
 The report has been prepared for the sole use of the entity and, where
appropriate, any parent undertaking and its auditors
 It must not be disclosed to a third party, or quoted or referred to, without
the written consent of the auditors; and
 No responsibility is assumed by the auditors to any other person.
5.5.5. Specimen paragraphs from the weaknesses section of a report to
management
i) Purchases – ordering procedures
Present system
During the course of our work we discovered that it was the practice
of the stores to order certain goods from X Limited without preparing
either a purchase requisition or purchase order.
Implications
There is therefore the possibility of liabilities being created in relation
to unauthorised items and of purchases being made at non-
competitive prices.
Recommendations
We recommend that stores personnel should be informed at a
department meeting that they are not permitted to place orders. The
correct procedure of making a request through the buying
department should be explained and training in completing a
purchase requisition should be given. Spot checks should be made by
the internal audit department over the next six months to monitor
compliance.
ii) Purchase ledger reconciliation
Present system
Although your procedures require that the purchase ledger is reconciled
against the control account on the nominal ledger at the end of every
month, this was not done in December or January.
Implications
The balance on the payables ledger was lower than the nominal ledger
control account balance at 31 December 2003 by $2,120 for which no
explanation could be offered. This implies a serious breakdown in the
purchase invoice and/or cash payment batching and posting procedures.
Recommendations
It is important in future that this reconciliation is performed regularly by
a responsible official independent of the day to day purchase ledger,
cashier and nominal ledger functions. We recommend that a control
sheet is signed off monthly by the purchase ledger supervisor (or the
finance controller in his absence) indicating that the reconciliation has
been completed and reviewed
5.6. Internal Audit Reports
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 Internal auditors typically issue reports at the end of each audit that
summarize their findings, recommendations, and any responses or action plans
from management.
5.6.1. Contents of a Report
An audit report may have the following
i) An Executive Summary
A body that includes the specific issues or findings identified and
related recommendations or action plans,
ii) Appendix
Information such as detailed graphs and charts or process
information.
5.6.2. Elements of a Report
Each audit finding within the body of the report may contain five elements,
sometimes called the "5 C's":
i) Condition:
What is the particular problem identified?
ii) Criteria:
What is the standard that was not met? The standard may be a
company policy or other benchmark.
iii) Cause:
Why did the problem occur?

iv) Consequence:

What is the risk/negative outcome (or opportunity foregone) because

of the finding?
v) Corrective action:
What should management do about the finding? What have they
agreed to do and by when?
5.6.3. Findings and Recommendations
i) The recommendations in an internal audit report are designed to
help the organization achieve
 Effective and efficient governance,
 Risk and control processes associated with operations objectives,
 Financial and management reporting objectives;
 Legal/regulatory compliance objectives.
ii) Audit findings and recommendations may also relate to particular
assertions about transactions, such as
 whether the transactions audited were valid or authorized,
 completely processed,
 accurately valued,
 processed in the correct time period, and
 properly disclosed in financial or operational reporting,
5.6.4. Quality of Internal Audit Report[
i) Objectivity – 
The comments and opinions expressed in the Report should be objective
and unbiased.
ii) Clarity – 
The language used should be simple and straightforward.
iii) Accuracy – 
The information contained in the report should be accurate.
iv) Brevity – 
The report should be concise.
v) Timeliness – 
The report should be released promptly immediately after the audit is
concluded, within a month.

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 5.6.5. An Example of an Internal Audit Report
Review reports can take many formats depending on the nature of the
assignment.
The following is an example of a systems review report following an assignment
carried out by internal audit or outsourced to an audit firm. Bear in mind
though, that usually this is an internal report and can therefore be of any
format. This is a brief example. More complicated assignments are likely to
summarise the main findings and include a number of appendices containing
detailed information.
REPORT

To: Directors of Robinson Co

From: Internal audit department

Subject: Review of sales system

Period of fieldwork: May 200X

Terms of Reference

The scope of the assignment was to carry out a thorough review of the sales system. This involved
carrying out tests of controls on the existing controls to determine whether the controls were
operating effectively. In addition, we considered the key risks surrounding the sales function and
identified any risks for which we found no related controls. Thus, we have been able to give
recommendations regarding existing controls as well as suggest new controls where we believe
they are needed.
Executive Summary
The main findings from our review are:
← the sales system, on the whole, comprises adequate controls
← some specific control weaknesses were identified and recommendations are given in
the Appendix to the report.
Follow-up
Responsibilities have been allocated for introducing/improving control procedures which we
found to be deficient.
We propose a follow-up review in six months’ time.

Dated……………………… Signed………………………….

Head Internal Auditor

5.6.5.1. Detailed Identification of Weaknesses, Risks and Recommendations

( Ref.7.5.5. above)

Weakness Risk Recommendation Responsibility Timescale

There is no credit check of
new customers prior to
taking an order.
There is no follow up of sales
orders unmatched to GDNs.
Customers are not asked to
sign a proof of delivery.
These new customers could
represent an increased risk of bad
debts.
If customers do not receive their
goods as ordered, they are unlikely
to use Robinson Co for further
purchases.
This could lead to disputes, loss of
customer goodwill and increased
bad debts.
All new customers should be To be implemented by September
subject to should be subject to the hea d of the credit 200X
this check and the computer control department.
system should have a compulsory
check before a sales order can be
accepted.
There should be a monthly To be implemented September
reconciliation between the month’s and managed by the 200X
sales orders and the related GDNs. head of the sales
Any unmatched orders should be department.
followed up with queries being
directed to head of sales.
The P.O.D should be signed and To be implemented by September
retained within the sales Head of Sales 200X
department along with the order department
and invoice.