CHAPTER 5

AUDITORS’ REPORTS

Objectives
After studying this chapter, you will be able to know about;
 statutory requirements
 pre audit preparation
 conducting the audit

Introduction
Dear students! The audit report is usually the only channel of communication between the
shareholders of the company whose financial statements have been subject to audit and the
auditors. As such the report acts as a bridge taking the large volume of information possessed by
auditors and conveying it to the shareholders in a much abbreviated form.

In order to convey information in a succinct form the audit report has become an extremely
formalized group of phrases, each of which has special significance.

Statutory Requirements

International Auditing Standards require the auditors to state explicitly whether in the auditors'
opinion the annual accounts have been properly prepared in accordance with the GAAP and in
particular whether a true and fair view is given.
 In the balance sheet, of the state of the company's affairs at the end of financial year.
 In the profit and loss account, of the company's profit or loss for the financial year; and
 In the case of group accounts, of the state of affairs at the end of financial year and the
profit or loss for the year of undertakings including in the consolidation, so far as
concerns member of the company.
In addition, certain requirements are reported on by exception; the auditor only has to report if
they have not been met. The following are matters with which the auditors imply satisfaction in
an unqualified report.
 Proper accounting records have been kept and proper returns adequate for the audit
 received from branches not visited.
 The accounts are in agreement with accounting records and returns.
 All information and explanations have been received as the auditors think necessary and
they have had access at all times to the company's book, accounts and vouchers.
 Details and directors' emoluments and other benefits, and particular of higher paid
employees have been correctly disclosed in the financial statements.
 Particulars of loans and other transactions in favor of directors and others have been
correctly disclosed in the financial statements.
 The information given in the directors' report is consistent with the accounts.

Directors' Emoluments

The auditor should include in their report the required disclosure particulars of directors'
emoluments and transactions with directors, if these requirements have not been complied with
in the accounts. This means that the auditors carryout various procedures to ensure that they are
aware of all such emoluments and transactions by reference to directors' service contracts, board
minutes, cash book payments and so on. Benefits received in kind may be particularly hard to
identify.

Qualifications in Audit Reports

Prior to the introduction of auditing standards, qualified audit reports were often criticized as
failing to convey the meaning intended.
The standard on audit reports aimed to:
a) outlaw the use of ambiguous ways of qualifying
b) categorize the circumstances giving rise to qualification
c) prescribe suggested wording and format for different categories of qualification
d) introduce a distinction between material and fundamental problems
e) promote better drafting by using non-technical language and clear presentation.

The Qualification 'Matrix'

Auditing standards give the circumstances in which each sort to qualification would be
appropriate where the auditors are unable to report affirmatively on the matters contained in the
paragraphs about which they are reservations, they should give:
a) a full explanation of the reasons for they qualification
b) whenever possible, a quantification of its effect on the financial statements. Where
appropriate, reference should be made to non-compliance with relevant legislation and
other requirements.
The standard stresses the fact that a qualified audit report should leave the reader in no doubt as
to its meaning and its implication for an understanding of the financial statements. In order to
promote a more consistent understanding of qualified audit reports, Accounting Practices Board
(APB) recommends that the forms of qualification described in the standard should be used
unless, in the auditors' opinion, to do so would fail to convey clearly the intended meaning.

The APB takes the view that the nature of the circumstances giving rise to a qualification of the
auditor's opinion will generally fall into one of two categories.
a) where there is a limitation in the scope of work which prevents the auditors from forming
an opinion on a matter (uncertainty).
b) where the auditors are able to form an opinion on a matter but this conflicts with the view
given by the financial statements (disagreement).
Case, uncertainty or disagreement, may give rise to alternative forms of qualification. This is
because the uncertainty or disagreement can be:
a) material but not fundamental; or
b) of fundamental importance to the overall true and fair view.

The standard requires that the following forms of qualification should be used in the different
circumstances outlined below.
Qualification Matrix
Nature of circumstances Material but not fundamental Fundamental
 Limitation in scope Except for … might Disclaimer Adverse
disagreement Except for …

- Except for …might:

…might: Auditors disclaim an opinion on a particular aspect of the accounts,
which is not considered fundamental.
- Disclaimer of opinion:
opinion: Auditors state they are unable to form an opinion on truth and
fairness.
- Except for:
for: Auditors express an adverse opinion on a particular aspect of the accounts,
which is not considered fundamental.
- Adverse opinion:
opinion: Auditors state the accounts do not give a true and fair view.

Pre-Audit Preparation
 Define the Purpose of the audit.
 Define the Objectives of the audit.
 Define the Scope of the audit.
Conduct a brief and informal question and answer session with department supervisor to
determine if there have been any material changes in operations since the last audit. If there has
been a material change, prepare a new Procedural Narrative for the permanent file.

If the scope of the audit is unusually large, or if the anticipated man-hours allotted for this audit
is projected to take longer than 10 business days, an Information and Documentation Request
form will be sent to the department manager giving them two weeks to gather all documentation
necessary to perform the audit.
 Establishing the Scope of the Audit
 Determine if this is an existent audit work program. If yes, go to #2.
If no, go to #3.
 Review work program and determine if there have been any material changes that would
warrant revising the work program:
 Have there been any changes in internal procedures?
 Has personnel been reduced in the area which could compromise dual controls?
 Have there been any regulatory updates that warrant review?
 Have any processes become automated?
 Create a work program for function to be audited.
  Review any published regulation or law and address all requirements.
 Incorporate internal processing procedures
 System Input/Output
 Written policies/procedures
 Secondary reviews/authorizations
 Develop an Internal Control Questionnaire if appropriate
 Substantially all questions should be answered with a YES/NO/NA

Conducting the Audit

Determine if Positive or Negative confirmations are applicable to the audit work conducted.
Prepare confirmations for delivery.
Determine the sampling method to be used for the audit. (See appendix for definitions of various
sampling methods).
Determine the type of reports needed to conduct the audit. Those typically best suited for audits
are: independent trial balances, summaries, exception listings, confirmation listings, analytical
reports, management reports, and internal audit administrative reports.

Preparing Work Papers

The work papers should tell a complete story of the work performed. It is imperative that the
record left by the auditor of the work that was performed and the conclusions reached is clear
and defensible. The following represents the way work papers should be created:
The work papers must document the scope of the work performed. This will include the audit
program, the percentage of items in the population that were tested, statistical sampling
techniques used, the inquiries made, the confirmations mailed and received, etc. The work
papers must clearly support the amount of testing that was undertaken was sufficient under the
circumstances.

The results of the audit test should be clear. This will include all of the audit exception items and
their resolution, the documents and document attributes examined, the reconciliations performed,
etc. This documents that all of the procedures in the audit program were indeed performed.

It should be made clear the link between any conclusion derived and the evidence obtained. All
of the judgments and interpretations made during the course of an audit should be in the work
papers and should be solidly based on the evidence gathered.
Tick marks should always be used consistently throughout the entire audit. No tick mark should
have more than one meaning at any time.

Preparing the Audit Report

Prepare an Excel spreadsheet of all audit findings. Fields should include: Work paper reference
Number, Section, ON/OFF report indicator, and a Comments Section. The Comments Section is
where the actual audit finding will be described.

Draft a Preliminary Report of all audit findings and audit recommendations. This report should
be discussed with the Department Manager and corrective actions should be addressed at this
time. The benefit of preparing a Preliminary Report is to allow the Department Manager to
defend itself against any findings. There may be a reasonable explanation for any finding.
However, additional documentation should be obtained before removing any exception from the
Final Audit Report. This provides an evidentiary trail to back up the Department Manager’s
position. Any exception to this requirement should be brought to the attention of the Internal
Auditor before the Final Audit Report is written. All Preliminary Reports should be indicated as
such by stamping “Tentative and Preliminary, Not for Distribution” to all pages of the report.
This will also be indicated on the audit findings report in the “Status of Finding” field.

The Final Audit Report should be prepared in accordance with the sample format attached. It
will be the policy of this department to obtain uniformity when writing all audit reports.

Each audit report should include:

 the purpose of the audit

 the objective of the audit
 the scope of the audit
 the sampling technique involved
 time frame in which the audit was conducted
  Description of audit procedures applied to test work
Assign a “PRIORITY” rating – LOW/MODERATE/HIGH – This directly correlates to the
associated risk.
State the “Status of Finding” – PRELIMINARY or FINAL.
Audit exception with the associated risk

Audit Recommendation
Corrective action taken. This is indicated in the audit report as the “Action Plan”.
Any Corrective Action taken must be completed prior to writing the Final Audit Report. This
demonstrates an agreement to each finding and facilitates corrective action. The Internal Auditor
must approve any exception.

Audit reports should be written in the active language, be impersonal, and be written in a positive
fashion. The Final Audit Report must express an opinion of the adequacy, effectiveness, and
efficiency of the control system and the quality of ongoing operations. When making a
recommendation for a corrective action in the report, a comment must be made on the potential
exposures that exist if the corrective action is not taken. For example, certain regulatory
violations could lead to Civil Money Penalties (CMPs) not only for the bank, but also for
individual employees.

For audits with an unusually high number of findings or for findings that are deemed to be in a
high-risk area, a time should be stated for an audit follow-up to ensure corrective actions have
been fully implemented.
For convenient reference, the auditors’ standard (unqualified) report is presented below.

Auditors’ Report to the Shareholders Of XYZ

We have audited the accompanying balance sheet of ABC Company as of December 31, 19 x 1,
and the related statements of income, retained earnings, and cash flows for the year then ended.
There financial statements are the responsibility of the company’s management. Our
responsibility is to express an opinion on those financial statements based on our audit.

We conducted an audit in accordance with generally accepted auditing standards. Those

standards require that we plan and perform an audit to obtain reasonable assurance whether the
financial statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting policies used and significant estimates made by management,
as well as evaluating the overall financial statements presentation. We believe that our audit
provide a reasonable basis for our audit 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 the company as of December 31, 19 x 1 and the
results of its operations and its cash flows for the year then ended in accordance with GAAP.
ABC Auditors

Date
Address
This report contains the following important elements:
- Title: Auditing standards require that the report be titled and include the word independent.
- Address: The audit report is addressed to the individual or group that engaged the auditors.
- Introductory paragraph: - The first paragraph of the report does three things:
 Specifies the financial statements to which the report relates,
 Specifies the respective responsibilities of directors and auditors, and;
 It makes the simple statement that the auditor has done an audit.

- Scope paragraph: -The scope paragraph describes the nature of an audit. The scope
paragraph states the following the:
 auditors followed GAAS,
 audit is designed to obtain a reasonable assurance about whether the financial
statements are free of material misstatements.
 audit evidence accumulated and the auditor believes the evidence accumulated was
appropriate for the circumstances to express the opinion presented.
- Opinion paragraph: The final paragraph in the standard report states the auditors’
conclusion based on the results the audit examination.
- Name of the audit firm.
- Audit report date. The appropriate data for the audit report is the one on which the auditor
has completed the most important auditing procedures in the field.

Expression Of An Opinion
The auditors’ opinions when expressing an opinion on financial statements may be summarized
as follows:
1. an unqualified opinion – standard report.
2. a qualified opinion.
3. an adverse opinion.
4. a denial opinion.
All significant reasons for the issuance of a qualified, adverse, or denial of opinion should be set
forth in a reservation paragraph between the scope and opinion paragraph.

Auditors must qualify their report whenever there are material deficiencies in the client’s
financial statements.

The Unqualified Report

The unqualified report is used when the following conditions are met:
1. All statements - balance sheet, income statement, statements of retained earnings, and
statement of cash flows are included in the financial statement.
2. The three general standards have been followed in all respects on the engagements.
3. Sufficient evidence has been accumulated.
4. The financial statements are presented in accordance with generally accepted accounting
principles.
5. There are no circumstances requiring the addition of an explanatory paragraph or
modification of the wording of the report.

In general, auditors express an unqualified opinion on the client’s financial statements when
there has been no material departure from GAAP and there have been no material unresolved
restrictions on the scope of their audit.

Under certain circumstances, however, auditors may add additional wording to the standard
report even though they are issuing an unqualified opinion. This additional wording draws
attention to certain statutory requirements or a specific matter. Another modification of a
standard audit report is the auditors’ emphasis of a matter regarding the client’s financial
statements. Emphasis of matter may require in the auditor’s unqualified report 1) to highlight a
matter regarding a going concern problem and 2) when there is a significant uncertainty (other
than going concern problem), the resolution of which is dependent upon future events and which
may affect the financial statements.

Qualified Opinions
Auditors may issue opinions other than unqualified opinion when 1) they do not agree with the
accounting principles used in preparing financial statements or when they believe disclosures in
the statement are inadequate; 2) a change in accounting principle is not applied properly a as per
GAAP, and is not adequately disclosed in the financial statements; 3) there are limitations on
scope of examination; and /or 4) there is major uncertainty affecting a client’s business’.

A. Qualified opinion -except for: This is issued when there is a limitation of Scope; or the
auditor disagrees with an accounting treatment or disclosure. The opinion states that
except for the effects of some material departure from GAAP, or some material limitation
in the scope of the auditors’ examination, the financial statements are presented fairly.

The auditors’ reports should have a separate reservation paragraph disclosing the reasons
for the qualification.
B. Adverse opinion: This is a stronger form of ‘except for’ opinion – the disagreement is so
material that the financial statements as a whole are misreading. When the auditors
express an adverse opinion, they must have accumulated sufficient appropriate evidence
to support their unfavourable opinion.

Whenever the auditors issue an adverse opinion, they should disclose in a separate paragraph of
their report the reasons for the adverse opinion and the principal effects of the adverse opinion on
the client company’s financial position and operating results.

Example, an audit report that included an adverse opinion might have an opinion paragraph such
as the one as follows:

In our opinion, because of the effects of the matters discussed in the preceding paragraph, these
financial statements do not present fairly the financial positions of the company as at December
31, 19 x 1, and the results of its operations and cash flow position for the year then ended, in
accordance with generally accepted accounting principles.

C. Denial of opinion. A denial (disclaimer) of opinion is no opinion. In an audit

engagement, a denial is required when very significant restrictions on the scope of the
audit preclude compliance with generally accepted auditing standards.
A very significant scope limitation may be caused by the client or by the timing of the
auditors’ appointment and their audit work or by factors beyond the control of the client
or the auditors, rather than by restrictions imposed by the client.