Auditing Theory (AT-12)

CKC- BSA 3

THE AUDITOR’S REPORT ON FINANCIAL STATEMENTS

(Based on PSA 700 revised – The Independent Auditor’s Report
On a Complete Set of General Purpose Financial Statements)

INDEPENDENT AUDITOR’S REPORT

[Appropriate addressee]

Report on the financial statements

[This subheading is unnecessary in circumstances when the second subheading “Report on
Other Legal and Regulatory Requirements” is not applicable.

We have audited the accompanying financial statements of ABC Company which comprise a
balance sheet as at date December 31, 20X1, and the income statement, statement of changes
in equity and cash flow statement for the year ended, and a summary of 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 the Philippine Financial Reporting Standards. This responsibility includes:
designing, maintaining and implementing internal control relevant to the preparation and fair
presentation of financial statements that are free from material misstatements, whether due to
fraud or error; selecting and applying appropriate accounting policies; and making accounting
estimates that are reasonable in 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 Philippine 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 upon the auditor’s
judgment, including the assessment of the risks of material misstatements on 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 internal control of the entity.
An audit also includes evaluating the appropriateness of the accounting policies used and the
reasonableness of accounting estimates made by the 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 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 the Philippine 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 Auditor’s
report] [Auditor’s
address]
MODIFICATIONS TO THE INDEPENDENT AUDITOR’S REPORT (BASED ON PSA 701)
Matters that do not affect the auditor’s opinion
 You may add an emphasis of matter paragraph to the report to highlight a matter
affecting the financial statements which is included in the note of the financial
statements that more extensively discuss the matter
 The paragraph would preferably be included after the opinion paragraph but before the
section on any other reporting responsibilities, if any.
 Emphasis of matter paragraph is used to highlight the existence of:
 Material uncertainty relating to the event or condition that may cast significant
doubt on the entity’s ability to continue as a going concern; or
 Significant uncertainty (other than a going concern problem), the resolution of
which is dependent upon future events and which may affect the financial
statements
 Emphasis of matter paragraph to report on matters other than those affecting the financial
statements. For example, if an amendment to other information in a document containing
audited financial statements is necessary and the entity refuses to make an amendment

Example of an emphasis of matter paragraph relating to a going concern problem:

Without qualifying our opinion, we draw attention to Note X in the financial statements
which indicates that the Company incurred a net loss of P during the year ended
December 31,20X1 and, as of date, the company’s current liabilities exceeded its total assets by
P . These conditions, along with other
matters, as set forth in Note X, indicate the existence of a material uncertainty which may cast
significant doubt about the Company’s ability to continue as a going concern.

Matters that affect the auditor’s opinion

 If the following circumstances exists that the auditor may not be able to conclude an
unqualified judgment and the effect of the matter is or may be material to the financial
statements:
 There is a limitation on the scope of the auditor’s work. – could lead to a
qualified opinion or a disclaimer of opinion
 A disagreement with the management regarding the acceptability of the
accounting policies selected the method of their application on the
adequacy of financial statement disclosures. Could lead to a qualified
opinion or an adverse of opinion.

Qualified opinion
 Should be expressed when the auditor concludes that the unqualified opinion cannot be
expressed but that the effect of any disagreement with management, or limitation on
scope is not so material and pervasive as to require an adverse opinion or a disclaimer of
opinion.
 A qualified opinion should be expressed as being “except for” the effects of the matter
to which the qualification relates.
Adverse opinion
 Should be expressed when the effect of the disagreement is so material and pervasive to
the financial statements that the auditor concludes that a qualification of the report is
not adequate to disclose the misleading or incomplete nature of the financial
statements.
Disclaimer of Opinion
 Should be expressed when the possible effect of a limitation on the scope is so material
and pervasive that the auditor has not been able to obtain sufficient appropriate audit
evidence and accordingly is unable to express an opinion on the financial statements.
REPORT MODIFICATIONS

Limitation on scope

ILLUSTRATIVE EXAMPLES OF MODIFIED REPORTS

1. LIMITATION ON SCOPE – QUALIFIED OPINION

We have audited … (remaining words are the same as in the introductory page)

Management is responsible for … (same as illustrated in the management’s

responsibility
paragraph)

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 … (auditor’s responsibility paragraph)

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 we been able to satisfy ourselves as to
physical inventory quantities, the financial statements fairly presents, in all
material respects … (opinion paragraph)

2. LIMITATION ON SCOPE – DISCLAIMER OF OPINION

We were engaged to audit the accompanying financial statements of ABC
Company, which comprise the balance sheet date as of December 31, 20X1, and
the income statements, statement of changes in equity and cash flow statement
for the year ended, and a summary of significant accounting policies and other
explanatory notes.

Management is responsible for … (same as illustrated in the management’s

responsibility
paragraph)

(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 describing the scope limitation as follows:

We were not able to observe all physical inventories and confirm accounts
receivables 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.

3. DISAGREEMENT ON ACCOUNTING POLICIES – INAPPROPRIATE ACCOUNTING

METHOD QUALIFIED OPINION
We have audited … (remaining words are the same as in the introductory page)
 Management is responsible for … (same as illustrated in the management’s
responsibility
paragraph)
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 … (auditor’s responsibility paragraph)

As discussed in the Note X to the financial statements, no depreciation has been

provided in the financial statements which practice, in our opinion, is not in
accordance in PFRS. The provision for the year ended December 31, 20X1,
should be xxx based on the straight-line method of depreciation using annual
rates of 5% for the building and 20% for the equipment. Accordingly, the fixed
assets should be reducedby accumulated depreciation of xxx and the loss for the
year and accumulated deficit should be increased by xxx and xxx, respectively.

In our opinion, except for the effects of such adjustments, if any, as might have
been determined to be necessary had we been able to satisfy ourselves as to
physical inventory quantities, the financial statements fairly presents, in all
material respects … (opinion paragraph)

4. DISAGREEMENT ON ACCOUNTING POLICIES – INADEQUATE

DISCLOSURES QUALIFIED OPINION
We have audited … (remaining words are the same as in the introductory page)

Management is responsible for … (same as illustrated in the management’s

responsibility
paragraph)

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 … (auditor’s responsibility paragraph)

On January 31,20X2, the Company issued debentures in the amount of… for the
purpose of financing plant expansion. The debenture agreement restricts the
payment of future cash dividends to earnings after December 31,19X1, which
restrictions was not disclosed in the company’s financial statements. Disclosure
of this is required by the PAS 1, Presentation of financial statements.

In our opinion, except for the omission of the information included in the
preceding paragraph, the financial statements present fairly, in all material
respects… (opinion paragraph)

5. DISAGREEMENT ON ACCOUNTING POLICIES – INADEQUATE

DISCLOSURE ADVERSE OPINION
We have audited … (remaining words are the same as in the introductory page)

Management is responsible for … (same as illustrated in the management’s

responsibility
paragraph)

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 … (auditor’s responsibility paragraph)
 (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 present fairly, in all material
respects, the financial position of ABC Company as of December 31,19X1, and
of its financial performance and its cash flows for the year then ended in
accordance with PFRS… (Opinion paragraph)

SUBSEQUENT EVENTS (BASED ON PSA 560)

1. The auditor should consider the effect of subsequent events on the financial statements
and on auditor’s report.

Events occurring up to the date of the auditor’s report

2. The auditor should perform procedures designed to obtain sufficient appropriate audit
evidence that all events up to date of the auditor’s report that may require adjustment
of, or disclosure in, the financial statements have been identified.
3. When the auditor becomes aware of events which materially affect the financial
statements, the auditor should consider whether such events are properly accounted
for and adequately disclosed in the financial statements.

Facts discovered after the date of the auditor’s report but before the financial statements are
issued
4. During the period from the date of the auditor’s report to the date the financial
statements are issued:
o The responsibility to inform the auditor of facts which may affect the financial
statements rests with management
o When the auditor becomes aware of the facts that will materially affect the
financial statements, the auditor should:
 Consider whether the financial statements needed amendment
 Discuss the matter with the management
 Take the action appropriate in the circumstances
When the management amends the financial statements, the auditor would carry out the
procedures necessary in the circumstances and would provide management with a new report on
the amended financial statements
5. The new auditor’s report would be dated not earlier than the date the amended financial
statements are signed or approved and, accordingly, the procedures to identify
subsequent events would be extended to the date of the new auditor’s report
6. When management does not amend the financial statements but the auditor believes
they need to be amended and the auditor’s report has not been released to the entity, the
auditor should express a qualified opinion or an adverse opinion.

Facts discovered after the financial statements have been issued

7. After the financial statements have been issued, the auditor has no obligation to make
any inquiry regarding such financial statements.
8. When, after the financial statements have been issued, the auditor becomes aware of a
fact which existed at the date of the auditor’s report and which, if known at date, may
have caused the auditor to modify the auditor’s report, the auditor should:
o Consider whether the financial statements need revision
o Discuss the matter with management
o Take the appropriate action in the circumstances
9. When management revises the financial statements, the auditor would:
o Carry out the audit procedures necessary in the circumstances
o Review the steps taken by management to ensure that anyone in receipt of the
previously issued financial statements together with the auditor’s report thereon is
informed of the situation.
o Issue a new report on the revised financial statements:
 Include an emphasis of a matter paragraph.
 Would be dated earlier than the date the revised financial statements are
approved
  The auditor is permitted to restrict the audit procedures regarding the
revised financial statements to effects of the subsequent event that
necessitated the revision.
10. It may not be necessary to revise the financial statements and issue a new auditor’s
report when issue of the financial statements for the following period is imminent,
provided appropriate disclosures are to be made in such statements

USING THE WORK OF ANOTHER AUDITOR (BASED ON PSA 600)

1. The principal auditor is the auditor with responsibility for reporting on the financial
statements of an entity when those financial statements include financial information of
one or more components audited by another auditor
2. The auditor should consider whether the auditor’s own participation is sufficient to be
able to act as principal auditor. The following would be considered:
o The materiality of the portion of the financial statements which the principal
auditor audits
o The principal auditor’s degree of knowledge regarding the business of the
components
o The risk of material misstatements in the financial statements of the
components audited by the other auditor
o The performance of additional procedures as set out in PSA 600 regarding the
components audited by other auditor resulting in the principal auditor having
significant participation in such audit
3. When planning to use the work of another auditor, the principal auditor should:
o Consider the professional competence of the other auditor in the context of
specific assignment
o Perform procedures to obtain sufficient appropriate audit evidence that the work
of the other auditor is adequate for the principal auditor’s purposes in the
context of the specific assignment
o Consider the significant findings of the other auditor
4. Reporting conclusions

o When the principal auditor concludes that the work of the other cannot be used
and the principal auditor has not been able to perform sufficient additional
procedures regarding financial information of the component audited by the
other auditor, the principal auditor should express a qualified or a disclaimer of
opinion because of a scope of limitation.
o If the auditor issues or intend to issue, a modified auditor’s report, the principal
auditor would consider whether the subject of modification is of such a nature and
significance, in relation to the financial statements of the entity on which the
principal auditor is reporting that a modification on the principal auditor’s report
is required.

5. Division of responsibility
o When the principal auditor bases the audit opinion on the financial statements
taken as a whole solely upon the report of another auditor regarding the audit of
one or more components, the principal auditor’s report should state this fact
clearly and should indicate the magnitude of the portion of the financial
statements audited by the other auditor.

COMPARATIVES (BASED ON PSA 710)

1. Two broad financial reporting frameworks for comparatives:

CORRESPONDING FIGURES
o For the prior periods, these are an integral part of the current period financial
statements and have to be read in conjunction with the amounts and other
disclosures relating to the current period.
o These are not presented as complete financial statements capable of standing
alone
o The auditor should obtain sufficient appropriate audit evidence that the
corresponding figures meet the requirements of GAAP in the Philippine
o The auditor should assess whether:
 Accounting policies used for the corresponding figures are consistent
with those of the current period or whether appropriate adjustments
and/or disclosures have been made
  Corresponding figures agree with the amounts and other disclosures
presented in prior period or whether appropriate adjustments and/or
disclosures have been made
COMPARATIVE FINANCIAL
STATEMENTS
 These comparative financial statements for the prior period(s) are considered separate
financial statements.
 These are presented for comparison with the financial statements of the current period,
but do not form part of the current period financial statements
 The auditor should obtain sufficient appropriate evidence that the comparative financial
statements meet the requirements of GAAP in the Philippines
 The auditor should assess whether:
o Accounting policies of the prior period are consistent with those of the current
period or whether appropriate adjustments and/or disclosures have been made
o Prior period figures presented agree with the amounts and other disclosures
presented in the prior period or whether appropriate judgments and disclosures
have been made

REPORTING – CORRESPONDING
FIGURES
1. The comparatives are not specifically identified in the audit report because the auditor’s
opinion is on the current period financial statements as a whole, including the
corresponding figures
2. When the auditor’s report on the prior period, as previously issued, included an opinion
other than unqualified and the matter which gave rise to the modification is:
 a. Unresolved, and results in modification of the auditor’s report regarding the
current figures period, the auditor’s report should also be modified regarding the
corresponding figures
b. Unresolved, but does not result in a modification of the auditor’s report regarding
the current period figures, the auditor’s report should also be modified regarding
the corresponding figures
c. Resolved, and properly dealt with in the financial statements, the current period
report does not ordinarily refer to the previous modification. However, if the
matter is material to the current period, the auditor may include an emphasis of
the matter paragraph dealing with the situation

3. When the incoming auditor decides to refer to the predecessor auditor’s report, the
incoming auditor’s report should indicate:
a. That the financial statements of the prior period were audited by another
auditor
b. Type of report issued by the predecessor auditor and, if the report was modified,
the reasons therefore;
c. Date of that report

4. When the prior period financial statements were not audited, the incoming auditor
should state that the corresponding figures are unaudited.
5. If the incoming auditor identifies that the corresponding figures are materially
misstated, the auditor should request management to revise the corresponding figures or
if management refuses to do so, appropriately modify the report

REPORTING – COMPARATIVE FINANCIAL

STATEMENTS CONTINUING AUDITOR
1. The auditor may express adverse or qualified opinion, disclaim an opinion, or include an
emphasis of paragraph with respect to one or more financial statements for one or more
period, while issuing a different report on the other financial statements
2. When finding the connectivity of the prior period financial statements with the current
financial statements, if the opinion on such prior period is different from the opinion
previously expressed, the auditor should disclose the substantive reasons for the
different opinion in an emphasis of matter paragraph

INCOMING AUDITOR
When the financial statements of the prior period were audited by another auditor,
 The predecessor auditor may reissue the audit report on the prior period with the
incoming auditor only reporting on the current period; or
 The incoming auditor’s report should state that the prior period was audited by another
auditor and the incoming auditor’s report should indicate:
o That the financial statements of the prior period was audited by another auditor
o The type of report issued by the predecessor auditor, and if the report was
modified, the reasons; therefore
o Date of the report

PRIOR PERIOD FINANCIAL STATEMENTS NOT AUDITED

1. When the prior financial statements were not audited, the incoming auditor should
state in the auditor’s report that the comprehensive financial statements are unaudited
2. If the prior period financial statements were materially misstated, the auditor should
request management to revise the prior year’s figures or if management refuses to do
so, appropriately modify the report

OTHER INFORMATION IN DOCUMENTS CONTAINING AUDITED FINANCIAL

STATEMENTS (BASED ON PSA 720)
 1. An entity ordinarily issues on an annual basis a document which includes its audited
financial statements together with the auditor’s report thereon, also called “annual
report”.

Material inconsistencies
2. This exists when the other information contradicts information contained in the audited
financial statements
3. If, on reading the other information, the auditor identifies material inconsistency, the
auditor should determine whether the financial statements need to be amended
 If the amendment is necessary and the entity refuses to make an
amendment, the auditor should express a qualified or adverse opinion
 If the amendment is necessary and the entity refuses to make an
amendment, the auditor should consider including in the auditor auditor’s
report an emphasis of matter paragraph.

Material misstatements of facts

4. A Material misstatements of fact in other information exists when such information, not
related to matters appearing in the audited financial statements, is incorrectly stated or
presented
5. If the auditor becomes aware that there is a misstatement of fact, the auditor should
discuss the matter with the entity’s management
6. When the auditor still considers there is an apparent misstatement of fact in the other
information which management refuses to correct, the auditor should consider taking
appropriate action such as notifying those persons ultimately responsible for the overall
direction of the entity in writing of the auditor’s concern regarding the other information
and obtaining legal advice

THE AUDITOR’S REPORT ON SPECIAL PURPOSE AUDOT ENGAGEMENTS

(BASED ON PSA 800)
1. Special purpose audit engagements include:
a. Financial statements prepared in accordance with a comprehensive basis of
accounting other than GAAP in the Philippines
b. Specified accounts, elements of accounts, or terms in a financial statement
c. Compliance with contractual agreements
d. Summarized financial statements
2. The auditor should assess and review the conclusions drawn from the audit evidenced
obtained during the special purpose audit engagement as the basis for an expression of
opinion. The report should contain a clear written expression of opinion
3. Before undertaking a special purpose audit engagement, the auditor should ensure
there is agreement with the client as to the exact nature of the engagement and the
form and content of the report to be issued
4. The auditor’s report on a special purpose audit engagement, except for a report on
summarized financial statements, should include the following basic elements,
ordinarily in the following layout:
 Title
 Addressee
 Opening or introductory paragraph
o Identification of the financial information audited
o A statement of the responsibility of the entity’s management and the
responsibility of the auditor
 A scope paragraph
o Reference to the PSAs applicable to special purpose audit engagements
o Description of the work the auditor performed
 Opinion paragraph containing an expression of opinion on the financial
information
 Date of the report
 Auditor’s address
 Auditor’s signature
Reports on an “other comprehensive basis of accounting” financial statements
1. The report should include a statement that indicates the basis of accounting used or
should refer to the note to the financial statements giving that information
2. The opinion should state whether the financial statements are prepared, in all material
aspects, in accordance with the identified basis of accounting
3. If the financial statements are not suitably titled or the basis of accounting is not
adequately disclosed, the auditor should issue an appropriately modified report

Reports on a component financial statement

1. This type of engagement may be undertaken as a separate engagement or in
conjunction with an audit of the entity’s financial statements
2. The auditor’s report on a component of financial statements should include a statement
that indicates the basis accounting in accordance with which the component is presented
or refers to an agreement that specifies the basis. The opinion should state whether the
component is prepared, in all material aspects, in accordance with the identified basis of
accounting.
3. When an adverse opinion or disclaimer of opinion on the entire financial statements has
been expressed, the auditor should report components of the financial statements only if
those components are not so extensive as to constitute a major portion of the financial
statements. To do otherwise may overshadow the report on the entitre financial
statements.

Reports on a compliance with contractual agreements

1. Engagements to express an opinion as to an entity’s compliance with contractual
agreements should be undertaken only when the overall aspects of compliance relate to
accounting and financial matters within the scope of the auditor’s professional
competence
2. The report should state whether, in the auditor’s opinion, the entity has complied with
the particular provisions of the agreement

Reports on summarized financial statements

1. Unless the auditor has expressed an audit opinion on the financial statements from
which the summarized financial statements are derived, the auditor should not report
the summarized financial statements
2. Summarized financial statements should be appropriately titled to identify the audited
financial statements from which they have been derived.
3. Summarized financial statements do not contain all the information required by the
financial reporting framework used for annual audited financial statements.
Consequently, wording such as “present fairly, in all material respects,” is not used
4. The following elements in an auditor’s report:
a. Title
b. Addressee
c. An identification of the audited financial statements from the summarized
financial statements were derived
d. A reference to the date of the audit report on the unabridged financial
statement and the type of opinion given in that report
e. An opinion as to whether the information in the summarized financial
statements is consistent with the audited financial statements from which it is
derived
f. A statements, or reference to t note within the summarized financial statements,
which indicates that for a better understanding of an entity’s financial
performance and position and of the scope of the audit performed, the
summarized financial statements should be read n conjunction with the
unabridged financial statements and the audit report thereon
g. Date of the report
h. Auditor’s address
i. Auditor’s signature