Modification to the audit opinion explained

Hayley Barker Hoogwerf, Saica project director: assurance

The advances in technology that provide the auditor with the ability to continue operating do not come without challenges. The two biggest are the inability to perform physical verification of assets and employees, and the inability to obtain and inspect original documents. The auditor’s inability to perform specific audit procedures may give rise to a limitation on the scope of the audit, when no alternative procedures can be performed, which in turn may impact the audit opinion expressed.

Auditors are permitted to resume their duties as the country has moved to lockdown alert level 3. However, certain opportunities to obtain sufficient appropriate audit evidence have been lost, with the most pertinent of these being the auditor’s ability to physically attend a March, April and even May 2020 year-end inventory count. These missed opportunities will be considered a limitation on the scope of the audit if the auditor is not able to obtain sufficient appropriate audit evidence by performing alternative procedures. As a result, the market may well see an increase in modified audit opinions expressed. What does this mean for the investor?

Types of modifications to the audit opinion

The auditor is required to form an opinion on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. This opinion must be supported by the necessary audit evidence. If the auditor is unable to obtain sufficient appropriate audit evidence to support the audit conclusion, the auditor is required to modify the audit opinion.

There are two types of modified audit opinions that the auditor can express when faced with an inability to obtain sufficient appropriate audit evidence, namely:

• Qualified opinion, or except for opinion; or
• Disclaimer of opinion, where the auditor does not express an opinion.

In determining which modification is appropriate, the auditor needs to consider whether the possible effects on the financial statements of undetected misstatements, if any, could be either material, or material and pervasive.

Materiality is a user-orientated concept and recognises that some matters, either individually or in aggregate, are important to users in making economic decisions based on the financial statements. It can also be described as a measure of users’ tolerance for misstatement. The auditor’s determination takes into account both quantitative and qualitative factors.

The Glossary of Terms to the International Auditing and Assurance Standards Board’s International Standards indicates that a matter is pervasive if it is not confined to specific elements, accounts or items of the financial statements, but if so confined, represents a substantial portion of the financial statements, or in relation to disclosures, is fundamental to users’ understanding of the financial statements.

Qualified opinion

If the auditor concludes that the possible effects on the financial statements of undetected misstatements could be material but not pervasive, a qualified opinion will be expressed. Here, the auditor states that except for a particular matter, the financial statements present fairly, in all material aspects, the state of affairs. The auditor is required to describe the matter that gave rise to the qualified opinion and make it clear why he/she was not able to obtain sufficient appropriate audit evidence and why the effect on the financial statements may be material, in a separate section of the auditor’s report.

Examples of the wording used in the auditor’s report under the Basis of Qualified Opinion paragraph are as follows:

• Due to the national lockdown, we were unable to observe the counting of physical inventories at the end of the year. We were unable to satisfy ourselves by alternative means concerning the inventory quantities held at 31 December 20X1, which are included in the balance sheet at xxx, by using other audit procedures. Consequently we were unable to determine whether any adjustment to this amount was necessary (based on Illustration 5 contained in International Standard on Auditing (ISA) 705 (Revised), Modifications to the Opinion in the Independent Auditor’s Report (ISA 705 (Revised)).
• The group’s investment in XYZ Company, a foreign associate acquired during the year and accounted for by the equity method, is carried at xxx on the consolidated statement of financial position as at 31 December 20X1, and ABC’s share of XYZ’s net income of xxx is included in ABC’s income for the year then ended. We were unable to obtain sufficient appropriate audit evidence about the carrying amount of ABC’s investment in XYZ as at 31 December 20X1 and ABC’s share of XYZ’s net income for the year because of the travel restrictions imposed as a result of the Covid-19 global pandemic and the inability to transfer information due to laws and regulations that restrict cross-border sharing of information. Consequently, we were unable to determine whether any adjustments to these amounts were necessary (based on Illustration 3 contained in ISA 705 (Revised)).It is important to note that the auditor is saying that except for the identified matter that is explained in the basis for the qualified opinion, the rest of the financial statements fairly present the state of affairs.

Disclaimer of opinion

If the auditor concludes that the possible effects on the financial statements of undetected misstatements could be both material and pervasive, the auditor will issue a disclaimer of opinion.

An example of the wording used in the auditor’s report under the Basis of Disclaimer of Opinion paragraph is as follows:

• Due to the national lockdown, we were unable to observe the counting of physical inventories at the end of the year. We were unable to satisfy ourselves by alternative means concerning the inventory quantities held at 31 December 20X1, which are included in the balance sheet at xxx, by using other audit procedures. Consequently, we were unable to determine whether any adjustment to this amount was necessary. In addition, the introduction of a new computerised accounts receivable system in September 20X1 resulted in numerous errors in accounts receivable. As of the date of our report, management was still in the process of rectifying the system deficiencies and correcting errors. We were unable to confirm or verify by alternative means accounts receivable included in the statement of financial position at a total amount of xxx as at 31 December 20X1. As a result of these matters, we were unable to determine whether any adjustments might have been found necessary in respect of unrecorded inventories and accounts receivables, and the elements making up the statement of comprehensive income, statement of changes in equity and statement of cash flows (based on Illustration 5 contained in ISA 705 (Revised)).

It is important to note that the auditor does not withhold the opinion on the affected elements of the financial statements; an opinion on the financial statements as a whole is not expressed.

In closing

The auditor’s report is the auditor’s primary means of communicating the results of the audit to the users of the financial statements. A modified opinion does not necessarily mean a complete failure on either the part of management or the auditor in preparing or reporting on the financial statements. In the event of a modification to the audit opinion, investors and other users of the financial statements are encouraged to pay close attention to the auditor’s report as it contains valuable information that is key to the users’ understanding of what gave rise to the modification.