1. 1 CHAPTER 6 AUDIT REPORT

2. Introduction 2  The auditor submits his report to his client giving clear and concise information of the result of audit performed by him.  The fact or information contained in the auditor’s report is not available from any other source.  Auditor’s report is the end product of his audit work.  By submitting the report, the auditor completes his duty as imposed by the respective statutes.  The most important value of the auditor’s report is reflected through its checking and verifying the procedure as to accuracy and fairness of the facts and figures that appear in the books of account of the company.

3. Introduction 3  An auditor’s report is the independent examination of, and expression of opinion on the financial statements of the company by appointed auditors in pursuance of that appointment and incompliance with any statutory obligations.  The responsibility for the preparation of the financial statements and the presentation of the information included therein rests with management of the company  The auditor’s report is, therefore, the means by which the auditors formally communicates the results of his /her/audit to the members of the company as well as to the readers of financial statements  The auditor’s report does not guarantee the truth or otherwise of the matter reported upon; it is expression of auditors’ opinion on the financial statements  All they can do is to report whether or not, in his/her opinion; the financial statements are true and fair

4. 6.1: Purpose and form of audit report 4 The auditor’s report thus, serves the under mentioned purposes. 1. It substantiates that the financial information of the company reflects a true and fair picture of the state of affair of clients business. 2. It summarizes the result of the audit work carried out by the auditors. 3. A report from acquainting the shareholders with material facts about the affairs of company’s business, it offers an opportunity to the readers of financial statements such as creditors, bankers, financial institutions, and potential investors and others to get reliable insight into the financial position of the company as reflected by its profit and loss accounts and the balances sheet. 4. Auditors’ report is the indicator of credibility of financial statements. Thus, an auditor’s report is a valuable document in which the auditors sets forth the scope and nature of the audit and also gives her/his impartial opinion as regards the financial statements of client’s business.

5. 6.1.2 Form of audit report-or Elements of the Auditor's Report a) Title The auditor's report should have a title that clearly indicates that it is the report of an independent auditor. b) Addressee The auditor's report should be addressed as required by the circumstances of the engagement. c) Introductory paragraph It should identify the entity whose FS have been audited and should state that the FS have been audited. It should also: Identify the title of each of the FS that comprise the complete set of FS. Refer to the summary of significant accounting policies and other explanatory notes; and Specify the date and period covered by the FS. PwC 5

6. Elements of the Auditor's Report (cont'd) d) Management's responsibility for the financial statements The auditors should state that management is responsible for the preparation and the fair presentation of the FS in accordance with the applicable financial reporting framework and that this responsibility includes: Designing, implementing and maintaining internal control relevant to the preparation and fair presentation of FS that are free from material misstatement; Selecting and applying appropriate accounting policies; and Making accounting estimates that are reasonable in the circumstances. PwC 6

7. Elements of the Auditor's Report (cont'd) e) Auditor's responsibility (scope) The auditor's report should state that : the responsibility of the auditor is to express an opinion on the FS based on the audit. the audit was conducted in accordance with International Standards on Auditing. the auditor believes that the audit evidence the auditor has obtained is sufficient and appropriate to provide a basis for the auditor's opinion The auditor's report should describe an audit by stating that: An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the FS The procedures selected depends on the auditor's judgment, including the assessment of the risks of material misstatement of the FS, whether due to fraud or error An audit also includes evaluating the appropriateness of the accounting policies used, the reasonableness of the accounting estimates made by management, as well as the overall presentation of the FS. PwC 7

8. Elements of the Auditor's Report (cont'd) f) Auditor's opinion( conclusion) An unqualified opinion that the FS give a true and fair view or are presented fairly, in all material respects, in accordance with applicable financial reporting framework. An expression of opinion on the financial statements. A reference of the financial reporting framework used to prepare the FS When IFRS are not used, the reference to the financial reporting framework should identify the jurisdiction or country of origin of the financial reporting framework e.g. United Kingdom generally accepted accounting standards. PwC 8

9. Elements of the Auditor's Report (cont'd) g) Other reporting responsibilities; Other reporting responsibilities should be addressed in a separate section in the auditor's report that follows the opinion paragraph. h) Auditor's signature The auditor's report should be signed. i) Date of the report Should date the report on FS no earlier than the date on which the auditor has obtained sufficient appropriate audit evidence on which to base the opinion on the FS. j) Auditor's address example..\Independent Auditor.docxIndependent Auditor.docx PwC 9

10. 6.2: Types of auditors’ reports (opinions) 10 the auditors’ reports may be classified as follows. 1) Unqualified ( clean ) report 2) Qualified report 3) Adverse report(negative report) 4) Disclaimer of opinion ( no-opinion)

11. 6.2: Types of auditors’ reports (opinions) 11 Unqualified ( clean ) or unmodified report: An auditors’ report with an unqualified opinion may be issued only when the following two conditions have been meet. i. The financial statements are presented in conformity with GAAP or IFRS or any law, including disclosure. ii. The audit was performed in accordance with GAAS or IAS, with no significant scope limitations preventing the auditors from gathering the evidence necessary to support their opinion.

12. STANDARDS OF REPORTING  GAAS includes four generally accepted reporting standards. These standards relate to GAAP, consistency, adequate disclosure, and expressing an opinion. FIRST STANDARD OF REPORTING  The first standard of reporting states: “The report shall state whether the financial statements are presented in accordance with generally accepted accounting principles (GAAP)”.  This statement requires the expression of an opinion rather than a statement of fact.  For purposes of this standard, GAAP include not only accounting principles, such the cost principle, but also the methods of applying them, such as the first-in-first-out (FIFO) and last-in-last-out (LIFO) methods for inventories, 12

13. STANDARDS OF REPORTING  GAAS includes four generally accepted reporting standards.  These standards relate to GAAP, consistency, adequate disclosure, and expressing an opinion. 13

14. and the straight line and sum-of-the-years’ digits methods of depreciation.  The phrase GAAP includes broad guidelines as well as specific conventions, rules, and procedures.  The AICPA says that whenever promulgated accounting principles apply to an entity’s financial statements, they must be followed in meeting the first standard of reporting. SECOND STANDARD OF REPORTING  The second standard of reporting is: “The report shall identify those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period”.  The objectives of this standard are (a). To give assurance that the comparability of financial statements between accounting periods has not been materially affected by changes in accounting principles and (b). To require: appropriate reporting by the auditor when comparability has been materially affected by such changes. 14

15. THIRD STANDARD OF REPORTING  The third standard of reporting states: “Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report”.  Thus, in the absence of explicit wording in the auditor’s report to the contrary, the reader can conclude that the disclosure reporting standard has been met.  If the financial statements and accompanying notes fail to disclose information required by GAAP, the statements are not fairly presented.  Informative disclosures involve material maters relating to the form, arrangement, and content of the financial statements and the accompanying notes. 15

16.  Authoritative bodies, such as the FASB and the SEC, frequently include disclosure requirements in their pronouncements. FOURTH STANDARD OF REPORTING  This standard requires the auditor to express an opinion or assert that an opinion cannot be expressed. In the later case, the reasons therefore should be stated in the auditor’s report.  The objective of this standard is to prevent misinterpretation of the degree of responsibility the auditor is assuming when his or her name is associated with financial statements. This standard directly influences the form, content, and language of the auditor’s report. 16

17. 6.2: Types of auditors’ reports (opinions) 17 The unqualified auditor’s report could take either of the following two forms. (A) An unqualified opinion- standards report- The standard report express a “ clean opinion” and may be issued only when the two conditions listed in the preceding sections have been met and when no conditions requiring explanatory language exists. (The auditor’s report presented before for Ring Corporation of this chapter is an example of unqualified standard auditor’s report.) (B) An unqualified opinion –with explanatory language- under certain circumstances, auditors add explanatory languages to their report, even when issuing an unqualified opinion. Adding the additions languages is not regarded as a qualified; rather, the language merely draws attention to a significant situation. For example, the following auditor’s report on the financial statements of Harar Brewery Share Company indicates unqualified opinion with explanatory paragraph.Audit Service Corporation.docx CompanyindicatesAudit Service Corporation.docx

18. 6.2: Types of auditors’ reports (opinions) 18 Auditors may add explanatory languages to a report to: (I ) Indicate that a part of the audit was performed by other auditors- e.g. audit of consolidated entities financial information. In such case The principal auditors have two basic alternatives : 1. Make no references to the other auditors-if the principal auditors make no reference in their report to the portion of the engagements performed by other auditors, the principal auditors assume full responsibilities for the other auditors’ work. 2. Make reference to the other auditors- making reference to the work done by other auditors divides the responsibility for the engagements among the participating auditors firm or audit firm. This type of report is called a shared responsibility opinion, even though it is signed only by the principal auditors. II. Point out an uncertainty about the company’s ability to continue as a going concern. ( is substantial doubt about the client’s ability to continue as a going concern for a reasonable period of time ?)

19. 6.2: Types of auditors’ reports (opinions) 19 (iii) Describe an inconsistency in the application of accounting principles- when the auditors believe that the new principle is generally accepted, the accounting proper, and the change is justified, the audit report is modified to highlight the lack of consistent application of acceptable accounting principles, but the opinion remains unqualified. (iv) Emphasize a matter- Auditors also may issue an unqualified opinion that departs from the wording of the standards report in order to emphasize a matter regarding the financial statement. (V.)Describe a justified departure from officially recognized accounting principles- sometimes clients may believe that it is appropriate for the financial statements to depart from officially recognized accounting principles in order to achieve the more important objectives of a fair presentation. When the auditors agree, they may still issue an unqualified report, but they must disclose the departure in explanatory paragraph, either before or after the opinion paragraph.

20. 6.2: Types of auditors’ reports (opinions) 20 2. Qualified opinions- a qualified opinion expresses the auditor’s reservations or uncertainty about fair presentation in some areas of the financial statements.  The opinion states that except for the effects of some deficiency in the financial statements, or some limitations in the scope of the auditors’ examination, the financial statements are presented fairly.  All qualified reports include a separate explanatory paragraph before the opinion paragraph disclosing the reasons for the qualification.  Opinion paragraph of a qualified report includes the appropriate qualifying language and a reference to the explanatory paragraph.  When the report is qualified, the introductory and scope paragraph of the standard report are un affected. The modification involves adding an explanatory paragraph following the scope paragraphs and qualifying the opinion paragraph. Example..\ Independent Audito1.docx

21. 6.2: Types of auditors’ reports (opinions) 21 Auditors may issue qualified audit opinion when: 1. There is a departure from generally accepted accounting principles by client and auditors do not agree with the accounting principles used in preparing financial statements. 2. Scope limitations- limitation on the scope of an audit arise when the auditors are unable to perform essential audit procedures. Limitation may be imposed either by circumstances surrounding the audit (for example, the auditors were engaged too late in the year to observe the client’s beginning inventory or by the client (for example, the client refuses to allow the auditor to send confirmation to customers. 3. When the account do not disclose a true and fair view of the companies’ affairs, and when books of accounts have not been kept in accordance with the law and profit and loss accounts are not in agreements with the books of account and other related issues.

22. (3) Adverse Opinions 22 An adverse opinion is the opposite of an unqualified opinion; it is an opinion that is issued when; 1. The financial statements do not present fairly the financial position, results of operation, and cash flows of the client in conformity with generally accepted accounting principles. 2. When the deficiencies (departure) in the financial statements are so significant, that the financial statements taken as a whole are misleading

23.  So, an adverse report is the report in which the auditor categorically states that the income statement and the balance sheet do not exhibit a true and fair view of the state of affairs and working results of the concern.  An adverse report should be given by the auditor, only when he has strong and convincing evidence to support his conclusion.  He should disclose all the reasons of adverse report.  Generally in extreme cases like excess provision for depreciation, charging fictitious expenses etc., compel the auditor to give negative or adverse report.  An audit report that express an adverse opinion generally includes standard introductory and scope paragraphs, one or more explanatory paragraphs preceding the opinion paragraph and describing the reasons for the adverse opinion, and an opinion paragraphs. Example 23

24. 24 In our opinion, because of the effects of the matters discussed in the explanatory paragraph, the financial statements referred to above do not present fairly, in conformity with generally accepted accounting principles, the financial position of XYZ- Company as of December-31, 20x9, or the results of its operations or its cash flows for the year then ended. Opinion Paragraph of adverse report

25. (4) Disclaimer of opinion- 25 A disclaimer of opinion means giving no opinion as to the status of the financial statements under audit. Auditors issue a disclaimer whenever: 1. Auditors are unable to form an opinion or have not formed an opinion as to the fairness of presentation of the financial statements due to significant scope limitations either by substantial circumstances and/ or by client and this limitations of scope precludes the auditors’ compliance with generally accepted auditing standards and 2. When a material uncertainty affects the financial statements. E.g. The probable outcome of a very significant lawsuit against the client

26. 26 Disclaimer of opinion – Scope limitation Independent Auditor’s Report We have audited the accompanying balance sheet of General Ring Corporation as of December 31, 1999 and 1988, and the related statements of income, retained earnings, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. [Scope paragraph of standard report should be omitted] We were unable to observe the taking of physical inventories stated in the accompanying financial statements at $4,550,000 as of December, 1999 and $4,357,000 as of December 1998, since those dates were prior to the time we were engaged as auditors for the company. The company’s records do not permit the application of other auditing procedures regarding the existence of inventories. Since we did not observe physical inventories and we were not able to apply other auditing procedures to satisfy ourselves as to inventory quantities, the scope of our audit work was not sufficient to enable us to express, and we do not express, an opinion on these financial statements. Disclaimer of opinion when the Auditor is independent We are not independent with respect to General Ring Corporation and the accompanying balance sheet of as of December 31, 1999 and 1988, and the related statements of income, retained earnings, and cash flows for the years then ended were not audited by us; we do not express an opinion on them.

27. Materiality 27 Materiality- the term materiality in the auditor’s report may be defined as “sufficiently important to influence Decisions made by reasonable users of financial statements. It is a relative term in a sense that what is material for a given circumstance may not be material in other circumstances. Levels of materiality 1) Immaterial amount: If the misstatement is immaterial, unqualified report could be issued. 2) Material amount that doesn't overshadow the financial statements: Here qualified opinion (using "except for") is issued. This affects decision only in specific areas and the overall statements are presented fairly.

28. Materiality 28 3. Material amount that affects the overall fairness of financial statements. This affects users to make incorrect decisions. So, disclaimer or adverse opinion may be issued. In addition, in the extent to which the misstatement affects different parts of financial statements must be considered. This is called pervasiveness. If misstatement is pervasive, adverse opinion is appropriate while lack of independence lead to disclaim opinion. Any deviation from independence is considered material.

29. 29 Materiality can also be looked in terms of failure to follow GAAP or scope Limitations. The following table is an example for such an aid Conditions requiring an unqualified report with modified wording or explanatory paragraph Level of Materiality ImmaterialMaterial Accounting Principles not consistently appliedUnqualified Unqualified with explanatory paragraph Doubt about Going concernUnqualified Unqualified with explanatory paragraph Departure from GAAPUnqualified Unqualified with explanatory paragraph Emphasis of matterUnqualified Unqualified with explanatory paragraph Use of another auditorUnqualified Unqualified with modified wording

30. 30 Conditions requiring departure from unqualified report Level of Materiality Immaterial Material but not overshadow Material and overshadow Scope restricted by client or conditionsUnqualifiedQualifiedDisclaimer Financial statements not prepared in accordance with GAAPUnqualifiedQualifiedAdverse The auditor is not independent-Disclaimer-

31. 31 The following situations are examples when more than one modification should be included in the report:  The auditor is not independent and the auditor know that the company has not followed GAAP  There is a scope limitation and there is substantial doubt about the company’s ability to continue as a going concern  There is a substantial doubt about the company’s ability to continue as going concern, and information about the cause of uncertainty is not adequately disclosed in a footnote  There is a deviation in the statements preparation in accordance with GAAP and other accounting principles was applied on a basis that was not consistent with that of the preceding year.

32. Write the Audit Report Essentials of Good Audit Report  Simplicity: It implies that ambiguous terms and facts should not be included in the audit report.  Clarity: This indicates that the audit report should not conceal material information which are required in evaluating and appraising the performance of the business.  Brevity/shortness: The term brevity signifies the conciseness in audit report.  Firmness: The report should clearly indicate the scope of work to be done and should clearly indicate whether the books of account exhibit ‘true and fair’ view of the business.  Objectivity: The report should be based on objective evidence. Opinion formed on the basis of information and evidences which are not measured in terms of money should not be incorporated in the audit report.  Consistency: Consistency in presenting accounting information is the basis of good audit report. A good audit report should take into consideration whether consistency, as to the method of inventory valuation and depreciation charges, has been adhered to.  Accepted Principles: The audit report should be based upon the facts and figures that are kept in accordance with GAAP. 32

33. 33

34. THANK YOU!! 34