Lesson 4.2: Modifications
Modifications
Types of modified opinions
ISA 700 (Revised)
- The auditor shall express an unmodified opinion when the auditor concludes that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework.
- If the auditor:
(a) Concludes that, based on the audit evidence obtained, the financial statements as a whole are not free from material misstatement; or
(b) Is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement, the auditor shall modify the opinion in the auditor’s report in accordance with ISA 705 (Revised).
- If financial statements prepared in accordance with the requirements of a fair presentation framework do not achieve fair presentation, the auditor shall discuss the matter with management and, depending on the requirements of the applicable financial reporting framework and how the matter is resolved, shall determine whether it is necessary to modify the opinion in the auditor’s report in accordance with ISA 705 (Revised). (Ref: Para. A16)
- When the financial statements are prepared in accordance with a compliance framework, the auditor is not required to evaluate whether the financial statements achieve fair presentation. However, if in extremely rare circumstances the auditor concludes that such financial statements are misleading, the auditor shall discuss the matter with management and, depending on how it is resolved, shall determine whether, and how, to communicate it in the auditor’s report. (Ref: Para. A17)
ISA 705 (Revised)
- This ISA establishes three types of modified opinions, namely, a qualified opinion, an adverse opinion, and a disclaimer of opinion. The decision regarding which type of modified opinion is appropriate depends on:
(a) The nature of the matter giving rise to the modification, that is, whether the financial statements are materially misstated or, in the case of an inability to obtain sufficient appropriate audit evidence, may be materially misstated; and
(b) The auditor’s judgment about the pervasiveness of the effects of possible effects of the matters on the financial statements. (Ref: Para. A1)
- The auditor shall modify the opinion in the auditor’s report when:
(a) The auditor concludes that, based on the audit evidence obtained, the financial statements as a whole are not free from material misstatement; or (Ref: Para. A2-A7_
(b) The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement. (Ref: Para. A8-A12)
Examples of the different types of opinions:
1. Qualified opinion:
(a) SAAPS 3 illustrative report example 22 – Individually immaterial departures from IFRS but material in aggregate (effects), and the auditor was unable to obtain sufficient appropriate audit evidence to substantiate certain disclosures (possible effects)
(b) SAAPS 3 illustrative report example 23 – The directors’ and prescribed officers’ remuneration has been disclosed in aggregate and not individually as required by the Companies Act of South Africa. The auditor has interpreted the Companies Act of South Africa to require disclosure of such remuneration to be per each individual director and / or prescribed officer. The auditor has determined that it is practical to include the omitted disclosures in the auditor’s report and the auditor has obtained sufficient appropriate audit evidence in this regard. The auditor has concluded that the matter above is material but not pervasive to the financial statements and a modified (i.e. “qualified”) opinion is appropriate based on the audit evidence obtained. Reportable irregularity identified and reported in terms of section 45 of the APA. Reportable irregularity does affect the fair presentation of the financial statements. Report on other legal and regulatory requirements.
2. Adverse opinion:
(a) SAAPS 3 illustrative report example 19 – The company is a parent of a major operating subsidiary and the company has not presented consolidated financial statements. The directors do not believe that they are required to prepare consolidated financial statements because they are the only users of the financial statements. The directors believe that the financial statements have been prepared in accordance with the financial reporting framework (International Financial Reporting Standards (IFRS)) and the requirements of the Companies Act of South Africa. The auditor concludes that this is a departure from the financial reporting framework (IFRS) and from the requirements of the Companies Act of South Africa as IFRS requires the presentation of consolidated financial statements. The effects of the misstatement on the consolidated financial statements have not been determined because it was not practicable to do so.
3. Disclaimer of opinion:
(a) SAAPS 3 illustrative report example 25 – Corresponding figures presented in the current year financial statements were subject to an independent review in terms of the Companies Act of South Africa and a review conclusion was issued on those figures. The directors did not believe that the retrospective application of additional procedures on the opening balances was warranted as the level of assurance in the prior year was appropriate in accordance with the Companies Act of South Africa. The auditor was unable to obtain sufficient appropriate audit evidence that the closing balances from the prior year were free of material misstatement, and have been brought forward correctly. The auditor was unable to obtain alternative audit evidence on the opening balances. Since opening balances enter into the determination of the financial performance and cash flows, the auditor was unable to determine whether adjustments might have been necessary in respect of the movements in the statement of comprehensive income, the net cash flows from operating activities reported in the statement of cash flows and the changes in equity reported in the statement of changes in equity. In addition, the auditor’s opinion on the current year’s financial position is modified because of the possible effects of this matter on the comparability of the current year’s financial position with that of the prior year.
Determining the type of modification
ISA 705 (Revised)
- The auditor shall express a qualified opinion when:
(a) The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are material, but not pervasive, to the financial statements; or
(b) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive.
- The auditor shall express an adverse opinion when the auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are bot material and pervasive to the financial statements.
- The auditor shall disclaim an opinion when the auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, and the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive.
- The auditor shall disclaim an opinion when, in extremely rare circumstances involving multiple uncertainties, the auditor concludes that, notwithstanding having obtained sufficient appropriate audit evidence regarding each of the individual uncertainties, it is not possible to form an opinion on the financial statements due to the potential interaction of the uncertainties and their possible cumulative effect on the financial statements.
Going concern reporting
In the handouts, there are two documents included for your reference:
- SAAPS 3 (Revised 2019 Updated) that was issued in 2021, and
- A later updated version of SAAPS 3 issued in 2022 which becomes effective 15 December 2022.
SAAPS 3 (Revised 2019 Updated) Appendix I: Going Concern Decision Tree [Based on ISA 570 (Revised)]
1. Going concern basis of accounting: The financial statements are prepared on the assumption that the entity is a going concern and will continue its operations for the foreseeable future. General purpose financial statements are prepared using the going concern basis of accounting, unless management either intends to liquidate the entity or to cease operations, or has no realistic alternative but to do so. (ISA 570 (Revised).2).
2. Material uncertainty: Exists when the magnitude of its potential impact and likelihood of occurrence is such that, in the auditor’s judgement, appropriate disclosure of the nature and implications of the uncertainty is necessary for: (a) In the case of a fair presentation financial reporting framework, the fair presentation of the financial statements; or (b) In the case of a compliance framework, the financial statements not to be misleading.
3. Multiple uncertainties: Paragraph 10 of ISA 705 (Revised) states that the auditor shall disclaim an opinion when, in extremely rare circumstances involving multiple uncertainties, the auditor concludes that, notwithstanding having obtained sufficient appropriate audit evidence regarding each of the individual uncertainties, it is not possible to form an opinion on the financial statements due to the potential interaction of the uncertainties and their possible cumulative effect on the financial statements. Paragraph A33 of ISA 570 (Revised) states that in situations involving multiple uncertainties that are significant to the financial statements as a whole, the auditor may consider it appropriate in extremely rare cases to express a disclaimer of opinion instead of including the statements required by paragraph 22 of ISA 570 (Revised).
4. ISA 570 (Revised) par. 21: If the financial statements have been prepared using the going concern basis of accounting but, in the auditor’s judgment, management’s use of the going concern basis of accounting in the preparation of the financial statements is inappropriate, the auditor shall express an adverse opinion. (Ref: Para. A26-A27)
5. ISA 570 (Revised) par. 22: If adequate disclosure about a material uncertainty is made in the financial statements, the auditor shall express an unmodified opinion and the auditor’s report shall include a separate section under the heading “Material uncertainty related to going concern” to: (Ref: Para. A28-A31, A34)
(a) Draw attention to the note in the financial statements that discloses the matters set out in paragraph 19; and
(b) State that these events or conditions indicate that a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern and that the auditor’s opinion is not modified in respect of the matter.\
6. ISA 570 (Revised) par. 23: If adequate disclosure about a material uncertainty is not made in the financial statements, the auditor shall: (Ref: Para. A32-A34)
(a) Express a qualified opinion or adverse opinion, as appropriate, in accordance with ISA 705 (Revised); and
(b) In the Basis for qualified (adverse) opinion section of the auditor’s report, state that a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern and that the financial statements do not adequately disclose this matter.
7. ISA 570 (Revised) par. A27: When the use of the going concern basis of accounting is not appropriate in the circumstances, management may be required, or may elect, to prepare the financial statements on another basis (e.g., liquidation basis). The auditor may be able to perform an audit of those financial statements provided that the auditor determines that the other basis of accounting is acceptable in the circumstances. The auditor may be able to express an unmodified opinion on those financial statements, provided there is adequate disclosure therein about the basis of accounting on which the financial statements are prepared, but may consider it appropriate or necessary to include an Emphasis of matter paragraph in accordance with ISA 706 (Revised) in the auditor’s report to draw the user’s attention to that alternative basis of accounting and the reasons for its use.
8. ISA 570 (Revised) par. 24: If management is unwilling to make or extend its assessment when requested to do so by the auditor, the auditor shall consider the implications for the auditor’s report. (Ref: Para. A35)
9. ISA 570 (Revised) par. A35: In certain circumstances, the auditor may believe it necessary to request management to make or extend its assessment. If management is unwilling to do so, a qualified opinion or a disclaimer of opinion in the auditor’s report may be appropriate, because it may not be possible for the auditor to obtain sufficient appropriate audit evidence regarding management’s use of the going concern basis of accounting in the preparation of the financial statements, such as audit evidence regarding the existence of plans management has put in place or the existence of other mitigating factors.