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Chapter 16

The auditors’ report

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Learning objectives • To explain the nature and importance of the audit report.

• To describe the various components of the audit report.

• To explain the nature of the auditor’s responsibility for ‘other information’ contained in the annual report.

• To discuss the nature of the assurance provided in the audit report in respect of information other than financial statements disclosed in the annual report.

• To describe the auditors’ responsibilities in respect of the directors’ report and the strategic report.

• To discuss the information provided in audit report about the auditor’s work.

• To discuss when an ‘emphasis of matter’ or ‘other matter’ paragraph might be required in the audit report.

• To discuss the various forms of modified opinions and identify the circumstances under which each type would be issued by auditors.

• To outline the reason why auditors have started to include a disclaimer to third parties paragraph in the audit report.

• To outline auditors’ responsibilities for reporting on corporate governance issues.

• To outline the procedures the auditor will undertake to review the corporate governance statement.

• To describe the implications of electronic publication of the audit report.

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Signing audit report completes audit process

• In signing audit report auditors communicate satisfaction or dissatisfaction with financial statements.

• If satisfied – unmodified or clean opinion.

• If dissatisfied – modified opinion (qualified opinions – disclaimers of opinion – opinions with ‘emphasis of matter’ or ‘other matter’ paragraph).

• FRC and APB earlier – adopted auditing standards issued by IAASB, except ISA 700 and APB revised and issued in 2013 a clarified version of ISA 700 for use in the UK and Ireland.

• APB/FRC did adopt ISA 705 and ISA 706.

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The modified audit opinion – main features

• Title

• To whom the report is addressed

• Identification of statements upon which the auditors are reporting

• Statement of auditors’ responsibilities

• Statement of directors’ responsibilities

• Scope of the audit of the financial statements

• The opinion on truth and fairness and compliance with CA 2006 and accounting standards

• Emphasis of ‘matter’ or ‘other matters’ paragraphs

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The unmodified opinion (1) Figure 16.1

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The unmodified opinion (2) Figure 16.1 (continued)

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The unmodified opinion (3) Figure 16.1 (continued)

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The unmodified opinion (4) Figure 16.1 (continued)

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Directors’ Report

• Companies Act 2006 requires a directors’ report to be prepared and for the auditor to report whether the information contained therein is consistent with the financial statements.

• Where the auditors consider that the directors’ report is inconsistent with the financial statements they should discuss the matter with the directors and try to get them to adjust either the directors’ report or the financial statements to remove the inconsistency.

• If the directors refuse and the auditors believe the inconsistency is material, the auditor is required to describe the inconsistency in a separate paragraph in their report.

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Strategic Report

• Statutory instrument in 2013 states that all companies except small companies) should prepare a strategic report to … inform users about the company and … how successful the directors have been in promoting the success of the company. All strategic reports must contain the following information:

– A fair review of the company’s business.

– A description of the principal risks and uncertainties facing the company.

• Quoted companies are required to disclose additional matters (see p 673-4)

• Auditors have, in their audit report, to provide a positive statement that the strategic report is consistent with the financial statements

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Quoted companies – additional audit requirements

• Explanations of audit work for companies complying with the UK Corporate Governance Code

• Directors’ remuneration

• Matters reported on by exception

• Corporate governance

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Companies complying with the UK Corporate Governance Code: Explanations of audit work

• Since 2013 ISA 700 requires the following to be disclosed in the audit report: i. Description of the assessed risks of material misstatement highlighted by the auditor as

having the greatest effect on: a) the overall audit strategy

b) the allocation of resources in the audit

c) directing the efforts of the audit team.

ii. An explanation of how the auditor applied the concept of materiality in planning and performing the audit.

iii. The audit report should provide an overview of the scope of the audit, identifying how they addressed the issues of risk and materiality.

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Directors’ remuneration

• The Cos Act 2006 states quoted companies must prepare an annual directors’ remuneration report, and the auditors must ensure it is consistent with their knowledge of the company.

• They have specific responsibility for checking the accuracy and completeness of information in a table showing as a single figure total remuneration of each director and the amount of each component, such as salary, fees, benefits, deferred amounts, the value of shares received or share options, and pension input.

• If it has not been prepared in accordance with the Act, and is not in agreement with the accounting records and returns, they must give details in the audit report. Before doing this they should try to convince the directors/audit committee to include the correct information in the remuneration report.

• Since the remuneration report contains both an audited and an unaudited part they should ensure the two parts are adequately distinguished in the annual report.

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Matters reported on by exception: FRC suggested wording

• We have nothing to report in respect of the following:

• Under the ISAs (UK and Ireland), we are required to report to you if, in our opinion, information in the annual report is:

– materially inconsistent with the information in the audited financial statements; or

– apparently materially incorrect based on, or materially inconsistent with our knowledge of the Group acquired in the course of performing our audit; or

– is otherwise misleading.

• In particular, we are required to consider whether we have identified any inconsistencies between our knowledge acquired during the audit and the directors’ statement that they consider the annual report is fair, balanced and understandable and whether the annual report appropriately discloses those matters that we communicated to the audit committee which we consider should have been disclosed.

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Emphasis of matter paragraph

• Likely to be rare.

• A modification but not a qualification, but paragraph refers to financial statement note where matter is described: – An uncertainty relating to the future outcome of exceptional litigation or

regulatory action or ability to continue as a going concern – Early application of a new accounting standard with pervasive effect in

advance of its effective date. – A major catastrophe with significant effect on the entity’s financial position.

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Emphasis of Matter – uncertain outcome of potential litigation

• In forming our opinion on the financial statements, which is not modified, we have considered the adequacy of the disclosures made in note 22 to the financial statements concerning the uncertain outcome of the potential litigation following the receipt of two letters before claim from legal advisors to Craig Whyte and Aidan Earley. The Company commissioned an independent investigation … to investigate the first letter before claim, which was concluded on 17 May 2013. On 30 May 2013, following the receipt of a second letter before claim, the Company announced that the investigation had been concluded. The Company is satisfied that a thorough investigation was conducted despite the inherent limitations of a private inquiry, and considers the claims have no legal merit. The Company has also engaged the services of Allen and Overy to defend against these possible claims, and the Company has had no communication with Messrs Whyte & Earley or their legal advisers since 30 May 2013. The ultimate outcome of this matter cannot presently be determined, and accordingly no adjustments have been made to these financial statements as a result of this matter.

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Other matter paragraph examples

• MAY BE QUALIFICATION

• where limitation of scope imposed by management is pervasive but auditor has not withdrawn from audit engagement – should disclaim an opinion and explain in other matter paragraph why not possible to withdraw

• OR NOT A QUALIFICATION

• where an entity prepares two sets of financial statements in compliance with two accounting frameworks, both appropriate, auditor may include an other matter paragraph stating they have issued an audit report on another set of financial statements prepared using a different Accounting Framework and that they issued an audit report on those statements.

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Forms of modification Figure 16.2

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Limitation of scope (1)

• Arises if auditors are not able to obtain all the evidence required to issue an unqualified opinion.

• May be material but not persuasive – except for limitation – see pages 684-5.

• May be persuasive – disclaimer see pages 686–7

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Limitation of scope (2)

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Limitation of scope (3)

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Disclaimer of responsibility(1)

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Disclaimer of responsibility (2)

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Disagreement

• Disagreement arises when auditors can form an opinion on a … matter that differs from opinion of management. For instance: – Inappropriate accounting policies

– Inappropriate application of accounting policies; or

– Inappropriate or inadequate disclosures.

• Material but not persuasive – except for disagreement – see page 691.

• Persuasive – adverse opinion – see page 692.

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Except for disagreement

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Adverse opinion

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Disclaimer of responsibility

• Suggested wording following the ‘Bannerman’ case

• This report is made solely to the company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the company’s members as a body, for our audit work, for this report, or for the opinions we have formed.

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Reporting on corporate governance (1)

• Combined Code and Listing Rules set framework for responsibilities of directors/auditors. Rules require directors of listed companies to set out in the Annual Report how they have applied the Code principles in a way useful and understandable to shareholders. The directors include a statement on whether they have complied, and, where not, state which provisions have not been complied with and why.

• Listing Rules require auditors to review ten provisions in the companies’ statement of corporate governance. Of particular importance is the requirement for auditors to review whether the information in respect of going concern and internal control are appropriately disclosed. Code requires auditors to describe their reporting responsibilities – usually in audit report.

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Reporting on corporate governance (2)

• Where, a company does not comply with a Combined Code requirement, within scope of the auditors’ review, but has properly disclosed fact in its corporate governance statement, the auditors are not required to make reference to non-compliance.

• Auditor need not perform additional procedures to determine the appropriateness of reasons given for nondisclosure of a provision but merely that the directors’ description of the non-disclosure is adequate. Where auditors do not believe the disclosure of a departure from a provision of the code has been adequate, they need to report this fact in their audit report – not a qualification but an other matter.

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Example of non-qualification of corporate governance matters – Rolls Royce 2013

• Under the Listing Rules we are required to review:

• the directors’ statement set out on page 72, in relation to going concern; and

• the part of the corporate governance report on page 39 relating to the company’s compliance with the nine provisions of the UK Corporate Governance Code (2010) specified for our review.

• We have nothing to report in respect of the above responsibilities

• Note: the 2012 Code increased to ten the number of provisions to be reviewed

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Ten listing rules on which auditor is to report (1) Table 16.1

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Nine listing rules on which auditor is to report (2) Table 16.1 (continued)

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Nine listing rules on which auditor is to report (3) Table 16.1 (continued)

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Nine listing rules on which auditor is to report (3) Table 16.1 (continued)

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Electronic publication of auditors’ reports

• Publication of audit reports on internet problematic:

– Information on the web is more easily changed.

– May not be apparent what information audited.

– Information can be accessed world-wide.

• Where a client intends to distribute its financial statements electronically auditors should:

– Review process by which electronic financial statements are derived from manually signed accounts.

– Check proposed electronic version is identical in content with manually signed accounts.

– Check conversion of manually signed accounts into an electronic form has not distorted overall presentation of the financial information.

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Figure 16.1 Example of an unmodified audit opinion for a non-

publicly traded company

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Figure 16.2 Forms of qualification matrix