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Unqualified With Explanatory Paragraph Or Modified Wording Accounting Essay

Paper Type: Free Essay Subject: Accounting
Wordcount: 2728 words Published: 1st Jan 2015

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An audit report is an evaluation done by an internal or an external independent professional auditor, regarding the financial status of a business entity. Auditor will express his/her opinion on whether the information on the financial status of a company is free of any misrepresentations or not in the audit report. This report is essential for all the users of financial statements such as individuals, companies or government because it provides guarantee on a company’s financial statements since the users rely on audit report to make any decision. Audit report can be classified into two broad categories, unmodified audit report and modified audit report, which are then further classified as follows:

In short, auditor can issue five different types of audit reports, which are standard unqualified, unqualified with explanatory paragraph or modified wording, qualified, adverse and disclaimer of opinion. Each types of these report is representing a different circumstance faced by the auditor during the audit process and the auditor will express different opinions in each report.

Firstly, standard unqualified audit report, also known as clean opinion because the auditor’s opinion is not necessary to be qualified or modified. It is the best type of report that a company can receive and also the most common audit opinion. This report is issued when the auditor concludes that financial statements appear to be presented fairly and there are no any significant reservations or any material misstatements found within the financial statements presented. The standard unqualified audit report covers seven distinct parts:

Report title

Introductory paragraph

Scope paragraph

Opinion paragraph

Name of auditor

Auditor’s address

Audit report date.

Typically, the report title will consists the word “independent” to demonstrate that the audit report prepared is unbiased in all aspects. The introductory paragraph states the responsibilities and roles of management and the auditor and it is the first paragraph of the report; the scope paragraph is a factual statement regarding the action of the auditor in audit process; the opinion paragraph indicates the conclusion made by the auditor based on the audit result obtained and it is the last paragraph of the report. The name will identify the audit firm and the address show the location of the audit firm. The date will show when the audit process is completed.

For an auditor to issue a standard unqualified audit report, there are five specific conditions required to be met:

The financial statements must comprise all statements. (Statement of Cash Flow, Income Statement & Balance Sheet)

The engagement is following the International Standards of Auditing (ISAs) in all respects.

Adequate evidences have been gathered to conclude that the three standards of fieldwork have been met.

The approved accounting standards, which is the Financial Reporting Standards (FRS) and the Company Act, 1965 in Malaysia are used to prepare the financial statements and the financial statements includes proper and sufficient disclosure of all relevant material matters.

The financial report is under the condition that is not requiring any additional explanation or any modification.

For example, if the company’s financial report had met these five circumstances, the opinion paragraph will contain the phrases: “In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of…” (“Auditor’s report,” 2012) to warrant the financial statements give a true and fair view of the company’s financial status. If any of the five conditions mentioned above are not met, the auditor cannot issue a standard unqualified report. Hence, auditor is necessary to issue other types of audit report.

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On some occasions, a business can receive an unqualified audit report on its financial statements, but it is not a standard unqualified audit report. It can be classified as unqualified audit report with explanatory paragraph or modified wording. This report met the criteria of satisfactory audit and the financial statements are presented in a true and fair view basis. However, the auditor believes that it is necessary to provide additional information or to modify in the wording of the standard unqualified report. In order to ensure the issuance appropriate unqualified report with an explanatory paragraph or modified wording, it depends on five circumstances:

Application of approved accounting standards is lacking of consistency.

There is significant doubt about going concern.

Auditor agrees with a deviation from the promulgated accounting principles.

There is specific matters about the financial statements need to be emphasized.

Other auditors are involved in the reports.

The first four circumstances mentioned above require the addition of an explanatory paragraph in the reports. Thus, the auditor has to issue an unqualified audit report with explanatory paragraph. For example, when the auditor found that the company does not have the ability to pay its debts when it is due (Going concern). For instance, auditor issues an unqualified audit report with explanatory paragraph which explain that there will be a misleading if the company continues to stick to the promulgated accounting principles (Deviation). Furthermore, the introductory paragraph, scope paragraph and opinion paragraph are remains without any modification while a separate explanatory paragraph is added after the opinion paragraph. The explanatory paragraph will begin with the phrases: “Without qualifying our opinion, we draw attention to…” (Alvin et al., 2008, p.58) In contrast, an unqualified audit report with modified wording will be used only when the audit report involving the use of other auditors. In this case, the report consists of three modified paragraph. For instance, an unqualified audit report with modified wording is issued when auditor wants to make reference in audit report or to qualify the opinion. (Other auditors are involved)

Due to some reasons, there are three circumstances that are inappropriate for an auditor to issue an unqualified report. The three conditions that required a departure from an unqualified audit reports are:

Scope limitation

Departure from approved accounting standards

Lack of independence of the auditor

Scope limitation exists when the auditors seemed unable to gather adequate evidence to make a conclusion on whether the financial statements are stated in line with the approved accounting standards. Departure from approved accounting standards arises in situation where the presented financial statements are not in conformity with the approved accounting standards. Lack of independence of the auditor means there is a non-independent relationship under the code of ethic between auditor and auditee or there is material conflict of interest occur between this both parties. When these three conditions exist and is material, the auditor is required to issue a report other than the unqualified report, which are qualified opinion, adverse opinion and disclaimer of opinion.

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A qualified report is issued when the auditor encountered any of these two situations, scope of audit is restricted or single deviation from approved accounting standards, but the financial statements presented are free of any misstatements. Typically, the writing of a qualified opinion is very similar to an unqualified opinion, but it includes an explanatory paragraph that is clearly explains the reasons for the qualified audit report before opinion paragraph but after scope paragraph. Moreover, the term “except for” must be used only when an auditor issue a qualified report. This will indicate that the auditor is satisfied that the overall financial statements are stated fairly except for certain aspect of them. The introductory paragraph is similar to the unqualified opinion whereas a slight modification is done in the scope and the opinion paragraphs. For example, in scope paragraph to inform the user about the exception of this qualification, the auditor performs the rest of the audit without qualifications by stating: “Except as discussed in the following paragraph, we conducted our audit…” (“Auditor’s report,” 2012) whereas in opinion paragraph, the auditor should states: “In our opinion, except for…” (“Auditor’s report,” 2012) to remind the user regarding the expressed qualification is explicitly excluded from auditor’s opinion.

In addition, a qualified report can be in the form of a qualification of both the scope and the opinion or of the opinion alone. Auditor may issue a scope and opinion qualification when he/she could not accumulate sufficient data required by the approved accounting standards. This may due to the client’s restriction or the auditor had encountered some circumstance that prevents him/her to conduct a complete audit. “Examples of this include an auditor not being able to observe and test a company’s inventory of goods. If the auditor audited the rest of the financial statements and is reasonably sure that they conform with GAAP, then the auditor simply states that the financial statements are fairly presented, with the exception of the inventory which could not be audited.” (“Auditor’s report,” 2012) In this case, a standard wording for introductory paragraph will be used and the scope paragraph will be edited to make user aware of the qualification and the opinion paragraph is to be modified. On the other hand, a qualification of the opinion alone is issued when specific records are missing or some parts of the financial statements are not followed with the approved accounting standards. “Examples of this include a company dedicated to a retail business that did not correctly calculate the depreciation expense of its building. Even if this expense is considered material, since the rest of the financial statements do conform with GAAP, then the auditor qualifies the opinion by describing the depreciation misstatement in the report and continues to issue a clean opinion on the rest of the financial statements.” (“Auditor’s report,” 2012) In this situation, auditor use standard wording for introductory and scope paragraph, then add an additional paragraph to explain the company’s deviation from the approved accounting standards and add in certain phrases in the opinion paragraph.

Adverse opinion is the worst type of audit report that a company received and it is considered the opposite of an unqualified opinion. Auditor will issue this type of report when it is believes that the financial reports presented are differ from the approved accounting standards. In addition, auditor had concluded that misstatement and misleading are both material and pervasive to the financial statements, this means the information contained have been falsified or are in other ways erroneous. For instance, the failure of a company to issue the consolidation of all its operations or a material account such as revenue account is not recorded properly.

The wording of the adverse report is exactly the same as with the qualified report. Auditor will modify the scope paragraph accordingly and add another paragraph after scope paragraph, but before opinion paragraph to discuss the reason why it is an adverse opinion. The opinion paragraph involves the most significant change with the qualified report, where it is stating the facts that the financial statements are not conformity with the approved accounting standards. For example, the opinion paragraph will contain the phrases: “In our opinion, because of the situations mentioned above (in the explanatory paragraph), the financial statements referred to in the first paragraph do not present fairly, in all material respects, the financial position of…” (“Auditor’s report,” 2012) to reveals that the financial reports are unreliable, inaccurate and do not present a fair view of the company’s financial status or results of operations and cash flows. It is an indication of fraud. An adverse opinion can arise only when the auditor has knowledge, after an adequate investigation, of the absence of conformity. (Alvin et al., 2008, p.60) When receiving an adverse report, the auditee is requested to do correction in its financial statements and send it to re-audit to obtain another audit report. Otherwise, the investors, lenders, governments and other users will generally not accept it.

Lastly, a disclaimer of opinion, generally referred to simply as a disclaimer, is a special type of audit report. In certain situation, due to various reasons, an auditor could not perform their work. He/She tried to audit the company but unable to obtain sufficient amount of audit evidence, thus he/she refuses to express an opinion on the company’s financial status. Since the auditor could not complete an accurate audit report, he/she will issue a disclaimer of opinion. A disclaimer opinion is differs from the adverse opinion. It is only issued when the auditor is lacking of the knowledge regarding the company’s financial statements while adverse opinion is issued when the auditor has the knowledge that the financial records provided has been misrepresented. “A disclaimer of opinion is appropriate in the following circumstances: lack of independence (SAS 26); scope limitations (inability to obtain sufficient competent evidential matter) (SAS 58); when the auditor concludes that there is substantial doubt about the entity’s ability to survive (going-concern) (SAS 59); and matters involving uncertainties (SAS 79).” (Davis, Robert R., 2004, para. 2) For example, the client intentionally hides or refuses to present sufficient appropriate information and evidence to the auditor in significant areas of the financial statements. (Scope limitation) For instance, the company has faced going concern problem which means that the company may not be able to continue operating in the near future. (Substantial doubt about the entity’s ability to survive)

Additionally, a disclaimer opinion is also distinguished from the other types of audit reports. This is because it only provides little information concerning the audit itself and consists of an additional paragraph that explaining the reasons for the issuance of disclaimer report. In this report, all the paragraphs are under extensively modification and with the exclusion of the entire scope paragraph since the auditor could not adequately perform the audit. The first phrase in the introductory paragraph will be changed to “We were engaged to audit…” (“Auditor’s report,” 2012) instead of “We have audited…” (“Auditor’s report,” 2012) in order to let the users aware of the audit is not completed. Since the audit was not completed and opinion cannot be expressed, the auditor disagrees to take any responsibility by omitting the last sentence in this paragraph, that is: “Our responsibility is to express an opinion on these financial statements based on our audit.” (“Auditor’s report,” 2012) Just like the qualified and adverse opinions, auditor must discuss the conditions for the disclaimer in explanatory paragraph. Lastly, the opinion paragraph is completely adjusted to “Because of the significance of the matters discussed in the preceding paragraphs, the scope of our work was not sufficient to enable us to express, and we do not express, an opinion of the financial statements referred to in the first paragraph.” (“Auditor’s report,” 2012) in order to let users know that the auditor cannot form and express an opinion on the company’s financial status due to the conditions stated in the explanatory paragraph.


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