November 2020
Those sitting ACCA AAA and AA exams should answer audit report
questions in two parts, says Steve Widberg.
This article is relevant to students studying for the ACCA exams in Audit and Assurance (AA) and Advanced Audit and Assurance (AAA).
A judge in a court of law has to be very careful when selecting language appropriate to a prisonerâs sentence. He/she will use words such as âfive years in prisonâ rather than âfive years in a dirty building with bars on the windowâ.
Similarly, we must use appropriate language when explaining the impact of a particular issue on the audit report, in order to leave no room for ambiguity.
I recommend that, in audit report questions, you structure your answer in two sections:
1: Impact on the AUDIT OPINION.
2: Additional paragraphs that may need to be included in the AUDIT REPORT.
Audit opinion
Consider the following scenario: âBoxo (the client) has a profit before taxation (PBT) of $5m. In the opinion of the auditor, potentially obsolete inventory is overvalued by $1m.â
I would always write four sentences:
1: Explain the problem, demonstrating accounting knowledge. âInventory must be measured at the lower of cost and net realisable value (NRV). In this case, because of obsolescence, NRV is $1m less than cost.â
2: Assess whether the problem is immaterial, material or pervasive. âThe overstatement of inventory is material because it represents 20% of PBTâ. (Note that anything less than 5% would normally be immaterial and anything exceeding 100% would be pervasive.)
3: Explain the reason for modifying your opinion. âThe audit opinion will be modified on the grounds of material misstatement.â (Remember that the alternative reason for modifying the opinion is âinability to obtain sufficient appropriate evidenceâ, which would be relevant, for example, if a client had inadequate accounting records).
4: Give your conclusion. âIn conclusion, the audit opinion will be qualifiedâ. The only alternative conclusions would be âunmodifiedâ (no problems), âadverseâ (pervasive misstatement), and âdisclaimerâ (pervasive inability to obtain sufficient appropriate evidence).
Additional paragraphs in the audit report
You may need to refer to the inclusion of additional paragraphs in the audit report. I want to concentrate on the ones that are most significant in the exam:
1: Basis for opinion paragraph. This is relevant if you have modified the audit opinion (above). So, in the scenario we discussed, I would say: âThe auditor will explain the reason for modifying the opinion and its financial effect in a basis for opinion paragraph. The basis for opinion paragraph is set out below the opinion in the audit report.â
2: Other information paragraph. The financial statements are often published alongside other information, such as Strategic or Governance Reports. If these additional reports are misleading or inconsistent with the financial statements, this will be reported in the âother informationâ paragraph. (Note that this used to be known as an âother matterâ paragraph, but this is no longer the case).
3: Material uncertainty relating to going concern paragraph. It is very common for companies to face uncertainties which may threaten its going concern. Examples would be renewal of a major customer contract or bank finance, or a potential product ban following safety concerns. These uncertainties must be disclosed by the directors in the notes to the financial statements. In these circumstances the auditor will draw attention to such matters in a âmaterial uncertainty relating to going concernâ paragraph. (Note that this used to be known as an âemphasis of matterâ paragraph, but this is no longer the case).
4: Key audit matters. Key audit matters paragraphs are only relevant to a company listed on a Stock Exchange. In order to help narrow the âexpectation gapâ between what auditors do and what the world believes they do, the auditor will highlight those matters that he/she believes were of most significance during the audit. Such matters include key audit risks (e.g. valuation of inventory at a retailer), matters involving significant judgement (e.g. fair values attributed to the assets of a subsidiary) and significant transactions or events (e.g. a major reorganisation). In all cases the auditor must explain how each key audit matter was addressed during the course of the audit.
Conclusion
You will need to practise as many audit report questions as possible. Ensure that you use the sub-headings âaudit opinionâ and âadditional paragraphs in audit reportâ in order to give structure to your answer.
Finally, make sure that you reach a single conclusion â examiners do not approve of candidates who sit on the fence and suggest a whole range of opinions.
âą Steve Widberg is a tutor at Open Tuition.
