SOLUTIONS MANUAL

to accompany

MODERN AUDITING

&

ASSURANCE SERVICES

4th edition

Prepared by

Philomena Leung, Barry J. Cooper and Peter

Richardson

© John Wiley & Sons Australia, Ltd 2009

Solution Manual to accompany Modern Auditing and Assurance Services 4e

Chapter 5
The Auditor’s Report

Review questions

5.11 What are the main effects of the Corporations Act on the auditor’s
reporting requirements?

The main effects of the Corporations Act on the audit report of a single company are:
 The opinion reflects ‘truth and fairness’ not ‘fair presentation’.
 The opinion must state whether the accounts are in accordance with the provisions
of the Act.
 The opinion must state whether the accounts are in accordance with applicable
accounting standards, being those approved by the Australian Accounting
Standards Board.
 The auditor has been given all information, explanations and assistance necessary
for the conduct of the audit.
 The financial records have been kept to enable the preparation and audit of the
financial statements.
 The records and registers have been kept as required by law.

5.12 What are the contents of an unqualified audit report? Explain each
section.

The basic elements of an unqualified audit report are briefly summarised below:
 Title. This identifies the audit report and distinguishes it from other reports issued
by management. The title includes the word ‘independent’ to indicate the nature of
the audit.
 Addressee. The report is normally addressed to those who requested the audit and
were ultimately responsible for the auditor’s appointment (for example, the
shareholders of a company or the members of a superannuation fund).
 Scope. This identifies the financial report audited, the name of the entity and the
reporting period covered. It also restates the responsibilities of the governing body
(usually represented by the directors) and the auditor. In essence, it describes the
nature of the audit, stating that it was conducted in accordance with auditing
standards.
 Audit opinion: An opinion is expressed that the financial statements are presented
in accordance with the Corporations Act 2001, giving a true and fair view and
complying with the Accounting Standards and the Corporations Regulations 2001.
 Signature. The report is signed by the audit firm or the individual audit partner, as
appropriate.
 Auditor’s address. A specific location where the auditor maintains an office.
 Date the audit report is signed. The audit report is dated after the governing body
has signed the financial statements. This date is important because the auditor has
responsibility for subsequent events up to this date.

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 Note that an unqualified report may be modified by an “emphasis of matter”

statement by the auditor.
 Also, the auditor makes an independence declaration in respect of the
requirements of the Corporations Act 2001 and any applicable code of
professional conduct in relation to the audit.

5.13 What are the different types of modified audit opinions? Explain each
type.

A modified auditor’s report is issued when the audit opinion is either qualified in
some way or when it is appropriate for the auditor to draw attention to, or emphasise,
a matter that is relevant to users. Guidance is given in ASA 701 Modifications to the
Auditor’s Report. When an audit report is other than unqualified, it is either qualified,
a disclaimer or an adverse opinion, as described in ASA 701.

The circumstances are:

 Scope limitation. When the auditor cannot perform the necessary procedures or
the procedures do not provide sufficient evidence, the auditor is said to have a
scope limitation.
Audit report
 Material but not extreme – qualified
 Extreme cases – disclaimer.

 Disagreement with those charged with governance. The auditor may disagree with
the directors and/or management over the following matters:
 appropriateness of accounting policies selected
 method of application of accounting policies selected
 adequacy of certain disclosures in the financial statements
 compliance of the financial statements with relevant statutory and other
requirements.
Audit report
 Material but not extreme : qualified
 Extreme cases: adverse.

 Conflict between applicable financial reporting frameworks. Application of

accounting policies in compliance with statutory and other requirements may not
result in fair presentation in accordance with accounting standards .
Audit report
 Material but not extreme: qualified
 Extreme cases: adverse.

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Solution Manual to accompany Modern Auditing and Assurance Services 4e

5.14 Under what circumstances may the auditor decide to include an

‘emphasis of matter’ section in the audit report?

The purpose of an ‘emphasis of matter’ section is to draw the attention of users of the
audit report to relevant information. Circumstances in which an emphasis of matter is
appropriate are:
 Significant uncertainty, both going concern and other circumstances
 additional disclosures with which the auditor concurs and which make the
accounts true and fair
 inconsistency with other information included with the audited financial
statements
 the financial report being reissued due to subsequent events.

5.15 What is the difference between (a) an unmodified auditor’s report and (b)
a modified auditor’s report?

(a) An unmodified auditor’s report is an unqualified report which states that the
financial statements present fairly, in all material respects, the financial
position and the results of operations and cash flows of the entity in
accordance with applicable accounting standards and other mandatory
professional reporting requirements, and relevant statutory and other
regulations. An unmodified audit report means that the financial statements do
not have an emphasis of matter or any qualifications.

(b) A modified audit report encompasses ‘other than unqualified’ audit reports
(such as qualified, disclaimer and adverse) as well as unqualified audit reports
with an emphasis of matter. An emphasis of matter relates to certain limited
circumstances in which the audit report is unqualified but the auditor believes
it is appropriate to draw attention to or emphasise a matter that is relevant to
the users of the financial statements

5.16 It is widely acknowledged that materiality is an important consideration

in auditing. Is materiality the only consideration for an auditor deciding
whether to qualify financial statements? Discuss.

Materiality is an important consideration in arriving at an appropriate opinion because

when the matter is immaterial, an unqualified opinion is appropriate. When the effect
is material but not extreme, then generally the report is qualified. In extreme cases,
there may be a disclaimer or adverse opinion as discussed above in question 5.13.
Extreme cases are where the effect(s) or possible effect(s) of the circumstances are so
material and pervasive, that an auditor has been unable to obtain sufficient appropriate
evidence, or where a qualified opinion is inadequate to disclose the misleading or
incomplete nature of the financial report.

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5.17 What does each of the modified types of auditor’s reports mean to users
wanting to rely on the financial statements?

The purpose of an emphasis of matter section in a modified report is to draw the

attention of users of the audit report to relevant information. An emphasis of matter
relates to certain limited circumstances in which the audit report is unqualified but the
auditor believes it is appropriate to draw attention to or emphasise a matter that is
relevant to the users of the financial statements

As stated in ASA 701:

1A disclaimer of opinion shall be expressed when the possible effect of a limitation on scope
is an extreme case and the auditor has not been able to obtain sufficient appropriate
audit evidence and accordingly is unable to express an opinion on the financial report.
The opinion paragraph shall be headed “Disclaimer of Auditor’s Opinion”.

1An adverse opinion shall be expressed when the effect of a disagreement or a conflict
between applicable financial reporting frameworks is an extreme case and the auditor
concludes that a qualification of the auditor’s report is not adequate to disclose the
misleading or incomplete nature of the financial report. The opinion paragraph shall
be headed “Adverse Auditor’s Opinion”. An adverse opinion is usually issued in
extreme cases when there is a disagreement with those charged with corporate
governance, or where there is a conflict between applicable financial reporting
frameworks.

2 Whenever the auditor expresses an opinion that is other than unqualified, a clear description
of all the substantive reasons shall be included in the auditor’s report and, unless
impracticable, a quantification of the possible effect(s) on the financial report. If the
effects or possible effects are incapable of being measured reliably, a statement to that
effect and the reasons therefore shall be included in the basis for modification
paragraph of the auditor’s report.

5.18 What circumstances may give rise to adverse opinion?

 Disagreement with those charged with governance. The auditor may disagree with
the directors and/or management over the following matters:
 appropriateness of accounting policies selected
 method of application of accounting policies selected
 adequacy of certain disclosures in the financial statements
 compliance of the financial statements with relevant statutory and other
requirements.
Audit report
 Material but not extreme : qualified
 Extreme cases: adverse.
 Conflict between applicable financial reporting frameworks. Application of
accounting policies in compliance with statutory and other requirements may not
result in fair presentation in accordance with accounting standards .
Audit report
 Material but not extreme: qualified
 Extreme cases: adverse.

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Solution Manual to accompany Modern Auditing and Assurance Services 4e

5.19 Why add an ‘emphasis of matter’ section to an audit report? Does the
matter need to be material to warrant such a section in the audit report?

An auditor may add an ‘emphasis of matter’ section to an audit report while still
expressing an unqualified opinion on the financial statements. The purpose of this is
to draw the attention of users of the audit report to relevant information. The emphasis
of matter is for very specific circumstances, which include:
• additional disclosures with which the auditor concurs and which make the
accounts true and fair
• an inherent uncertainty (going concern or other) that is adequately disclosed
• inconsistency with other information included with the audited financial
statements
• the financial statements being reissued due to subsequent events.
ASA 700 (ISA 700) allows an emphasis of matter for a broader range of
circumstances. It should be made clear that the contents of the ‘emphasis of matter’
section do not constitute a qualification (for example, by use of an opening phrase
such as: ‘Without [further] qualification to the opinion expressed above, attention is
drawn to …’).

The circumstances that give rise to an emphasis of matter should be material. It is a

common misconception that an emphasis of matter is given in circumstances where a
situation is not material enough to result in a qualification.

5.20 Under what circumstances may the auditor decide to qualify the financial
statements as a result of a question over going concern? Does it matter
whether the event that caused the going-concern problem occurred after
the reporting date?

If there is uncertainty that the entity will continue as a going concern that is
adequately disclosed, the auditor should issue an unqualified audit opinion with an
emphasis of matter. If it is highly improbable that the entity will continue as a going
concern, disclosure of the circumstances will not be enough and the auditor should
express an adverse opinion.

If it is highly improbable that an entity will continue as a going concern due to an

event that occurred after the reporting date (which provides new information that
does not relate to conditions that existed at reporting date), and there has been
adequate disclosure, the audit report should include an emphasis of matter. However,
if the disclosure is inadequate, or amounts and other disclosures are unreliable, a
qualified audit report should be expressed on the basis of a disagreement with
management.

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Professional application questions

5.21 Effect of circumstances on audit opinion

Required
Indicate the effect of these circumstances on the auditor’s report.

1. This is a disagreement with management. The audit report would be qualified

if the issue is material but not extreme, or an adverse opinion in extreme cases.
2. This is a scope limitation. The audit report would be qualified if material but
not extreme or a disclaimer in extreme cases.
3. If the matter of litigation is not adequately disclosed, then this constitutes a
disagreement with management, and the report would be qualified or an
adverse opinion, depending on the circumstances. If the matter of litigation is
adequately disclosed, an emphasis of a matter is added.
4. This is a scope limitation. The audit report would be qualified or a disclaimer,
depending on the circumstances.
5. This is a disagreement with management. Refer answer 1. above.
6. This is a going-concern uncertainty and may result in one of the following
audit opinions:
(i) If there is adequate disclosure of the going-concern uncertainty, express
an unqualified opinion and add an ‘emphasis of a matter’ paragraph after
the Opinion section.
(ii) If there is inadequate disclosure, express a qualified opinion (inadequate
disclosure). Add a qualification paragraph after the Scope section, but
before the Opinion section.
(iii) If it is highly probable that the entity will not continue as a going concern
express an adverse opinion.
7. This is a scope limitation. Refer answer 4 above.
8. This is an inconsistency with an accounting policy from last year. There is no
effect on the audit report as long as it is disclosed in accordance with
AASB 1001.

5.22 Effect of circumstances on audit opinion

Required

Nominate the type of audit report you would issue in each of the situations.
Explain your answer, and outline what you would state in the qualification
paragraph, if applicable.

1. In this case, there is a limitation on the scope of the audit as the auditor is
unable to gain sufficient appropriate audit evidence as to the completeness of
cash receipts. A qualified opinion should be issued, as the scope limitation is
material but not extreme.

Qualification
As is common for companies of this type, it is not practicable for CareMore to
maintain an effective system of internal control over donations received from
door-knock campaigns until their initial entry in the accounting records.

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Accordingly, our audit in relation to funds raised in this way was limited to
amounts recorded.

2. In this case, the auditor has a disagreement with management over its
accounting policy relating to revenue. A qualified opinion should be issued, as
the disagreement is material but not extreme.

Qualification
Saints Ltd has not recognised interest earned but not received at balance date.
This is a departure from generally accepted accounting principles. The total
interest earned but not received as at 30 June 2009 was $X. In our opinion, this
revenue should have been recognised in the year in which it was earned. Had
this been done, the operating profit before income tax would be $XX …

3. In this case, there is a limitation on the scope of the audit as the auditor is
unable to gain sufficient appropriate audit evidence on any of the material
balances in the accounts. A disclaimer of opinion should be issued, as the
scope limitation is extreme.

Qualification
As stated in Note X to the financial statements, an apparent sabotage of
Figtree Ltd’s computer system has destroyed many of the accounting records.
This event occurred prior to year-end and to the completion of our audit. As
the remaining accounting records are not adequate to permit the application of
necessary auditing procedures, we are unable to obtain all the information and
explanations we require in order to form an opinion on the financial
statements.

5.23 Auditor’s report

Required
Discuss whether June Ryan should be confident in going to the bank with this
‘modified’ audit report.

Ms Ryan does not have enough information to be confident about her ‘modified’ audit
report. The audit report may be modified with an ‘emphasis of matter’ paragraph. In
this case there is no great problem because it means that the audit report is
nevertheless still unqualified. However, the modification may mean an ‘other than
unqualified’ audit report. Thus the report may be qualified, have a disclaimer
attached or be an adverse report. This could be a problem for the bank in reviewing
Athletes Feet’s financial statements. Ms Ryan should obtain more information about
the nature of the qualification.

From the information given it appears that it is probable that the financial report is
modified due to a limitation of scope. What the modification means is not clear from
the limited information given.

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5.24 Going-concern issues, audit opinion

Required

(a) Explain the concept of going concern. Discuss the reporting options open
to an auditor when going-concern issues arise.

The going-concern concept means that it is assumed that the entity will realise its
assets and extinguish its liabilities in the normal course of business.

The auditors’ reporting options are:

 Going concern basis considered appropriate
Auditor should issue an unmodified audit report.
 Significant uncertainty about going concern
If the uncertainty is adequately disclosed in the financial statements, the audit
report should be qualified in accordance with ASA 700 (ISA 700).
If the financial statements do not adequately disclose the significant uncertainty, a
disclaimer of opinion should be expressed on the basis of a lack of disclosure in
accordance with ASA 700 (ISA 700).
 Going-concern basis considered inappropriate
If the auditor is satisfied that it is highly improbable that the entity will continue as
a going concern for the relevant period, an adverse opinion should be expressed in
accordance with ASA 700 (ISA 700).

(b) Discuss the potential audit report options in relation to Fly-by-Night.

There are a number of matters that indicate potential going-concern reporting issues
for Fly-by-Night Ltd (FBN). These include:
 FBN operates in the defence industry and there have been significant cuts to
defence expenditure.
 There is evidence that the cuts will have a direct impact on one of FBN’s
contracts.
 FBN has been experiencing cash flow difficulties.
 FBN’s borrowing facility is already fully drawn.
The auditor would need to perform a number of procedures to evaluate the
appropriateness of the going-concern basis.

In this case all of the above should be disclosed in a note to the accounts. If the
auditor is satisfied with the disclosure, he or she may issue an unqualified audit report
with an ‘emphasis of matter’ paragraph. However, if the auditor is unsatisfied as to
the ability of the entity to continue as a going concern (which is difficult to tell from
the information given in this case), he or she should issue an adverse audit opinion.

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5.25 Preparation of the audit report — various circumstances

Required

(a) Discuss the impact of the events on the audit report you intend to issue for
Toon Park for the year ending 30 June 2007.

1. Reconsideration of the useful lives of the assets.

This is a disagreement with management over the method of application of
accounting policies by the entity. You would request management to either
justify the basis for extending the assets’ useful life or reverse the changes
made. If management disagree with you over this matter, you would probably
issue a qualified audit opinion. This audit opinion is issued when the auditor in
his or her report can readily explain the nature of the disagreement and its
impact on the financial statements.
2. Financing from bank.
This is an ‘inherent uncertainty’ that relates to a disclosure that is contingent
on future events and is not capable of reasonable estimation at the date of the
audit report. An inherent uncertainty including a going-concern problem does
not require the auditor to issue a qualified opinion if the uncertainty is
adequately disclosed. When the inherent uncertainty in relation to the entity’s
ability to continue as a going concern is adequately disclosed, an emphasis of
matter is added to an unqualified opinion.

(b) Draft an audit report for Toon Park for the year ending 30 June 2009.

Independent Audit Report

To the shareholders of Toon Park Ltd

Auditor’s Responsibility
We have audited the financial statements of Toon Park Ltd for the year ended 30 June
2009 as set out in pages ... to ... The directors of Toon Park Ltd are responsible for the
financial statements. We have conducted an independent audit of the financial
statements in order to express an opinion on it to the shareholders of Toon Park Ltd.

Our audit was conducted in accordance with Australian auditing standards to provide
reasonable assurance whether the financial statements are free of material
misstatements. Our procedures included examination, on a test basis, of evidence
supporting the amounts and other disclosures in the financial statements, and the
evaluation of accounting policies and significant accounting estimates. These
procedures have been undertaken to form an opinion whether, in all material respects,
the financial statements are presented fairly in accordance with accounting standards
and other mandatory professional reporting requirements, so as to present a view
which is consistent with our understanding of Toon Park Ltd’s financial position, the
results of its operations and its cash flows.

The audit opinion expressed in this report has been formed on the above basis.

Qualification
Toon Park Ltd has reconsidered their method used to review the useful lives of the
amusement park assets. This new policy and the effect on profit of $xxxx has been
disclosed in Note X to the financial statements. In our opinion, Toon Park Ltd does
not have sufficient justification for this reappraisal of the useful lives of the assets as
required by AASB 116, ‘Property, Plant and Equipment’. We do not believe that the

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useful lives of assets should have been re-evaluated. Had this not been done, the
operating profit before income tax for this period would be $xx xxx.

Qualified audit opinion

In our opinion, except for the effects on the financial statements of the matter referred
to in the qualification paragraph, the financial statements of Toon Park Ltd are
properly drawn up:
(a) so as to give a true and fair view of:
(i) the company’s state of affairs as at 30 June 2009 and its profits or loss and
cash flows for the financial year ended on that date; and
(ii) the other matters required by Division 4, 4A and 4B of part 3.6 of
Corporations Act 2001 dealt with in the financial statements.
(b) in accordance with provisions of the Corporations Law; and
(c) in accordance with applicable accounting standards and other mandatory
professional reporting requirements (Urgent Issues Group Consensus Views).

Inherent uncertainty regarding litigation

Without qualification to the opinion expressed above, attention is drawn to the
following matter. As a result of the matters described in Note Y, there is significant
uncertainty whether the entity will be able to continue as a going concern and
therefore whether it will realise its assets and extinguish its liabilities in the normal
course of business and at the amounts stated in the financial statements.
Notwithstanding this uncertainty, in our opinion it is still appropriate for the financial
statements to be prepared on a going-concern basis.

The audit partner

20 August 2009

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5.26 Effect of circumstances on audit opinion

Required

Discuss the audit issues to be considered in each of the circumstances, and their
likely impact on the audit opinion to be issued. Justify your answer with
references to auditing standards and the Corporations Act, as appropriate.

1. In this case there are a number of breaches of the Corporations Act by Whale
Ltd. When the audit is conducted in accordance with the Corporations Act, the
auditor has a duty to report on compliance with the requirements of the
Corporations Act. An auditor will form an opinion on statutory requirements
where the financial statements include an assertion that those requirements
have been complied with. A qualified opinion is expressed when there is non-
compliance with relevant statutory or other requirements. The opinion may be
separate from the opinion on presentation in accordance with the Australian
Accounting Standards.

The auditor also has responsibilities to report certain breaches of the

Corporations Act to the ASIC:
 s. 332 (9) — The auditor is required to report to ASIC if the company does
not have an AGM or does not lay the financial statements before the
meeting.
 s. 332 (10) — If there are any other breaches of the law that have not been
adequately dealt with in the audit report, or by bringing the matters to the
directors, the auditor should report the matter to ASIC in writing.

2. LIFO is not a permitted method to account for inventory under AASB 102,
‘Inventories’. The difference between the company using LIFO and FIFO has
a material effect on the closing inventory account balance and on the profit
and loss statement. You would request management to change its inventory
valuation method to FIFO (or another acceptable method according to
AASB 102). If management disagree with you over this matter, you would
probably issue an adverse audit opinion . This audit opinion is issued when the
auditor in his or her report can readily explain the nature of the disagreement
and its impact on the financial statements. Even if the difference were not
material, you would issue a qualified opinion in this situation because of non-
compliance with an accounting standard.

3. The argument put forward by the company to not consolidate would be

unacceptable according to AASB 127, ‘Consolidated and separate Financial
Statements’.
In AASB 127, states ‘… consolidated financial statements are the financial
statements of a group presented as those of a single economic entity.’ If
management disagree with you over this matter, you would probably issue an
adverse audit opinion. This audit opinion is issued when the auditor in his or
her report can readily explain the nature of the disagreement and its impact on
the financial statements. Even if the difference were not material, you would
issue a qualified opinion in this situation because of non-compliance with an
accounting standard.

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5.27 Preparation of the audit report — various circumstances

Required

(a) Consider all the facts and the pertinent requirements of ASA 700 (ISA 700),
and then rewrite the audit report in an acceptable and complete format,
incorporating any necessary departures from the unqualified report.

NOTE: For this and subsequent questions on audit reports, refer to Figure 4.3
on page 182 for additional wording on areas such as the directors’
responsibility for the financial report and declaration on independence,
which apply under ASA 700 for reports issued from 30 June 2007 and
thereafter.

Independent Audit Report

To the shareholders of Trueline Ltd

Auditor’s Responsibility

We have audited the financial statements of Trueline Ltd for the year ended 30 June 2007 as set out in
pages ... to ... The directors of Trueline Ltd are responsible for the financial statements. We have
conducted an independent audit of the financial statements in order to express an opinion on then to the
shareholders of Trueline Ltd.

Our audit was conducted in accordance with Australian auditing standards to provide reasonable
assurance whether the financial statements are free of material misstatements. Our procedures included
examination, on a test basis, of evidence supporting the amounts and other disclosures in the financial
statements, and the evaluation of accounting policies and significant accounting estimates. These
procedures have been undertaken to form an opinion whether, in all material respects, the financial
statements are presented fairly in accordance with accounting standards and other mandatory
professional reporting requirements so as to present a view which is consistent with our understanding
of Trueline Ltd’s financial position, the results of its operations and its cash flows.

The audit opinion expressed in this report has been formed on the above basis.

Audit opinion
In our opinion, the financial statements of Trueline Ltd are properly drawn up:
(a) so as to give a true and fair view of:
(i) the company’s state of affairs as at 30 June 2009 and its profits or loss and cash flows for
the financial year ended on that date; and
(ii) the other matters required by Division 4, 4A and 4B of part 3.6 of Corporations Act 2001
dealt with in the financial statements.
(b) in accordance with provisions of the Corporations Act 2001; and
(c) in accordance with applicable accounting standards and other mandatory professional reporting
requirements..

Inherent uncertainty regarding litigation

Without qualification to the opinion expressed above, attention is drawn to the following matter. As
indicated in Note 26 of the financial statements, Trueline Ltd is the defendant in litigation. As
discussed in Note 26, the circumstances of the case are such that the ultimate outcome of the litigation
cannot presently be determined with an acceptable degree of reliability, and accordingly no provision
of any liability that may result has been made in the financial statements.

Mike Brady, CPA

25 August 2009

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(b) Identify any items included in the ‘Other information’ section that would
not affect the audit report. Explain why this is the case.

 Change in accounting methods has been adequately dealt with as required by

AASB 111. No comment or modification to the audit report is necessary.
 The confirmation of accounts receivable is a required audit procedure. However,
for unspecified reasons the auditor was unable to carry out the procedure. We
assume there were exceptional circumstances. The auditor has taken alternative
procedures and is satisfied with the evidence obtained. In these circumstances the
auditor needs to document the justification for the departure in the audit working
papers.

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Case studies

5.28 Preparation of the audit report — various circumstances

Required
Prepare the audit report that Lucy Chow should issue for the year ended
31 December 2009.

Independent Audit Report

To the members of Hillgrove Ltd

Auditor’s Responsibility
We have audited the financial statements of Hillgrove Ltd for the year ended 31
December 2009 as set out on pages ... to ... The company’s directors are responsible
for the financial statements. We have conducted an independent audit of the financial
statements in order to express an opinion on it to the members of the company.

Our audit has been conducted in accordance with Australian auditing standards to
provide reasonable assurance as to whether the financial statements are free of
material misstatement. Our procedures included examination, on a test basis, of
evidence supporting the amounts and other disclosures in the financial statements, and
the evaluation of accounting policies and significant accounting estimates. These
procedures have been undertaken to form an opinion as to whether, in all material
respects, the financial statements are presented fairly in accordance with accounting
standards and statutory requirements so as to present a view which is consistent with
our understanding of the company’s financial position, the results of its operations and
its cash flows.

The audit opinion expressed in this report has been formed on the above basis.

Qualification
The company has excluded from property and debt in the balance sheet certain lease
obligations, which, in our opinion, should be capitalised in order to conform to
applicable accounting standards. If these lease obligations were capitalised, assets
would be increased by $500 000 and liabilities due in more than one year would be
increased by $650 000.

The notes to the financial statements do not disclose the change in the method of
accounting for inventories from the first-in first-out method to the weighted average
method. The change was introduced in order to reflect net income more clearly by
providing a closer matching of costs and revenues. The change has the effect of
reducing inventory at 31 December 2009 by $65 000 and gross profit by the same
amount. The effect of the change on prior years is immaterial.

Qualified audit opinion

In our opinion, except for the effects on the financial statements of the matters
referred to in the qualification paragraphs, the financial statements present fairly in
accordance with applicable accounting standards and other mandatory professional
reporting requirements, the Corporations Act, the financial position of Hillgrove Ltd
as at 31 December 2009 and the results of its operations and its cash flows for the year
then ended.

28 February 2010
Lucy Chow

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(Note: The payment of consulting fees to the director who was formally a partner in
Lucy’s accounting firm would not affect the audit report.)

5.29 Review of the auditor’s report

Required
(a) State whether the above report meets the requirements of ASA 700 and ASA
701, and if not, why not.

The report should begin with “We have audited the financial accompanying financial
report ……..etc.” and then refer to the directors’ responsibility for the financial report.
Next, the auditor’s responsibility should be addressed and it is under this section that
reference can be made to the electronic presentation of the audited financial
statements, not at the beginning of the report where it is currently placed. Next a
statement needs to be made regarding independence, followed by the auditor’s
opinion and report on other legal and statutory requirements.

(b) Explain the following components of the audit report and discuss why they
are important:

Title
The title should clearly state that it is an ‘independent’ audit report. It should also be
addressed to the members or shareholders of the entity.
Scope
Under ASA 700, effective for reporting periods starting 1 July, 2006, the scope is
addressed by two sections, namely the Directors’ Responsibility for the Financial
Report and in particular the Auditor’s Responsibility section which outlines all the
inherent limitations of an audit. There is also a separate statement made regarding
independence.
Audit opinion
This is the most important part of the audit report. This is where the auditor makes the
final assessment whether the financial statements give a true and fair view of the
entity’s financial position and comply with the relevant Australian Accounting
Standards and Corporations Regulations 2001. It is also important to note that the
statement being made is only an ‘opinion’ not a statement of fact.
Date
It is essential that the audit report be dated and signed. The date of signing is
significant in terms of the auditor’s liability.

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 Chapter 5: The Auditor’s report

5.30 Effect of circumstances on audit opinion

Required

Identify the type of audit report to be issued for each of the situations.

1. Food Fund Foundation has insufficient controls over the collection of income,
creating a limitation on the scope of the audit. You would be unable to
conclude as to whether all income received has been recorded. This limitation
on the scope of the audit would give rise to a disclaimer of opinion. The
qualification would probably read as follows: As is common for organisations
of this type, it is not practicable for Food Fund Foundation to maintain an
effective system of internal control over donations, subscriptions and other
fund raising activities until their initial entry in the accounting records.
Accordingly, our audit in relation to fund raising was limited to amounts
recorded.

2. The following summary details the position in relation to Telken Ltd’s group.
 Did not act as auditor s.331C(1)
 Telfast Ltd
 Teldane Ltd
 Have not examined audit report s.331C(2)
 Telfast Ltd
 Accounts not in an appropriate form for consolidation s.331E(2)(d)(i)
 Teldane Ltd

In accordance with the Corporations Act, the auditor must specify the entities
of which they did not act as auditor, and the entities where they did not
examine the audit report. This does not give rise to a qualification. However,
the auditor must also report on any ‘deficiency, failure or shortcoming’
(s.332E(1)) in relation to controlled entity’s accounts being in a form
appropriate for consolidation. As Teldane’s accounts are not in a proper form,
this will give rise to an ‘except for’ opinion on the basis of a disagreement
with management over inappropriate accounting policies.

It should be noted that the Corporations Act (s.323) provides the auditor of a
reporting entity for which consolidated accounts are required with the right of
access to the accounting records and registers of controlled entities, and the
right to require from their officers and auditors such information and
explanation as is needed.

3. The auditor has evidence that Eureka & Co. will not be a going concern after
the relevant period (approximately 12 months after the date the audit report is
signed). ASA 570 (ISA 570) states: ‘You should be alert to the possibility that
reasonably foreseeable circumstances may exist beyond the relevant period
that bring into question the appropriateness of management preparing the
financial report on a going concern basis’.

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Solution Manual to accompany Modern Auditing and Assurance Services 4e

Given that Eureka & Co. is not expected to be a going concern after the
relevant period, and that this fact is not disclosed in the financial statements,
you should issue a qualified opinion. There is no disclosure of the amount of
gold left in the vein or the board’s decision to shut down. An ‘except for’
opinion should be issued on the basis of a disagreement with management
over the lack of disclosure.

4. As AASB 124 has not been applied, an ‘except for’ opinion should be given
due to a disagreement with management over the appropriateness of
accounting policies. This qualification also arose in previous years, therefore
you must consider ASA 570 which states: ‘ … when the auditor’s report on
the prior period, as previously expressed, was qualified, the current period
audit report should be qualified regarding the comparatives when the matter
which gave rise to the qualification results in a qualification of the audit report
on the current period’s financial information’.

Research question

5.31 Audit Quality Review Board

Required
The first AQRB review of activities covers the period 31 December 2006 and its
report is available on the public reports section of the AQRB website,
www.aqrb.org.au. Review the report and assess whether the AQRB adds value to
the credibility of auditors in Australia and, if so, why.

This is a straightforward question that can be answered by reviewing the report and
commenting accordingly, with particular reference to the credibility of auditors as
discussed in earlier chapters.

© John Wiley & Sons Australia, Ltd 2009 15.18