Solutions manual

to accompany

Audit and assurance

1st edition
by

Leung et al.

© John Wiley & Sons Australia, Ltd 2019

1
 Chapter 6: The auditor’s report

Chapter 6: The auditor’s report

Review questions

6.11 Outline the contents of a general purpose financial report.

The disclosure and presentation requirements for such reports are generally
determined by accounting standards and statutory and other requirements. The
Corporations Act 2001 outlines the contents of a financial report (s. 295), including:

· the financial statements for the year required by accounting standards such as
AASB 101, including:
· an income statement (in Australian accounting standards, this is also
known as a statement of comprehensive income)
· a balance sheet (known in Australian accounting standards as a statement
of financial position)
· a cash flow statement (called a statement of cash flows in Australian
accounting standards)
· a statement of changes in equity

· notes to the financial statements, including:

· disclosures required by regulations
· notes required by accounting standards
· any other information necessary to give a true and fair view (see s. 297)

· the directors’ declaration that:

· the financial statements and notes comply with accounting standards
· the financial statements and notes give a true and fair view
· in the directors’ opinion, there are reasonable grounds to believe that the
company will be able to pay its debts as and when they become due and
payable
· in the directors’ opinion, the financial statements and notes are in
accordance with the law.

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6.12 What are the contents of an unmodified auditor’s 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).
· 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.
· Basis for opinion: Outlines that the audit was conducted in accordance with
Australian auditing standards and refers to the section of the auditor’s report that
describes the auditor’s responsibilities. This section should also identify the
relevant ethical requirements that the auditor has complied with.
· Key audit matters: Matters of most significance to the audit of
the financial report and should be taken from matters that have
been communicated with those charged with governance (in
accordance with ASA 701).
· Other information: Outlines the auditor’s responsibility for other
information in the annual report in accordance with ASA 720. The
directors are responsible for this information contained in the
annual report (information other than the audit report and
financial report). Even though this information is not audited, the
auditor reads this information and reports any material
inconsistencies found.
· Responsibilities of the directors for the financial report: Outlines
the directors responsibility for the preparation and truth and
fairness of the annual report and for assessing the ability of the
company to continue as a going concern.
· Auditor’s responsibilities for the audit of the financial report:
Outlines the auditor’s responsibilities for obtaining reasonable
assurance that the annual report is free of material
misstatements, whether due to fraud or error.
· Report on the Remuneration Report: Auditor’s opinion on the
Remuneration Report as to compliance with section 300A of the
Corporations Act 2001, and notes that the directors are
responsible for the preparation of the Remuneration Report.
· Auditor’s name and signature. The report is signed by the audit firm or the
individual audit partner, as appropriate.
· Name of firm.
· Date the audit report is signed. The audit report is dated after the governing body
has signed the financial reports. This date is important because the auditor has
responsibility for subsequent events up to this date.
· Auditor’s address. A specific location where the auditor maintains an office.
· Note that an unqualified report may be modified by an “emphasis of matter”
and/or “other matter” statement by the auditor.

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6.13 Explain what a ‘Key Audit Matter’ is and under what circumstances
it should be included in the auditor’s report?

Key Audit Matters (KAMs) are those matters that, in the auditor’s professional
judgement, were of most significance in the audit of the financial report in the current
period. KAMs are selected from matters communicated with those charged with
governance.
The auditor does not have to report KAMs in the audit report but it is expected to be
an extremely rare situation where there are no KAMs. Communication of KAMs is no
substitute for disclosures that management are required to make as part of the
financial report. Where the auditor modifies the auditor’s report, this matter is not
included in the KAM section of the auditor’s report.

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

A modified auditor’s report is issued when the auditor concludes that, based on the
audit evidence obtained, the financial report as a whole is not free from material
misstatement, or, the auditor is unable to obtain sufficient appropriate audit evidence
to conclude that the financial report as a whole is free from material misstatement.
Material misstatements may be the result of a number of factors, including an
inappropriate selection or application of accounting policies that are required by the
applicable financial reporting framework, or inadequate disclosures of matters that are
required or disagreement with management relating to the financial statements to
conflict between applicable financial reporting frameworks. Guidance is given in
ASA 705 Modifications to the Opinion in the Independent 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 705.

Type of audit opinions:

· Qualified opinion is expressed when the auditor, having obtained sufficient
appropriate audit evidence, concludes that misstatements, individually or in
the aggregate, are material, but not pervasive, to the financial report; or the
auditor is unable to obtain sufficient appropriate audit evidence on which to
base the opinion, but the possible effects on the financial report of undetected
misstatements, if any, could be material but not pervasive.

· Adverse opinion is expressed when the auditor, having obtained sufficient

appropriate audit evidence, concludes that misstatements, individually or in
the aggregate, are both material and pervasive to the financial report.

· Disclaimer of opinion is expressed 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 report of undetected
misstatements, if any, could be both material or pervasive. In extreme cases,
the auditor may conclude that, even after having obtained sufficient
appropriate audit evidence, it is not possible to form an opinion on the
financial report due to the potential interaction of multiple uncertainties and
their possible cumulative effect on the financial report.

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6.15 Under what circumstances may the auditor decide to include an

‘emphasis of matter’ section in the auditor’s report?

The purpose of an ‘emphasis of matter’ section is to draw the attention of users of the
auditor’s report to relevant information. Circumstances in which an emphasis of
matter may be necessary are:
· An uncertainty relating to the future outcome of an exceptional litigation, or
regulatory action
· A significant subsequent event that occurs between the date of the financial
report and the date of the auditor’s report
· An early application, where permitted, of a new accounting standard that has a
material effect on the financial report
· A major catastrophe that has had or continues to have, a significant effect on
the entity’s financial position

6.16 What is the difference between an unmodified auditor’s opinion and

a modified auditor’s opinion?

An unmodified auditor’s opinion is an unqualified report which states that the

financial report present fairly, in all material respects, in accordance with the
applicable financial reporting framework; or the financial report gives a true and fair
view of the financial position and the results of operations and cash flows of the entity
in accordance with the applicable financial reporting framework. An audit report may
have an unmodified opinion but include an emphasis of matter or other matter
paragraph.

A modified audit opinion encompasses ‘other than unqualified’ audit reports that
include opinions in relation to material or pervasive limitations of scope or
disagreements, these opinions would be qualified, disclaimer or adverse as
appropriate.

6.17 Is materiality the only consideration for an auditor deciding whether

to qualify the audit opinion?

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. 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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6.18 What does each of the modified types of auditor’s opinions mean to
users wanting to rely on the financial report?

Qualified Opinion
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 report; 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 report of undetected misstatements, if any, could be material but not
pervasive.

Adverse Opinion
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 both material and pervasive to the financial report.
←
Disclaimer of Opinion
(a) 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 report of undetected
misstatements, if any, could be both material and pervasive.
(b) 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
report due to the potential interaction of the uncertainties and their possible
cumulative effect on the financial report.

When the auditor modifies the opinion on the financial report, the auditor shall, in
addition to the specific elements required by ASA 700, include a paragraph in the
auditor’s report that provides a description of the matter giving rise to the
modification. The auditor shall place this paragraph immediately before the opinion
paragraph in the auditor’s report and use the heading “Basis for Qualified Opinion,”
“Basis for Adverse Opinion,” or “Basis for Disclaimer of Opinion,” as appropriate.
Auditor should include a clear description of all the substantive reasons and unless
impracticable, a quantification of the possible effect(s) on the financial report.
If it is not practicable to quantify the financial effects, the auditor shall so state in the
basis for modification paragraph.

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6.19 What circumstances may give rise to (1) an adverse opinion and (2)
a disclaimer of opinion?

(1) Circumstances that give rise to an 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.

(2) Circumstances that give rise to disclaimer of opinion:

· 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.

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6.20 What might constitute “other matters” on which an auditor may be

required to report?

The circumstances in which another matter paragraph may be necessary include:

· Where the auditor is unable to withdraw from an engagement even though the
possible effect of an inability to obtain sufficient appropriate audit evidence,
due to a limitation on the scope of the audit as imposed by management, is
pervasive. The auditor would include another matter paragraph to explain why
it is not possible to withdraw from the engagement.
· The auditor is permitted to elaborate on matters that provide further
explanation of the auditor’s responsibilities or the auditor’s report, such as
those that are required by law, or regulation; or such other matters that the
auditor has been asked to perform and report on or express an opinion on, but
are in addition to the auditor’s responsibility under the Australian auditing
standards.
· The auditor may also include another matter paragraph referring to the fact
that another financial report has been prepared by the same entity in
accordance with another general-purpose framework and that the auditor has
issued a report on that financial report.
· Other auditing standards that contain the requirements for the auditor to
include other matter paragraphs are ASA 560 Subsequent Events (ISA 560),
ASA 710 Comparative Information — Corresponding Figures and
Comparative Financial Reports (ISA 710) and ASA 720 The Auditor’s
Responsibilities Relating to Other Information in Documents Containing an
Audited Financial Report (ISA 720). Appendices 3 and 4 of ASA 706
Emphasis of Matter Paragraphs and Other Matter Paragraphs in the
Independent Auditor’s Report (ISA 706) includes illustrations of various types
of auditors’ opinions.

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Professional application questions

 BASIC |  MODERATE |  CHALLENGING

6.21 Effect of circumstances on an audit opinion 

Assume you are an auditor and you are facing the following separate
circumstances; the effects of all the items below are material:
1. The provision for stock is inadequate.
2. A retailer values inventory at sales price less an allowance
for sales margin.
3. A manufacturing company is currently negotiating with the
bank an extension of a loan facility that is due for repayment shortly after
the AGM; without this refinancing the business will not be able to continue
operations.
4. A significant proportion of a retailer’s sales are on a cash
basis and inadequate records have been maintained; there are no audit tests
that can be done to satisfy yourself that the cash sales are accurate.
5. Management have excluded from the financial report the
necessary disclosures in relation to a contingent liability.
6. The company that runs a dairy farm has prepared the
financial report on a going concern basis; shortly after the year end the
company’s contract with a major supermarket was cancelled. Without this
customer, you expect the business to cease trading within six months and it is
unlikely that the company will be able to secure any new contracts in that
time.
7. The directors of a construction company refuse to give you
access to reports produced by an independent quantity surveyor in relation
to the value of work done on some of their construction projects.
8. A wholesaler has a policy of including all of its buildings in
the balance sheet at cost less depreciation. You establish that one of the
warehouses included in the balance sheet at a value of $20m has an actual
market value of $23m.

Required
Indicate the effect of the above circumstances on your auditor’s
report if management were to refuse to make any changes you feel
necessary in order that the financial report gives a true and fair
view.

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 an acceptable method of valuing inventory at cost and therefore an
unmodified opinion can be given.
3. If the matter of loan negotiations 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 the loan negotiations 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.

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5. This is a disagreement with management and a qualified opinion is necessary,

refer to 1 above.
6. It appears that it is highly likely that the business will not continue to trade and
therefore the financial report should not be prepared on a going concern basis;
some alternative such as a break-up basis would be appropriate. This gives rise to
an adverse audit opinion.
7. This is a scope limitation. Refer answer 4 above.
8. The policy is to include buildings at cost less depreciation and therefore the
accounts do not need to be changed to include the market value of the property.
An unmodified opinion is appropriate.

6.22 Effect of circumstances on audit opinion 

Scarborough Hydraulics Ltd contracts with governments to carry out a variety of
infrastructure projects including water treatment and desalination plants and
other drainage works. It also acts as a contractor to maintain a range of
government infrastructure assets. The contracts that it has with its government
customers have very strict turnaround times to ensure that, in the event of
problems, water services to the public are quickly brought back on-line.
You have completed your audit of Scarborough Hydraulics and the following
material events occurred:
1. Scarborough holds a stock of high-value drainage
components to allow them to be able to respond quickly to their customers’
needs. Due to the size and quantity of these items, they were stored in a
large outdoor space on the outskirts of Sydney. Shortly after the year end a
significant amount of this stock was stolen. The security at this site was
inadequate and no record of the theft is available.
2. Scarborough has a large manufacturing centre in
Melbourne which provides prefabricated concrete for the company’s
infrastructure projects. The company policy is to include factories in the
balance sheet at market value less accumulated depreciation. The
Melbourne factory is included in the balance sheet based on a valuation
carried out five years ago. The company has not engaged a valuer to
revalue the property because the directors believe that market values have
remained fairly level over the last five years, so the existing carrying value
is not materially different from current value.
3. During the year, Scarborough completed a contract
to provide drains for a private construction company that was building
500 houses in a new suburb of Brisbane. Shortly before the year end, a
downpour of rain saw the drainage system fail causing damage to the
houses being built. The construction company is suing Scarborough for the
costs of rectifying the damage. Scarborough have not provided for any
possible payout because they expect their losses to be covered by a claim
against one of their sub-contractors that supplied the faulty part that
caused the failure.

Required
Discuss each of the above issues, state what effect each would
have on the audit opinion and give reasons.

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1. This is an event that takes place after year end and is a post balance sheet
event. The event does not give further information about the position at the
balance sheet date as loss the inventory takes place after the year end and so
this is a non-adjusting post balance sheet event which requires disclosure in
the financial report. The loss does not need to be provided for in the balance
sheet.

Qualification
Assuming no disclosure note is included in the financial report this is a
disagreement that is material but not pervasive and a qualified opinion is
therefore required.

2. The directors will not provide a valuation to support their assertion that the
carrying value is not materially different to the market value of the property.
This is a limitation on the scope of the audit as without the valuation the
auditor is unable to form an opinion as to whether the asset value is correctly
stated.

Qualification
This is a limitation on scope that is material but not pervasive and therefore a
qualified opinion is required.

3. In this case the liability to pay the construction company cannot be offset
against any claim made against the supplier. The events take place before the
year end and therefore the financial report should include a provision for the
probable amount that will be paid to the construction company and
disclosures explaining the circumstances should also be included. A
receivable from the supplier would only be included to the extent that this
was considered virtually certain.

Qualification
Without the necessary adjustments, there is a disagreement due to inadequate
liabilities and inadequate disclosures. These items are material but not
pervasive so would give rise to a qualified opinion.

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6.23 Going Concern? 

HomeRus Ltd is a retailer a range of low cost household products and is listed on
ASX. It is highly geared because it borrowed heavily to finance the purchase of
shopping centres around Australia. There has been a squeeze on the prices it can
charge for its products due to a dip in the economy creating sluggish demand
from customers. There has also been a fall in the value of a large part of its
property portfolio. The share price of the company has fallen significantly in
recent years and a change in senior management last year has done nothing to
turn this around. Market analysts continue to forecast poor performance for the
company and have suggested that the low share price puts the company at risk of
being taken over by one of its competitors.
There have been some approaches by other companies to take over the
company, but all negotiations have come to nothing. Some commentators have
indicated that the company is sound with good locations and some minor
changes will prepare the company for an improving economy. Others, however,
have suggested that a buyer coming in at a cheap price could sell off the more
valuable properties to make a profit and close the other parts of the business.
No reference has been made to going concern issues in any recent financial
report.

Required
Discuss the problems facing HomeRus and the auditor when
considering disclosures around going concern and possible audit
opinions.

There are some indications that the company may be suffering going concern
problems even though these issues have not been included in recent financial reports
or the auditor’s reports. The situation in the current year seems to be consistent with
previous years and is part of a general decline.

It could be argued that the company must have some value because there have been
others interested in buying the company, the low share price could encourage these
buyers to purchase a cheap company and then continue to trade where the underlying
business is sound.

There is nothing to suggest that the company is not a going concern. It is more
reasonable to suggest going concern difficulties remain and the market place is
difficult. Therefore, it is unlikely that going concern will need to be referred to in the
current financial report or auditor’s report.

If there was a mention of going concern difficulties in the financial report then there is
a signal to the stock market which may cause an overreaction in shareholders who
will then look to sell the shares creating a downward spiral in the share price. Where a
company has loans this may lead to breaches of loan contract terms which may
stipulate that certain share based ratios need to be maintained. This reaction can cause
the going concern problems to be brought even though the fundamentals are sound.

The auditor’s duties include reporting where there are going concern problems.
However, if the auditor were to mention the going concern difficulties in the audit
report and the company subsequently failed, then the auditor is at risk of being sued

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by the company for causing that failure. It is likely that the auditor would face
resistance from directors to include any reference to going concern in the auditor’s
report so he will need to be sure that all the facts are available to make the right
decision.

Both the auditor and the directors therefore must be careful to give information that
the users of financial information need but also to provide information carefully so
that signals are not given that can be misinterpreted and cause difficulties.

6.24 Going-concern issues, audit opinion 

Temper Telecommunication Ltd is a listed public company that manufactures
communication equipment. Last year the company engaged in a contract
involving the engineering and infrastructure for a highly complex broadband
network in Adelaide. The company has a 30 June year-end, and the statutory
accounts are due to be signed one week after the board of directors meeting on 5
August 2020. During the course of the audit, you become aware that, due to
complex negotiations with the Australian Government on broadband networks,
and the likely change in government policies, the company was advised that the
plan for the broadband network engineering project may be suspended until
further notice. Temper Telecommunications had bought sophisticated
equipment which was to be paid off through the life of the project over 3 years. It
also commenced the architectural planning, employing two highly paid experts
in broadband architecture. Temper Telecommunications is now experiencing
growing cash flow difficulties (the project was meant to be able to save its
business).
It has recently applied for a significant increase to a borrowing facility that is
already fully drawn. Management is adamant that the company will continue to
be viable. If necessary, it claims it can resort to cutbacks in its other future
capital expenditure program, seek additional off-balance-sheet financing and/or
reschedule existing debt arrangements.

Required
(a) Discuss the reporting options open to an auditor when going
concern issues arise.

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 report, the audit report
should be unmodified in accordance with ASA 570 (ISA 570). However, the
auditor should include a statement in a separate section of the auditor’s report
under the heading ‘Material Uncertainty Related to Going Concern’ to draw
attention to the note in the financial report that discloses the uncertainty.
If the financial report does not adequately disclose the significant uncertainty, a
qualified or disclaimer of opinion should be expressed on the basis of a lack of
disclosure in accordance with ASA 705 (ISA 705).
· Going-concern basis considered inappropriate

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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 570 (ISA 570).

(b) Discuss the auditor’s report options in relation to Temper

Telecommunications Ltd.

There are a number of matters that indicate potential going-concern reporting issues
for Temper Telecommunications Ltd (TT). These include:
 Due to the complex negotiations with the Australian Government on broadband
networks, and the likely change in government policies, TT was advised that the
plan for broadband network engineering project may be suspended until further
notice.
 TT has been experiencing cash flow difficulties and the project was meant to be
able to save its business.
 TT’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 a statement in a separate section of the auditor’s report under the heading
‘Material Uncertainty Related to Going Concern’.
If the financial report does not adequately disclose the significant uncertainty, a
qualified or disclaimer of opinion should be expressed on the basis of a lack of
disclosure in accordance with ASA 705 (ISA 705).
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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6.25 Preparation of the auditor’s report — various circumstances 

You are the audit partner of Gerrotown Housing Ltd, which provides social
housing to approximately 1000 tenants at below normal market rents.
Gerrotown is a reporting entity under the Corporations Act. Consider the
impact of the following two situations on your auditor’s report for the year
ending 30 June 2021:
1. During the year, there has been a review of the basis for
calculating the lives of the houses owned by the organisation. Previously, these
houses were assessed to have a useful life of 30 years, but this has now been
changed to 50 years. During your audit work, you reviewed the Gerrotown
Housing Ltd asset management policy which only plans for maintaining and
upgrading properties up to 30 years old. You also found that, during the year,
Gerrotown Housing Ltd demolished a house that it built in 1989.
2. Approximately 700 of the houses that Gerrotown Housing Ltd provides to its
clients are leased from the state government. The lease obliges Gerrotown
Housing Ltd to sub-let the houses to social housing tenants at low rents
calculated using a formula in the lease. The current lease for these houses
expires on 31 December 2021 and Gerrotown Housing Ltd is negotiating new
lease terms. From your review of the board minutes, it appears that the state
government is looking to increase the lease costs that will be charged to
Gerrotown Housing Ltd by 20% due to increases in rates and maintenance
costs on these houses. The board minutes record that these houses would now
not generate any surplus and may put the long-term survival of Gerrotown
Housing Ltd in jeopardy. The board are unwilling to sign the new lease as it is
currently drafted.

Required
Discuss the impact of these events on the auditor’s report you
intend to issue for Gerrotown Housing Ltd for the year ending 30
June 2021. In each case,provide the wording for any additional
paragraphs you may include in your audit report.

1. Reconsideration of the useful lives of houses.

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.

Basis for Qualified Opinion

Gerrotown Ltd has reconsidered their method used to review the useful lives
of their houses. This new policy and the effect on profit of $xxxx has been
disclosed in Note X to the financial statements. In our opinion, Gerrotown 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 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.

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2. Lease of houses from State government.

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, the uncertainty
is outlined in a separate section to refer users to the section of the report where
the matter is disclosed. This uncertainty does not require the opinion to be
modified.

Material uncertainty related to going concern

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.

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Solutions manual to accompany Audit and assurance 1e by Leung et al.

6.26 Effect of circumstances on audit opinion 

You are an audit manager finalising your 30 June 2021 audits. The following
independent and material matters have come to your attention:
1. The audit of the statutory records of Whale Ltd, a
reporting entity, revealed the following problems:
(a) failure to update the members’ register for changes in shareholders
(b) failure to obtain written consent from directors to act
(c) no preparation of minutes of directors’ meetings in respect of the
current year
(d) failure to hold the annual general meeting in the previous financial
year
(e) the company made no comment in respect of either the failure to keep
properly updated statutory registers or the failure to hold an annual
general meeting.
2. Shark Ltd, a reporting entity, uses last-in first-out in
respect of valuation of closing inventories, which is one of the most
significant balance sheet accounts. The difference between first-in first-
out and last-in first-out has a material effect on the closing inventory
balance.
3. Dugong Ltd is a holding company with a number of wholly
owned subsidiaries. One of these, Manatee Ltd, is a self-sustaining foreign
subsidiary with manufacturing and distribution facilities throughout
South-East Asia. The group accounts of Dugong and its subsidiaries
consist of the consolidated statements of Dugong and its subsidiaries and
exclude those of Manatee, which are attached separately. The
consolidated statements include a note stating that the directors believe it
is misleading to consolidate Manatee because its operations are very
different from those of the rest of the group and are carried out under
substantially different conditions. The note includes details of
intercompany balances and transactions.

Required
Discuss the audit issues to be considered in each of the above
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:

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 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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Solutions manual to accompany Audit and assurance 1e by Leung et al.

6.27 Preparation of the auditor’s report — various circumstances 

Mike Brady, a registered company auditor, has completed the audit of the
financial report of Trueline Ltd for the year ended 30 June 2021. Mike also
audited the financial report for Trueline for the previous financial year. He
drafted the following report for 30 June 2021:

We have audited the statement of financial position, income statement, statement of

cash flows and statement of changes in equity for Trueline Ltd as of 30 June 2021.
Our audit was made in accordance with an applicable financial reporting
framework. In our opinion, the above-mentioned financial reports are accurately and
fairly presented in accordance with generally accepted accounting principles in effect
at 30 June 2021.
Mike Brady, CPA
25 August 2021

Other information
1. During the year, Trueline changed its method of accounting
for long-term construction contracts. It properly reflected the effects of the
change in the current year’s financial report and restated the previous
year’s statements. Mike is satisfied with Trueline’s justification for making
the change. The change is discussed in Note 24 to the financial reports.
2. Mike was unable to perform normal accounts receivable
confirmation procedures, but he used alternative procedures to satisfy
himself as to the validity of the receivables.
3. Trueline is the defendant in a litigation case, of which the
outcome is highly uncertain. If the case is settled in favour of the plaintiff,
Trueline will be required to pay a substantial amount of cash that may
require the sale of certain non-current assets. The litigation and possible
effects have been properly disclosed in Note 26 to the financial reports.

Required
(a) Consider all the above facts and the pertinent requirements of
ASA 700 (ISA 700), and then rewrite the auditor’s report in an
acceptable and complete format, incorporating any necessary
departures from an unmodified report.

Independent Auditor’s Report

To the shareholders of Trueline Ltd

Report on Audit of the Financial Report

Opinion
We have audited the financial report of Trueline Ltd, which comprises that statement
of financial position as at 30 June 2021, the statement of comprehensive income,
statement of changes in equity and statement of cash flows for the year then ended,
and notes to the financial report, including a summary of significant accounting
policies and the director’s declaration.
In our opinion the accompanying financial report of Trueline Ltd, is in accordance
with the Corporations Act 2001, including:

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(a) giving a true and fair view of the company’s financial position as at 30 June 2021
and of its financial performance for the year then ended; and
(b) complying with Australian Accounting Standards and the Corporations
Regulations 2001; and

Basis for opinion

We conducted our audit in accordance with Australian Auditing Standards. Our
responsibilities under those standards are further described in the Auditor’s
Responsibilities for the Audit of the Financial Report section of our report. We are
independent of the Company in accordance with the auditor independence
requirements of the Corporations Act 2001 and the ethical requirements Accounting,
Professional and Ethical Standards Board’s APES 110 Code of Ethics for
Professional Accountants (the Code) that are relevant to our audit of the financial
report in Australia. We have also fulfilled our other ethical responsibilities in
accordance with the Code.
We confirm that the independence declaration required by the Corporations Act 2001,
which has been given to the directors of the Company, would be in the same terms if
given to the director as at the same time as this auditor’s report.
We believe that the audit evidence we have obtained is sufficient and appropriate to
provide a basis for our opinion.

Emphasis of Matter
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 report, 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 report.
Responsibility of the Directors for the Financial Report
The directors of the company are responsible for the preparation of the financial
report that gives a true and fair view in accordance with Australian Accounting
Standards and the Corporations Act 2001 and for such internal control as the
directors determine is necessary to enable the preparation of the financial report that
gives a true and fair view and is free from material misstatement, whether due to fraud
or error.
In preparing the financial report, the directors are responsible for assessing the
Company’s ability to continue as a going concern, disclosing, as applicable, matters
related to going concern and using the going concern basis of accounting unless the
directors either intend to liquidate the Company or to cease operations, or have no
realistic alternative but to do so.
Auditor’s Responsibilities for the Audit of the Financial Report
Our objectives are to obtain reasonable assurance about whether the financial report
as a whole is free from material misstatement, whether due to fraud or error, and to
issue an auditor’s report that includes our opinion. Reasonable assurance is a high
level of assurance, but is not a guarantee that an audit conducted in accordance with
the Australian Auditing Standards will always detect a material misstatement when it

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exists. Misstatements can arise from fraud or error and are considered material, if,
individually or in the aggregate, they could reasonably be expected to influence the
economic decisions of users taken on the basis of this financial report.

Mike Brady, CPA

Name of firm
25 August 2021
Auditor’s address

(b) Identify any items included in the ‘Other information’ section

that would not affect the auditor’s 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

6.28 Standardised audit reports 

The report produced by the auditor should be the first thing that a user of a
financial report reads. It is only having read the audit report that the user can
have any confidence that the contents of the financial report are a reasonable
representation of the financial position and performance of the company.
In order to understand what comfort the audit report gives, any user must
understand what an audit is, the role of the auditor and the role played by
management and the board of directors of the company.
The amount of information included in the auditor’s report has increased in
recent years in an attempt to reduce the expectation gap.

Required
(a) Discuss the advantages and disadvantages of the
standardisation of audit reports.

Advantages
• Familiarisation of the report by users means exceptions can be easily identified.
• Efficiency of preparation by the auditor.
• Comparability across different companies and different jurisdictions.
• Prevents directors and auditors agreeing formats and wordings that may hide the
truth.

Disadvantages
• Statements made may be very general statements about what an audit is and not deal
with specific issues, and therefore may have limited use.
• Standardisation may not be able to capture all the nuances of different businesses.
• In order to reduce the size of the report some issues will be excluded, these may be
important for some users.
• Encourages language to be used that may not be familiar to non-accounting experts
and therefore may not give the information in a form that is useful to all users.
• Familiarity with the format means they may be ignored because they are always the
same.

(b) Explain the following components of an auditor’s report and

discuss why they are important:
(i) auditor’s and directors’ responsibilities.
(ii) independence.
(iii) audit opinion.

Auditor’s and directors’ responsibilities

It is important for users to understand exactly what is, and is not, the responsibility of
the auditor. Many users may think that the auditor has a responsibility to detect and
report fraud. It is therefore necessary to make it clear that the auditor is expressing an
opinion on the financial report. Whilst the auditor may have a reasonable expectation
of detecting material fraud that has an impact on the financial report, that is not the
main purpose of the audit.

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It is the responsibility of the directors to prepare a financial report that shows a true
and fair view and complies with accounting standards. The director’s must also select
appropriate accounting policies that are the basis for the preparation of the financial
report. If the financial report contains material errors then this is the responsibility of
the directors, the auditor has the responsibility to report these issues in the auditor’s
report.

Independence
The audit acts as protection for the company’s members that the financial report that
they are receiving from the company gives a true and fair view of the financial
position and performance. For the audit to have any credibility it must be an objective
process and therefore the auditor must be able to demonstrate independence from the
company and those responsible for the preparation of the report.

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 performance 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.

6.29 Effect of circumstances on audit opinion 

You are an audit partner finalising your 30 June 2021 audits. The following
independent and material matters have come to your attention.
1. Food Fund Foundation, a charity, is a non-reporting entity.
As in previous years, you have performed the audit in accordance with its
constitution. The financial report is prepared by another firm of
accountants on behalf of Food Fund’s board of directors, because Food
Fund does not have the in-house expertise to perform this function. During
your review of the internal control structure, you noted that the company
did not have sufficient controls over the collection of income to enable you
to be satisfied that all income received was recorded. However, you have
been satisfied that the company has correctly accounted for all income
recorded.
2. Telken Ltd is the parent entity of the Telken Group, a
reporting entity. Your firm did not act as auditor of either Telfast Ltd or
Teldane Ltd — the entities controlled by Telken. You were unable to
obtain the auditor’s report for Telfast, although you do have a copy of the
final draft auditor’s report, and the other auditor’s verbal assurance that
an unqualified auditor’s report was issued. In addition, despite receiving a
copy of the audited report for Teldane, you do not believe the financial
report is suitable for consolidation with the other entities in the group. This
is because Teldane operates in Afghanistan, which has a vastly different
accounting framework from that used in Australia. You have been able to
quantify the financial effect of the required adjustments on the financial
report of the Telken Group. However, management has refused to make
the adjustments and has consolidated the existing version of Teldane’s
financial report.
3. Eureka & Co. Pty Ltd, a non-reporting entity, operates a

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small goldmine, which is run as a family business. The board consists of Mr

Lalor and his sister, Ms Lalor, who are also the principal shareholders. As
part of the final audit meeting, Ms Lalor tells you: ‘I reckon the vein we’re
currently mining will last 18 months at the most — 14 months at the least.
After the gold is extracted, we are shutting up shop; we’ll let the license
expire and retire to Kalgoorlie.’ Ms Lalor then shows you a surveyor’s
report backing up her assertion regarding the amount of gold in the vein.
The financial report does not disclose this information.
4. Prime Trust is a reporting entity. Ms Ford, the finance
director, refuses to adopt AASB 124 Related Party Disclosures (IAS 24) on
the grounds that it ‘requires information to be disclosed to the public that
should remain known only to the parties concerned’. This is consistent with
her stance in previous years, which resulted in your issuing a qualified
auditor’s report. You are satisfied that the current financial report is
materially correct in all regards, apart from the non-compliance with
AASB 124 (IAS 24).

Required
Identify the type of auditor’s report to be issued for each of the
above 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 and 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

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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’.

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 report, 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. This 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’.

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Research question

6.30 Heart Transplant Pty Ltd

The following is an auditor’s report for the Heart Transplant Pty Ltd for the
year ended 30 June 2021. Heart Transplant Pty Ltd is an intermediary
consultant which organises the affairs of heart transplant patients with the
hospitals, using a fee for service. It also accepts donations and has been active in
charitable activities.

The Auditor’s Report

We have audited the attached financial report of Heart Transplant Pty Ltd, for the
year ended 30 June 2021. The Committee is responsible for the financial report and
has determined that the accounting policies used and described in Note 1 to the
financial reports which form part of the financial report are appropriate to meet
the requirements of the Corporations Act and are appropriate to meet the needs of
the patients. We have conducted an independent audit of this financial report in
order to express an opinion on it to the members of Heart Transplant Pty Ltd. No
opinion is expressed as to whether the accounting policies used are appropriate to
the needs of the members.
The financial reports have been prepared for the purpose of fulfilling the
requirements of the Corporations Act 2001. We disclaim any assumption of
responsibility for any reliance on this report or on the financial report to which it
relates to any person other than the members, or for any purpose other than that
for which it was prepared.
Our audit has been conducted in accordance with Australian Auditing Standards.
Our procedures included examination, on a test basis, of evidence supporting the
amounts and other disclosures in the financial report, and the evaluation of
significant accounting estimates. These procedures have been undertaken to form
an opinion whether, in all material respects, the financial report is presented fairly
in accordance with the accounting policies described in Note 1 so as to present a
view that is consistent with our understanding of the company’s financial position,
and performance as represented by the results of the operations. These policies do
not require the application of all Accounting standards and other mandatory
professional reporting requirements in Australia. The audit opinion expressed in
this report has been formed on the above basis.
Qualification
It is not practicable to establish control over monies received from voluntary
revenue, including gifts and donations received prior to entry in the financial
records. Accordingly, audit procedures with respect to monies received from
voluntary revenue had to be restricted to the amounts recorded in the financial
records.
Qualified Audit Opinion
In our opinion, except for the effects of the matters in the Qualifications paragraph,
the financial report presents fairly, in accordance with the accounting policies
described in Note 1 to the financial reports, the financial position of Heart
Transplant Pty Ltd as at 30 June 2021 and the results of its operations for the year
then ended.
Signed on: 23 September 2021.

Required

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Examine the audit report and the areas whereby the audit report
should be amended in accordance with ASA 700, ASA 705 and ASA
706.

Areas whereby audit report should be amended:

• The audit report should distinguish clearly between directors’ responsibilities and
auditor’s responsibilities. It didn’t outline the responsibility of the auditors.
• Auditors should express an opinion as to the appropriateness of the accounting
policies to meet the need of the members.
• There are a number of unclear areas such as the responsibilities of the Committee as
mentioned in the first paragraph.

Students should investigate the extent of matters that may affect the financial report of
an organisation for which the Australian accounting standards are not applicable.

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