Coronavirus: understanding audit reports

While COVID-19 will affect businesses in different ways and to different degrees, it is likely to have a significant impact on audit reports on company financial statements for the foreseeable future.

The FAQs below, created by the Audit and Assurance Faculty, are designed to help investors and other users of audit reports to better understand the different types of audit report wordings used by auditors, and their significance.

How might COVID-19 impact audit reports?

We expect to see more ‘modified’ audit opinions as a result of COVID-19. The possible types of audit opinions that auditors may give are explained below.

We also expect to see more ‘material uncertainties’ highlighted in audit reports in relation to going concern, and more ‘emphases of matter’. These do not, however, modify the audit opinion. These are also explained below.

For listed entities and other public interest entities, we are likely to see more ‘key audit matters’ (sometimes referred to as ‘KAM’) included by auditors in their reports in relation to the impact of COVID-19. Key audit matters are a standard feature of audit reports of such entities, intended to provide useful additional information to investors and other users. They are not modifications to the audit opinion, nor are they material uncertainties or emphases of matter.

What opinions on the financial statements are included in audit reports?

Auditors are required to give either an unmodified opinion (commonly referred to in business as a ‘clean’ opinion), or a modified opinion.

An unmodified opinion is provided where the auditor considers that the financial statements give a true and fair view of the company affairs at the balance sheet date and of its profit or loss for the accounting period.

Why might an audit opinion be modified?

A modified audit opinion can arise where there is an error, a disagreement over a particular matter or a lack of sufficient audit evidence in a particular area of the financial statements, including disclosures. How material or pervasive the impact is will determine the type of modification.

There are three types of modified audit opinion:

Qualified opinion - this could be because either:

the auditor has been unable to obtain ‘sufficient appropriate audit evidence’ concerning a particular matter, but, except for the possible effects of this matter, the auditor is able to state that the financial statements give a true and fair view; or
there is a particular material misstatement in the financial statements, ie, a misstatement that the auditor judges could impact the decisions of users of the financial statements, but except for the effects of this matter, the financial statements give a true and fair view.

The opinion section is headed up ‘Qualified opinion’.

Example 1: an auditor has been unable to attend a year-end inventory count of goods that are due to be sold by the company or to put in place suitable alternative measures to obtain the audit evidence considered necessary about the existence and condition of inventory. This might be particularly relevant for March 2020 year-ends onwards, until restrictions on movement are lifted. As a result the auditor has determined that this is a limitation in the scope of the auditor’s work, but in all other respects the financial statements give a true and fair view.

Example 2: a disagreement arises over the fair value of an item in the financial statements given the impact of COVID-19. The auditor has determined that this misstatement could impact the decisions of users of the financial statements but that in all other respects the financial statements give a true and fair view.

Disclaimer of opinion - the auditor is unable to obtain ‘sufficient appropriate audit evidence’ and this is material and so pervasive that the auditor is unable to form a view as to whether the financial statements give a true and fair view. The opinion section will be headed up ‘Disclaimer of opinion’.

Example: there are a significant number of overseas subsidiaries that make up the majority of a group’s operations and as the auditor is unable to obtain evidence to audit the results of those overseas subsidiaries, an opinion on whether the financial statements give a true and fair view cannot be given by the auditor.

Adverse opinion - the auditor judges, having obtained sufficient evidence, that there is a material and pervasive misstatement in the financial statements and that, because of the significance of the matter, the financial statements do not give a true and fair view. The opinion section will be headed up ‘Adverse opinion’.

Example: revenue on long-term contracts has been significantly overstated as it has not been recognised in accordance with applicable accounting standards. This misstatement is considered by the auditor to be material and pervasive and because of the significance of this matter, the auditor has determined that the financial statements do not give a true and fair view.

Are there other matters that may be highlighted in audit reports?

Yes. These may include reference to material uncertainties in relation to going concern or to other specific matters in the financial statements that the auditors believe require specific emphasis (emphases of matter). These do not change the audit opinion and these sections will state specifically that the audit opinion is not modified in respect of these matters.

In addition, there may be potential modifications to other matters in the audit report, for example in relation to other matters prescribed by law, matters reported by exception (eg. in relation to the adequacy of accounting records) or regarding other information presented in the annual report that accompanies the financial statements.

A standard feature of audit reports are key audit matters, intended to provide additional information to investors and other users. These are not material uncertainties or emphases of matter.

What does ‘going concern’ mean in this context?

A company is a going concern if it is able to remain in business for the foreseeable future. Unless management intends to liquidate the company or to cease trading, or has no realistic alternative but to do so, the financial statements will be prepared on a going concern basis. This does not mean, however, that there are no risks to future operations.

Auditors will evaluate management’s going concern assumptions for a minimum period of one year from the date of the audit report and will consider whether any material uncertainties exist which may cast significant doubt about the company’s ability to continue as a going concern.

What does a ‘conclusions relating to going concern’ paragraph in the audit report mean?

This indicates that the auditor’s assessment of the company is that it is a going concern and that there are no material uncertainties.

Does the inclusion of a ‘material uncertainty relating to going concern’ section in the audit report mean that the company is not a going concern?

The impact of COVID-19 on the economy is likely to make the inclusion of ‘material uncertainty relating to going concern’ sections in audit reports much more common for the foreseeable future. But the inclusion of such information does not mean that the company is not a going concern. It means that the directors have concluded that there is a material uncertainty about the company’s future operations, and that the auditors agree with that judgement. It also means, importantly, the directors have made clear, transparent disclosures in the financial statements regarding the nature and implications of the material uncertainty. If this section is included in the audit report it would replace ‘a conclusions relating to going concern’ paragraph.

Does the inclusion of a ‘material uncertainty relating to going concern’ section in the audit report mean that the audit opinion is modified?

No, the inclusion of the material uncertainty in the audit report does not change the audit opinion.

What is an ‘emphasis of matter’ paragraph in the audit report?

Emphasis of matter paragraphs do not change the audit opinion. They are used by auditors to draw the attention of users to a matter that the auditor thinks is important to their understanding of the financial statements.

Example: an emphasis of matter paragraph might relate to property valuations where valuers specifically reference in their reports material uncertainty related to COVID-19 and the directors have accordingly disclosed this in the financial statements. The inclusion of an emphasis of matter paragraph does not mean that the auditors believe that the valuation in the financial statements is inappropriate; the auditors are simply highlighting the disclosed material uncertainty as they believe that the information is important for users seeking to understand the financial statements. Reporting an emphasis of matter is not the only possible outcome in this situation; the impact on the auditor’s report will depend on the auditor’s assessment of the facts and circumstances in each case.

How might COVID-19 impact audit reports for different reporting periods?

COVID-19 is likely to impact audit reports in different ways for different reporting periods.

For example, for December 2019 year-ends, we expect to see more ‘material uncertainties in relation to going concern’. For March 2020 and later year-ends, we may well see modified audit opinions due to ‘limitations of scope’, given the challenges companies may face in providing their auditors with sufficient audit evidence as a result of government restrictions, for example in relation to social distancing.

Resources

ICAEW’s Audit and Assurance Faculty is recognised internationally as a leading authority and source of expertise on audit and assurance matters. The Faculty has over 7,500 members drawn from accountancy firms and organisations of all sizes in the private and public sectors. Further resources produced by the Faculty can be found at icaew.com/aaf.