The auditor's report can only be issued when the auditor has gathered and reviewed evidence supporting the financial statements. I shall consider here some of the main issues you will encounter in the Professional Stage Audit and Assurance examination. The June 2002 examination will cover the provisions of Auditing Practices Board Bulletin 2001/2, Revisions to the Wording of Auditors' Reports on Financial Statements and the Interim Review Report, and SAS 600, Auditors' Reports on Financial Statements. Please use this bulletin and SAS 600 (both in Auditing & Reporting 2001/2002) when reading this article.

The Companies Act imposes on the auditor a number of duties that must be fulfilled, irrespective of whatever terms of reference have been agreed with the board of directors.

'Express opinions'

There are three matters on which the auditor must always express an opinion in the report. These are whether the financial statements:

• have been prepared in accordance with the Companies Act 1985;
• give a true and fair view of the state of the company's affairs (balance sheet) at the year end date; and
• give a true and fair view of the profit for the year then ended (profit and loss account).

If the auditor is satisfied that these three matters have been attended to, an 'unqualified' report is given. If any one or more matter is not materially satisfied, a 'qualified' opinion is given.

'Implied opinions'

The auditor must also consider whether the following matters have been fulfilled. If any one or more of them has not, then the auditor must refer to that or them in the audit opinion section of the report. Otherwise no mention of them is made in the auditor's opinion section. These matters are:

• Returns have been received from branches of the business not visited by an auditor. (It would be impossible for the auditor of, for example, Marks and Spencer plc to visit every branch.)
• Accounts agree to the underlying records and returns. (Think of your Accounting paper studies and how the final accounts need to reconcile to the trial balance and underlying ledger accounts.)
• Proper accounting records have been maintained.
• Information and explanations have been received from the officers of the business.
• Directors' Report is consistent with the audited financial statements. and Directors' loans, emoluments and transactions have been properly disclosed in the financial statements.

(Note RAPID+D.)

The report will help the auditor to discharge both his legal and professional duties. A full audit report can be found in the study text or in Auditing & Reporting (APB Bulletin 2001/2, Appendix 2). It is essentially split into sections.

• Title. Auditors have a statutory responsibility to report to the shareholders of the business. Shareholders will want to know how the company has performed (ie, how the directors have looked after their investment!). The title includes the word 'independent', emphasising the arm's-length relationship between the auditor and the company. This quality lends the accounts an air of credibility.
• Financial statements audited. The auditors only give an opinion on the balance sheet, p&l account, cash flow statement and notes to the financial statements (you will encounter much of this in your Financial Reporting studies). This is clearly highlighted in the opening paragraph of the report.
• Respective responsibilities of directors and auditors. The directors are expected to state clearly in the financial statements what their responsibilities are with reference to those statements (namely to prepare them in accordance with UK company law and accounting standards). The auditor's statutory duties (in terms of both 'express' and 'implied' opinions) are also described here. This section helps the reader to distinguish the roles of directors and auditors in the reporting process.
• Basis of audit opinion. The auditor here explains the main issues underlying the audit approach. That the audit is conducted in accordance with UK auditing standards indicates to the reader that the work is performed to high professional standards. The examination on a test basis of information indicates to the reader that the auditor cannot examine every transaction and instead relies on techniques such as selective testing, sampling and analytical review. The reader is also told that the audit involves the assessment of significant estimates and judgments made by the directors. This shows that a set of accounts is based on subjective decisions and is not a set of precise figures. The auditor also emphasises that the audit is designed to have a reasonable expectation of detecting material misstatements. This is so the reader understands that the audit is not a guarantee that the accounts are error free.
• The audit opinion. Where the auditor discharges his statutory duty by giving his opinion.
• Signature. The auditor will sign and date the audit report, identify himself and confirm that the firm is a registered auditor.

One reason is to help narrow the 'expectations gap'. This is the difference between what users of accounts think an audit involves and what it actually does involve. For example, the uninformed reader may consider that an auditor will consider every transaction a business is involved in, when in fact that would be impossible if auditing (say) Tesco plc! Another is to help overseas readers understand UK auditors' reports by harmonising the presentation of UK and overseas reports.

The diagram gives an overview of how to form an audit opinion. The auditor must first consider whether sufficient evidence has been gathered to form an opinion, then, in the light of the evidence gathered, whether the financial statements do indeed give a true and fair view and have been properly prepared in accordance with the Companies Act. If so, the auditor will give an unqualified report.

However, if the auditor has material misgivings about the accounts, then (having tried to resolve the matter with the directors) the auditor will issue a qualified report. It is important to make a distinction between the only two types of qualification that can be given.

Disagreement qualification

Here, the auditor has sufficient evidence to form an opinion. That evidence, however, disagrees with the presentation or treatment the directors have selected in the financial statements. Therefore the auditor actually thinks that there is a material misstatement or omission in the financial statements. This could be for one or more of four reasons:

• Incorrect accounting treatment - for example, the directors refuse to depreciate buildings and the depreciation charge that should be made is, in the auditor's opinion, material.
• Incorrect/inadequate disclosure - for example, not fully disclosing the company's accounting policy for fixed asset depreciation or not fully disclosing directors' loans.
• Disagreement on facts and amounts - for example, a material debtor who is unlikely to pay is not provided for in the accounts at all, overstating both profit and net assets (this is an incorrect accounting treatment as well).
• Failure to comply with statute - for example, the business chooses a balance sheet format or stock valuation method that the Companies Act 1985 does not permit.

Scope limitation qualification

Here the auditor has not been able to gather information that he would reasonably expect to be available. For example, if the company has failed to perform any form of stocktake, the auditor has no evidence on which to satisfy himself that stock quantities are fairly stated. The auditor would, however, expect a company to be able to provide such evidence. Other examples include the destruction of accounting records or directors refusing or being unable to allow the auditor access to information and explanations.

As a result there is the potential for a material-misstatement. The auditor does not know whether there actually is a misstatement, for not enough information was available to form that conclusion. For example, Harry Ltd, a manufacturing company, fails to perform a stock-take and includes stock in the accounts at an estimated value of £125,000. This figure may be correct, but it could be overstated by £125,000 or (albeit rather far-fetched) understated by an infinite amount. The key is that what is normally a material balance for a manufacturer could be materially misstated. The auditor will explain in the basis of audit opinion paragraph the nature and circumstances of the scope limitation.

It is also quite possible that the auditor may need (by statute) to report by exception that he has not received all the information and explanations necessary to form an opinion. Additionally (as in the Harry Ltd example above), the scope limitation may result in the company failing to keep proper accounting records (Harry Ltd is required by statute to produce a statement of year-end stocks and to perform a stock count).

What type of opinion?

In any qualified report, the auditor needs to say why he is qualifying his opinion, where possible quantify the effect and show which parts of the financial statements are affected.

In order to qualify the auditor's report, the matter must at the very least be material. To decide if a matter is material, the easiest rule of thumb is to consider whether the matter: is significant to the reader - ie, its omission or misstatement would affect the decision of a reasonable user of the financial statements; is easily isolated - ie, it affects only one or two areas of the financial statements. For example, if a debt is to be written off, it affects only debtors in the balance sheet and operating profit in the p&l account. All other balances are unaffected.

The diagram shows that for both material disagreements and scope limitations, an 'except for' opinion is given. This in essence means that 'apart from' the matter on which the auditor disagrees or is uncertain, the rest of the financial statements are true and fair.

However, the matter may be 'so material' (has a very large impact on the financial statements) or pervasive (significantly affects many areas of the financial statements) that the auditor has to qualify his report.

In the case of a disagreement, the auditor will consider that the matter is so important that unless corrected, the accounts as a whole do not give a true and fair view. The auditor therefore gives an 'adverse' opinion.

In the case of a scope limitation, the auditor considers that the lack of evidence is so significant that he is unable to form an opinion. In this circumstance, a 'disclaimer' of opinion is given.

If the auditor knows that the directors have deliberately imposed a significant scope limitation on their work such that a disclaimer of opinion is likely to be given, the auditor may consider resigning his position (SAS 601, Imposed Limitation of Audit Scope).

The final area to consider is whether, at the time of forming an opinion, there are any significant uncertainties affecting the business. With an inherent uncertainty, however, no conclusive evidence actually exists. For example, the company may have an ongoing legal case or insurance claim that will only be resolved some time after the audit report is given. If the directors have made all evidence available to the auditor, this cannot be a scope limitation. Similarly, if the directors have correctly treated the matter in the financial statements (eg, via a prudent provision or note to the accounts describing the matter), then there are no grounds for a disagreement.

In these circumstances, the auditor draws the reader's attention to the issue through a separate paragraph of the report. The report itself will not, however, be qualified (see example 4, SAS 600).

Auditors' reports are probably one of the most technical areas of the syllabus. It is important that you understand the component parts of an unqualified and qualified report. Fortunately you will not be expected to draft a full report!

Dan Tuckey is a senior tutor at the Financial Training Company in Southampton