FRC guidance on modified audit opinions
On 16 March 2020 the FRC issued guidance for auditors in which it highlighted the possibility that the impact of COVID-19 may require auditors to consider modifying their audit opinion. On 21 April 2020 the FRC issued guidance in relation to modified audit opinions and circumstances in which they might be issued.
The guidance highlights that two primary factors contribute to the kind of modified opinion which auditors can give:
- whether the auditor has been able to obtain sufficient, appropriate audit evidence to form an opinion on whether the financial statements are free from material misstatement; and
- how pervasive any error may be to the financial statements.
As a direct consequence, audit opinions may be modified in the following ways and provides a brief explanation of each:
Additional disclosures in the auditor’s report which are not modifications of the opinion. The guidance also highlights those situations where there are additional disclosures in the auditor’s report which are not modifications of the opinion, which remains unqualified.
(i) Key audit matters (where applicable as per International Standard on Auditing (UK) 701 Communicating Key Audit Matters in the Independent Auditor’s Report). Those matters that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements. Matters giving rise to a modified opinion are not included within the Key Audit Matters (KAM) section of the auditor’s report, but under a separate heading. Similarly, issues relating to going concern are only included within the KAM section of the auditor’s report when the auditor has concluded that management has accounted for going concern appropriately and there is no material uncertainty about the company’s ability to continue as a going concern.
(ii) An emphasis of matter
This is a paragraph included in the auditor’s report that refers to a matter appropriately presented or disclosed in the financial statements that, in the auditor’s judgment, is of such importance that it is fundamental to users’ understanding of the financial statements.
(iii) Certain disclosures relating to going concern
The auditor is required to make certain additional disclosures relating to going concern where management’s accounting treatment is appropriate and:
(i) where no material uncertainty has been identified - reporting is by exception under the heading ‘Conclusions relating to Going Concern’.
(ii) where a material uncertainty has nevertheless been identified, and this is appropriately disclosed in the financial statements – reporting is under the heading ‘Material Uncertainty Related to Going Concern’.
It is only where the auditor concludes that management’s proposed approach to the use of the going concern basis of accounting is not appropriate, or that there is insufficient disclosure about a material uncertainty, that a modified opinion will arise:
(i) Where the use of the going concern basis is not appropriate, the auditor gives an adverse opinion.
(ii) Where there is insufficient disclosure about a material uncertainty, the auditor gives either a qualified or adverse opinion.
(iii) Where there is insufficient evidence to support management’s determination that the financial statements should be prepared on a going concern basis, the auditor disclaims their opinion.
Modified opinions are set out in a separate dedicated part of the auditor’s report.
A decision-making tree is included in the guidance to illustrate the thought making process that leads to the different types of modifications to the audit report that are possible.