Financial statement users’ understanding of the messages in the audit report



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6.2 Analyzing the research results


This paragraph contains the qualitative analyses of the research results, presented in paragraph 6.1. In this paragraph, the research results will be interpreted. This part of the research is aimed at understanding the respondents’ understanding of the audit report, and their visions concerning the contents of the current form audit report, and possible changes or additions to the audit report.

6.2.1 Audit report - general


As is presented figure 6.1, respondents do agree that the audit report enhances the credibility of the financial statements. In addition, the greater part of the respondents is of the opinion that in the audit report the purpose of the audit is clearly communicated; consequently, the respondents are acquainted with the role and the purpose of the audit. The respondents support the relevance of the audit report to represent an unqualified opinion on the financial statements.
The greater part of the respondents does not agree with the statement on going concern. Respondents are of the opinion that an unqualified audit report does not necessarily vouch for the entity’s ability to continue as a going concern. This may imply respondents’ demand for additional information related to the entities’ going concern status.
Research results indicate that the main message of the audit report, that is, ‘the unqualified audit report implies that the audited financial statements present a true an fair view of the company's financial position as at December 31, 20X1 and of its financial performances and cash flows for the year then ended’, is positively understood by almost all respondents. The respondents understand that when the financial statements are covered by an unqualified audit report, the company’s financial situation is fairly stated, and may be relied on by financial statement users.

6.2.2 The nature and scope of the auditor’s work


As could be deducted from figure 6.3, respondents are positive on the explanatory power of the audit report concerning the nature and the scope of the auditor’s work. Respondents support the effectiveness of the audit report in communicating on audit procedures and the application of auditing standards.
Because the audit report lacks detail in describing the auditor’s effort to comply with auditing standards, to some extent the research results are remarkable. The audit report explains that certain procedures are performed in order to obtain audit evidence about the financial statements and that the procedures selected depend on the auditor’s judgment. The audit report however, does not attend to the contents of audit procedures and their contribution in forming the audit opinion.
The remaining part of the respondents who neither agree nor disagree, or who disagree with the statements on the nature and scope of the auditor’s work doubt the understandability of the audit report. Respondents may require more transparency into the audit process and what the auditor has performed to obey his responsibilities. Research results here may indicate the existence of an ‘information gap’ between the information that investors need to realize informed investment decisions and the information that is disclosed.

6.2.3 The audit opinion


The auditor’s responsibility is to perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. The greatest part of the respondents understands that the audit report does not imply the audited financial statements to be free of material error. Based on this it could be concluded that the audit report effectively communicated the level of assurance provided by the audit, that is, the auditor does not guarantee the correctness of the financial statements.
Nevertheless, it is surprising that such a great part of the respondents is skeptical as to the correctness of the financial statements. Respondents take into account the financial statements to contain mistakes or misstatements, despite the audit, which serves the purpose of adding credibility to the financial statements. The value relevance of performing audit procedures could be doubted.
The last phrase of the section ‘Auditor’s responsibility’ in the audit report states whether the auditor believes that the audit evidence as obtained by the auditor is sufficient and appropriate to provide a basis for the auditor’s opinion. Based on table 6.6 could be deducted that the basis of the opinion, that is, sufficient and appropriate audit evidence, is clearly communicated. Because the concept of ‘sufficient and appropriate audit evidence’ is explained no further and could be interpreted in many different ways, it is conceivable that a part of the respondents disagreed the assertion.
The section ‘Auditor’s responsibility’ in the audit report states that the audit procedures selected depend on the auditor’s judgment, including the assessment of risks of material misstatements of the financial statements. ‘Professional judgment’ however, is a high usage but vague concept, which may be incomprehensible for the financial statement user. Research results presented that 40% of the respondents have no opinion to, or do not understand the role of judgment in the audit process.
Professional judgment synthesizes the collection of information and the formation of conclusions. Throughout the course of the audit, extensive judgments are made by the auditor. The audit report fails to reflect those judgments, which is confirmed by the greater part of the respondents in this research. The audit report provides no answers, for example, for the following questions:



  • What have been specific risks and points of attention in the audit and why?

  • What audit steps have been taken accordingly?

  • What materiality criteria have been used?

  • What items from the scope of the audit have been specifically excluded, or are subjected to more limited direct work?

  • What has the auditor performed to ensure high quality work if he used other auditors?

Opposite, the judgmental process involved in performing an audit is complex and may not have to be conveyed in detail. Besides, a requirement for auditors to provide a narrative audit report, including a description of the work performed and judgments used, may raise concerns that audit firms would be required to disclose proprietary information.



6.2.4 The auditor and auditors’ responsibilities


As stated in the audit report, the auditor’s responsibility is to express an opinion on the financial statements. According to the research results, respondents clearly understood this statement of the audit report. This statement on auditors’ responsibility however, does not propose an approach concerning the auditor’s responsibility in relation to fraud.
The audit report provides little information on the auditor’s responsibility in relation to fraud. The section ‘Auditor’s responsibility’ in the audit report states that the audit procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. Fraud is attended to as part of the auditor’s risk assessment procedures.
International Standard on Auditing (ISA) 240 deals with the auditor’s responsibilities relating to fraud in an audit of financial statements. ISA 240 states that the primary responsibility for the prevention and detection of fraud rests with those charged with governance of the entity and management.
Concerning the responsibilities of the auditor, ISA 240 postulates: ‘An auditor conducting an audit in accordance with ISAs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error. Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements may not be detected, even though the audit is properly planned and performed in accordance with the ISAs.’
Over 23% of the respondents do not agree that the audit report clearly communicates the auditor’s responsibility in relation to fraud. 33% of the respondents neither agree nor disagree with this statement. Respondents do not ascertain the audit report’s message concerning fraud responsibilities. The greater part of the respondents (44%) who do agree with this statement, may be familiar with the auditor’s communications, and do realize the joint responsibility of management and the auditor relating to the detection of fraud.
Regarding to the auditor’s professional behavior, the audit report appoints that International Standards on Auditing require the auditor to comply with ethical requirements. The International Ethics Standards Board for Accountants (IESBA) as established by the IFAC board develops and issues high quality ethical standards for professional accountants (auditors) for use around the world.
The Code of Ethics for Professional Accountants (IESBA code) establishes ethical requirements. In acting in the public interest, auditors shall comply with this code. The auditor should comply with the fundamental principles, that is, integrity, objectivity, professional competence, confidentiality, and professional behavior.
The principle of objectivity imposes an obligation on all professional accountants, amongst others, not to compromise their professional or business judgment because of bias, conflict of interest, or the undue influence of others.
The research results reveal the greater part of the respondents to be positive concerning the auditor’s professional behavior. The audit report appoints that the auditor be required to comply with the ethical requirements. The audit report however, further does not attend to the content and the application of the ethical requirements. The research results may indicate that respondents are already familiar with the concept of the auditor independence, and the auditor’s social responsibility.
A great part of the respondents trusts the auditor to act in the public interest, which is an important solution. According to the handbook of the code of ethics (IFAC, 2010), independence of mind and in appearance is necessary to enable the professional accountant in public practice to express a conclusion, and be seen to express a conclusion, without bias, conflict of interest, or undue influence of others.
The objective of the audit; to enhance the credibility of the financial statements, could only be realized if the users of the financial statements believe the auditor is objective and unbiased. Independence is fundamental to the reliability of the audit report. Audit reports would not be credible, and investors and creditors would have little confidence in them, if auditors were not independent in both fact and appearance.

6.2.5 Changes or additions to the audit report


Disclosure of methodologies and assumptions used by auditors may be useful to financial statement users. Concerning the auditor’s assessment of the ‘going concern’ status of the client, this is agreed upon by the greater part of the respondents. Respondents’ demand for an auditors’ opinion concerning the overall health and future prospects (going concern disclosure) of the company, may be attributed to the last decennium’s accounting scandals (Enron, Worldcom and Royal Ahold), and to economic circumstances; the financial crisis, as of the past three years.
Before issuing an audit report, auditors are required to consider the entity’s ability to continue as a going concern. An auditor should consider whether certain conditions or events discovered during the course of the audit contradict the going-concern assumption. The auditor is required to include an explanatory paragraph in the audit report if ‘substantial doubt’ exists about the ability of an entity to continue as a going concern.
Almost 14% of the respondents neither agrees nor disagrees the audit report to contain a statement on the going concern status of the client. Respondents may support the view of the issuance of a going-concern opinion to be a self-fulfilling prophecy. Auditors are handling an ethical dilemma: whether to issue a going-concern opinion and risk escalating the financial distress of their client, or not issue a going-concern opinion and risk not informing interested parties of the possible failure of the company.

In the ‘audit opinion’ – section of this chapter, it has already been raised that the audit report effectively communicates the level of assurance provided by the audit. Respondents correctly interpreted the audit report as to explain that an audit was designed to provide reasonable, but not absolute, assurance that the financial statements are free of material misstatements. The auditor does not guarantee the correctness of the financial statements.


Although the respondents seem to understand that auditors do not audit everything to every penny, they may not understand the level of assurance related to the concept of materiality.
Misstatements, including omissions, are considered to be material if they, individually or taken together, could reasonably be expected to influence the economic decisions of users taken based on the financial statements (ISA 320). The auditor applies the concept of materiality both in planning and in performing the audit, and in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements and in forming the opinion in the auditor’s report.
Throughout the audit, materiality is considered, in particular when

  • Identifying and assessing the risks of material misstatement;

  • Determining the nature, timing and extent of further audit procedures; and

  • Evaluating the effect of uncorrected misstatements, if any, on the financial statements, and in forming the opinion in the auditor’s report (ISA 320).

Disclosure of the materiality levels might provide guidance to users of the extent to which the financial statements could potentially be misstated. It provides the quantitative context in which the auditor has arrived at his opinion that the financial statements present a true and fair view.


More than half of the respondents agree that the audit report should contain an explanation of the materiality levels as practiced in the audit of financial statements. Respondents here may wish to obtain an understanding of the auditor’s judgmental processes, and the extent of immaterial errors, which could be contained in the financial statements.
Respondents who neither agree nor disagree (33%), or who disagree (10%) the audit report to contain an explanation of materiality levels, may regard to materiality as sensitive information that auditors do not wish to be known to the users of financial statements and management of their clients.



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