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Proposed revised International Standards on Auditing issued for comment
by the International Auditing and Assurance Standards Board of the International Federation of Accountants

Comments from ACCA
July 2005

Executive Summary

The Association of Chartered Certified Accountants (ACCA) is pleased to comment on the proposed International Standards on Auditing 705 Modifications to the Opinion in the Independent Auditor’s Report (proposed ISA 705) and 706 Emphasis of Matter Paragraphs and Other Matters Paragraphs in the Independent Auditor’s Report (proposed ISA 706), issued for comment by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants.

ACCA supports the updating of these ISAs, which is necessary following the issue of updated ISA 700 (Revised) The Independent Auditor’s Report on a Complete Set of General Purpose Financial Statements (ISA 700 revised).

We do not agree that there is a need to split the subject matter into two ISAs; indeed, we recommend that both should be combined with ISA 700 revised, as that presentation would be more useful.

Although we raise theoretical arguments about the relationship between elements of an auditor’s report we disagree with a proposal to eliminate the term ‘modified report’ mainly on pragmatic grounds. We believe that auditors and others will continue to need the term.

In respect of this and other proposed amendments to terminology, we caution against making significant changes in advance of IAASB’s clarity project

Comments on Significant Proposals

The explanatory memorandum forming part of the exposure draft refers to certain significant proposals and directs commentators to consider certain questions. We comment below on these matters.

ISA NUMBERING

The proposed numbering scheme may well be expedient for the short-term. As the structure of ISAs is one of the matters that is to be considered as part of the first phase of the clarity project, we look forward to commenting on those proposals in due course.

As set out below, we would prefer to have all matters relating to reporting on a complete set of general purpose financial statements dealt with in one ISA (or at the most, two).

SPLIT BETWEEN ISA 705 AND ISA 706

We do not agree with the splitting of guidance between proposed ISA 705 and proposed ISA 706. In our experience, auditors have little difficulty in appreciating the structure of extant ISA 701 Modifications to the Independent Auditor’s Report. That ISA is divided into sections dealing separately with matters that do not affect the auditor’s opinion and those that do. Moreover, the introduction to extant ISA 701 deals with the distinction between the two in a better way than would be possible in separate documents.

Proposed ISA 706 is much shorter than proposed ISA 705. Once the repetition between the two documents is eliminated, the combination of the two would not produce an overly long ISA.

A combined document could be structured in a way that emphasises not only the distinction between matters that affect the opinion and those that do not, but also the differences between ‘emphasis of matter’ and ‘other matters’, as these do not fit easily together in proposed ISA 706.

The case of disclaimer of opinion for multiple uncertainties (see below) is one where the circumstances affect both proposed ISAs, and which could be better dealt with if there were only one document.

Proposed ISA 705 contains a section dealing with communication with those charged with governance. We assume that the absence of a similar section in proposed ISA 706 reflects a deliberate decision that a similar mandatory requirement would be unnecessary here. Nevertheless, in a combined ISA, such circumstances could be discussed in the guidance to make it clear that that was the case.

As well as recommending that there should be no split between proposed ISA 705 and ISA 706, we further recommend that both should be combined with ISA 700 (Revised) The Independent Auditor’s Report on a Complete Set of General Purpose Financial Statements. We understand that the separation originally took place because resources did not allow for concurrent updating.

TERMINOLOGY

We are concerned by the proposal to eliminate the term ‘modified report’ but support the use of the word ‘modified’ in relation to opinions.

We find the current usage of ‘modified’ in extant ISA 701 to be correct and useful. A report is understood to be ‘modified’ when it is not a report that would be issued in normal circumstances (ie it is not a ‘standard’ report). The term ‘modified’ has gained ground only in the last ten years or so and many would still refer to a ‘qualified report’.

We note the statement in the explanatory memorandum that ‘jurisdictions that translate the ISAs have found it difficult to explain the difference between a qualified opinion and a modified auditor’s report.’ We foresee such difficulties increasing, however, if no collective noun is available for all non-standard wording.

Realistically, the term ‘unmodified report’ (colloquially a ‘clean’ report) will remain and will be used with its antonym. If ISAs do not include such a term, auditors and others are unlikely to begin to refer to a category of reports as: ‘reports that contain neither a modification to the opinion nor an emphasis of matter paragraph or any other matters paragraphs that are not ordinarily present in reports on similar entities in the jurisdiction that report under the same financial reporting framework’.

In addition to these pragmatic reasons for retaining the term, there is a sound argument that it is logically necessary (as evidenced by the difficulty in jurisdictions that translate the ISAs, mentioned above).

The underlying logic for the proposed terminology appears to be that the opinion is capable of being modified (adverse, disclaimed or ‘except for’) in isolation from the remainder of the report. In reality, it is only the report that is capable of modification without affecting the opinion, for example by the inclusion of a further paragraph emphasising a matter (although that statement is itself open to challenge). A modified opinion is ordinarily accompanied by other changes to the report; the most obvious being those to the ‘basis of opinion’ paragraph.

As a modified opinion necessarily affects other aspects of the report, we believe that it is logical to retain the term ‘modified report’ and to deal with the cause(s) of the modification. We do not go so far as to suggest that the terminology be changed so as to require, for example that a modified report which contains an adverse opinion be referred to as an ‘adverse report’, but we consider that such an approach may promote greater understanding.

We strongly suggest that the time is not right to make these changes. Terminology is one of the matters that will be considered in the clarity project and it is not appropriate, in advance of that, to make significant changes that may be short-lived. The changes will impose additional costs on auditors but there will be no opportunity to see whether any benefits arise.

Under the heading of ‘terminology’, we would also like to register disapproval of the introduction of the term ‘financial statement line item’. This is unfamiliar in many jurisdictions and may unwittingly restrict consideration of matters that are not naturally thought of as being confined to a ‘line’ of the financial statements.

DISCLAIMER OF OPINION FOR MULTIPLE UNCERTAINTIES

We agree with the inclusion of paragraph 33 of ISA 705, as there is merit in having a mechanism to deal with the exceptional circumstances where multiple uncertainties cause the auditor to decide to issue a disclaimer of opinion.

The guidance should make clear whether the disclaimer of opinion replaces, or is additional to, the emphasis of matter paragraphs in the auditor’s report. Our current understanding of proposed ISA 706 is that paragraph 6 still requires an emphasis of matter paragraph for each matter, irrespective of an associated disclaimer.

There is a danger that such a mechanism could be overused as a means of reducing risk to the auditor, especially where going concern is one of the uncertainties. We suggest, therefore, that the guidance should make it clear that it is intended to deal with what would be an exceptionally rare combination of circumstances. It is perhaps unfortunate that this text has disproportionate prominence, taking up four of the nine lines of guidance in paragraphs 32
and 33.

USE OF SUB-HEADINGS

We agree with the use of sub-headings as this aids readers’ understanding.

SIGNIFICANT UNCERTAINTY AND MATERIAL UNCERTAINTY

We are concerned that the use of the terms ‘significant uncertainty’ and ‘material uncertainty’ could cause confusion because the latter is used without explanation only in relation to going concern (paragraph 11 of proposed ISA 706). A conforming amendment is proposed to ISA 570 Going Concern, but this excludes any change to the use of ‘material’ in this context.

ISA 570 uses the words ‘material’ and ‘significant’ in close proximity, such as in this sentence in paragraph 34: ‘The report should include specific reference to the fact that there is a material uncertainty that may cast significant doubt about the entity’s ability to continue as a going concern.’

Extant ISA 701 already contains both terms and we are not convinced, therefore, that extensive change to terminology is appropriate in advance of the first phase of the clarity project. If the majority of respondents is of the view that such terminology is inappropriate, it should suffice to introduce a footnote to explain that a material uncertainty that may cast significant doubt about the entity’s ability to continue as a going concern is considered to be a significant uncertainty for the purposes of proposed ISA 706.

FURTHER CONSIDERATIONS

The explanatory memorandum calls for comments on whether:

• considerations in the audit of small entities have been dealt with appropriately
• special considerations in the audit of public sector entities have been appropriately included
• there are any foreseeable difficulties in application in a developing nation environment, and
• there are any potential translation issues.

We have no comments on the above except to note that the section in proposed ISA 705 that deals with communication with those charged with governance does not acknowledge the common circumstance in small entities of considerable overlap between management and those charged with governance. We elaborate on this in our separate comments on proposed ISA 260 (Revised) The Auditor’s Communication with Those Charged with Governance.

PIECEMEAL OPINIONS

Paragraph 34 of proposed ISA 705 defines the term and states that a ‘piecemeal opinion’ is not permitted when there is an adverse opinion or disclaimer of opinion. We do not consider it appropriate for the term to be used in this narrow way. In many countries, the words ‘piecemeal opinion’ take their natural language meaning, which is not limited to rare cases where an adverse opinion or disclaimer of opinion is present.

Although we agree with the prohibition in the case of a full set of financial statements, we do not agree that it is always appropriate in a special purpose audit engagement. We can foresee circumstances where the auditor would validly use an adverse opinion or disclaimer of opinion on one, but not all, components of the subject matter information of a special purpose audit engagement.

We further recommend the inclusion of guidance, in relation to adverse opinion and disclaimer of opinion, on the interpretation of ‘material and pervasive’ outside the context of a full set of financial statements.

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