In every audit engagement, the auditor issues a report based on the audit procedures performed and other audit findings. In audit reports, the auditor gives an opinion about the fairness of the financials. Opinions are of FOUR types:
- Unmodified Audit Opinion
- Qualified Audit Opinion
- Adverse Opinion
- Disclaimer of Opinion
This article focuses on explaining the disclaimer of opinion, its effect on the company, and the circumstances under which the auditors may choose to issue a disclaimer of opinion.
Definition
Disclaimer of opinion, as defined by ISA 705, is issued when the auditor is unable to obtain sufficient appropriate audit evidence on which to base the audit opinion, and the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive.
That means, in a disclaimer of opinion, the auditor does not have an opinion at all about the financial statements. It arises due to factors like poor business documentation, management blocking the auditor’s way to conduct the engagement, etc…
Here’s the logic behind the disclaimer of opinion; Audit opinion is based on evidence that supports the auditor’s opinion about the financials. The auditor just cannot make up his opinion and it must be backed up by evidence. But, what if the auditor cannot find evidence even after performing thorough procedures and samplings?
Of course, they will unable to assure the users that financial statements are true and fair or that we’ve found significant misstatements. Therefore, instead of issuing one of the other THREE types of opinions, they will issue a disclaimer of opinion.
When does the Auditor issue a Disclaimer of Opinion?
As mentioned, lack of evidence in an audit engagement will result in a disclaimer of opinion. Inability to find evidence arises due to factors like missing business records, putting limitations on the work of the auditor ie; not granting access to the auditor to test or perform procedures on key audit areas.
In circumstances where the management restricts the scope of the auditor’s work, the auditor shall request that the management remove the limitation. If the issue is not resolved, the auditor’s next move is to communicate the matter to those charged with governance. If alternative procedures could be applied to gather sufficient appropriate evidence, they will reach an agreement. Otherwise, the auditor has TWO options. They will either:
- Withdraw from the audit engagement where practicable or possible under applicable law or regulation. OR
- If it is not practicable to do so before issuing an audit report, a disclaimer of opinion will be issued.
If the management imposes restrictions on the auditor’s work and the auditor has completed the audit engagement substantially, the auditor may decide to complete the audit to an extent possible, disclaim an opinion and explain the limitation in the disclaimer of opinion section before withdrawing from the audit.
However, in some circumstances, withdrawing may not be an option. When the auditors are appointed by the state for public entity audits or the law requires the auditor to continue the engagement. Sometimes, the auditor is appointed for a specific period of time and the contract restricts the auditor to withdraw from the engagement.
In addition, when the auditor decides to withdraw from the audit, there may be legal, regulatory or professional requirement for the auditor to communicate matters relating to the withdrawal to regulators or the entity’s owners.
Some other situations in which the auditor may choose not to render an opinion include:
- When the auditor is doubtful about the financial statements and could not decide one.
- When the auditor feels pressurized or influenced and cannot continue the engagement further.
The effect of Disclaimer of Opinion on the entity
When the auditor decides not to render an opinion (issues a disclaimer of opinion), it can create dire circumstances for the entity. The severity, however, depends on the “why” of the disclaimer. To understand the severity of the disclaimer of opinion for the entity, let me first explain how severe the disclaimer of opinion itself is.
If there is uncertainty about an item of the financial statements and the likely misstatement is material but not pervasive, the auditor issues a modified or qualified audit opinion. In case of likely misstatements that are expected to be both material and pervasive, the auditor goes with a disclaimer of opinion. Pervasiveness here, is a key terminology and needs to be interpreted.
Pervasiveness refers to the effect of misstatements. If a misstatement is material but does not affect other items of the financial statements or has nothing to do with other items, it is considered not pervasive. On the other hand, if a misstatement affects other items, which ultimately affects the overall financial statements, it is considered pervasive.
That being said, if the auditor expects misstatements that are not likely to be pervasive, they may choose to issue a modified form of audit opinion which means; except for this, the financial statements, in our opinion give a true & fair view. But if the misstatement is likely to be both material and pervasive, the auditor issues a disclaimer of opinion which means no opinion at all!
It affects the entity in the worst of ways and is damaging for the entity’s reputation. In addition, once it receives a disclaimer of opinion, it will have problems in hiring new auditor as no auditor would be willing to work with a problematic client.
