Important definitions

Pervasive—This term is used in the context of material misstatement due to an error of fraud. The misstatement is pervasive when its impact is not confined to specific elements of the financial statement, and if confined, it represents a substantial proportion of the financial statement. Similarly, in the context of disclosure, disclosure is fundamental to the user’s understanding of the financial statement. In other words, the misstatement is pervasive when it’s impact is affected on the overall financial statement.

Modified opinion – When audit opinion is qualified, disclaimed, or adverse.

Scope of ISA 705

This ISA covers the auditor’s responsibility in the context of modifying an audit report. It defines the form and content of the audit report when modifying an audit opinion.

Types of modification in the audit opinion

The following are three types of audit reports.

1. Qualified audit opinion
2. Adverse audit opinion
3. Disclaimer audit opinion

The decision related to modification is based on the following aspects.

1. Inability to obtain audit evidence or material misstatement identified.
2. Auditor’s judgment on pervasiveness.

Objectives of ISA 705

The objective of ISA 705 is to appropriately modify an audit opinion when the auditor concludes that the financial statement contains material misstatements or when the auditor is unable to obtain sufficient and appropriate audit evidence.

Requirements of ISA 705

Circumstances When a Modification to the Auditor’s Opinion Is Required

The modification is required in the audit report when the auditor concludes that the financial statement contains material misstatements or that they have been unable to obtain sufficient and appropriate audit evidence (scope limitation).

Determining the Type of Modification to the Auditor’s Opinion (ISA 700)

Qualified opinion 

The qualified opinion is issued when,

1. Based on sufficient and appropriate audit evidence, the auditor concludes that the financial statement contains material misstatements, either individually or in aggregate.
2.  The auditor could not obtain sufficient and appropriate audit evidence and believes the possible effects of undetected misstatement can be material but not pervasive. In other words, the possible effect of scope limitation is material.

Adverse opinion

The adverse opinion is formed when,

Based on sufficient and appropriate audit evidence, the auditor concludes material misstatement is pervasive individually or in aggregate.

Disclaimer of opinion

The disclaimer of opinion is issued when the auditor cannot obtain sufficient and appropriate audit evidence, and the possible effects of audit evidence are expected to be material and pervasive. It can also be issued when multiple uncertainties exist, and it’s impossible to form an opinion.

Summarized basis of opinion

Qualified opinion = material misstatement based on audit evidence.

Qualified opinion = possible material misstatement due to inability to collect sufficient and appropriate audit evidence.

Adverse opinion = material and pervasive misstatement based on audit evidence.

Disclaimer opinion = Possible material and pervasive misstatement when sufficient and appropriate misstatement is impossible.

Wrap up

ISA 705 defines guidelines for the form and content of an audit report when an auditor decides to modify the audit opinion. The audit opinion is modified in case of material misstatement or when the auditor cannot obtain sufficient and appropriate audit evidence.

A qualified audit report is issued when a financial statement contains material misstatements or the auditor is not able to collect sufficient and appropriate audit evidence. The auditor concludes that the possible effect of undetected misstatement is material but not pervasive.

An adverse opinion is issued when a financial statement contains material and pervasive misstatements. On the other hand, a disclaimer is issued when the auditor is not able to obtain sufficient and appropriate audit evidence, and the possible impact seems material and pervasive.