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Query No. 39
Subject:
Adverse opinion in auditor’s report.1
A. Facts of the Case
1. The auditee is a distillery and the issue relates to the statutory audit
report. The querist is the auditor of the company.
2. According to the querist, the distillery is a going concern and is funded by
leading financial institutions and banks. The company, however,
is a sick industrial company and has been referred to the Board for Industrial
and Financial Reconstruction (BIFR).
3. The accounts of the company as drawn up by the management show a loss of Rs.
32.38 crore and a negative net worth of Rs. 40.07 crore. Its cumulative losses
are Rs. 178.70 crore.
4. The auditor qualified his report on the following aspects:
(i) Assets have been given on lease, whose book value is Rs.26.13 crore and have
not been returned after the lease period. This has not been provided for and the
company is yet to take possession of those assets. (The Board of Directors of
the company has stated in its reply that the lessee is a State Electricity Board
and the company is entitled to set-off the value of assets against the
equivalent security deposit).
(ii) Loans to the extent of Rs. 268 crore were considered by the auditors as
doubtful of recovery and have not been provided for. (The Board of Directors of
the company has stated in its reply that the advances were given in the course
of business and are fully recoverable. Further, the company has also given an
undertaking to the financial institutions to recover them over a period).
(iii) Debts considered doubtful not provided for is Rs. 8.12 crore. (The Board
of Directors of the company has stated in its reply that these are amounts due
from parties like a State Electricity Board and others and legal steps have been
initiated for recovery).
(iv) The company has written back certain liabilities with a book value of Rs.
6.47 crore which in the view of the auditors are not to be written back. (The
company has taken a view that there is no continuing liability in respect of
these and hence, the amounts were credited to the expenditure accounts).
(v) The company has not provided for the liability that has devolved on it in
respect of corporate guarantees extended to other bodies corporate where notices
have been issued. The principal amount of the loan that had devolved on the
company aggregates to Rs. 56.75 crore and interest thereon is Rs. 93.75 crore,
aggregating to Rs. 150.50 crore. (The company has taken the view that the
liabilities were disputed liabilities and hence, treated as ‘Claims against the
company not acknowledged as debts’).
5. The auditors have also quantified the total impact of the audit
qualifications as required in the ‘Statement on Qualifications in Auditor’s
Report’, issued by the Institute of Chartered Accountants of India, in their
report as follows:
“Had our observations made as above been considered by the company, the loss for
the current period ended on March 31, 2004, would have been Rs. 46,568.16 lakh
(as against the reported figure of Rs. 3,228.00 lakh), the debit balance in the
profit and loss account would have been Rs. 61,209.91 lakh (as against the
reported figure of Rs. 17,869.75 lakh), etc.”
The querist has stated that the qualifications are material in amount.
6. As auditor, the querist had qualified the audit report stating that subject
to the above qualifications, the accounts reflect a true and fair view having
regard to the following:
(a) The company is still a going concern.
(b) The company’s profit and loss account shows a loss and its balance sheet
shows a negative net worth.
There is no change in situation of profit into a loss or from a positive net
worth to a negative net worth due to issues considered worthy of qualification.
7. The views of the management of the company are different from the views held
by the auditors and in the view of the querist, matters are not like
non-compliance with mandatory accounting standards, where no two opinions are
possible.
8. The business of the company is appraised by the financial institutions, who
continue to fund the operations of the company. There is a restructuring package
under formulation before BIFR.
9. The querist has stated that there are very few occasions in India where a
total negative report, i.e., stating that the accounts DO NOT REFLECT A TRUE AND
FAIR VIEW (emphasis supplied by the querist) have been given in respect of going
concerns by the auditors. The querist has further stated that even where serious
issues were involved, the auditors have only resorted to qualifications. As per
the querist, this has been a consistent contemporary practice of the profession
in India, as a negative opinion of ‘not a true and fair view’ has drastic
consequences for the company concerned.
10. The querist has reproduced the following paragraphs of Auditing and
Assurance Standard (AAS) 28, ‘The Auditor’s Report on Financial Statements’,
issued by the Institute of Chartered Accountants of India, for the reference of
the Committee, as below:
“37. An auditor may not be able to express an unqualified opinion when either of
the following circumstances exists and, in the auditor’s judgment, the effect of
the matter is or may be material to the financial statements:
(a) there is a limitation on the scope of the auditor’s work; or
(b) there is a disagreement with management regarding the acceptability of the
accounting policies selected, the method of their application or the adequacy of
financial statement disclosures.
The circumstances described in (a) could lead to a qualified opinion or a
disclaimer of opinion. The circumstances described in (b) could lead to a
qualified opinion or an adverse opinion. These circumstances are discussed in
paragraphs 42-47.
38. A qualified opinion should be expressed when the auditor concludes that
an unqualified opinion cannot be expressed but that the effect of any
disagreement with management is not so material and pervasive as to require an
adverse opinion, or limitation on scope is not so material and pervasive as to
require a disclaimer of opinion. A qualified opinion should be expressed as
being ‘subject to’ or ‘except for’ the effects of the matter to which the
qualification relates.
39. A disclaimer of opinion should be expressed when the possible effect of a
limitation on scope is so material and pervasive that the auditor has not been
able to obtain sufficient appropriate audit evidence and is, accordingly, unable
to express an opinion on the financial statements.
40. An adverse opinion should be expressed when the effect of a disagreement is
so material and pervasive to the financial statements that the auditor concludes
that a qualification of the report is not adequate to disclose the misleading or
incomplete nature of the financial statements.”
11. The querist notes from the above that an adverse opinion is called for only
if “there is a disagreement with management regarding the acceptability of the
accounting policies selected, the method of their application or the adequacy of
financial statement disclosures.” In the view of the querist, for mere
differences in opinion between management and auditors, an adverse opinion is
not called for even if amounts are material. For example, when the management
feels that a debt/advance or an investment is recoverable and auditors feel it
is not recoverable and qualify either as ‘being unable to express an opinion’ or
‘in their opinion, the debt, etc. is not recoverable’. A disclaimer is given
when there is a limitation on scope of the work of the auditor.
12. In the view of the querist, it is not only the quantum of qualifications
which matters when an auditor decides on whether he should give a qualified
opinion, or a disclaimer or an adverse opinion. According to the querist, the
auditor has to conclude that in view of the nature of qualifications which have
to be both material and pervasive to the financial statements, a qualification
is not adequate to disclose the misleading and incomplete nature of the
financial statements. The querist is of the view that certainly there is an
amount of judgement involved in this if the qualification does not cover acceptability of the accounting policies selected, the method of their
application or the adequacy of the financial statement disclosures. (Emphasis supplied by the querist.)
13. The querist has stated that as per his observation from a cross- section of
audit reports issued in the country, either (a) the auditors have qualified the
reports stating that they are unable to express an opinion on various matters,
but still have given only a qualified opinion and not a disclaimer of a true and
fair view, or (b) the auditors have heavily qualified the audit reports on
various matters which cover material amounts as seen relative to the profit/loss
for the period etc., but still have not given an adverse opinion on true and
fair view.
B. Query
14. The querist has sought the opinion of the Expert Advisory Committee on the
following issues:
(a) Whether the querist is right in qualifying the accounts subject to
adjustment of monetary amounts of the qualifications; or he should have reported
that the balance sheet and the profit and loss account do not reflect a true and
fair view.
(b) In case a disclaimer opinion had been given on the same issues instead of a
negative report, whether he would still be required to give a disclaimer of
opinion on true and fair view.
C. Points considered by the Committee
15. The Committee restricts itself to the particular issues raised by the
querist in paragraph 14 above and has not examined other issues that may be
contained in the Facts of the Case, such as, whether the company is a ‘going
concern’, or whether the qualifications have been correctly made.
16. The Committee notes that in paragraph 1 above, the querist has used the
words, ‘Auditee is a distillery’ and in paragraph 2, ‘the company, however, is a
sick company and has been referred to BIFR’. It is not clear from the facts
whether the distillery and the company are the same. The opinion given by the
Committee hereinafter is based on the presumption that both the distillery and
the company are the same.
17. The Committee notes paragraph 8 of the ‘Clarification regarding Authority
Attached to Documents Issued by the Institute’, issued by the Institute of
Chartered Accountants of India, which states as follows:
“8. There can be situations in which certain matters are covered both by a
‘Statement’ and by an ‘Accounting Standard’/‘Statement on Standard Auditing
Practices’. In such a situation, the ‘Statement’ shall prevail till the time the
relevant ‘Accounting Standard’/ ‘Statement on Standard Auditing Practices’
becomes mandatory. It is clarified that once an ‘Accounting Standard’/‘Statement
on Standard Auditing Practices’ becomes mandatory, the concerned ‘Statement’ or
the relevant part thereof shall automatically stand withdrawn.”
From the above, the Committee is of the view that after AAS 28 becoming
mandatory for all audits relating to accounting periods beginning on or after
1st April, 2003, the ‘Statement on Qualifications in Auditor’s Report’, has
become redundant to the extent it is covered by AAS 28. Hence, the provisions of
AAS 28 are applicable to the case under consideration.
18. The Committee has considered various arguments given by the querist under
the ‘Facts of the Case’ for not giving an adverse opinion. The views of the
Committee thereon are as follows:
(i) The fact that the company is still a ‘going concern’ does not necessarily
have a bearing on whether the accounts give a true and fair view. For instance,
where the profit as shown in the profit and loss account by the management is
converted into a loss on account of the qualifications made by the auditors, the
profit as per the profit and loss account does not give a true and fair view
even if the company continues to be a ‘going concern’. In fact, the
qualification in respect of a going concern is a separate matter which is
addressed by Auditing and Assurance Standard (AAS) 16, ‘Going Concern’, issued
by the Institute of Chartered Accountants of India.
(ii) The mere fact that there is no change of a situation of profit into a loss
or from the positive networth into a negative networth due to issues considered
worthy of qualifications does not mean that in other situations, adverse opinion
cannot be given.
(iii) In the auditor’s report, the auditor expresses his opinion on the profit
and loss account of the company and the state of affairs thereof as reflected in
the financial statements. The auditor’s professional judgement on various
aspects of accounts of the auditee determines the nature of the opinion to be
expressed in his report, i.e., whether it should be a disclaimer of opinion or a
qualified opinion or an adverse opinion. In other words, the other than
unqualified opinion of the auditor always arises because of differences of
opinion between the auditor and the management. The Committee notes that the
‘difference’ of opinion has been termed as ‘disagreement’ in paragraph 40 of AAS
28. In many cases, the auditor is able to base his opinion in the light of the
requirements of the accounting standards. In other cases, for example, where the
accounting standard on a matter does not exist, the auditor’s opinion is based
on other sources of generally accepted accounting principles. In this context,
the Committee notes from the ‘Facts of the Case’ that there have been violations
of the accounting standards on the matters of qualifications as stated in
paragraph 4 of the ‘Facts of the Case’. For instance, provision not made as per
paragraph 4(i) above, where the company has not taken possession of the assets,
is a violation of Accounting Standard (AS) 29, ‘Provisions, Contingent
Liabilities and Contingent Assets’, issued by the Institute of Chartered
Accountants of India. Similarly, loans not provided for and debts considered
doubtful not provided for as per paragraph 4(ii) and (iii) above, are clear
violations of Accounting Standard (AS) 4, ‘Contingencies and Events Occurring
After the Balance Sheet Date’, which requires in paragraph 10 thereof that if it
is probable that an asset has been impaired and a reasonable estimate of the
amount of the resulting loss can be made, the amount should be provided for by a
charge to the statement of profit and loss account.
(iv) The mere fact that the business of the company is appraised by the
financial institutions who continue to fund the operations of the company or
that there is restructuring package under formulation before BIFR, does not have
any relevance for determining whether the qualifications affect the true and
fair view of the profit or loss or state of affairs as per the financial
statements of the company.
(v) The Committee does not agree with the querist that since there are very few
occasions in India where a total negative opinion has been given by the auditor,
it is not necessary to give a negative or adverse opinion. The auditor has to
determine under the facts and circumstances of a particular case whether an
adverse opinion is warranted or not.
(vi) The mere fact that an adverse opinion may have drastic consequences for the
company is not relevant in deciding about the nature of qualification to be
given by the auditor.
19. The Committee also notes the Illustration on Disagreement on Accounting
Policies – Inadequate Disclosure – Adverse Opinion, as contained in paragraph 47
of AAS 28, which is reproduced below:
“We have audited the attached Balance Sheet of ……… (Name of the entity), as at 31st March 2XXX, and also the Profit and Loss Account for the year ended
on that date annexed thereto. These financial statements are the responsibility
of the entity’s management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with ……..(remaining words are the same as
illustrated in the scope paragraph–paragraph 30 above).
(Paragraph(s) discussing the disagreement).
In our opinion and to the best of our information and according to the
explanations given to us, because of the effects of the matters discussed in the
preceding paragraph(s), the financial statements do not give a true and fair
view in conformity with the accounting principles generally accepted in India:
(a) in the case of the Balance Sheet, of the state of affairs of the company as
at 31st March 2XXX; and
(b) in the case of the Profit and Loss Account, of the profit/loss for the year
ended on that date.”
The Committee notes from the above that an adverse opinion stating that the
financial statements “do not give a true and fair view” may be given for
non-conformity with the accounting principles generally accepted in India,
provided the conditions contained in paragraph 40 of AAS 28, reproduced in
paragraph 10 above are fulfilled.
20. The Committee notes from paragraph 40 of AAS 28 that where the effect of a
disagreement is ‘so material’, the auditor concludes that a qualification of the
report is not adequate to disclose the misleading nature of financial
statements. The word ‘so’ appearing before the word ‘material’ indicates
that it is not sufficient that the amounts should be material, the requirement
is that the amounts should be ‘so’ material, that the profit or loss and the
state of affairs reflected in the profit and loss account and the balance sheet
are misleading or are meaningless. Thus, the Committee notes that if the amounts
are material, a qualification is warranted and if the amounts are ‘so material’,
an adverse opinion is warranted. The Committee further notes that as per
paragraph 40 of AAS 28, it is not only that the amounts have to be ‘so material’
to warrant an adverse opinion but also the disagreement should be ‘pervasive’.
The Committee is of the view that in case the disagreement results into
qualifications on the financial statements, the ‘pervasiveness’ thereof is to be
judged keeping in view various other relevant items of the financial statements.
For instance, the amounts in absolute terms may be ‘so material’ but when
considered in relation with, say, sales, the amounts may not be ‘so material’.
Similarly, in the case of the balance sheet, the amount of the accumulated
losses may be ‘so material’ in absolute terms but when considered in relation to
various assets, it may not be that material. Thus, the auditor has to use his
judgement while considering the pervasiveness of the matters of qualifications
included in his report while giving an adverse opinion.
D. Opinion
21. On the basis of the above, without going into the merits of the
qualifications, the Committee is of the following opinion on the issues raised
by the querist in paragraph 14 above:
(a) The auditor should consider the factors stated in paragraph 20 above while
determining whether an adverse opinion is warranted.
(b) In the facts and circumstances of the case, since it is not a matter of
limitations on scope which is so material and pervasive that the auditor has not
been able to obtain sufficient appropriate audit evidence, a disclaimer of
opinion on the financial statements is not warranted.
1 Opinion finalised by the Committee on 25.1.2006
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