ISA 705 Modifications to the opinion in the independent auditor’s report requires the auditor to modify his opinion in the auditor’s report in the following situations of: i. Material misstatement – This occurs when the auditor concludes that, based on the audit evidence obtained, the financial statements as a whole are „not free from material misstatement‟. In other words, the auditor considers that there is a material misstatement in the financial statements.

ii. Limitation on scope – This occurs when the auditor is unable to obtain sufficient appropriate evidence to conclude that the financial statements as a whole are free from material misstatement. The auditor has been unable to obtain sufficient appropriate audit evidence to reach an opinion that the financial statements give a true and fair view, therefore, the financial statements may contain a material misstatement. iii. Going concern uncertainty – Significant doubts exist about the entity’s ability to continue as a going concern, and the disclosures are either inadequate or the uncertainty is fundamental. The negative shareholders‟ funds, persistent losses, and inadequate cashflows for instance, raise going concern issues.

For an opinion to be modified, the audit firm will issue any of the following:

i. a qualified opinion;

ii. an adverse opinion; and

iii. a disclaimer of opinion.

According to ISA 705, the auditor has to determine if the misstatement or limitation of scope is „material but not pervasive‟ or „material and pervasive‟ to determine what type of opinion to issue.

In the case of Night Insurance Company Ltd, the following material issues exist:

i. Material uncertainty relating to the going concern – Night Insurance Company Limited has prepared its financial statements in line with the going concern basis of accounting, despite the existence of material uncertainty relating to this and liquidity issues. Though the client has expressed confidence in its ability to continue as a going concern, the firm can issue an adverse opinion as this is material and pervasive.

ii. However, if they are able to provide proof of positive actions taken to reverse this position, the firm may only issue a „qualified opinion‟

iii. Material uncertainty relating to liquidity – Night Insurance has three months’ unpaid salaries, unpaid withholding and Company income taxes, unpaid pension contributions and unaccrued claims pending for settlement. Although the company has provided plans to generate cash, the Audit firm could still issue a „qualified opinion.‟ The qualified opinion is right as the issue is material but not pervasive;

iv. Failure to meet regulatory requirement – Night Insurance has been unable to meet the regulatory capital requirement for its business for a few years. This creates a material uncertainty on the going concern, which can lead to a withdrawal of licence by the regulators. If Night Insurance Company Limited is unable to meet this regulation, it is expected to restate its financial statements in line with break-up basis. Its refusal to comply will lead to the auditor issuing an „adverse opinion‟ as this is material and pervasive; and

v. Unreconciled bank statements – The auditor’s inability to reconcile with some banks, given the current liquidity challenges, creates a limitation of scope to the auditor. However, this is material but not pervasive since it is limited to just one element of the financial statements. The audit firm will likely issue a „qualified opinion‟ as a result of this.

The form and contents of the Auditor’s report when the opinion is modified:

i. Opinion paragraph

The opinion paragraph at the start of the auditor’s report must be headed „Qualified opinion‟, „Adverse opinion‟, or „Disclaimer of opinion‟, as appropriate.

ii. Basis for modified opinion paragraph When a modified opinion is issued, ISA 705 requires the „Basis for opinion‟ paragraph to be amended to „Basis for qualified opinion‟, „Basis for adverse opinion‟, or „Basis for disclaimer of opinion‟, as appropriate. This „basis for modified opinion‟ paragraph must include the following:

 for a material misstatement relating to specific amounts – a description and quantification of the impact on the financial statements (or a statement that quantification is not possible);

 for a material misstatement relating to narrative disclosures – an explanation of how the disclosures are misstated;

 for a material misstatement relating to the non-disclosure of information that should have been disclosed – the nature of the omitted information and, unless prohibited by law or regulation, the omitted disclosures; and

 if the modification results from an inability to obtain sufficient appropriate audit evidence – the reasons for the inability.

For qualified or adverse opinions, the basis for the qualified/adverse (as appropriate) opinion paragraph will also state:

“We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified/adverse (as appropriate) opinion”.

Reasons why communication with those charged with governance is necessary include:

i. ISA 260: communication with those charged with governance explicitly emphasises the importance of effective two-way communication between the auditor and those charged with governance. This fosters a constructive working relationship and ensures a shared understanding of matters related to the audit;

ii. if the auditor identifies a material misstatement, discussing it with those charged with governance gives them the opportunity to correct the financial statements before the audit report is finalised. This is the primary desired outcome – for the financial statements to be presented fairly;

iii. if the issue is a limitation on the scope of the audit (for example, inability to obtain sufficient appropriate audit evidence), discussing it allows those charged with governance to potentially remove the limitation or provide alternative evidence;

iv. discussions allow the auditor to ensure they have a complete understanding of the facts and circumstances surrounding the issue that might lead to a modification. Those charged with governance may provide additional information or context that the auditor was not fully aware of;

v. It is an opportunity for those charged with governance to explain their perspective or the rationale behind certain accounting treatments or decisions;

vi. while the auditor must maintain independence and objectivity, the discussion helps them gain further insight into the entity’s operations and the implications of the issues. This deeper understanding can refine the auditor’s judgment regarding the nature and pervasiveness of the misstatement or scope limitation;

vii. a discussion might reveal that a misstatement initially thought to be pervasive is actually confined to a specific element after further explanation from those charged with governance;

viii. surprising those charged with governance with a modified opinion without prior discussion can lead to misunderstandings, disputes, and potential legal challenges. A professional dialogue can help manage expectations and clarify the auditor’s reasoning;

ix. professional auditing standards (like ISAs) mandate this communication. Non-compliance could lead to sanctions for the auditor;

x. ethically, it promotes fairness and due process, giving the entity the chance to address the auditor’s concerns; and xi. professional obligation: ISA 260 requires auditors to communicate matters such as:

 significant deficiencies in internal control;

 uncorrected misstatements;

 significant risks identified; and

xii. corrective action opportunity: provides management and the board an opportunity to respond, correct errors, or provide additional evidence before finalising the opinion.