ISA 705 (Revised) – Modifications to the Opinion In the Independent Auditor’s Report

Overview & Scope of ISA 705 (Revised)

ISA 705 (Revised) – Modifications to the Opinion in the Independent Auditor’s Report It is the International Standard on Auditing issued by the International Auditing and Assurance Standards Board (IAASB) that governs the circumstances under which an auditor departs from a standard unmodified opinion, and the precise form and content requirements that must be followed when doing so.

The standard applies to all audits of financial statements conducted in accordance with International Standards on Auditing. It must be read in conjunction with ISA 700 (Revised), Forming an Opinion and Reporting on Financial Statements, and ISA 706 (Revised), which addresses Emphasis of Matter and Other Matter paragraphs.

ISA 705 does not apply to limited assurance engagements, review engagements, or compilations – it is specifically scoped to full-scope statutory and contractual audits of general purpose financial statements.

Objective of ISA 705 (Revised)

The overarching objective of ISA 705 (Revised) is to ensure that the auditor expresses a clearly communicated modified opinion when:

• The auditor concludes that the financial statements are not free from material misstatement, or
• The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement.

The standard requires that the auditor’s report clearly communicates the nature of the modification, the matters giving rise to it, and the effect (or possible effect) on the financial statements – enabling users to understand the limitation or disagreement that has led to a departure from an unmodified opinion.

Types of Modified Opinions Under ISA 705

ISA 705 (Revised) establishes three and only three types of modified opinions. Each has a distinct trigger, a distinct level of severity, and a distinct form in the auditor’s report.

Choosing Among the Three Types

The selection of the appropriate type of modification is not a matter of professional preference – it is determined by the nature of the matter giving rise to modification (disagreement vs. inability to obtain evidence) and the auditor’s assessment of materiality and pervasiveness. The decision is governed by a structured framework described in ISA 705.

Circumstances That Require a Modified Opinion

ISA 705 (Revised) prescribes that a modification is required in one of two broad circumstances:

Circumstance A – Material Misstatement

A material misstatement arises when the financial statements contain errors, omissions, or inappropriate accounting policies that individually or in the aggregate cause the financial statements to not present a true and fair view. Misstatements can relate to:

• The appropriateness of selected accounting policies
• The application of selected accounting policies
• The appropriateness and adequacy of disclosures in the financial statements

Where the auditor disagrees with management over one of these dimensions and the effect is material, a modification is required. Whether the opinion is qualified or adverse depends on whether the misstatement is pervasive.

Circumstance B – Inability to Obtain Sufficient Appropriate Audit Evidence

This circumstance arises when the auditor cannot gather adequate evidence due to management-imposed limitations, circumstances beyond the entity’s or auditor’s control (e.g., destruction of records), or the nature of the entity’s operations. Where the possible effects of undetected misstatements could be material, a qualified opinion is appropriate. Where the possible effects could be material and pervasive, a disclaimer of opinion is required.

Materiality and Pervasiveness – The Central Determinants

The two concepts that sit at the heart of ISA 705’s decision framework are materiality and pervasiveness. Together, they determine both whether a modification is required and which type of modification is appropriate.

Materiality

Information is material if its omission or misstatement could reasonably influence the economic decisions of users of the financial statements. ISA 705 works within the broader materiality framework established by ISA 320. The auditor must assess materiality both at the overall financial statement level and at the individual class of transactions, account balance, or disclosure level.

Pervasiveness

Pervasiveness is a concept specific to ISA 705 and describes the extent to which matters affect the financial statements as a whole. Under ISA 705, effects are considered pervasive when they:

• Are not confined to specific elements, accounts, or items of the financial statements
• If confined to specific elements, represent or could represent a substantial proportion of the financial statements
• In relation to disclosures, are fundamental to users’ understanding of the financial statements

The assessment of pervasiveness requires significant professional judgment. An item that is immaterial on its own can nonetheless be pervasive in its effects – for example, a fundamental error in revenue recognition methodology that invalidates multiple line items across the statements.

Decision Framework – Selecting the Type of Modified Opinion

The table below summarises the ISA 705 (Revised) decision matrix for determining the appropriate type of modified opinion based on the auditor’s assessment of the nature of the matter and the degree of materiality and pervasiveness.

Form and Content of the Modified Auditor’s Report

ISA 705 (Revised) prescribes specific requirements for the content and structure of an auditor’s report that contains a modified opinion. All modified reports must include a dedicated section titled “Basis for Qualified Opinion”, “Basis for Adverse Opinion”, or “Basis for Disclaimer of Opinion” as appropriate.

Opinion Paragraph Language

The language used in the opinion section varies by modification type:

Pervasive Impact on Report Structure

When a disclaimer of opinion is expressed, ISA 705 requires that the Key Audit Matters section (if otherwise required by ISA 701) is not included in the report. This is because including a KAM section when the auditor has disclaimed an opinion would be contradictory – the auditor cannot simultaneously disclaim all opinion and identify matters of particular significance.

The Basis for Modified Opinion Paragraph

The Basis for [Qualified/Adverse/Disclaimer of] Opinion paragraph plays a critical communicative role under ISA 705. Its purpose is to describe transparently the matter giving rise to the modification so that users can understand the nature, magnitude, and effect (or possible effect) on the financial statements.

Required Content

• A description of the matter giving rise to the modification
• A quantification of the financial effects where practicable
• Where the modification relates to a scope limitation, an explanation of why the auditor was unable to obtain sufficient appropriate evidence
• Where financial effects cannot be quantified, a statement to that effect

Interaction with Going Concern

If the auditor issues a disclaimer of opinion because of a management-imposed scope limitation that could result in multiple possible adjustments to the financial statements, ISA 705 requires the auditor to describe this comprehensively in the basis paragraph. Where going concern matters are also present, the interaction with ISA 570 (Revised) must be carefully navigated.

Key Changes Introduced by the Revised Standard

The revised version of ISA 705, which replaced the previous 2009 standard effective for audits of financial years ending on or after 15 December 2016, introduced several significant enhancements as part of the IAASB’s broader Auditor Reporting project.

Relationship with Other International Auditing Standards

ISA 705 (Revised) does not operate in isolation. It is part of a suite of interrelated standards that together govern the auditor’s reporting responsibilities.

ISA 700 (Revised) – Forming an Opinion

ISA 700 is the parent standard that establishes requirements for forming the audit opinion and the overall structure of the auditor’s report. ISA 705 modifies those requirements specifically for situations where the opinion departs from unmodified form. Together, these two standards must be read as a unified framework.

ISA 706 (Revised) – Emphasis of Matter and Other Matter Paragraphs

ISA 706 governs the use of emphasis of matter paragraphs (for drawing attention to appropriately presented matters) and other matter paragraphs (for relevant information not presented in the financial statements). An emphasis of matter paragraph must not be used as a substitute for a modification – ISA 705 modifications and ISA 706 paragraphs serve fundamentally different purposes.

ISA 701 – Communicating Key Audit Matters

ISA 701 applies to audits of listed entities and requires reporting on KAMs. The interaction with ISA 705 is significant: where a disclaimer of opinion is issued, KAM reporting is prohibited. Where qualified or adverse opinions are expressed, KAMs may still be reported, but the basis for modification takes precedence in ordering and prominence.

ISA 570 (Revised) – Going Concern

Going concern uncertainties can interact with ISA 705 in complex ways. Typically, material uncertainties about going concern that are adequately disclosed lead to an emphasis of matter paragraph under ISA 706, not a modification. However, where management fails to make appropriate disclosures about going concern, or adopts inappropriate accounting assumptions, a modification under ISA 705 may be required.

ISA 260 – Communication with Those Charged with Governance

ISA 705 (Revised) requires that the auditor communicate with those charged with governance before finalising a modified report. This includes explaining the expected form of modification and the reasoning behind it, allowing management and governance bodies an opportunity to respond or provide additional information.

Practical Considerations in Applying ISA 705

Management-Imposed vs. Circumstance-Driven Limitations

A critical distinction in applying ISA 705 relates to the source of a scope limitation. When management imposes a limitation prior to engagement acceptance, ISA 705 suggests the auditor should decline the engagement. When limitations arise after acceptance, the auditor must evaluate whether withdrawal is possible and appropriate, or whether a disclaimer is required.

Quantifying the Effect of Modifications

Where the modification relates to a material misstatement, ISA 705 requires the auditor to quantify the financial effect if practicable. This means the Basis paragraph should include specific monetary amounts or ranges where determinable. Where quantification is not practicable, the auditor must explicitly state this and explain why.

Component Auditors and Group Situations

In group audits governed by ISA 600, situations may arise where a component auditor has issued a modified report on a significant component. The group auditor must evaluate whether such modifications permeate the consolidated financial statements and, if so, whether a group-level modification under ISA 705 is warranted.

Documentation Requirements

ISA 230 requires auditors to document all significant judgments made during the audit. For ISA 705 purposes, this includes documentation of the nature of the matter giving rise to modification, the basis for the materiality and pervasiveness assessment, the type of modification determined to be appropriate, communications with those charged with governance, and the final wording of the basis paragraph and opinion.

Frequently Asked Questions – ISA 705 (Revised)