Exploring the reasons for Modified audit reports

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Registered Maltese companies are, by law (Companies Act 1995), obliged to file a set of financial statements together with the opinion of an independent external auditor. The external auditor is required to examine the financial statements of a company and express an opinion thereon. The auditor should ensure that the financial statements are prepared according to the "International Financial Reporting Standards" and base his opinion in accordance to the "International Standards of Auditing".

The auditor's opinion is expressed in an auditor's report and is normally in a brief and standard form. An auditor can issue two main types of opinions being a qualified opinion or an unqualified opinion. The latter may be expressed only when the auditor is able to conclude that the financial statements give a true and fair view in accordance to the identified financial reporting framework. When auditors do not believe that they can state without reservation that the accounts give a true and fair view, they issue a modified opinion.

Modified audit reports can be of two types. Matters that do not affect the auditor's opinion require the inclusion of an emphasis of matter paragraph. While the second type concerns matters that do affect the auditor's opinion. The latter is the type we are interested in for this area under discussion. For the auditor not to issue an unqualified report one of the following circumstance must be in place:

There is a limitation on the scope of the auditor's work. Or/and

There is a disagreement with management regarding the acceptability of the accounting policies selected, the method of their application or the adequacy of financial statements disclosures.

The circumstance described in a) could lead to a qualified opinion or a disclaimer of opinion while the circumstance described in b) could lead to a qualified opinion or an adverse opinion.

A qualified opinion is issued when the matter is material but not pervasive, in which case the auditor disclaims an opinion or expresses an adverse opinion only on a particular aspect of the accounts. In the case of a disclaimer of opinion (material and pervasive limitation on scope), auditors state that they were unable to form an opinion, while in the case of an adverse opinion (material and pervasive disagreement) auditors state that the accounts do not give the true and fair view.

This study is focused on the main types of qualifications issued in Malta and also tries to examine significant relationships between qualified audit opinions and firm-specific variables, (e.g. company type and the industry in which it operates) and the auditors (e.g. differences between Big Four audit firms and sole practitioners). Similar foreign based studies and research such as that undertaken by Hopkins (1995) and Butler (2002) were used in this study for comparison purposes to abet the study be more meaningful.


'Qualified audit opinions in Malta' relates to a four year study, between 1997 and 2000, aimed to scrutinize the auditor's reports of various companies in Malta. Using the random sampling technique a sample of companies was selected and included some of all the different types of companies as assorted in the Maltese Registry of Companies, being public, private exempt, private non-exempt, international trading non-exempt and international trading exempt. The results of this study were supported by an additional 12 semi-structured interviews with audit partners in different practices.


As already stated in the introduction, Limitations on scope arise if the auditor is not able to obtain all the evidence required to issue an unqualified opinion. Such limitation can either be imposed by the entity or by circumstances. The study indicated that this was the most frequent qualification issued (65.5%). Furthermore, the limitation-on-scope qualification was mainly common in small companies namely private and international trading exempt companies. Research indicated that for the most part these were audited by sole practitioners, who usually do not report in line with the most recent International Standards on Auditing. The next most common type of limitation-on-scope qualification was the non-specific one. In such cases even though the auditor issued a qualified opinion, the reasons leading to this conclusion and possible adjustments were not mentioned in the report. It is important to note that at the time of the study the above two types of limitations-on-scope qualifications were still being issued in breach of ISA 700, "The Independent Auditor's Report on General Purpose Financial Statements". The main reason for this was mainly the fact that these were small companies many of which were audit by sole practitioners. Moreover although limitation-on-scope was the most common type of qualification, the aforementioned which were issued in breach of the International Standards on Auditing were the most common type of such qualification with over 62%. The third common type of qualification was the specific limitation generally found in international trading companies rendering it difficult for auditors to verify balances which relate to branches abroad. Deficiencies in the internal control systems, non-attendance for stock-takes, lack of balances' confirmation and lack of proper books and accounts are some other reasons for this type of limitation-on-scope.

The above findings were also complemented by the answers obtained throughout the interviews were 10 out of 12 respondents stated that limitation-on-scope was the major type of qualification issued to their clients. The study also revealed that the Big Four audit firms are less likely to issue the non-specific limitation-on-scope and the Type Six one than are the other audit firms and sole practitioners.

Disagreement with management

Disagreement with management is the third type of qualification, which makes up 15% of the total qualifications. This was related to disagreement with the treatment of disclosures of matters in the financial statements. Such qualification was both found on its own in some companies and in others it was also included as a multiple qualification.

This type of qualification was sub-divided in three categories:

The most common disagreement was where the auditor disagreed with the management as to the non-preparation of consolidated financial statements by the company. In this case, the main issue was the fact that not all auditors were treating this situation uniformly due to the complete inconsistency between the law and the IFRS's.

Another category was that of disagreement due to inappropriate accounting treatment, with the majority of disagreements being due to a lack of professional valuation of property.

The last category was disagreement as to factors or amounts in the financial statements, mainly because management did not provide for depreciation on fixed assets primarily on property.

Most of the qualifications relating to these last two categories were found in auditor's reports of private non-exempt companies since such companies are usually much larger than exempt companies. Thus, they could employ competent staff i.e. their own professional accountants whose view might differ from that of the auditor regarding the accounting treatment of certain items in the financial statements.

Therefore one could observe that this type of qualification was mostly encountered by audit firms and not by sole practitioners. A valid reason behind this finding was due to the fact that sole practitioners preferred to iron out any disagreements with directors before the financial statements were signed by the latter.

Furthermore, results showed that larger companies were more prone to the disagreement-with-management qualification because of the complex structure of the business. To the contrary of small businesses, directors in larger companies would usually have an accounting background.


There is certainly the need for more consistency between the law and IFRS's. Harmonization is essential in order for both audit firms and sole practitioners to hold the same view in cases where it is necessary to issue this type of qualification.

Disclaimers of opinion

Normally a disclaimer of opinion is expressed when the possible effect of a limitation of scope is so material and pervasive that the auditor would not be able to obtain sufficient, appropriate audit evidence and so would be unable to express an opinion on the financial statements. In general disclaimer of opinion is very rare, in fact as stated in the report only 3 out of 419 where issued during the 4 year period. Two were due to the fact that the auditors could not perform audit procedures on a number of financial statement items, while the other was expressed because the company had seriously impaired going concern and furthermore no provision of depreciation was being applied.

Also from the 12 interviews held with audit partners in different practices, 9 of these reported that they only encountered few such qualifications throughout their career, while the other 3 denied that they have ever expressed such an opinion. Furthermore when such opinions were expressed these were due to the fact that such companies lacked certain standards which often, were eventually met the year after.

Going concern

The going concern qualification is the next most issued qualification after limitation of scope qualifications. Although such qualifications should be based and worded on the guidelines set by ISA570 only 4.2% of such qualifications compiled with such ISA. The other going concerns qualifications were either based on the old UK model, or else being qualified but having an emphasis of matter situation, or having ambiguous wording. Those qualifications which were based on the old UK model (19.4%) where expressed solely by sole practitioners, which implies that they are not up to date with the current standards, since according to the ISA such companies should have been provided with an unqualified opinion and add an emphasis of matter. Such fact can have an adverse affect to such a firm since a wrong impression would be given to various stakeholders having access to their reports, when actually the firm was on the right track, duly caused by the irresponsibility of such sole practitioners.

The remaining group of 57% of the going concerns qualifications not complying with the ISA involved ambiguous wording which didn't follow the professional standard guidelines in expressing auditor reports. These ambiguities were committed only by sole practitioners, which again show the lack of keeping up with contemporary standards when compared to Big Four audit firms. Furthermore 2 sole practitioners said that they would qualify a situation which according to the standards was an emphasis of matter.

Qualifications and firm specific variables

The researched tried to identify any relationships between the different classifications of qualified audit opinions and several variables using the chi squared test.

The study showed a correlation between the disagreement with management qualification and the type of company, resulting in a significant relationship, mostly with large firms, probably due to more educated and experienced management. Baldacchino also tried to identify correlations between the auditor's opinion and the type of industry. It was found that disagreement with management qualifications were mostly found in companies in the import, wholesale and retail business followed by the financial intermediation sector. Mostly because the auditor disagreed with the company's accountant on financial statement issue.

Another relationship for testing was between the net asset values of companies with a qualified opinion and the type of qualification obtained. A relationship was found between going concern qualification and negative net asset values, which is obvious since a going concern issue is due to liquidity problems.

Finally correlations were investigated to identify any possible relationship between companies with a repeated qualified auditor's report and firm specific variables. A relationship was found and showed that a qualification in a private exempt company and in an international trading non exempt company had a higher chance of being a repeated one. The association between the auditor's opinion and two variables; namely whether the company was small or not and the issued share capital of the company, was tested, resulting in no association between them.

The auditor and qualifications

Furthermore the relationship between qualified opinions and the type, hence the size, of the auditor giving such qualification was tested. For the disagreement with management qualification a highly significant relationship was found which most of which were expressed by a Big Four audit firm.

For the limitation on scope qualification, it resulted in a significant relationship with the type of auditor for three out of the four years of study. Most of the limitations on scope qualifications were issued by sole practitioners, leaving a small percentage to the Big Four. For the going concern qualification no relationship was found with the type of auditor issuing it.