## SA-705: Modifications to the Independent Auditor's Opinion

### Objective

To issue a modified opinion when:

1. Financial statements are not free from material misstatement (MM), OR

2. Auditor is unable to obtain Sufficient & Appropriate (S&A) evidence to conclude whether FS are free from MM

---

### Two Root Causes of Modification

Root Cause	What It Means
Detected misstatement	Auditor finds the FS contain material errors/omissions
Inability to obtain evidence	Auditor cannot get enough evidence; undetected misstatements may exist

---

### The Pervasiveness Concept

"Pervasive" describes how widely the effect of misstatements spreads across the FS.

Pervasive effects are those:

Not confined to a specific element of FS, OR
If confined, represent a substantial proportion of FS, OR
In relation to disclosures, are fundamental to users' understanding of FS

> Memory tip: Pervasive = "It spreads everywhere / affects the whole picture"

---

### Decision Matrix — Which Opinion to Issue?

Nature of Matter	Material but NOT Pervasive	Material AND Pervasive
FS are materially misstated (detected)	Qualified Opinion	Adverse Opinion
Inability to obtain S&A evidence (undetected possible)	Qualified Opinion	Disclaimer of Opinion

> Key insight: Adverse opinion is ONLY for detected misstatements. Disclaimer is ONLY for inability to obtain evidence.

---

### Three Types of Modified Opinion — Compared

#### 1. Qualified Opinion

When: Effect of misstatement OR possible undetected misstatement is material but NOT pervasive
FS view: Present true and fair view — except for the specific matters described
Language: "Except for the matters described in the Basis for Qualified Opinion…"

#### 2. Adverse Opinion

When: Detected misstatement is both material AND pervasive
FS view: Do NOT present true and fair view
Language: "FS are not presented fairly / do not give a true and fair view"

#### 3. Disclaimer of Opinion (DOO)

When: Unable to obtain S&A evidence; possible undetected misstatement is material AND pervasive
FS view: Cannot conclude either way
Language: "Auditor does not express any opinion…because of significance of matters described…auditor was unable to obtain S&A evidence"

---

### Basis for Modified Opinion Section

Heading renamed: "Basis for Qualified/Adverse/Disclaimer of Opinion" (as applicable)
Describe the matters giving rise to modification
Quantify misstatement where applicable; if impossible, state so
If inability to obtain evidence: state the reasons
If non-disclosure misstatement:
Communicate to TCWG
Describe nature of omitted information
Provide the disclosure in the report
Obtain S&A evidence about the omitted information

---

### Auditor's Responsibilities Section — Disclaimer of Opinion

Must state:

1. Audit conducted in accordance with SAs

2. Because of matters in the Basis for Disclaimer section, auditor was not able to obtain S&A evidence on which to base an opinion

3. Auditor remains independent and has complied with ethical responsibilities

---

### Management-Imposed Limitation: Step-by-Step Decision Flow

```

Management imposes limitation

↓

Ask management to remove limitation

→ Removed: NOT AN ISSUE

↓

Management refuses → Ask TCWG to remove

→ TCWG removes: NOT AN ISSUE

↓

TCWG refuses → Perform alternative procedures

→ Evidence obtained: NOT AN ISSUE

↓

Evidence NOT obtained → Possible undetected misstatement:

• Material but not pervasive → QUALIFIED OPINION

• Material and pervasive → Can auditor withdraw?

Yes → WITHDRAW from engagement

No → DISCLAIMER OF OPINION

```

Worked example

### Example 1

Q: During audit of ABC Ltd, the auditor discovers that inventory worth ₹50 lakhs is overvalued by ₹15 lakhs. Total FS size is ₹500 lakhs. The misstatement is confined to inventory only. What opinion should be issued?

A: The auditor has detected a misstatement. The misstatement (₹15 lakhs) is material relative to FS (₹500 lakhs). Since it is confined to inventory alone and does not affect the entire FS, it is material but NOT pervasive. Therefore, the auditor should issue a Qualified Opinion stating "except for the overvaluation of inventory by ₹15 lakhs, the FS present a true and fair view."

### Example 2

Q: The management of PQR Ltd refuses to provide access to a subsidiary's accounts, which accounts for 60% of total revenues. What opinion should the auditor issue?

A: This is a case of inability to obtain S&A evidence (management-imposed limitation). The subsidiary accounts for 60% of revenues — this is a substantial proportion of FS, making the possible undetected misstatement both material AND pervasive. The auditor should: first ask management, then TCWG to remove the limitation. If both refuse and alternative procedures are unavailable, and if withdrawal is not possible, the auditor should issue a Disclaimer of Opinion.

### Example 3

Q: An auditor finds that the company has not disclosed related party transactions at all, which are fundamental to users' understanding. What type of opinion is appropriate?

A: This is a detected misstatement (non-disclosure). Since the non-disclosure is fundamental to users' understanding, the effect is pervasive. Combined with the fact it is material, the auditor should issue an Adverse Opinion. Additionally, in the Basis for Adverse Opinion section, the auditor must: communicate with TCWG, describe the nature of omitted information, and provide the actual disclosure in the audit report.

⚠️ Common exam mistakes

Issuing an Adverse Opinion when the auditor CANNOT obtain evidence — Adverse Opinion is only for DETECTED misstatements. When evidence cannot be obtained and effect is material + pervasive, it's a Disclaimer of Opinion.
Confusing 'material but not pervasive' (qualified) with 'material and pervasive' (adverse/disclaimer) — students often pick adverse when they should pick qualified because they overlook the pervasiveness test.
Forgetting that management limitation → qualified opinion (not pervasive) vs. disclaimer (pervasive) — the management limitation path leads to qualified or disclaimer, NEVER adverse.
Writing that a Disclaimer of Opinion means the auditor says the FS are wrong — it means the auditor is UNABLE TO CONCLUDE either way, not that the FS are incorrect.
Omitting quantification in the Basis for Modified Opinion section when the misstatement relates to a specific amount — SA-705 requires quantification unless impracticable.

Reference:

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SA-705: Modifications to the Auditor's Opinion (Qualified, Adverse, Disclaimer)

Worked example

⚠️ Common exam mistakes