Appendix 1: Audit reports and our framework for assessing environment, systems, and controls

This Appendix provides an overview of what an audit report contains. It also set out the framework auditors use to assess an entity's environment, systems, and controls.

Audit reports

An audit report is addressed to the readers of an entity's financial and non-financial information. All public entities are accountable to Parliament for their use of public money and their use of any statutory powers or other authority given to them by Parliament.

Non-standard audit reports

A non-standard audit report⁶¹ is one that contains:

• a modified opinion; and/or
• an "emphasis of matter" or an "other matter" paragraph.

A modified opinion is given because of:

• a misstatement about the treatment or disclosure of a matter in the financial and/or non-financial information; or
• a limitation in scope. This may occur when the appointed auditor has been unable to obtain sufficient appropriate evidence to support, and accordingly is unable to express, an opinion on the financial or non-financial information or a part of the financial or non-financial information.

There are three types of modified opinion (which are discussed below):

• an "adverse" opinion;
• a "disclaimer of opinion"; and
• a "qualified opinion".

The appointed auditor will include an "emphasis of matter" paragraph (see below) or "other matter" paragraph (see below) in the audit report to draw attention to matters such as:

• fundamental uncertainties;
• breaches of law; or
• concerns over probity or financial prudence.

The appointed auditor has to include an "emphasis of matter" paragraph or an "other matter" paragraph in the audit report in such a way that it cannot be mistaken for a modified opinion.

Figure 26 outlines the decisions that an appointed auditor has to make when considering the appropriate form of the audit report.

Adverse opinions

An adverse opinion is the most serious type of non-standard audit report.

An adverse opinion is expressed when the appointed auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are both material and pervasive to the financial and/or non-financial information.

Disclaimers of opinion

A disclaimer of opinion is expressed when the appointed auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion (that is, a limitation in scope), and the appointed auditor concludes that the possible effects on the financial and/or non-financial information of undetected misstatements, if any, could be both material and pervasive.

A disclaimer of opinion is also expressed when, in extremely rare circumstances involving multiple uncertainties, the appointed auditor concludes that, notwithstanding having obtained sufficient appropriate audit evidence regarding each of the individual uncertainties, it is not possible to form an opinion on the financial statements and/or non-financial performance information because of the potential interaction of the uncertainties and their possible cumulative effect on the financial and/or non-financial information.

We are pleased to report that it was not necessary for us to express a disclaimer of opinion on the financial and/or non-financial information of any entity in the central government portfolio covered by this report.

Qualified opinions

A qualified opinion is expressed when the appointed auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in aggregate, are material, but not pervasive, to the financial and/or non-financial information.

A qualified opinion is also expressed when the appointed auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the appointed auditor concludes that the possible effects on the financial and/or non-financial information of undetected misstatements, if any, could be material but not pervasive.

In addition, a qualified opinion is expressed when the appointed auditor concludes that a breach of statutory obligations has occurred and that the breach is material to the reader's understanding of the financial and/or non-financial information. An example of this is where a Crown entity has breached the requirements of the Crown Entities Act 2004 because it has not included budgeted figures in its financial statements.

Figure 26
Deciding on the appropriate form of the audit report

Note: This flowchart is based on the requirements of the New Zealand equivalents to the International Standards on Auditing No. 700: Forming an Opinion and Reporting on Financial Statements; No. 705: Modifications to the Opinion in the Independent Auditor's Report; and No. 706: Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor's Report.

"Emphasis of matter" paragraphs

In certain circumstances, it may be appropriate for the appointed auditor to include additional comments in the audit report to draw readers' attention to a matter that, in the appointed auditor's professional judgement, is fundamental to their understanding of the financial and/or non-financial information. The additional comments will be included in the audit report in an "emphasis of matter" paragraph, provided the appointed auditor has obtained sufficient appropriate audit evidence that the matter is not materially misstated in the financial and/or non-financial information.

"Other matter" paragraphs

In certain circumstances, it may be appropriate for the appointed auditor to communicate a matter that is not adequately presented or disclosed in the financial and/or non-financial information because, in the appointed auditor's professional judgement, the matter is relevant to readers' understanding of the financial and/or non-financial information. The additional comments will be included in the audit report in an "other matter" or similarly titled paragraph.

Environment, systems, and controls

As part of the audit process, we separately examine, assess, grade, and report on central government entities' environment, systems, and controls for managing and reporting financial and service performance.

Our auditors recommend improvements to ensure that there are effective internal controls for sound management and good governance, and to help entities to manage risks (such as errors and potential fraud).

This is the sixth year we have used our current assessment framework to support entities in their effort to strengthen systems and controls and to report more meaningful information on their financial and non-financial performance. Accordingly, we assess these three aspects:

• the management control environment;
• financial information systems and controls; and
• service performance information and associated systems and controls.

If auditors identify deficiencies in any of these aspects, they will recommend improvements. The grades reflect the recommendations for improvement as at the end of the financial year (see Figure 27).

Fluctuations in grades can occur from year to year – for example, because of changes in the operating environment, organisational structure, good practice expectations, or auditor emphasis. How an entity responds to an auditor's recommendations is more important than the grade change from year to year. Consequently, the long-term trend is a more useful indicator of progress than year-to-year changes.

Figure 27
Grading scale for assessing public entities' environment, systems, and controls

We report our assessments to the entity, the responsible Minister, the relevant select committee, and relevant monitoring agency. We also advise the central agencies: the Treasury, the State Services Commission, and the Department of the Prime Minister and Cabinet.

Given that our assessments and grades are focused on encouraging improvements, we do not grade entities that are, or will subsequently be, disestablished.

61: A non-standard audit report is issued in accordance with the requirements of the New Zealand equivalents to the International Standards on Auditing: No. 700: Forming an Opinion and Reporting on Financial Statements; No 705: Modifications to the Opinion in the Independent Auditor's Report; and No. 706: Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor's Report.