Pervasiveness as a Basis for
Determining the Type of Modification
to an Audit Opinion
Table of Contents
Background.............................................................................................................................................. 3
Application of pervasiveness is limited to audit opinions ....................................................................... 3
Definition of pervasiveness ..................................................................................................................... 4
First step of determining pervasiveness: Focus on the term “confined”................................................ 5
Second step of determining pervasiveness: Focus on the term “substantial” ....................................... 5
Combination of the first and second step: Conditions for a meaningful determination of
pervasiveness .......................................................................................................................................... 6
Relation between materiality and pervasiveness ................................................................................... 7
Conclusions.............................................................................................................................................. 7
Annex 1: Table illustrating the impact of pervasiveness on the type of audit opinion to be expressed
Annex 2: Table 1: Scenarios for determining pervasiveness (Hypothetical results – Fictitious
ministries)
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Background
1.
The first complete set of International Standards of Supreme Audit Institution (ISSAIs) requires
that a SAI plans and performs its compliance audits related to the audit of financial statements to
obtain reasonable assurance about whether the activities, financial transactions and information
reflected in the financial statements are, in all material respects, in compliance with the authorities
which govern them. Reasonable assurance is a high level of assurance. It is achieved when sufficient
appropriate audit evidence has been obtained to reduce audit risk (that is the risk that the SAI
expresses an inappropriate audit opinion) to an acceptably low level 1.
2.
ISSAIs 1705 “Modifications to the Opinion in the Independent Auditor’s Report” and 4200
“Compliance Audit Guidelines – Compliance Audit related to Audits of Financial Statements” describe
the SAI’s responsibilities in taking the appropriate decisions in circumstances when, in evaluating the
audit evidence, it concludes that a modification of the audit opinion is necessary 2. Three different
types of modified opinions are possible: a qualified opinion, an adverse opinion, and a disclaimer of
opinion.
3.
The decision regarding which type of modified opinion is appropriate depends upon:
(a)
The nature of the matter giving rise to the modification, that is, whether the financial
statements are materially misstated/the transactions reflected therein are materially affected
by error or, in the case of an inability to obtain sufficient appropriate audit evidence, may be
materially misstated/affected by error; and
(b)
The auditor’s judgement about the pervasiveness of the effects or possible effects of the
matter on the financial statements/transactions underlying them (for details see annex 1).
4.
The following analysis of a possible approach for the implementation of the concept of
pervasiveness focuses only on compliance audit issues 3 which are in the remit of the INTOSAI
Compliance Audit Sub-committee.
Application of pervasiveness is limited to audit opinions
5.
While the ISSAIs contain no guidance for different types of audit conclusions, the requirements
as regards the modifications to audit opinions are very strict. According to ISSAIs 1705 and 4200 4 a
1
See ISSAIs 1200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with International Standards of Auditing”, paragraph 5 and 4200 “Compliance Audit
Guidelines – Compliance Audit related to Audits of Financial Statements”, paragraph 87.
2
See ISSAIs 1700 “Forming an Opinion and Reporting on Financial Statements” and 4200, sections 8
“Evaluating Evidence and Forming Conclusions” and 9 “Reporting”. ISSAI 4100 “Compliance Audit
Guidelines For Audits Performed Separately from the Audit of Financial Statements” does not contain
guidance concerning modifications of audit opinions. Instead they refer to conclusions and long form
reports. However, the section on reporting includes a reference to ISSAI 1705.
3
Pure financial audit issues or the inability to obtain sufficient appropriate audit evidence (which would
lead to a disclaimer of opinion) are not covered. However, the principles adopted in this paper would
also be applicable in these contexts.
4
See paragraph P5 of the Practice Note on ISSAI 1705.
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SAI, having obtained sufficient appropriate audit evidence on whether subject matter information is
materially affected by error, shall express:
(a) A qualified opinion when it concludes that compliance deviations are material but not
pervasive; or
(b) An adverse opinion when it concludes that compliance deviations are both material and
pervasive.
6.
The concept of pervasiveness is not to be applied at the level of audit conclusions. However,
as will be shown below, the application of pervasiveness in the context of the audit opinion will be
facilitated by the application of an appropriate approach for being able to obtain a high level of
assurance for each intermediary audit conclusion which forms the bases of the audit option 5.
Definition of pervasiveness
7.
Pervasive is a term used, in compliance audits, to describe the effects of a material level of
error on the population of transactions reflected in the financial statements. Pervasive effects of a
material error on these transactions can be classified into three categories. According to ISSAI 1705 6,
they are those that, in the SAI’s judgement:
(a)
Are not confined to specific elements, accounts or items of the financial statements;
(b)
If so confined, represent or could represent a substantial proportion of the transactions
reflected in the financial statements; or
(c)
In relation do disclosures, are fundamental to users’ understanding of the financial
statements 7 .
8.
Neither the ISSAIs themselves nor papers analysing comments received during the exposure
process 8, literature on audit methodology or other documents contain precise guidance, for example
in the form of quantitative thresholds, on how the key terms “confined” or “substantial” of the
definition of pervasiveness should be interpreted. As regards the latter, the International Auditing
and Assurance Standards Board (IAASB) of the International Federation of Accountants (IFAC) took
the view “that what would be considered a substantial proportion of the financial statements would
5
See for example the approach described in ISSAI 1200, paragraph 5.
6
See ISSAI 1705, paragraph 5. ISSAI 4200 does not include such a precise definition. However, it applies
an identical approach for determining the type of modification of the audit opinion (see paragraphs 169
and 170) and refers to the guidance included in ISSAI 1705 (see paragraph 175).
7
Only relevant for financial audits.
8
See for example the two papers of the International Federation of Accountants, “Basic for Conclusions:
ISA 705 (Revised and Redrafted), Modifications to the Opinion in the Independent Auditors’s Report”,
(paragraphs 4 to 10) or “Basis for Conclusions: Close off Documents – ISA 705 (Revised), Modifications to
the Opinion in the Independent Auditor’s Report, and ISA 706 (Revised), Emphasis of Matter Paragraphs
and Other Matter(s) Paragraphs in the Independent Auditor’s Report” (paragraphs 17 to 24), which have
been prepared by the staff of the International Auditing and Assurance Standards Board.
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ultimately depend on the auditor’s professional judgement in the circumstances.” 9 While the IAASB
did not make a similar statement concerning the term “confined”, it seems logic that is should be
treated in the same way.
9.
The ISSAIs define professional judgement as “the application of relevant training, knowledge
and experience, within the context provided by auditing, accounting and ethical standards, in making
informed decisions about the courses of action that are appropriate in the circumstances of the audit
engagement.“ 10 On the basis of this guidance, an attempt is made in the following to develop a
possible approach for implementing the concepts “confined” and “substantial”.
First step of determining pervasiveness: Focus on the term “confined”
10. In the context of an audit opinion on transactions, a material level of error is pervasive if it is
not confined to specific elements, accounts or areas of the overall population of the transactions
reflected in the financial statements. Depending on the approach, the SAI may obtain the necessary
reasonable assurance for calculating the most likely error at the level of different policy areas,
ministries or other units of reporting. Therefore, those units of reporting have, in general, to be the
units which serve as a basis for determining whether a material level of error is confined. In a first
step, it has therefore to be examined how many of the units of reporting are affected by a material
level of error.
11. Where exactly the line for pervasiveness has to be drawn is not clear, in particular because no
SAI, so far, has published documents or issued audit opinions explaining how it applied this concept.
As will be shown below, professional judgement should, in order to be meaningful, also take into
consideration the proportion of the total financial volume of the units of reporting affected/not
affected by material error.
Second step of determining pervasiveness: Focus on the term
“substantial”
12. In the context of an audit opinion on transactions, a material level of error is also pervasive if it
affects a substantial proportion of the overall population of transactions reflected in the financial
statements. Again, the SAIs will, in general, obtain the necessary reasonable assurance for calculating
the most likely error at the level of different policy areas, ministries or other units of reporting.
Therefore, those units of reporting have, in general, also to be the units which serve as a basis for
determining whether a material level of error is present in a substantial proportion of transactions
reflected in the financial statements.
13. Thus, the second step for determining pervasiveness consists in the calculation of the
proportion of the total financial volume of the units of reporting affected by a material level of error
as compared to the overall population of transactions.
9
Papers of IFAC, “Basis for Conclusions: Close off Documents – ISA 705 (Revised), Modifications to the
Opinion in the Independent Auditor’s report, and ISA 706 (Revised), Emphasis of Matter Paragraphs and
Other Matter(s) Paragraphs in the Independent Auditor’s Report”, paragraph 20.
10
See ISSAI 1200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with International Standards on Auditing“, paragraph 13(k).
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14. Where exactly the line for pervasiveness has to be drawn is not clear, in particular because no
SAI, so far, has published documents or issued opinions explaining how it applied this concept.
However, it seems that 20 % or more represent a considerable share of the population 11.
15. As the ISSAIs do not provide for the fixing of precise “pervasiveness thresholds”, the
consequences of different professional judgements will be illustrated hereafter on the basis of
hypothetical examples of audit results with fictitious ministries as units of reporting. Starting point of
the examples is the hypothesis that the “grey zone” between a “substantial proportion” and a “nonsubstantial proportion” may lie somewhere between 20% and 30% of the overall amount of
transactions reflected in the financial statements (see annex 2).
(a) If the biggest or the second biggest ministry in the example were affected by material
error and if 27% was considered as a substantial part of the overall population, errors
would always be pervasive.
(b) If the three biggest ministries in the example were not affected by material error and if it
was considered that the number of ministries affected by a material level of error should
be maximum 26% of the overall population, errors would never be pervasive. If the
accepted maximum was 20%, the three biggest ministries plus one other (with the
exception of the smallest) would be necessary.
Combination of the first and second step: Conditions for a meaningful
determination of pervasiveness
16. It is self-evident that the two-step determination of pervasiveness on the basis of a single
representative sample (consisting of the minimum number of transactions) would not be in line with
the requirements of the ISSAIs. Such an approach would, in general, provide reasonable assurance
for estimating the most likely error of the transactions reflected in the financial statements but it
would, in general, not provide sufficient appropriate evidence which allows assessing whether:
(a) The material level of error is confined to specific elements, accounts or items of the
financial statements; or,
(b) If so confined, the total financial volume of problem areas represents a substantial
proportion of the overall population.
17. Furthermore, the examples of the section above show that bigger units of reporting have an
over-proportional importance for the determination of pervasiveness. In extreme cases, imbalances
between the financial volumes of the different units of reporting could even make the results of the
combined determination of the first and second aspect of pervasiveness meaningless.
18. The implementation of a too rigid, mechanic approach for determining pervasiveness on the
basis of
11
The only quantified information was identified concerning the US Government Accountability Office. For
example, it considered in its report GA-10-637T “Centres for Medicare and Medicaid Services –
Pervasive Internal Control Weaknesses hindered Effective Control Management”: “Our October 2009
report identified pervasive deficiencies in internal control over contracting and payments to contractors
... Based on the results of our work, we are 95 percent confident that the percentage of contract actions
did not meet three or more control tests is at least 37,2 percent.” (see page 6, footnote 18).
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(a) A fixed number of units of reporting affected by a material level of error as compared to
the total number of units of reporting; and
(b) A fixed percentage for the proportion of the overall financial volume of units of reporting
affected by a material level of error as compared to the overall population of transactions
reflected in the financial statements
would not be adequate. Instead a high degree of professional judgement is required which takes into
account all audit results obtained 12. Particular attention has to be given to the financial volume of
units of reporting affected/not affected by error.
Relation between materiality and pervasiveness
19. In the exposure process of ISA 705, which forms an integral part of ISSAI 1705, the IAASB did
not support the view presented by a few respondents “that the concept of materiality needed to be
incorporated into the definition of pervasive; in developing the requirements in ED-ISA 705, the
IAASB had previously considered whether the word ‘material’ should be subsumed into ‘pervasive’;
however the IAASB agreed that in practice the phrase ‘material and pervasive’ was frequently used
and well understood.” 13
20. The methodology underlying the new ISSAIs concerning necessary modifications to audit
opinions requires therefore clearly an independent analysis of both the level of error (in order to
determine whether the materiality threshold is exceeded) and the spread of error (which takes into
consideration pervasiveness). However, a determination of pervasiveness is only necessary in cases
where a material level of error has been identified.
21. A combined assessment of these two aspects (for example by introducing a link between the
level of the most likely error and the number of units of reporting or the proportion of the overall
population affected by material error considered as being not pervasive) would not respect the
requirements of ISSAIs 1705 and 4200.
Conclusions
22. The analysis of a possible approach for the implementation of the new ISSAI concept of
pervasiveness concerning the compliance of activities, financial transactions and information
reflected in the financial statements with the authorities governing them provided the following
results:
(a) Pervasiveness is only to be determined at the level of audit opinions (in order to decide on
whether a qualified or adverse opinion has to be issued); not for intermediary audit
conclusions.
(b) Depending on the approach, the units of reporting of the audit have, in general, to be the
units which serve as a basis for examining whether :
12
E.g. effectiveness of internal control, types of transactions affected by a material level of error.
13
Paper of IFAC, “Basis for Conclusions: ISA 705 (Revised and Redrafted), Modifications to the Opinion in
the Independent Auditor´s report”, (paragraph 9).
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−
A material level of error is confined to specific elements, accounts or areas of the overall
population of transactions reflected in the financial statements (first step of determining
pervasiveness); or
−
If so confined, it affects a substantial proportion of the overall population of transactions
reflected in the financial statements (second step of determining pervasiveness).
(c) The application of a too rigid, mechanic approach for determining pervasiveness on the
basis of :
−
A fixed number of units of reporting affected by a material level of error; and
−
A fixed percentage for the proportion of the overall financial volume of units of
reporting affected by a material level of error
would not be adequate.
(d) Instead, a high degree of professional judgement has to be applied which:
−
Takes into account all audit results obtained; and
−
Gives particular attention to the financial volume of units of reporting affected/not
affected by material error.
(e) Decisions concerning modifications to audit opinions have to respect the following
requirements:
−
In cases where no material error is identified, no determination of pervasiveness is
necessary because the audit opinion will be unmodified.
−
In the case of material error an additional analysis of pervasiveness has to be
undertaken. In this context, no link should be introduced between the level of the most
likely error and the number of units of reporting or the proportion of the overall amount
of policy groups affected by material error which are considered as being pervasive.
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ANNEX 1
Impact of pervasiveness on the type of opinion to be expressed
Nature of matter giving rise to a
modification
Auditor’s Judgement about the Pervasiveness of the Effects or
Possible Effects on the Financial Statements
Material but Not Pervasive
Material and Pervasive
Financial statements are
materially misstated
Qualified opinion
Adverse opinion
Inability to obtain sufficient
appropriate audit evidence
Qualified opinion
Disclaimer of opinion
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ANNEX 2
Scenarios for determining pervasiveness (Hypothetical results - Fictitious ministries)
Payments made
% of total payments Material level of error Material level of error Material level of error Material level of error
Ministry A
43 990,00
36%
Ministry B
12 851,00
11%
Ministry C
33 554,00
27%
Ministry D
7 076,00
6%
x
Ministry E
6 543,00
5%
x
x
Ministry F
8 953,00
7%
x
x
Ministry G
9 264,00
8%
x
x
122 231,00
100%
Total
Indicator for the term "confined": Material level of error affects x out of y ministries
Indicator for the term "substantial": Material level of error affects ministries representing z% of total payments
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x
x
1/7 (14%)
1/7 (14%)
4/7 (57%)
3/7 (43%)
36%
27%
26%
20%
10