A scope limitation refers to a situation in which an auditor is unable to obtain sufficient appropriate evidence to form an opinion on certain aspects of the financial statements or the entire financial statements. It can also occur when the auditor is not allowed to perform a necessary audit procedure. Scope limitations can arise for a variety of reasons, some of which may be beyond the control of both the entity being audited and the auditor.
There are two main types of scope limitations:
- Imposed by the Entity: This occurs when the management or those charged with governance prevent the auditor from performing a procedure that the auditor believes is necessary. For instance, they might restrict the auditor’s access to certain records, information, or personnel.
- Circumstances beyond Control: This is when events or conditions prevent the auditor from completing a necessary procedure. Examples include a natural disaster that destroys accounting records, or the unavailability of key personnel due to unforeseen circumstances.
The impact of a scope limitation on an auditor’s report can vary:
- Qualified Opinion: If the scope limitation is material but not pervasive, the auditor may issue a qualified opinion, indicating that except for the effects of the matter to which the qualification relates, the financial statements are presented fairly.
- Disclaimer of Opinion: If the scope limitation is both material and pervasive, the auditor may choose to disclaim an opinion on the financial statements, indicating that they’re unable to express an opinion due to the significance of the limitation.
- Unmodified Opinion with Emphasis of Matter: In some cases, if there’s a scope limitation that is material but not pervasive and the auditor has been able to obtain sufficient appropriate evidence about the matter, they might choose to issue an unmodified (or “clean”) opinion but include an emphasis of matter paragraph drawing attention to the issue.
In any case, scope limitations need to be clearly communicated in the auditor’s report to ensure that users of the financial statements are informed of the areas where information might be incomplete or uncertain.
Example of Scope Limitation
Let’s consider a hypothetical company, XYZ Ltd., and explore a scope limitation scenario.
XYZ Ltd. is a company that has a significant amount of inventory stored in a warehouse. In the current year, a major flood occurred in the area where the warehouse is located, just a few days before the year-end inventory count was scheduled. Due to the flood, a significant portion of the inventory was damaged, and the warehouse was inaccessible.
When the external auditors came in for their year-end audit, they intended to observe the inventory count, which is a common audit procedure to verify the existence and condition of the inventory. However, because of the flood, they were unable to physically observe a significant portion of the inventory. This posed a scope limitation.
Given the circumstance, the auditors might address the scope limitation in their report as follows:
We have audited the accompanying financial statements of XYZ Ltd., which comprise the statement of financial position as at December 31, 20XX, and the statements of comprehensive income, changes in equity, and cash flows for the year then ended, and a summary of significant accounting policies and other explanatory information.
In our opinion, except for the possible effects of the matter described in the Basis for Qualified Opinion section of our report, the financial statements present fairly, in all material respects, the financial position of XYZ Ltd. as at December 31, 20XX, and its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards (IFRS).
Basis for Qualified Opinion
XYZ Ltd. holds a significant amount of inventory in a warehouse located in [location]. As described in Note X to the financial statements, due to a major flood in the area shortly before the year-end, we were unable to observe and verify a significant portion of the year-end inventory count. Consequently, we were unable to determine whether any adjustments to the amounts reported for inventory and related accounts might be necessary.
This is a simplified example, but it gives an idea of how a scope limitation can arise and how it might be addressed in an auditor’s report. In the real world, the auditors would also likely engage in discussions with management about alternative procedures or evidence that might be available to mitigate the impact of the scope limitation.