How to Qualify an Audit Report: Requirements, Reasons, Impact and Comprehensive Illustrations

Introduction
An auditor’s report culminates months of planning, risk assessment, evidence gathering and evaluation. Its central promise is an opinion on whether the financial statements present a true and fair view in accordance with the applicable financial reporting framework (Ind AS/AS and the Companies Act, 2013). Most audits conclude with an unmodified (clean) opinion. However, where departures from the framework, inadequate disclosures, limitations in scope, or pervasive uncertainties exist and are material, the auditor must qualify or otherwise modify the opinion. Qualification is not a punitive act; it is a professional communication intended to faithfully
inform users of the statements about the specific matters that prevent a clean opinion. This article provides a practitioner’s guide to qualification—when and how to do it; the required pre-conditions; quantification and disclosure; impact on profits and equity; and how to draft the Basis for Qualified Opinion. It also includes composite case studies inspired by public-domain patterns observed in annual reports of large listed (“blue chip”) companies, real-life scenarios, and numerical illustrations relevant for Indian practice. 

References are made to Standards on Auditing (SAs), Ind AS/AS, and the Companies Act, 2013.

1) Core Concepts: “True and Fair”, Materiality, and Pervasiveness
True and fair view does not imply absolute accuracy. “True” relates to factual correctness supported by sufficient appropriate audit  evidence; “fair” refers to neutrality, faithful representation and freedom from bias, consistent with the substance of transactions. Materiality (SA 320) sets the threshold where misstatements—individually or in aggregate—could reasonably influence the economic decisions of users. Pervasiveness (SA 705) describes effects that are not confined to specific elements or represent a substantial portion of the statements or fundamental to users’ understanding. The interplay between materiality and pervasiveness determines
whether the auditor issues (a) a qualified opinion (material but not pervasive), (b) an adverse opinion (material and pervasive departure from the framework), or (c) a disclaimer of opinion (material and pervasive scope limitation or inability to obtain evidence).

2) When Does a Qualification Arise?
Under SA 705, an auditor modifies the opinion in two broad situations:
A. Disagreement with management about accounting policies, application, or disclosures—e.g., non-compliance with Ind AS/AS, inadequate disclosure of a material uncertainty, incorrect measurement or classification.
B. Inability to obtain sufficient appropriate audit evidence due to a scope limitation—e.g., inventory not observed without effective alternative procedures, inaccessible records, or restrictions imposed by management or circumstances.

3) Pre-Qualification Requirements: What Must the Auditor Do First?
Before concluding that a qualification is necessary, the auditor should:
i. Engage in robust two-way communication with those charged with governance (TCWG) (SA 260). Escalate unresolved matters from management to the Audit Committee/Board, presenting proposed adjustments and disclosures.
ii. Reassess risk and perform additional procedures targeted to the matter (SA 330). Where evidence was initially inadequate, design alternative procedures to the extent practicable.
iii. Evaluate materiality and pervasiveness (SA 320, SA 450). Consider both quantitative and qualitative aspects (law/regulation breaches, covenant implications, related party sensitivities, going concern).
iv. Request management to correct misstatements and/or expand disclosures. Obtain a written management representation (SA 580) addressing the matter (but remember, representations do not substitute for other evidence).
v. Quantify the effect to the extent practicable. If exact quantification is not possible, provide a reasonable range or state that the effect could not be determined and explain why.
vi. Consider the impact on Key Audit Matters (KAMs) in listed entities (SA 701). KAMs do not replace modifications; if a matter results in a qualification, it must be described in the Basis for Qualified Opinion section, not merely as a KAM.
vii. Consider Emphasis of Matter (EOM) or Other Matter (OM) paragraphs (SA 706) when the opinion is unmodified but attention is drawn to significant matters. EOM is not a substitute for qualification: when there is a material departure or evidence limitation, qualification (or adverse/disclaimer) is required.
viii. Assess the interaction with CARO 2020 reporting (for applicable companies), Schedule III presentation, and Section 143 of the Companies Act, 2013 (including 143(3)(f) and (h) on observations, qualifications, and adverse remarks).

4) Reasons for Qualification: Typical Patterns Seen in Practice
The following categories commonly lead to qualification in Indian audits. Each is paired with an illustration and discussion of the impact on profit and equity.
a) Non-recognition/under-recognition of provisions and liabilities (Ind AS 37/AS 29): Statutory dues, onerous contracts, litigations, decommissioning, or asset retirement obligations.
b) Revenue recognition departures (Ind AS 115/AS 9): Bill-and-hold, cut-off errors, variable consideration constraints ignored, improper gross vs net presentation.
c) Inventory valuation (Ind AS 2/AS 2): Overstatement due to not writing down to net realisable value (NRV); obsolete stock not provided. 
d) Impairment of non-financial assets (Ind AS 36/AS 28): Cash-generating units (CGUs) not tested despite impairment indicators.
e) Financial instruments and ECL (Ind AS 109): Inadequate expected credit loss modelling for receivables/loans; staging errors.

f) Foreign currency and hedging (Ind AS 21/109): Non-recognition of MTM losses; incorrect hedge accounting documentation.
g) Leases (Ind AS 116): Non-recognition of right-of-use (ROU) assets and lease liabilities; short-term/low-value exemptions misapplied.
h) Consolidation and investments (Ind AS 110/111/28): Non-consolidation of subsidiaries/JVs; equity method not applied; fair value through OCI/PL classification errors.
i) Related party transactions and disclosures (Ind AS 24): Omitted or incomplete disclosures that are material to users.
j) Going concern (SA 570): Inadequate disclosure of material uncertainty; basis not supported; non-adjusting vs adjusting events.
k) Scope limitations: Physical inventory not observed; system failure; legal restrictions; records lost/destroyed.

5) Impact on Profit and Equity: How to Compute and Present
The auditor’s objective is to quantify the effect wherever practicable. Illustratively:
• Provision shortfall: Expense understated; profit overstated; liabilities understated; equity overstated.
• NRV write-down not recorded: Cost of goods sold understated; inventories overstated; profit overstated.
• Impairment not recorded: Depreciation and impairment expense understated; assets and equity overstated.
• ECL shortfall: Finance cost/credit loss expense understated; trade receivables overstated.
• Lease not recognized: EBITDA overstated (lease expense omitted), finance cost and depreciation understated; liabilities understated.
• Forex MTM losses ignored: Other expenses and derivative losses understated; borrowings at amortised cost misstated.

6) Drafting the Modified Opinion: Structure and Language
The Independent Auditor’s Report should contain the following elements in line with SA 700 (Revised) and SA 705:
• Opinion: “In our opinion, except for the possible effects of the matters described in the Basis for Qualified Opinion paragraph… the accompanying standalone financial statements give a true and fair view…”
• Basis for Qualified Opinion: Describe the matter clearly, quantify the effect on each primary statement (P/L, OCI, Balance Sheet, Cash Flows) if practicable, or state that it cannot be determined. Refer to the relevant note in the financial statements.
• Key Audit Matters (for listed entities): KAMs are reported separately. If the qualified matter is a KAM, cross-reference.
• Responsibilities of Management and Auditor’s Responsibilities: As per SA 700.
• Other Information, Report on Other Legal and Regulatory Requirements: CARO, Section 143(3) clauses, etc.
For adverse opinions and disclaimers, adapt the Opinion paragraph accordingly.

7) Composite Case Studies Inspired by Blue-Chip Annual Report Patterns
The following case studies are composites synthesised from patterns seen in annual reports of large listed companies in India and abroad. They are intended for learning and do not attribute issues to any single identified company.

Case Study 1: Manufacturing Conglomerate (NIFTY-50 type) — Provisioning for Onerous Contracts and NRV
Facts: The group has long-term supply contracts. Due to a steep fall in commodity prices, unavoidable costs exceed expected benefits on certain contracts. Management has recognised a provision of INR 120 crore; the auditor’s procedures (including contract-by-contract forecasting) indicate the provision should be INR 180–200 crore. Further, slow-moving spares and finished goods of INR 75 crore are carried at cost despite NRV being INR 50 crore.
Assessment: Ind AS 37 requires full provision for onerous contracts; Ind AS 2 requires inventory write-down to NRV. Management argues
uncertainty. The Audit Committee accepts a partial adjustment only.
Quantification: Provision shortfall: INR 60–80 crore; inventory overstatement: INR 25 crore; total profit overstatement INR 85–105 crore;
equity overstatement by the same net of tax.
Illustrative Basis for Qualified Opinion (extract): “…the provision recognised for expected loss on certain long-term supply contracts
is lower by INR 60–80 crore and inventories include items carried above NRV by INR 25 crore. Had the Company recognised the additional
provision and the write-down, profit before tax for the year would have been lower by INR 85–105 crore and total equity as at year-end
lower by INR 85–105 crore (before considering tax effects).”
Impact: Analysts adjust EBITDA and EPS; covenants tied to EBITDA may be impacted.

Case Study 2: Large IT Services Company — Revenue Recognition (Variable Consideration) and Unbilled Receivables
Facts: The company recognises revenue for milestone-based fixed-price projects. Liquidated damages (LD) clauses and service credits
create variable consideration. Management constrained variable consideration at 5%; auditor analysis of historical outcomes indicates
a 9–12% reduction is more realistic. Unbilled receivables of INR 1,200 crore include INR 180 crore aged over 12 months without
corresponding specific loss allowance.
Quantification: Revenue overstatement INR 120–210 crore; ECL shortfall INR 60–80 crore. Net profit overstatement INR 180–290 crore.
Qualification: Material but not pervasive to the financial statements; hence a qualified opinion.
Illustrative Journal Entries (if corrected): Dr. Revenue Reversal 150; Dr. Impairment Loss 70; Cr. Contract Asset/Receivable 220.
Takeaway: Detailed constraint assessments and ECL overlay models are critical under Ind AS 115/109.

Case Study 3: Energy & Infrastructure Player — Borrowings in Foreign Currency and Hedge Accounting
Facts: The company has USD-denominated project loans and cross-currency swaps designated as cash flow hedges. Hedge documentation
was not completed at inception; effectiveness testing performed post-facto. MTM losses on swaps of INR 340 crore were deferred in OCI
though criteria in Ind AS 109 were not met.
Quantification: Profit after tax understated by INR 340 crore if losses are correctly routed to P/L; equity presentation (OCI reserve)
overstated by INR 340 crore. Certain debt covenants linked to DSCR would breach if losses are recognised.
Illustrative Basis Extract: “…the Company has recognised fair value losses on derivative contracts as part of other comprehensive
income. In our view, the hedge accounting criteria under Ind AS 109 were not met at inception; accordingly, the losses of INR 340 crore
should have been recognised in the Statement of Profit and Loss. Had the above treatment been followed, profit for the year would have
been lower by INR 340 crore and other equity lower by INR 340 crore.”

Case Study 4: Diversified Consumer Company — Ind AS 116 Leases Not Recognised
Facts: The Company operates 1,100 retail outlets under cancellable leases with economically enforceable terms exceeding 12 months.
Management treats them as short-term leases; auditor’s assessment of reasonably certain extension options indicates recognition of
ROU assets INR 1,050 crore and lease liabilities INR 1,100 crore is required.
Quantification: EBITDA currently overstates operating performance by deferring lease expense; if recognised, depreciation and finance
cost would increase, reducing PAT by INR 120–150 crore. Balance sheet leverage increases.
Qualification vs EOM: Because misstatement is material to the balance sheet and P/L but confined to leases, a qualification is appropriate.

Case Study 5: Large Bank (Public Sector) — ECL and NPA Classification
Facts: Retail and SME portfolios show staging anomalies. Management overlays reduce ECL by INR 700 crore relative to model outputs;
certain accounts restructured during the year are not moved to Stage 2. Auditors are unable to obtain sufficient evidence for
management overlays and identify exceptions in NPA recognition.
Quantification: Additional ECL INR 600–800 crore; interest income reversal INR 120–150 crore. Profit overstatement INR 720–950 crore.
Regulatory Linkage: RBI IRACP norms and Ind AS 109 (or AS for non-Ind AS banks) interact; disclosures in notes are inadequate.
Outcome: Material but not pervasive—qualified opinion on Standalone, with a KAM detailing ECL methodology and overlays.

Case Study 6: Metals & Mining Major — Impairment of CGUs
Facts: A downturn triggers impairment indicators for an iron ore CGU. Management uses aggressive long-term price assumptions and a
pre-tax discount rate of 8% though WACC analysis suggests 11–12%. Recoverable amount is overstated by INR 2,000–2,500 crore.
Quantification: If corrected, impairment charge of INR 1,200–1,600 crore would be required. Given size relative to total assets, the
matter may be pervasive; adverse opinion could be considered if impairment affects multiple CGUs.
Audit Response: Engage valuation specialists, sensitivity analysis, benchmarking commodity curves.

Case Study 7: Telecom Operator — Non-consolidation of a Structured Entity
Facts: A network infrastructure SPV is de facto controlled via substantive rights though voting power is <50%. Management treats it as
an associate at cost. Auditor concludes control exists (Ind AS 110) and consolidation is required. Non-consolidation misstates assets,
liabilities, revenue and expenses materially across the statements.
Outcome: Likely pervasive—adverse opinion warranted unless adjustments are made. Basis for Adverse Opinion would explain failure to
prepare consolidated financial statements in accordance with Ind AS 110.

8) Real-Life Style Numerical Illustrations and Working Notes
Illustration A: Provision for Litigation (Ind AS 37)
• Background: A tax litigation at the CIT(A) stage with unfavourable jurisprudence. External counsel estimates a 70% likelihood of
outflow INR 90–110 crore. Management recognises only a contingent liability disclosure.
• Auditor’s computation: Expected provision INR 100 crore; after-tax impact (assuming 25%) INR 75 crore.
• Qualification extract: “…provision for pending litigation has not been recognised. Had the provision been recorded, profit after
tax would have been lower by INR 75 crore and liabilities higher by INR 100 crore.”

Illustration B: Inventory NRV (Ind AS 2)
• Data: Inventory at cost INR 600 crore; NRV analysis indicates INR 540 crore; obsolescence write-down INR 30 crore; total reduction
required INR 90 crore.
• Effect: PBT lower by INR 90 crore; EPS adjusted accordingly. Equity lower by INR 90 crore pre-tax.
• Working note pointers: Ageing matrix, post-period sales, scrap realisations, standard cost variances, slow/non-moving SKUs.

Illustration C: Revenue Cut-off (Ind AS 115)
• Data: FY-end dispatches of INR 250 crore include INR 70 crore billed on 30 March but delivered on 3 April under FOB destination
terms. Control transferred post year-end.
• Effect: Revenue overstatement INR 70 crore; trade receivables overstated; contract liabilities understated. PBT lower by INR 70 crore
if corrected.
• Procedure: Sales return trends in April, matching GRNs, third-party logistics confirmations.

Illustration D: Lease Recognition (Ind AS 116)
• Data: Annual rentals INR 480 crore. Weighted average incremental borrowing rate 9%. Average remaining lease term 5 years. PV of
lease liabilities approximates INR 1,800 crore; ROU asset INR 1,760 crore after initial costs/lease incentives.
• P&L: Former operating lease expense 480 replaced by depreciation 350 and finance cost 220 → PAT lower by ≈90.
• Balance sheet: Net debt increases; interest coverage metrics adjust.

Illustration E: ECL Shortfall (Ind AS 109)
• Data: Trade receivables INR 3,500 crore. Lifetime ECL model suggests 4.5% loss (INR 157.5 crore). Management booked 2% (INR 70 crore).
• Effect: Additional impairment required INR 87.5 crore; PBT lower by same; equity lower by INR 87.5 crore (pre-tax).
• Audit approach: Back-testing, macroeconomic overlays, segregation by geography/industry, PD/LGD calibration.

Illustration F: Forex and Hedge Accounting (Ind AS 109/21)
• Data: USD 300 million loan at 78/USD; year-end 84/USD → forex loss INR 1,800 crore (approx). Cross-currency swap MTM loss INR 240 crore.
• Issue: Hedge documentation absent at inception; losses taken to OCI. Correct treatment routes to P/L.
• Impact: PAT lower by INR 2,040 crore; equity lower by transfer out of OCI reserve.

Illustration G: Impairment (Ind AS 36)
• Data: CGU carrying amount INR 8,000 crore; recoverable amount (VIU) under auditor’s assumptions INR 6,900 crore.
• Impact: Impairment INR 1,100 crore; tax shield effect if applicable; EPS and book value per share reduce accordingly.

9) Decision Framework: Qualified vs Adverse vs Disclaimer
Create a three-step test:
Step 1 (Materiality): Are the misstatements, individually or in aggregate, material?
Step 2 (Pervasiveness): Are the effects confined to specific elements or do they pervade multiple statements or are fundamental to
users’ understanding?
Step 3 (Evidence): Is the issue a departure from the framework (disagreement) or an evidence limitation (inability to obtain evidence)?
• Qualified Opinion: Material but not pervasive misstatements OR possible effects of material but not pervasive limitations.
• Adverse Opinion: Material and pervasive misstatements (departure from framework).
• Disclaimer: Material and pervasive scope limitation (unable to obtain evidence), including situations where numerous areas are affected.

10) Quantifying and Disclosing the Effect of Qualification
Principles for quantification:
• Quantify each affected line item: revenue, expense, assets, liabilities, equity. Provide ranges if uncertainty remains.
• State tax effects and EPS impact where practicable.
• Explain qualitative effects (covenants, going concern, dividend capacity).
• Cross-reference to the note; keep the Basis paragraph precise and non-argumentative.
Model wording for inability to quantify: “The Company has not carried out an independent valuation… Consequently, we are unable to
determine the adjustments, if any, that might have been necessary to property, plant and equipment, depreciation, and the related
elements of the Statement of Profit and Loss.”

11) Interactions with Other Reporting: KAMs, EOM, CARO and Regulatory Matters
• KAMs (SA 701): Describe why the matter was of most significance and how it was addressed in the audit. Do not include the effects of
any qualification in the KAM section—keep them in the Basis paragraph.
• EOM/OM (SA 706): Use when drawing attention to important disclosures in an unmodified opinion. Do not use EOM to rectify a departure.
• CARO 2020: Certain matters (inventory discrepancies, title deeds, default in repayment, internal audit, etc.) may echo the modified
opinion. Ensure consistency.
• Section 143(3)(f) and (h): Report on observations with adverse remarks; any qualification must be linked to these clauses appropriately.
• SEBI LODR and investor communications: Management should avoid selective disclosures that contradict the auditor’s report.

12) Practical Workflow Before Issuing a Qualification
1. Early flagging: During planning and interim, identify areas likely to create modified opinions; inform TCWG early.
2. Issue papers: For each potential qualification, prepare an issue paper: criteria, condition, cause, consequence, corrective action,
quantification, disclosure draft, management response, auditor conclusion.
3. Draft financial statement note: Encourage management to make robust note disclosures—even when qualification remains.
4. Draft the Basis paragraph: Clear, concise, quantified; avoid emotive language.
5. Internal consultation and EQCR: For listed and high-risk audits, involve engagement quality control reviewer.
6. Final communications to TCWG: Provide the written report of significant findings, uncorrected misstatements, and reasons for
modification. Obtain updated management representation letter covering the matter.
7. Post-issuance monitoring: Consider whether the qualification triggers reporting to regulators or lenders.

13) Extended Examples of Basis for Qualified Opinion (Templates)
Template A — Departure (Provision/NRV)
“Basis for Qualified Opinion
As described in Note X, the Company has recognised a provision of INR 120 crore towards expected losses on certain long-term supply
contracts. Based on the terms of the contracts and our procedures, we believe an additional provision of INR 60–80 crore is required.
Further, inventories include items carried at cost aggregating INR 75 crore for which the estimated NRV is lower by INR 25 crore. Had the
Company recognised the additional provision and the write-down, profit before tax for the year would have been lower by INR 85–105 crore,
total equity as at 31 March 20XX lower by INR 85–105 crore (before tax effects), and inventories and provisions would have been adjusted
accordingly.”

Template B — Scope Limitation (Inventory Observation)
“Basis for Qualified Opinion
We were appointed as statutory auditors subsequent to the year-end and were therefore unable to observe the physical counting of inventories
at 31 March 20XX. We were also unable to satisfy ourselves by alternative means concerning the inventory quantities by other auditing
procedures. Consequently, we were unable to determine whether any adjustments might have been necessary in respect of inventories,
cost of goods sold and the elements making up the Statement of Profit and Loss and Balance Sheet.”

Template C — Revenue Recognition (Cut-off and Variable Consideration)
“Basis for Qualified Opinion
As indicated in Note Y, revenue includes sales of INR 70 crore for which control transferred after the reporting date based on delivery
terms, and estimates of variable consideration that, in our judgment, exceed the constraint required under Ind AS 115. Had the Company
recognised revenue when control transferred and applied an appropriate constraint, revenue for the year would have been lower by INR
120–210 crore and profit after tax lower by INR 90–165 crore.”

14) Analytical Impacts for Users: Profit, EPS, and Ratios
When qualifications are quantified, analysts and lenders often prepare “adjusted” metrics. Examples using Case Study 2 (midpoints):
• Reported PAT: INR 2,300 crore; adjustments (revenue 165 + ECL 70) = 235; Adjusted PAT: INR 2,065 crore.
• EPS impact with 300 crore shares: INR 0.78 per share reduction.
• EBITDA/EBIT impact when leases/ECL/NRV are involved; Net debt/EBITDA, Interest coverage, DSCR and covenant headroom may change.
• Dividend capacity and buyback limits (based on free reserves) may be affected.

15) Going Concern: When Qualification Is Not Enough
If material uncertainty exists and is appropriately disclosed, the auditor includes a separate “Material Uncertainty Related to Going
Concern” section (SA 570) without modifying the opinion. If disclosure is inadequate, a modification (qualification or adverse) is
required. In distressed sectors (aviation, infrastructure), inadequate disclosure has led auditors to qualify opinions; pervasiveness
may push towards adverse or disclaimer where uncertainties are so significant that audit evidence cannot be obtained.

16) Frequently Encountered Pitfalls
• Over-reliance on management representations where contradictory evidence exists.
• Ambiguous Basis paragraphs that describe procedures rather than effects.
• Failure to align CARO observations with the modified opinion.
• Not quantifying the effect even when practicable.
• Using EOM in lieu of a modification where there is a clear departure.
• Inadequate evaluation of tax effects and EPS implications.
• Not re-assessing materiality late in the audit when misstatements accumulate.

17) Auditor’s Documentation Checklist (Abbreviated)
• Risk assessment linking to the eventual modification.
• Alternative procedures attempted and their results.
• Materiality and pervasiveness assessment with thresholds.
• Computations of quantified effects and ranges.
• Communications with management and TCWG (minutes/emails).
• Drafts and final Basis paragraph; internal consultations/EQCR comments.
• Cross-references to financial statement notes and CARO clauses.
• Final evaluation under SA 700/705/706/701 and Companies Act reporting.

Conclusion
Qualification is a disciplined, transparent way to uphold the promise of true and fair presentation when departures or evidence limitations are material. The auditor must first exhaust reasonable procedures, press for corrections and fuller disclosure, and quantify the effect. When a qualification remains necessary, the report should clearly identify the matter, explain its financial statement impacts, and reference relevant notes and standards. For preparers and those charged with governance, early engagement, robust estimates and disclosures, and prompt remediation reduce the likelihood and severity of modifications. For users—investors,
lenders, analysts—a well-drafted qualified report enhances decision-usefulness by illuminating precisely what stands between the reported numbers and a clean opinion.