What does a Part A Qualification on an SMSF Audit Report mean?
Historically, a Part A qualification in an SMSF audit report was not considered significant and was mainly for the trustee’s attention. The ATO was not made aware of it unless the fund was selected for a random audit or had other serious audit issues. However, since 2019, the ATO has required annual reporting of Part A qualifications in the SMSF tax return asking the question “Was Part A of the audit report qualified?”. The qualification did and still does act as an early indicator of potential issues within the fund.
What is a Part A Qualification?
There are two parts to an SMSF audit being Part A and Part B. Part A is a financial audit of the fund and Part B is an audit of the fund’s compliance with the superannuation laws being Superannuation Industry (Supervision) Act 1993 (SISA) and the Superannuation Industry (Supervision) Regulations 1994 (SISR).
Part A, the financial audit, involves the SMSF auditor conducting an audit of the fund’s financial statements in accordance with the Australian auditing standards.
The auditor is required to report material misstatements and common examples include:
- insufficient independent evidence of the market value of the fund’s assets has not been provided
- incorrect classification of assets in the fund’s financial statements
- the fund’s income tax expense is under or over provided i.e. non-arm’s length income (NALI) has not been correctly classified resulting in under provision of the fund’s income tax expense
- unable to verify the underlying investment when being reported as part of a management investment scheme (MIS) or other platforms
- unable to verify the opening balances when auditing an SMSF for the first time
Each auditor chooses a level of materiality they believe is sufficient. For example, it could be anywhere in the range of 5%-20%. If the auditor chooses a materiality level of 10% and your fund has over 10% of the total assets in cryptocurrency exchanges, foreign custodial shareholdings or platforms the auditor is required to qualify Part A of the audit report.
Hint – The ATO no longer require an auditor to report a Part A qualification in the fund’s annual return when it relates only to the verification of opening balances as it is considered low risk. The SMSF auditor is still required to report the opening balances in accordance with the Australian Auditing Standards as a Part A qualification.
A common audit issue for Investment Platforms
A significant issue faced by accountants and financial advisors is explaining to SMSF clients holding MIS or other investment platforms the reason an auditor must include a Part A qualification in the fund’s audit report. While annual statements provided by the MIS detail the SMSF’s holdings and account title, as well as income, expense, and taxation information, which seem to constitute independent audit evidence to clients, the fact remains that these reports are based on internally reviewed processes assessed by independent auditors to enhance transparency and reliability. This type of review is known as a type 2 audit report.
Nevertheless, SMSF auditors are required to independently verify the title to investments held by the SMSF, and when assets are managed by custodians, such verification is not possible.
Auditing standards may be met if an SMSF auditor is supplied with a type 2 audit report, annual investor statement, external confirmation from the investment platform, and analysis comparing investment returns with market indices. Additionally, reconciling balances and transactions with SMSF records, such as purchase and sale contracts and bank transactions, is required. However, undertaking these additional reviews involves substantial cost, leading SMSF auditors to qualify the audit report to reduce audit expenses and time commitments.
What audit tests must an SMSF auditor undertake?
The ATO enforces the auditing standards requiring an SMSF auditor to undertake testing of the financial statements prepared for the fund. The tests include ensuring:
- existence of fund assets as at 30th June
- title to the assets at 30th June
- member balances are materially stated
- fund liabilities are materially stated
- assets, liabilities, income, expenses and member entitlements are correctly classified
- correct allocations and classification of contributions
- tax is materially calculated
- transactions are completed and recorded correctly
The ATO’s approach to a Part A qualification
The ATO only asks trustees to indicate whether the audit report contains a Part A qualification but does not require any specifics about it. There is no need to notify the ATO if the qualification has been addressed. Historically, the ATO has clarified that a Part A qualification alone won’t prompt compliance action unless there are additional audit concerns. For SMSF audit selection, the qualification plays a minor part in the risk assessment, with more weight given to fund-related information, breaches reported via the auditor’s contravention report (ACR), and risks stemming from incorrect income tax reporting. If an SMSF is chosen for audit, any Part A qualification will be reviewed.