Chap t e r 3 Audit Rep ort s Key obje c ti v e s : 1.

Describe the parts of the stand ar d unqu alified audit report for non- public entities under AICPA auditing stand ar d s . 2. Specify the conditions required to issue the stand a r d unqu alified audit report. 3. nderst a n d reporting on financial stat e ! e n t s and intern al control o"er financial reporting required under PCA#$ auditing stand a r d s . %. Describe the fi"e circu!s t a n c e s &hen an unqu alified report &ith an e!ph a sis- of-!att er e'plan a t or y paragr a p h or !odified &ording is appropriat e. (. Identify the types of audit reports that can be issued &hen an unqu alified opinion is not )ustified. *. +'plain ho& !at eriality affects audit reporting decisions. ,. -no& the .ey ter!s that identify different audit reports. /. Deter !in e the appropriat e audit report for a gi"en audit situation. 1. Purp o s e of audit report 2. Com m u n i c a t e s auditor0s &or. conclusions reach e d. It0s the auditor0s prod u c t 1 and the "isible outco ! e of the audit proces s. rep ort 2unqu alified or and only

Short- form opinion4 A.

3clean3

5hen appropriat e 1. All 4 sta t e m e n t s and appropriat e discl o s u r e 2An opinion can be issued on less than a full set of financial stat e ! e n t s - see Ch. 2%4. 6AAS specifically pro"ides that in the cas e of omi s s i o n of th e cas h flo s stat e ! e n t 1 a !ualifi e d opinio n is issued. Auditor has gath er e d sufficient appropriate evide nc e in accord a nc e &ith "AAS State ! e n t s in accord a n c e &ith "AAP 2including adequ a t e disclosure4 or other applicable accounting fra!e& or.. 1%

3. %.

(. $.

7o other circu!s t a n c e s .

8here are se"e n parts to the report. It is i!porta n t to unders t a n d the conte n t of the three !ain paragr a p h s 2in bold4.

Part s of Audit Rep ort 1. 8itle 2. 9eport addre s s e e 3. Introductory paragr a p h %. #an a $ e m e n t % s Res p o n s i b ilit y (. Auditor%s Res p o n s i b liit y - Scop e para $r a p h *. &pinio n ,. 7a!e and Addres s of CPA fir! /. 9eport Date - 8he date is the last day of the auditor0s field o r' . Auditor is respon sible for reporting on e"ent s occurring up to that date.

3.

()p e c t a t i o n s $ap - 5hat is the 3e'pect a tion gap3: 2 *iscu s s i o n 4 ()p e c t a t i o n "ap
Public e)p e c t s ()pe c t a t i o n "ap Audit provi d e s Pre- So)+

,oday

8he e'pect a tions gap is the differenc e bet& e e n &hat the public e'pects1 and &hat the audit pro"ides. 8here are continue d concern s about the quality of audits. +'a!ples of percei"ed audit failures include +nron1 5orlCo!1 Adelphia1 8yco and 1(

Sunbe a ! . As a result1 the S+C has been critical of the profession1 and the Public #"ersight $oard perfor! e d an e'te nsi"e e'a !in a tion of audit effecti"en e s s . 8he profession &as also under attac. in the !idto late 1;,<0 s. 8he di"isions for CPA fir!s and peer re"ie& ca!e about in respons e to thos e attac.s.

1*

8he profes sio n ca ! e und e r scrutiny fro! Congr e s s in the late 1;/<0 s. 8he profes sion respon d e d to thes e concern s by issuing nine SASs 2=( 3- = * 14. -no&n as the e)p e c t a t i o n $ap sta n d a r d s 1 they &ere design e d to reduc e the gap by i!pro"ing the auditor0s product1 and by !a.ing the audit report !ore infor!a ti"e. 8he audit report in >igure 3- 1 on p. %; of the te't is ne& &ording under the clarified AICPA auditing stand a r d s . . Frau d continue s to be a significant part of the e'pect a tion gap. SAS = ; ;1 Consideration of Fraud in a Financial State m e n t Audit 1 requires auditors to consider and respon d to identified ris.s of fraud. %. Key ele m e n t s of rep ort 2see figure 3- 11 p. %; of te't4 A. $. C. Introduction ? Indicate s that an audit &as perfor! e d and the financial stat e ! e n t s audite d. #ana $ e m e n t is responsible for the financial state ! e n t s and intern al control. Auditor@s 9esponsibility Scope 1. Rea s o n a b l e as s u r a n c e that stat e ! e n t s are free of mat e ri al mis s t a t e m e n t 2. +"idence depe n d s on ris.s and intern al control 3. +"idence is sufficient 2unless li!itation noted4 DC. in"ol"ed (. Cate $ o ri e s of Audit Rep ort s Opinion - not a guara n t e e 1 jud$ m e n t is

Stand ard nqualified nqualified &B e'plan a tory paragr a p h

Aeets the conditions described on p. 1% of note s >BS fairly pres e n t e d 1 adequ a t e audit1 but additional infor!a tion is nece s s a r y in report

1,

Cualified

#"erall >BS are fairly pres e n t e d 1 but scope !at e rially restrict e d 26AAS proble ! - Qualified Scope and Opinion 4 or 6AAP not follo&ed 2 Qualified Opinion only 4 >BS not fairly pres e n t e d 2 Advers e 4 or auditor is unable to for! an opinion or auditor lac.s indep e n d e n c e 2 Disclaim er 4

Ad"ers e or Disclai! er

*.

Rep ort s on -ntern al Control As a result of Section %<% of the Sarba n e s- #'ley Act1 auditors of public co!p a nie s !ust also issue a report on !an a g e ! e n t@s ass ertion regarding the effecti"en e s s of intern al control. 8his report !ay be separ a t ely issued1 or co!bin e d &ith the report in the financial state ! e n t s .

9eport includes auditor@s opinion on !an a g e ! e n t@s ass es s ! e n t of intern al control and the operating effecti"en e s s of controls Includes addition al paragr a p h s for the definition and the inhere n t li!itations of intern al control 7ote that public co!p a n y reports also refer to PCA#$ auditing stand a r d s

,.

(mph a s i s - of- #att er ()plan a t o r y para $r a p h or modifi e d ordin $ - In so!e cas es it is neces s a r y to !odify or e'plain the audit report. sually the underlying opinion is unqu alified1 althoug h e'plan a t ory paragr a p h s can apply to other opinions. A. ,yp e s 2first four are e'plan a t or y paragr a p h s D last is !odified &ording4 Eac. of consiste n cy Substa n tial doubt about going concern Agree &ith 6AAP departur e +!ph a sis of a !att er 9eports in"ol"ing other auditors

Aanag e ! e n t is respon sible for esti!a ting and disclosing poten tial effects of uncert ainties. Auditors !ust ass e s s &heth er !an a g e ! e n t 0 s esti!a t e s and disclosure s are support e d by e"idenc e. 1/

1.

Con si s t e n c y Applies to chang e s in accounting principl e 2not esti!a t e s 4. a. Applies to both voluntary and manda tor y 2due to ne& accounting stand ar d4 chang e s Co!!o n due to frequ e n t !and a t o r y chang e s .olun t ar y chang e mus t be to pref er a b l e stand ar d. Co!p a ni es can use !ore than one !etho d 2i.e.1 so!e in"entory EI>#1 so!e >I>#4D this is not lac. of consist e nc y. Consiste ncy relate s to chang e in !etho d s betw e e n periods . "s.

b.

c.

d.

Con si s t e n c y com p ar a b ilit y . a.

Consi s t e n c y in"ol"es 1;

b/

chang e s in accounting principl e s 1 not esti!a t e s . Chan $ e s in es ti m a t e s in"ol"e com p a r a b ili ty and are usually not an e'plan a t ory paragr a p h

"oin $ con c e r n nder SAS = ( ;1 the auditor !ust issue a going concern report if sBhe belie"es the co!p a n y &ill not continu e in e'istenc e for one year fro! date of financial stat e ! e n t s . 28he auditor !ay also issue a disclai!er1 but this is rarely done.4 3. Agree &ith 6AAP departur e 2rare4 %. +!ph a sis of !att er 2surprisingly rare4 8ypes of e"ents that !ay be e!p h a siF e dG relate d parties subs e q u e n t e"ent s 2topic of Chap. 2%4 lac. of co!p ar a bility (. Rep ort s involvi n $ oth er audit or s 2so!e& h a t co!!o n4 - 8hree possibilitiesG

2.

2<

Ass u m e res p o n s i b ilit y Shar e d res p o n s i b ilit y

No referenc e in report Unqualified opinion odify auditor!s responsibility and opinion para"rap#s 2>ig. 3- , on p. (, in te't4 Qualify or disclai!

0o res p o n s i b ilit y

21

#ultipl e Choic e 3- 14 2a3 An entity chang e d fro! the straight- line !etho d to the declining balanc e !eth o d for all ne&ly acquired ass ets . 8his chang e has no !at erial effect on the current year financial stat e ! e n t s 1 but is reaso n a bly certain to ha"e a !at erial effect in later years. If the chang e is adequ a t ely disclos ed in the financial stat e ! e n t s 1 the auditor should issue a report &ith a2n4G 1. Cualified opinion. 2. nqualified opinion &ith e'plan a t or y paragr a p h . 3. nqualified opinion. %. Cualified opinion &ith e'plan a t ory paragr a p h regarding consiste nc y.

,.

&th er tha n 4n!u alifi e d Rep ort s - 8he auditor0s report is a function of the auditor0s 'no l e d $ e as to the e'iste nc e of errors1 and their mat e ri alit y . +rrors !ay be incorrect am o u n t s 1 or failure to follo& 6AAP 2incorrect m et h o d or inade q u a t e dis cl o s u r e 4. Auditor has 'no l e d $ e 2not "AAP3 nqualified Audit or lac' s 'no l e d $ e 2non- "AAS3

#at eri ali ty lev el

I!!at e ria l

nqualified

22

Aaterial Highly !at erial A.

Cualified opinion Ad"ers e

Cualified opinion Disclai!er

Kno l e d $ e - if the auditor has .no&ledg e of a !at erial error1 it !ust be noted in the report. 1. #at erial - >airly stat e d1 3e'cept for3 the ite! 2 qu alifi e d opinion4. 2. 5i$hly mat e ri al the stat e ! e n t s are so !issta t e d as to be co!plet ely !isleading. 8he stat e ! e n t s are 3not fairly state d3 2 ad v e r s e opinion4. $. 6ac' of 'no l e d $ e Inability to co!plet e neces s a r y audit proced ur e s 2scope restriction I lac. of 6AAS4. 1. #at erial qu alifi e d sco p e an d opini o n . 5e can0t issue an opinion to the e'tent &e lac. .no&ledg e1 and &e !ust note this in the scope paragr a p h and opinion. 2. 5i$hly mat e ri al dis cl ai m e r . 5e are unable to issue any for! of 23

opinion on financial stat e ! e n t s .

the

8he scope !ay be limit e d by th e clien t 1 or by fact or s bey o n d th e clie n t or audit or7s con tr ol 2such as inability to obser" e in"entory due to appoint ! e n t after year- end in"entory4. Clients frequ e n tly ha"e legiti!a t e reas ons to i!pos e scope li!itations. 8he auditor !ust e"alua t e the reas on s for1 and !at eriality of thes e li!itations. 5hen the auditor lac.s ind e p e n d e n c e this is a special for! of dis cl ai m e r . Altern a ti v e proc e d u r e s An auditor is often able to o"erco ! e a scope li!itation by perfor!ing a different type of audit test. In this cas e1 it is not neces s a r y to qualify the opinion. 8he auditor do e s not de s cri b e the nature of the altern a ti" e proced ur e s in the report. Practic e #ultipl e Choic e In &hich situations of the follo&ing &ould an auditor 2%

ordinarily choos e bet& e e n e'pres sing an 3e'cept for3 qualified opinion or an ad"ers e opinion: 1. 8he auditor did not obser" e the entity0s physical in"entory and is unable to beco ! e satisfied as to its balanc e by other auditing proced ur e s . 8he financial stat e ! e n t s failed to disclos e infor!a tion that is required by gen er ally accept e d accounting principles. 8he auditor is as.ed to report only on the entity0s balanc e she et and not on the other basic financial state ! e n t s . +"ents disclos ed in the financial stat e ! e n t s caus e the auditor to ha"e subst a n tial doubt about the entity0s ability to continue as a going concern.

2.

3.

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/. #at erialit y - Discuss e d in great e r detail in Chapt er ; A !issta t e ! e n t in the financial stat e ! e n t s can be consider e d !at erial if .no&ledg e of the !isst at e ! e n t &ould affect the decision of a reaso n a bl e user of the stat e ! e n t s 2 so m e help 8 4. 9ule of thu !b 2error is !at erial if e'ce e d s a perce nt a g e of so m e 2(

bas e - usually 3- *J of net inco!e for public co!p a ni e s1 perha p s (1<J of net inco!e for pri"at e co!p a ni e s4. Aateriality decisions neces s a rily in"ol"e a large degre e of )udg! e n t1 including !ualit a ti v e fact or s 1 such as the sensiti"ity of the account affect e d1 or &heth er the chang e affects a trend or .ey ratio. 9er' s h ir e 5ath a a y 2*is c u s s i o n 3 Cas e

;.

:ordin $ of Rep ort s It is i!port a n t to .no& report &ording1 and recogniFe the .ey &ords that identify the type of opinion. It is also i!port a n t to .no& &here an adde d paragr a p h is placed.

A. 6ocatio n ()plan a t o r y paragr a p h #ther than nqualified 9eports +'plana tory Paragr a p h
K Ad"ers e and Disclai!er Cualified

of

9ef or e opinion paragr a p h After opinion paragr a p h

opinion1

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Chap t e r 3 *isc u s s i o n Cas e ? $er.shire Hatha& a y 5om e o r ' Probl e m s

9eport Proble ! 2p. 2( ? colle c t e d 4 3- 2/2c4 3- 3< 2c4 Sam pl e #ultipl e Choic e 8e't 3- 2% 2a41 2b41 2c4 3- 2( 2a41 2b41 2c4 #ther 1. 6reen1 CPA1 &as enga g e d to audit the financial stat e ! e n t s of +sse' Co. after its fiscal year had ende d. 8he ti!ing of 6reen0 s appoint ! e n t as auditor and the start of field &or. !ad e confir!a tion of accounts recei"a ble by direct co!! u nic a tion &ith debtors ineffecti"e. Ho&e"er1 6reen applied other proced ur e s and &as satisfied as to the reaso n a bl e n e s s of the account balanc e s. 6reen0 s auditor0s report !ost li.ely contain e d a2an4G a/ 4n!u alifi e d opinio n / b. nqualified opinion &ith e'plan a t or y 2,

paragr a p h. c. Cualified opinion due to a scope li!itation. d. Cualified opinion due to a dep art ur e fro! gen er ally accept e d auditing stand ar d s . Scope li!itation proced ur e s . &as o"erco ! e by altern a ti" e

2/

Probl e m 3- 1; a/ Conditi o n 1. Scope restriction b/ #at eri alit y Highly !at erial c/ &pinio n Disclai!er

Com m e n t Disclai!er beca us eG 14 client i!pos e d 24 in"entory usually highly !at erial Eac. of indep e n d e n c e by audit staff. Aateriality is not a factor. Chang e in financing is disclos ed and is not a chang e in principle.

2.

Eac. of indep e n d e n c e 7one

7ot applicable

Disclai!er

3.

7ot applicable Aaterial

nqualified

6oing concern

nqualified &ith e!ph a sis- of!att e r e'plan a t or y paragr a p h nqualified Specialist@s report pro"ided sufficient e"idenc e. Disclosure is required 2inade q u a t e disclosur e is lac. of 6AAP4. Depen d e n t upon the circu!s t a n c e s 1 ite! !ay require ad)ust ! e n t .

(.

7one

7ot applicable Aaterial 2or highly !at erial4

*.

Eac. of 6AAP

Cualified 2Ad"ers e if highly !at erial4

2;

Probl e m 3- 3<

a/ Conditi o n 1. 6AAP departur e

b/ #at erialit y Aaterial or Highly !at erial

c/ &pinio n Cualified opinion only or Ad"ers e nqualified stand ar d Cualified Scope L #pinion or Disclai!er nqualified on $alance Sheet

()plan a ti o n Eac. of disclosure is not 6AAP 2assu ! e s client un&illing to disclos e4 I!proper re"enu e recognition1 but i!!at e rial $eginning in"entory is proba bly highly !at erial1 so cannot issue opinion on IBS1 Cash >lo&s. Can issue opinion on $BS.

2.

6AAP departur e Scope restriction

I!!at e rial

3.

Aaterial or Highly !at erial

%.

Scope restriction

Aaterial or Highly !at erial

Cualified Scope L #pinion or Disclai!er

Ainutes are "ery i!porta n t1 and !at eriality of poten tial ite!s is un.no&n1 so disclai!er !ore li.ely. 7ot really a scope li!itation since satisfied &ith altern a ti" e proced ur e s . 9eplace ! e n t cost not 6AAP Chang e in life is not a chang e in principle1 and it is adeq u a t ely disclos ed.

(.

Scope restriction

7BA

nqualified stand ar d &ording

*. ,.

6AAP departur e 7one

Aaterial 7BA

Cualified opinion only nqualified stand ar d

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ACC4= >? = 1 > Rep ort Probl e m 0am e :@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@ >or each of the follo&ing situa tio n s 1 indicat e the opinion you &ould choos e. Assu! e ther e are no reportin g issu e s oth er tha n thos e indicat e d . &pinio n 1. nqu alified stan d a r d &ording 2. nqu alified &ith e'pla n a t o r y par a g r a p h 3. nqu alified !odified &ording %. Cualified opinion only (. Cualified scop e and opinion *. Ad"ers e opinion ,. Disclai! e r of opinion /. #ther 2e'plain4

&pinio n 1.

Situ a ti o n 8he co!pany is in the airline leasing business. During the year1 they e'tended the useful li"es of their planes fro! 12 to 1( years1 &hich had a !aterial effect on depreciation e'pense. 8he auditor agrees &ith the change in useful li"es1 &hich is adequately disclosed. A principal auditor is un&illing to ta.e full responsibility for the &or. of another CPA &ho audited a &holly-o&ned subsidiary of the entity and issued an unqualified opinion. 8he total assets and re"enues of the subsidiary represent 12J and 1%J1 respecti"ely1 of the total assets and re"enues of the entity being audited. Mou &ere engaged by the client to perfor! the audit after year-end. As a result1 you &ere unable to obser"e the ending balance in in"entory1 &hich is highly !aterial1 and &ere unable to satisfy yourself as to the balance of in"entory by the use of alternati"e procedures. During the year1 your client changed fro! the straight-line to an accelerated !ethod of depreciation1 &hich had a significant effect on depreciation e'pense. Mou do not agree &ith the change1 &hich is adequately disclosed. 8he entity issues financial state!ents that present financial position and results of operations1 but o!its the state!ent of cash flo&s. I!!ediately after year-end1 your client recei"ed notice of a 1(J increase in the cost of in"entories. Accordingly1 the client recorded an increase in the "alue of its in"entory to recogniFe its "alue at replace!ent cost.

2.

3.

%.

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