Audit Reports

Chapter 3
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

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Learning Objective 1

Describe the parts of the standard

unqualified audit report.

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Parts of the Standard

Unqualified Audit Report
1. Report title
2. Audit report address
3. Introductory paragraph
4. Scope paragraph
5. Opinion paragraph
6. Name of CPA firm
7. Audit report date

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Learning Objective 2

Specify the conditions required

to issue the standard unqualified
audit report.

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Conditions for Standard

Unqualified Audit Report
1. All financial statements are included.
2. The three general standards have been
followed in all respects on the engagement.
3. Sufficient evidence has been accumulated
to conclude that the three standards of
field work have been met.
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Conditions for Standard

Unqualified Audit Report
4. The financial statements are presented in
accordance with generally accepted
accounting principles.
5. There are no circumstances requiring the
addition of an explanatory paragraph or
modification of the wording of the report.

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Four Categories of Audit Reports

Standard unqualified

Unqualified with
explanatory paragraph
or modified wording

Qualified

Adverse or disclaimer

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Learning Objective 3
Understand combined reporting
on financial statements and
internal control over financial
reporting under Section 404 of
the Sarbanes-Oxley Act.
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Sarbanes-Oxley Act
This Act requires the auditor of a public
company to attest to managements
report on the effectiveness of internal
control over financial reporting.
PCAOB Auditing standard 2 requires
the audit of internal control to be integrated
with the audit of the financial statements.

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Sarbanes-Oxley Act
Combined Report on Financial Statements and
Internal Control Over Financial Reporting
1. Introductory paragraph
2. Scope paragraph
3. Definition paragraph
4. Inherent limitations paragraph
5. Opinion paragraph

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Learning Objective 4
Describe the five circumstances
when an unqualified report with
an explanatory paragraph or
modified wording is appropriate.

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Unqualified Report with

Explanatory Paragraph
1. Lack of consistent application of generally
accepted accounting principles
2. Substantial doubt about going concern
3. Auditor agrees with a departure from
promulgated accounting principles
4. Emphasis of a matter
5. Reports involving other auditors

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Consistency Versus
Comparability
Changes that affect consistency and require
an explanatory paragraph if they are material:
1. Changes in accounting principles
2. Changes in reporting entities
3. Corrections of errors involving principles

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Consistency Versus
Comparability
Changes that affect comparability but not
consistency:
1. Changes in an estimate
2. Error corrections not involving principles
3. Variations in format and presentation
of financial information
4. Changes because of substantially
different transactions or events
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Consistency Versus
Comparability
The Auditing Standards Board has issued
a proposal to the PCAOB to eliminate
the consistency explanatory paragraph.

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Substantial Doubt About

Going Concern
1. Significant recurring operating losses
or working capital deficiencies
2. Inability of the company to pay its
obligations as they come due
3. Loss of major customers, the occurrence
of uninsured catastrophes
4. Legal proceedings, legislation that might
jeopardize the entitys ability to operate

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Auditor Agrees with a Departure

from a Promulgated Principle
The auditor must be satisfied and must state
and explain, in a separate paragraph or
paragraphs in the audit report, that adhering
to the principle would have produced a
misleading result in that situation.

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Emphasis of a Matter

Under certain circumstances, the CPA may

want to emphasize specific matters regarding
the financial statements, even though the
CPA intends to express an unqualified opinion.

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Reports Involving Other Auditors

1. Make no reference in the audit report.
2. Make reference in the report
(modified wording report).
3. Qualify the opinion.

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Learning Objective 5

Identify the types of audit reports

that can be issued when an
unqualified opinion is not justified.

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Departures from an
Unqualified Opinion
1. Scope limitation

2. GAAP departure

3. Auditor not independent

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Qualified Opinion

A qualified opinion report can result from

a limitation on the scope of the audit or
failure to follow generally accepted
accounting principles.

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Adverse Opinion

It is used only when the auditor believes

that the overall financial statements are
so materially misstated or misleading that
they do not present fairly the financial
position or results of operations and cash
flows in conformity with GAAP.

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Disclaimer of Opinion
It is issued when the auditor is unable
to be satisfied that the overall financial
statements are fairly presented.

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Learning Objective 6

Explain how materiality affects

audit reporting decisions.

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Materiality

A misstatement in the financial statements

can be considered material if knowledge of
the misstatement would affect a decision
of a reasonable user of the statements.

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Levels of Materiality
Amounts are immaterial.
Amounts are material but do not overshadow
the financial statements as a whole.
Amounts are so material or so pervasive that
overall fairness of the statements is in question.

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Relationship of Materiality to
Type of Opinion
Materiality Significance in Terms of
Type of
Level
Reasonable Users Decisions Opinion
Users decisions are unlikely
Immaterial to be affected.

Unqualified

Material

Users decisions are likely

to be affected.

Qualified

Highly
material

Users decisions are likely

to be significantly affected.

Disclaimer
or adverse

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Materiality Decisions
Failure to
follow GAAP
Audit report

Unqualified

Qualified
opinion only

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Adverse

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Materiality Decisions
Dollar amount compared with a base
Measurability
Nature of the item

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Materiality Decisions
Scope
limitation
Audit report

Unqualified

Qualified scope
and opinion

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder

Disclaimer

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Learning Objective 7

Draft appropriately modified

audit reports under a variety
of circumstances.

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Discussion of Conditions
Requiring Departure
Auditors scope has been restricted.
Statements are not in conformity with GAAP.
Auditor is not independent.

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Learning Objective 8

Determine the appropriate audit

report for a given audit situation.

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Auditors Decision Process

Determine whether any condition exists
requiring a departure from a standard
unqualified report.
Decide the materiality for each condition.
Decide the appropriate type of report.
Write the audit report.
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Scope Restricted by Client

or Other Conditions
Level of Materiality
Immaterial

Material

Extremely
Material

Unqualified
report

Qualified scope, additional

paragraph, and qualified
opinion (except for)

Disclaimer
of opinion

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Statements Not Prepared in

Accordance With GAAP
Level of Materiality
Immaterial

Material

Extremely
Material

Unqualified
report

Additional paragraph
and qualified opinion
(except for)

Adverse
opinion

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The Auditor Is Not Independent

Level of Materiality
Immaterial

Material

Extremely
Material

Disclaimer of opinion
(regardless of materiality)

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Number of Paragraphs
in the Report
Type of Report
Standard unqualified
Unqualified with explanatory paragraph
Unqualified shared report with other auditors
Qualified opinion only
Qualified scope and opinion
Disclaimer scope limitation
Adverse
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4
3
4
4
3
4
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Learning Objective 9

Discuss the impact of e-commerce

on audit reporting.

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Impact of E-Commerce on
Audit Reporting
Most public companies provide access to financial
information through their home Web page.
Auditors are not required to read information
contained in electronic sites.
Auditing standards note that electronic sites
are not considered documents.
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End of Chapter 3

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