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CHAPTER 29

PROCEDURES AND REPORTS ON SPECIAL PURPOSE


AUDIT ENGAGEMENTS

I. Review Questions

1. The report simply states: “The financial statements are not intended to be
presented in conformity with generally accepted accounting principles.” The
opinion expression thereafter refers to a description of the comprehensive basis
used.

Non-GAAP accounting bases include:


1. Statutory or regulatory accounting requirements
2. Tax basis accounting
3. Cash and modified cash bases
4. General price level-adjusted statements
5. Any other basis having “substantial support” (Auditing standards do not
explain how non-GAAP accounting can have “substantial support.” In
practice, accountants will report on any reasonable accounting basis, which
explains why reports exist on diverse types of current value financial
statements.)

2. The following are four comprehensive bases of accounting other than GAAP:
1. A basis of accounting to comply with the requirements of a governmental
regulatory agency (for example, insurance companies use a basis of
accounting pursuant to the rules of the insurance commission)
2. A basis of accounting used to file an income tax return
3. The cash receipts and disbursements basis of accounting (cash basis) and
modifications to the cash basis, such as recording depreciation on fixed
assets or accruing income tax.
4. A definite set of criteria having substantial support that is applied to all
material items in the financial statements, such as the price-level basis of
accounting.
29-2 Solutions Manual - Principles of Auditing and Other Assurance
Services
3. A CPA may be asked to report on the application of GAAP by another auditor’s
client who disagrees with the auditor’s view of proper accounting for the
transaction. Auditing standards apply when a CPA in public practice, either in
connection with a proposal to obtain a new client or otherwise, provides oral or
written advice on the application of accounting principles to a specific
transaction or the type of opinion that may be rendered on an entity’s financial
statements. In forming a judgment, the CPA should perform the following
procedures:
• Obtain an understanding of the form and substance of the
transaction(s).
• Review applicable GAAP.
• If appropriate, consult with other professionals or experts.
• If appropriate, perform research or other procedures to ascertain and
consider the existence of creditable precedents or analogies.
• The reporting CPA is required to consult with an entity’s continuing
CPA to ascertain all the relevant facts. The continuing CPA can
provide information about the form and substance of the transaction,
how management has applied accounting principles to similar
transactions, and whether the method of accounting recommended by
the continuing CPA is disputed by management.

4. The following difficulties might arise:

Prior-year statements were unaudited: The auditor should label the prior-year
columns “Unaudited” and modify the report by adding a paragraph that
disclaims an opinion on the statements.

Audited by another auditor:


• Alternative 1: Predecessor auditor reissues report.
• Alternative 2: If predecessor’s report is not presented, the auditor
indicates in the introductory paragraph (1) that the financial statements
of the prior period were audited by another auditor (but does not name
the predecessor auditor), (2) the date of the report, (3) the type of report
issued by the predecessor auditor, and (4) if the report was not a
standard unqualified report, the substantive reasons therefor. When
the predecessor auditor’s report is not presented, the audit report would
have an added sentence at the end of the first paragraph, and the
opinion paragraph would refer only to the current-year statements.
Procedures and Reports on Special Purpose Audit Engagements 29-3
Different reports on comparative statements: An auditor may issue modified
reports on either of the financial statements reported on comparatively. In this
situation, the auditor must exercise care to relate the opinion to the appropriate
year’s financial statements.

II. Multiple Choice Questions

1. b 5. b 9. a 13. d 17. b
2. a 6. a 10. a 14. a 18. c
3. c 7. a 11. d 15. a 19. b
4. a 8. a 12. d 16. a 20. a

III. Comprehensive Cases

Case 1.
To the Board of Directors of Neiny Ltd.:
We have reviewed the accompanying balance sheet of Neiny Ltd. as of
December 31, 2004, and the related statements of income,
retained earnings, and cash flows for the year then ended, in
accordance with standards established by the Auditing Standards
and Practices Council. All information included in these financial
statements is the representation of the management of Neiny Ltd.
A review consists principally of inquiries of company personnel and
analytical procedures applied to financial data. It is substantially
less in scope than an examination in accordance with generally
accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken
as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications
that should be made to the accompanying 2004 financial
statements in order for them to be in conformity with generally
accepted accounting principles.
The financial statements for the year ended December 31, 2003, were
audited by us, and we expressed an unqualified opinion on them in
our report dated February 27, 2004, but we have not performed
any auditing procedures since that date.

Modelle & Co.


March 3, 2006

Case 2. a. The assertions that are incorrect and should otherwise be deleted are the
following:
29-4 Solutions Manual - Principles of Auditing and Other Assurance
Services
1. Report should be addressed to Ms. Clean Corporation’s Board of
Directors.
2. Delete the entire paragraph describing the scope except for the
reference to cash in banks and accounts receivable.
3. Delete the opinion rendered on cash in banks and accounts receivable.
4. Delete the recommendation to acquire Ajacks.
b. The assertions that are missing and should be inserted are the following:
1. Date of the report.
2. Statement limiting the distribution of the report to Ms. Clean’s
management.
3. Description of the procedures performed.
4. Statement that the agreed-upon procedures applied are not adequate to
constitute a GAAS audit.
5. Description of the accountant’s findings.
6. Disclaimer of an opinion concerning cash in banks and accounts
receivable.
7. Statement limiting the report only to cash in banks and accounts
receivable and indicating that the report does not extend to the
financials taken as a whole.

Case 3.
Independent Auditor’s Report
[Addressee]

We have audited the statement of assets, liabilities, and capital


(income tax [cash] basis) of Vanda & Corona, a partnership, as of
December 31, 2004, and the related statements of revenue and
expenses (income tax [cash] basis) and statement of changes in
partners’ capital accounts (income tax [cash] basis) for the year
then ended. These financial statements are the responsibility of
the company’s management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted


auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
Procedures and Reports on Special Purpose Audit Engagements 29-5
As described in Note X, the partnership’s policy is to prepare its
financial statements on the accounting basis used for income tax
purposes; consequently, certain revenue and related assets are
recognized when received rather than when earned, and certain
expenses are recognized when paid rather than when the
obligation is incurred. Accordingly, the accompanying financial
statements are not intended to present financial position and
results of operations in conformity with generally accepted
accounting principles.

In addition, the company is involved in continuing litigation relating to


patent infringement. The amount of damages resulting from this
litigation, if any, cannot be determined at this time.

In our opinion, the financial statements referred to above present fairly


the assets, liabilities, and capital of the Vanda & Corona
partnership as of December 31, 2004, and its revenue and
expenses and changes in its partners’ capital accounts for the year
then ended, on the income tax (cash) basis of accounting as
described in Note X, which basis has been applied in a manner
consistent with that of the preceding year.

[Sterling & Co.]


[Date]