CHAPTER SIX

AUDITORS’ REPORTS
6.1 INTRODUCTION

The audit report is usually the only channel of communication between the shareholders of the
company whose financial statements have been subject to audit and the auditors. As such the
report acts as a bridge taking the large volume of information possessed by auditors and
conveying it to the shareholders in a much abbreviated form.

In order to convey information in a succinct (brief) form the audit report has become an
extremely formalized group of phrases, each of which has special significance.
Types of Audit Reports

Four Types/Categories of Audit Reports

1. Standard unqualified audit report

2. Unqualified with explanatory paragraph or modified wording

3. Qualified opinion

4. Adverse or disclaimer opinion

Standards of reporting

• GAAS includes four generally accepted reporting standards related to:

– GAAP

– consistency;

– Adequate disclosure;

– Expressing an opinion;

FIRST STANDARD OF REPORTING

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 • First standard of reporting states that:

• The report shall state whether the financial statements are presented in accordance with
Generally Accepted Accounting Principles (GAAP).

The meaning of the standard:

The accounting principle selected and applied have general acceptance;

The accounting principles are appropriate in the circumstances;

The f/statements, including the related notes, are informative of matters that may affect their use,
understanding, and interpretation;

SECOND STANDARD OF REPORTING

• Second standard of reporting states that:

• The report shall identify those circumstances in which such principles have not been
consistently observed in the current period in relation to the preceding period.

• Note: unless the report contains a specific language to the contrary, the reader can
conclude that accounting principles have been consistently applied.

 The objectives of this standard are :

• To give assurance that comparability of f/statements b/n accounting periods have not
been materially affected by change in accounting principles; and

• To require appropriate reporting by the auditor when comparability has been materially
affected by such changes.

THIRD STANDARD OF REPORTING

 Third standard of reporting states that:

• Informative disclosures in the f/statements are to be regarded as reasonably adequate

unless otherwise stated in the report.

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 • In the absence of explicit wording in the auditor’s report to the contrary, the reader can
conclude that the disclosure reporting standard has been met.

• The meaning of the phrase “presented fairly in conformity with GAAP” extends to the
adequate disclosures

FOURTH STANDARD OF REPORTING

It states that:

• The report shall either contains an expression of opinion regarding the f/statements taken
as a whole, or an assertion to the effect that an opinion cannot be expressed.

• When an overall opinion cannot be expressed, the reason therefore should be stated.

• In all cases where the auditor’s name is associated with the f/statements, the report
should contain a clear – cut indication of the character of the auditor’s work, if any, and
the degree of responsibility the auditor is taking.

2.4.1.Parts of the Standard Unqualified Audit Report/A Clean Opinion

The auditor’s standard unqualified audit report contains seven distinct parts

1. Report title. Auditing standards require that the report be titled and that the title include
the word independent.

For example, appropriate titles include “independent auditor’s report,” “report of independent
auditor,” or “independent accountant’s opinion.

2. Audit Report Address-to company, Shareholder’s or Board Of Directors

3. Introductory paragraph – contains 3 things:

-Specifies the financial statements to which the report relates,

-Specifies the respective responsibilities of directors and auditors, and;

-It makes the simple statement that the auditor has done an audit.

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4. Scope paragraph- is a factual statement about what the auditor did in the audit.

GAAP/GAAS, Also in this paragraph states that the audit is designed to obtain reasonable
assurance that whether financial information free from material misstatement, the evidence
accumulated written in this paragraph.

5. Opinion paragraph- states auditor’s conclusion based on the result of the audit.

It is an opinion rather than a statement of absolute fact or a guarantee, it is professional

judgment, state F/S is prepared according to GAAP

6. Name of CPA firm- legal & professional responsibility /signature

7. Audit report date: The appropriate date for the report is the one on which the auditor
completed the auditing procedures in the field. Specimen for Unqualified.doc

Independent Auditor's Report Report Title

To the board of directors and shareholders Audit Report Address

ABC Company

Oak land

Introductory paragraph(Factual statement)

We have audited the accompanying balance sheet of X Company as of December 31,

20XX, and the related statements of income, retained earnings, and cash flows 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 audit.

Scope Paragraph (Factual statement)

We conducted our audit 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

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management, as well as evaluating the overall financial statement presentation. We believe that
our audit provides a reasonable basis for our opinion.

 Opinion Paragraph(conclusion)

In our opinion, the financial statements referred to above, present fairly, in all material
respects, the financial position of X Company as of [at] December 31, 20XX, and the results of
its operations and its cash flows for the year then ended in conformity with generally accepted
accounting principles.

Anderson & Zinder P.C CPAs [Signature] Name & signature of CPA firm

[Date] March 10/2011 Audit report date

CONDITIONS FOR STANDARD UNQUALFIED AUDIT REPORT

The standard unqualified audit report is issued when the following conditions have been met:

1. All statements — balance sheet, income statement, statement of retained earnings, and
statement of cash flows—are included in the financial statements.

2. The three general standards have been followed in all respects on the engagement.

3.Sufficient appropriate evidence has been accumulated, and the auditor has conducted the
engagement/commitment in a manner that enables him or her to conclude that the three standards
of field work have been met.

4.The financial statements are presented in accordance with GAAP.

5. If there are no circumstances requiring the addition of an explanatory paragraph or

modification of the wording of the report.

2.4.2.UNQUALIFIED AUDIT REPORT WITH EXPLANATORY PARAGRAPH OR

MODIFIED WORDING:

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Describe the 5 circumstances when an unqualified report with an explanatory paragraph or
modified wording is appropriate.

A complete audit took place with satisfactory results and financial statements that are
fairly presented but the auditor believes that it is important or is required to provide
additional information.
In a qualified, adverse, or disclaimer report, the auditor either has not performed a
satisfactory audit, is not satisfied that the financial statements are fairly presented, or is
not independent

Causes of such Audit Reports are:

1. Lack of consistent application of GAAP

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

The first four reports all require an explanatory paragraph.

In each case, the 3 standard report paragraph are included without modification, and a separate
explanatory paragraph follows the opinion paragraph.

Only reports involving the use of other auditor use a modified wording report. This report
contains three paragraphs and all three paragraphs are modified.

1. Lack of Consistent Application of GAAP

Audit report requires the auditor to call attention to circumstances in which accounting principles
have not been consistently observed in the current period in relation to the preceding period.

GAAP require that changes in accounting principles or their method of application be to a

preferable principle and that the nature and impact of the change be adequately disclosed
(Consistency and comparability)

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 2. Substantial Doubt About Going Concern
• Significant recurring operating losses or working capital deficiencies.
• Inability of the company to pay its obligations as they come due.
• Loss of major customers, the occurrence of uninsured catastrophes.
• Legal proceedings, legislation that might jeopardize/expose or put at risk the entity’s
ability to operate.
• The auditor’s concern in such situation is the possibility that the client may not be able to
continue its operation or meet its obligations for reasonable period.

3. Auditor Agrees with a Departure from a Promulgated Principle

Rule 203: states that in unusual situations, a departure from a GAAP may not require a qualified
or adverse opinion.

However, to justify an unqualified opinion, the auditor must be satisfied and must state &
explain, in a separate paragraph or paragraphs in the audit report, that adhering/following to the
principle would produce a misleading result in that situation

4. 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.

• E.g.The existence of significant related party transaction

• Important events occurring subsequent to the balance sheet date, etc.
• Material uncertainties disclosed in the footnotes

5. Reports Involving Other Auditors

When the CPA relies on a different CPA firm to perform part of the audit, which is common
when the client has several widespread branches or subdivisions, the principal CPA firm has
three alternatives.

Only the second is an unqualified report with modified wording.

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When part of the audit is carried out by another CPA firm, the principal CPA firm has two
options:

A. MAKE NO REFERENCE IN THE AUDIT REPORT.

When:

Immaterial portion, well known or closely supervised, or thoroughly reviewed the other
auditor’s work.

The other auditor is still responsible for his own report & work in the event of lawsuit or SEC
action.

Making no reference to other auditor’s work:

The principal auditor assumes full responsibility;

This is true when the other auditor is well known;
When the principal hired the other auditor;
The principal auditor has visited and reviewed the work of the other auditor;
No need of explanatory paragraph/wording.

B) MAKING REFERENCE TO OTHER AUDITOR(modified wording report)

It is called shared opinion or report.

A shared unqualified report is appropriate when it is impractical to review the work of the other
auditor or when the portion of FSs audited by other CPA is material in relation to the whole.

• Make reference to the other auditor:

– Shared responsibility opinion is issued;

– Usually issued when the other auditors were engaged by the client, rather than the
principal;

– The auditors’ additional wording is not qualification, rather indication of shared

responsibility;

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 – it is illustrated below:

Independent Auditor's Report

We have audited the consolidated balance sheets of ABC Company and subsidiaries as of
December 31, 20X2 and 20X1, and the related consolidated statements of income, retained
earnings, and cash flows for the years 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 did not audit the financial statements of B
Company, a wholly-owned subsidiary, which statements reflect total assets of $_______ and
$________ as of December 31, 20X2 and 20X1, respectively, and total revenues of $_______
and $_______ for the years then ended. Those statements were audited by other auditors whose
report has been furnished to us, and our opinion, insofar as it relates to the amounts included for
B Company, is based solely on the report of the other auditors.

We conducted our audits in accordance with auditing standards generally accepted. 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 and the report of other auditors provide a reasonable basis for our opinion.

In our opinion, based on our audits and the report of other auditors, the consolidated
financial statements referred to above, present fairly, in all material respects, the financial
position of ABC Company and subsidiaries as of December 31, 20X2 and 20X1, and the results
of their operations and their cash flows for the years then ended in conformity with generally
accepted accounting principles.

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 4.2.3. DEPARTURES FROM AN UNQUALIFIED AUDIT REPORT

 Identify the types of audit reports that can be issued when an unqualified opinion is not
justified.

Departures from An Unqualified Opinion:

1. Scope limitation

2. GAAP departure

3. Auditor not independent

1. The Scope of the Audit Has Been Restricted (Scope Limitation): When the auditor has not
accumulated sufficient appropriate evidence to conclude whether financial statements are stated
in accordance with GAAP, a scope restriction exists.

Scope limitations

 Arise when the auditors are unable to perform essential audit procedures.

 The limitations can be imposed by circumstances surrounding:

– the audit (e.g. the auditors were engaged too late in the year to observe the client’s
beginning inventory); or

– the client (e.g., the client refuses to allow the auditors to send confirmations to
customers.

Level of materiality determines whether to issue qualified or disclaimer of opinion.

Introductory paragraph is unaffected, but there is modification on the scope and opinion
paragraph.

Explanatory paragraph is added b/n the scope and opinion paragraph.

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 • Except as discussed in the following paragraph, we conducted our audit in accordance
with GAAS. Those standards require that we plan and perform the audit to obtain
reasonable assurance whether the f/statements are free of material misstatements. An
audit includes examining, on a test bases, evidence supporting the amounts and disclosure
in the f/statements. An audit also includes assessing the accounting principles used and
significant estimates made by mgt, as well as evaluating the overall f/statement
presentation. We believe that our audit provides a reasonable basis for our opinion.

• We were unable to obtain audited f/statements supporting the company’s investment in a

foreign affiliate stated $------and its equity in earning of that affiliate of $ ------which is
included in net income, as described in Note 8 to the f/ statements; nor were we able to
satisfy ourselves as to the carrying value of the investment in the foreign affiliate or the
equity in earnings by other auditing procedures.

• In our opinion, except for the effects of such adjustments, if any, as might have been
determined to be necessary had we been able to examine evidence regarding the foreign
affiliate investment and earnings, the f/ statements referred to above present fairly, in all
material respects, the financial position of XYZ company as of Dec., 31, 20xx, and the
result of its operations and its cash flows for the year then ended in conformity with
GAAP.

2. The Financial Statements Have Not Been Prepared in Accordance with GAAP (GAAP
Departure)

E.g. if the client insists on using replacement costs for fixed assets or values inventory at selling
price rather than historical cost as required by GAAP, a departure from the unqualified report is
required.

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 • Sony corporation has not presented segment information for each of the three years in the
period ended march 3, 1992. The presentation of segment information concerning
operations in different industries, and foreign operations and export sales is required by
generally accepted accounting principles for a complete presentation of the consolidated
f/statements.

• In our opinion, except for the omission of the segment information as discussed in the
third paragraph of this report, the f/statements audited by us presents fairly, in all material
respects, the financial position of sonny corporation and its consolidated subsidiary at
March 31, 1991 and 1992, and the results of its operations and their cash flows for each
of the three years in the period ended march 31, 1992, in conformity with generally
accepted accounting principle.

3. The Auditor Is Not Independent

Independence ordinarily is determined by Rule 101 of the rules of the Code of Professional
Conduct.

Three main types of audit reports are issued under these conditions:

1. Qualified Opinion

2. Adverse Opinion

3. Disclaimer of Opinion.

All significant reasons for the issuance of a qualified, adverse, or denial of opinion should be set
forth in a reservation paragraph between the scope and opinion paragraph.

Auditors must qualify their report whenever there are material deficiencies in the client’s
financial statements.

1. Qualified Opinion

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. A qualified opinion report can result from a limitation on the scope of the audit or failure to
follow generally accepted accounting principles

2. Adverse Opinion

It is issued 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.

3. Disclaimer of Opinion

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

• Disclaimer of opinion states that the auditor does not express an opinion on the financial
statements.

• It is with no – opinion.

• Issued when there is substantial scope limitations.

• Issued in rare cases.

• Scope paragraph is omitted and replaced by explanatory paragraph.

We were engaged to audit the accompanying b/sheet of XYZ Co. as of Dec., 31, 20x2 and the
related statements of income, retained earnings, and cash flows for the year then ended. These
f/statements are the responsibility of the company’s mgt.

The Co. did not make a count of its physical inventory, stated in the accompanying f/statement at
$----- as of Dec., 31, 20x2. Further, evidence supporting the cost of property and equipment
acquired prior to Dec., 31, 20x1, is no longer available. The Company’s records do not permit
the application of other auditing procedures to inventories or property and equipment.

Since the Co. did not take physical inventories and we were not able to apply other auditing
procedures to satisfy ourselves as to inventory quantities and the cost of property and equipment,

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the scope of our work was not sufficient to enable us to express, and we do not express, an
opinion on these f/statements.

Explain how materiality affects audit reporting decisions.

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.

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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Determine the appropriate audit report for a given audit situation.

Auditor’s 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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