Audit Reports

Chapter 3
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©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3-1

 Learning Objective 1

Describe the parts of the standard

unqualified audit report.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3-2

 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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3-3

 Parts of the Standard
Unqualified Audit Report

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3-4

 Learning Objective 2

Specify the conditions required to issue the

standard unqualified audit report.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3-5

 Conditions for Standard
Unqualified Audit Report

1. Includes all financial statements

2. Three general standards are met

3. Complies with the three standards of field work

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3-6

 Conditions for Standard
Unqualified Audit Report
4. Financial statements comply with GAAP

5. No circumstances require an explanatory

paragraph or report modification

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3-7

 Four Categories of Audit
Reports

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3-8

 Learning Objective 3

Understand reporting on financial

statements and internal control over
financial reporting under Section 404 of
the Sarbanes-Oxley Act.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3-9

 Reporting on Internal Control
over Financial Reporting
Auditors of public companies subject to Section
404 of the Sarbanes-Oxley Act must
report on the effectiveness of internal
control over financial reporting.

PCAOB Auditing Standard 5 requires

the audit of internal control to be integrated
with the audit of the financial statements.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 10

 Reporting on Internal Control
over Financial Reporting

Sarbanes- ICFR
Oxley Accelerated Filer Effectiveness
Sec.404 Audits

Permanent
2010 Non-accelerated
Filer Exemption
Legislation

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 11

 Sarbanes-Oxley Act
Separate 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
6. Cross-Reference Paragraph

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 12

 Separate Report on ICFR

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 13

 Learning Objective 4

Describe the five circumstances when an

unqualified report with an explanatory
paragraph or modified wording is
appropriate.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 14

 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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 15

 Lack of Consistent Application of
GAAP
Auditors must note circumstances in which
accounting principles are not consistently
applied

Auditor should modify the report when a

material change occurs by adding an
explanatory paragraph in the report

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 16

 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 the entity’s ability to operate.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 17

 Auditor Agrees with a Departure
from a Promulgated Principle
Departure may not require a qualified or
adverse opinion

The auditor must separately explain in the

audit report that adhering to the principle
would have produced a misleading result.

Circumstances are most unusual

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 18

 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.

Subsequent Related Party

Events Transactions

Financial
Material
Statement
Uncertainties
Comparability
©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 19
 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

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 20

 Reports Involving Other
Auditors

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 21

 Learning Objective 5

Identify the types of audit reports that can

be issued when an unqualified opinion is
not justified.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 22

 Departures from an
Unqualified Opinion
1. Scope limitation

2. GAAP departure

3. Auditor not independent

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 23

 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.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 24

 Qualified Opinion

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 25

 Adverse Opinion

Auditor believes the financial statements are

not presented fairly in conformity with GAAP.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 26

 Adverse Opinion

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 27

 Disclaimer of Opinion

It is issued when the auditor is unable

to be satisfied that the overall financial
statements are fairly presented.

It can arise only from a lack of

knowledge by the auditor.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 28

 Disclaimer of Opinion

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 29

 Learning Objective 6

Explain how materiality affects audit

reporting decisions.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 30

 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.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 31

 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.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 32

 Materiality Decisions

Failure to
follow GAAP

Audit report

Qualified
Unqualified Adverse
opinion only

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 33

 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

Users’ decisions are likely

Material to be affected. Qualified

Highly Users’ decisions are likely Disclaimer

material to be significantly affected. or adverse
©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 34
 Materiality Decisions

 Dollar amount compared with a base

 Measurability

Nature of the item

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 35

 Materiality Decisions

Scope
limitation

Audit report

Qualified scope
Unqualified Disclaimer
and opinion

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 36

 Learning Objective 7

Draft appropriately modified audit reports

under a variety of circumstances.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 37

 Discussion of Conditions
Requiring Departure

 Auditor’s scope has been restricted

Statements are not in conformity with GAAP

Auditor is not independent

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 38

 Learning Objective 8

Determine the appropriate audit report for a

given audit situation.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 39

 Auditor’s Decision Process

Determine whether any condition exists

requiring a departure from a standard
unqualified report.

Write
Decide Decide appropriate
Audit
type of report
Materiality Report

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 40

 More Than One Condition Requiring
a Departure or Modification

The auditor is not independent.

There is a scope limitation.

Going concern uncertainty exists.

Statements are not prepared in

accordance with GAAP.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 41

 Number of Paragraphs
in the Report
Type of Report

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 42

 Learning Objective 9

Understand proposed use of international

accounting and auditing standards by U.S.
companies.

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 43

 Proposed Use of International
Accounting and Auditing Standards
by U.S. companies
Globalization of world’s capital markets are
leading to calls for a single set of accounting
standards to be used around the world.

2015
SEC Implementation
If plan is approved?
Developing of IFRS
into U.S.
Workplan

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 44

 End of Chapter 3

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 45