MODERN AUDITING

7th Edition
William C. Boynton
California Polytechnic State
University at San Luis Obispo
Raymond N. Johnson
Portland State University
Walter G. Kell
University of Michigan
Developed by:
Dr. Raymond N. Johnson, CPA
Gregory K. Lowry, MBA, CPA
John Wiley & Sons, Inc.
 CHAPTER 2
FINANCIAL STATEMENT AUDITS AND
AUDITORS’ RESPONSIBILITIES
 Fundamentals Underlying Financial
Statement Audits
 Independent Auditor Relationships
 Auditing Standards
 Assurance Provided by an Audit
 The Auditor’s Report
 Trends Affecting Auditor Responsibilities
Relationship Between
Accounting and Auditing
Figure 2-1
 Need for Financial
Statement Audits
1. Conflict of Interest
• Management and Board of Directors
• Shareholders and Creditors
2. Consequence
3. Complexity
4. Remoteness
Economic Benefits of an Audit

1. Access to Capital Markets

2. Lower Cost of Capital
3. Deterrent to Inefficiency and Fraud
4. Control and Operational
Improvements
 Limitations of a
Financial Statement Audit
Following are 2 important economic
limits:
1. Reasonable Cost
2. Reasonable Length of Time
 Limitations of a
Financial Statement Audit
Following are 2 important limitations
associated with the established
accounting framework:
1. Alternative Accounting Principles
2. Accounting Estimates
 Independent Auditor
Relationships
1. Management
– Assumption of management honesty
– Need for professional skepticism
2. Board of Directors and Audit Committee
3. Internal Auditors
– Not a substitute for independent auditor’s work
4. Stockholders (and other users)
 Generally Accepted Auditing Standards
Figure 2-2
General Standards
1. The audit is to be performed by a person or
persons having adequate technical training and
proficiency as an auditor.
2. In all matters relating to the assignment, an
independence in mental attitude is to be
maintained by the auditor or auditors.
3. Due professional care is to be exercised in the
performance of the audit and the preparation of
the report.
 Generally Accepted Auditing Standards
Figure 2-2
Standards of Field Work
1. The work is to be adequately planned, and
assistants, if any, are to be properly supervised.
2. A sufficient understanding of the internal
control structure is to be obtained to plan the
audit and to determine the nature, timing, and
extent of tests to be performed.
3. Sufficient competent evidential matter is to be
obtained through inspection, observation,
inquiries, and confirmations to afford a
reasonable basis for an opinion regarding the
financial statements under audit.
 Generally Accepted Auditing Standards
Figure 2-2
Standards of Reporting
1. The report shall state whether the financial
statements are presented in accordance with
generally accepted accounting principles.
2. 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.
3. Informative disclosures in the financial
statements are to be regarded as reasonably
adequate unless otherwise stated in the report.
 Generally Accepted Auditing Standards
Figure 2-2
Standards of Reporting
4. The report shall either contain an expression of
opinion regarding the financial 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 reasons therefore
should be stated. In all cases where an auditor’s
name is associated with financial 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.
 Assurance Provided
by an Audit
1. Auditor Independence
2. Reasonable Assurance
3. Definition of Fraud
– Fraudulent financial reporting
– Misappropriation of assets
4. Responsibility to Detect Fraud
– Assess risk of fraud
– Design plan to provide reasonable assurance that
fraud does not exist that is material to the financial
statements based on risk assessment.
– Use due professional care in implementing audit plan
 Assurance Provided
by an Audit
5. Responsibility to Report Fraud
– Employee fraud
– Management fraud
– Confidential client information
6. Illegal Client Acts
– Direct and material
– Indirect
7. Assurance About a Going Concern
 Auditor’s Standard Report
Basic Elements of Auditor’s Standard Report
Title
Addressee
Introductory Paragraph
Scope
Paragraph
Opinion
Paragraph
Firm’s Signature
Date
 Introductory Paragraph
We have audited the accompanying consolidated balance sheets of
Intel Corporation as of December 25, 1999 and December 26,
1998, and the related consolidated statements of income,
stockholders’ equity and cash flows for each of the three years in
the period ended December 25, 1999. These financial statements
are the responsibility of management. Our responsibility is to
express an opinion on these financial statements based on our
audits.
 Scope Paragraph
We conducted our audits in accordance with auditing standards
generally accepted in the United States. 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 disclosure in the financial
statements. An audit also includes assessing the accounting
principles used and significant accounting 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.
 Opinion Paragraph
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the consolidated
financial position of Intel Corporation at December 25, 1999 and
December 26, 1998, and the consolidated results of operations
and its cash flows for each of the three years in the period ended
December 25, 1999, in conformity with accounting principles
generally accepted in the United States.
Types of Auditors’ Reports
and Circumstances
Figure 2-4
Types of Auditors’ Reports
and Circumstances
Figure 2-4
 Standard Report with
Explanatory Language
• Reason for Opinion
– The financial statements present fairly in all material
respects
– Used with
• Changes in accounting principles
• Material uncertainties
• Going concern matters
• Emphasis of a matter
• Form of Opinion
– 4th paragraph to explain issue and refer to note in the
financial statements
 Qualified Opinion

• Reason for Opinion

– Material departure from GAAP
– Material scope limitation
– Except for the qualification, the financial statements
present fairly.
• Form of Opinion
– 3rd paragraph before the opinion to explain the
exception its impact on the financial statements
– 4th paragraph is opinion paragraph. “In our opinion,
except for ….
 Adverse Opinion

• Reason for Opinion

– Departures from GAAP are so material and so
pervasive to the financial statement that the auditor
concludes that the financial statement do not present
fairly …
• Form of Opinion
– 3rd paragraph before the opinion to explain the
exception its impact on the financial statements
– 4th paragraph is opinion paragraph. “In our opinion,
… the financial statements referred to above do not
present fairly….
 Disclaimer of Opinion

• Reason for Opinion

– The auditor is unable to obtain sufficient evidence to form an
opinion on the financial statements
– Common with client imposed scope restrictions
• Form of Opinion
– Omit 2nd scope paragraph
– 3rd paragraph before the opinion to explain the reason for the
disclaimer of opinion
– 4th paragraph is opinion paragraph. “… the scope of our work
was not sufficient to enable us to express, and we do not
express, an opinion on the financial statements.
Management Responsibility Report
Figure 2-5
 Trends Affecting Auditor
Responsibilities
1. Information Technologies
2. Assurance Services
 CHAPTER 2
FINANCIAL STATEMENT AUDITS AND
AUDITORS’ RESPONSIBILITIES
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