3 Audit Report

Auditing and Assurance Services
Seventeenth Edition
Chapter 3
Audit Reports
Copyright © 2020, 2017, 2014 by Pearson Education, Inc. All Rights Reserved
Learning Objectives (1 of 2)
3.1 Describe the parts of the standard unmodified opinion audit
report for nonpublic entities under AI C PA auditing standards
3.2 Specify the conditions required to issue the standard
unmodified opinion audit report
3.3 Understand reporting on financial statements and internal
control under P CAO B auditing standards
3.4 Describe the five circumstances when an emphasis-of-matter
explanatory paragraph or nonstandard wording is appropriate
to include in an unmodified opinion audit report
Learning Objectives (2 of 2)
3.5 Identify the types of audit reports that can be issued when an
unmodified opinion is not justified
3.6 Explain how materiality affects audit reporting decisions
3.7 Draft appropriately modified opinion audit reports under a
variety of circumstances
3.8 Determine the appropriate audit report for a given audit
situation
3.9 Understand the use of international accounting and auditing
standards by U.S. companies
Learning Objective 3.1
Describe the parts of the standard unmodified opinion audit
report for nonpublic entities under AI C PA auditing standards
Parts of Standard Unmodified
Opinion Audit Report
• The auditor’s standard unmodified opinion audit report
contains eight distinct parts:
– Report title
– Auditor report address
– Opinion section
– Basis for opinion
– Management’s responsibility
– Auditor’s responsibility
– Signature and address of CPA firm
– Audit report date
Disclosure of Key Audit Matters
• International auditing standards and PCAOB auditing standards
require communication of “key audit matters” or “critical audit
matters” in the standard unmodified audit report
– The AICPA reporting standards do not require the
communication of key audit matters
• Key audit matters, if disclosed, are included in a section
following the Basis for Opinion section
Specify the conditions required to issue the standard unmodified
opinion audit report
Conditions for Standard Unmodified
Opinion Audit Report
• Standard unmodified opinion audit report is issued when:
– All statements and required disclosures are included in the
financial statements
– Sufficient appropriate evidence has been accumulated
– Financial statements are presented fairly in accordance with
GAAP or other appropriate accounting framework
– No circumstances requiring the addition of an emphasis-of-
matter paragraph or modification of the wording or
auditor’s opinion in the report
Figure 3.2 Categories of Audit
Reports
Let’s Discuss (1 of 6)
• Explain why auditors’ reports are important to users of
financial statements.
• Why is it desirable to have standard wording?
• What four circumstances are required for a standard
unmodified opinion audit report to be issued?
Understand reporting on financial statements and internal control
under PCAOB auditing standards
Standard Unmodified Opinion Audit
Report for Public Companies
• PCAOB refer to the standard unmodified opinion audit
report as an “unqualified opinion” audit report, which
requires:
– The audit firm is registered with the PCAOB standards
and is independent of the company
– A statement indicating that an audit is designed to provide
reasonable assurance
– The disclosure of critical audit matters
– The signature, tenure, and city and state of the audit firm
and the audit report date
Critical Audit Matters
• PCAOB auditing standards define a critical audit matter
as:
• Any matter arising from the audit of the financial statements
that was communicated or required to be communicated to the
audit committee and that
– (1) relates to accounts or disclosures that are material to
the financial statements and
– (2) involved especially challenging, subjective, or complex
auditor judgment
Reports on Internal Control over
Financial Reporting
• PCAOB auditing standards require the audit of internal control
to be integrated with the audit of the financial statements
• Auditor may choose to issue separate reports or a combined
report
– The combined report addresses both the financial
statements and management’s report on internal control
over financial reporting
Describe the five circumstances when an emphasis-of-matter
explanatory paragraph or nonstandard wording is appropriate to
include in an unmodified opinion audit report
Emphasis-of-Matter Explanatory
Paragraph/Nonstandard Report
Wording (1 of 2)
• The unmodified opinion audit report with emphasis-of-
matter paragraph or nonstandard report wording:
– Meets the criteria of a complete audit with satisfactory
results and financial statements that are fairly presented
– But the auditor believes it is important to draw the reader’s
attention to certain matters or the auditor is required to
provide additional information
Emphasis-of-Matter Explanatory
Paragraph/Nonstandard Report
Wording (2 of 2)
• The most important causes of the addition of an emphasis-
of-matter paragraph/nonstandard report wording:
– Lack of consistent application of GAAP
– Auditor agrees with a departure from promulgated
accounting principles
– Substantial doubt about going concern
– Emphasis of other matters
– Reports involving other auditors
Emphasis of Other Matters
• Auditor may want to emphasize specific matters regarding
the financial statements under certain circumstances:
– Material related party transactions
– Subsequent events
– Comparability of the financial statements
– Material uncertainties disclosed in the footnotes
– A major catastrophe that has had or continues to have a
significant effect on the entity’s financial position
Figure 3.5 Explanatory Paragraph Because of
Change in Accounting Principle
Figure 3.6 Explanatory Paragraph Because of
Substantial Doubt About Going Concern
Figure 3.7 Unmodified Opinion Shared
Report—AICPA Auditing Standards
• What are the eight parts of a standard unmodified opinion audit
report for a nonpublic entity and what is the main content
provided in each part?
• What are the most significant differences between the AICPA
and the PCAOB standard unmodified opinion audit reports?
• When should the auditor include an explanatory paragraph in
an unmodified opinion audit report?
• Describe the information included in the opinion and basis for
opinion sections in a separate audit report on the effectiveness
of internal control over financial reporting.
– What is the nature of the additional paragraphs in the audit
report?
• Describe what is meant by reports involving the use of other
auditors.
– What are the three options available to the primary auditor
responsible for the opinion, and when should each be
used?
• Identify the types of audit reports that can be issued when an
unmodified opinion is not justified
Modifications to the Opinion in the
Audit Report (1 of 2)
• Three conditions requiring a modification to the opinion:
– The scope of the audit has been restricted (scope
limitation)
– The financial statements have not been prepared in
accordance with GAAP (GAAP Departure)
– The auditor is not independent
Modifications to the Opinion in the
Audit Report (2 of 2)
• When any of the three conditions requiring a departure from an
unmodified opinion exists and is material, the opinion in the
audit report must be modified
• Three main types of audit reports are issued under these
conditions:
– Qualified opinion
– Adverse opinion
– Disclaimer of opinion
Explain how materiality affects audit reporting decisions
Materiality (1 of 3)
• Materiality is an essential consideration in determining the
appropriate type of report for a given set of circumstances
• The common definition of materiality is as follows:
– A misstatement in the financial statements can be
considered material if knowledge of the misstatement will
affect a decision of a reasonable user of the statements
• Three levels of materiality are used for determining the
type of opinion to issue:
– 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
• In application, deciding on actual materiality in a given
situation is a difficult judgment
• The evaluation of materiality also depends on the
following:
– Materiality decisions—non-GAAP condition
– Dollar amounts compared with a benchmark
– Measurability
– Nature of the item
– Materiality decisions—scope limitations condition
Table 3.1 Relationship of Materiality
to Type of Opinion (1 of 2)
Materiality Significance in Terms of Type of Opinion
Reasonable Users’ Decisions
Immaterial Users’ decisions are unlikely to be Unmodified
affected.
Material Users’ decisions are likely to be Qualified
affected only if the information in
question is important to the specific
decisions being made. The effect of
the misstatement(s) is not pervasive
to the financial statements and the
overall financial statements are
presented fairly.
Table 3.1 Relationship of Materiality
to Type of Opinion (2 of 2)
Materiality Significance in Terms of Type of Opinion
Reasonable Users’ Decisions
Highly Most or all Users’ decisions based on Disclaimer or Adverse
material the financial statements are likely to
be significantly affected. The effect of
the misstatement(s) is pervasive to
the financial statements.
Note: Lack of independence requires a disclaimer regardless of materiality.
• Distinguish between a qualified opinion, an adverse opinion,
and a disclaimer of opinion, and explain the circumstances
under which each is appropriate.
• Define materiality as it is used in audit reporting.
– What conditions will affect the auditor’s determination of
materiality?
Draft appropriately modified opinion audit reports under a
variety of circumstances
Conditions Requiring a Modification
of Opinion (1 of 2)
• Auditor’s scope has been restricted
– Qualified or disclaimer of opinion, depending on
materiality
• Statements are not in conformity with GAAP
– Qualified or an adverse opinion, depending on the
materiality of the item in question
Conditions Requiring a Modification
of Opinion (2 of 2)
• Justified departure from GAAP
– Unmodified opinion except for the reference to the added
explanatory paragraph
• Auditor is not independent
– Disclaimer of opinion
– Overrides any other scope limitations
Figure 3.8 Qualified Report Due to Scope
Restriction—AICPA Auditing Standards
Figure 3.9 Disclaimer of Opinion Due to
Scope Restriction—AICPA Auditing
Standards
Figure 3.10 Qualified Opinion Report Due to
Non-GAAP—AICPA Auditing Standards
Figure 3.11 Adverse Opinion Report Due to
Non-GAAP—AICPA Auditing Standards
Determine the appropriate audit report for a given audit situation
Auditor’s Decision Process for Audit
Reports
• Auditors use a well-defined process for deciding the
appropriate audit report in a given set of circumstances:
– Determine whether any condition exists requiring a
departure from a standard unmodified opinion report
– Decide the materiality for each condition
– Decide the appropriate type of report for the condition,
given the materiality level
– Inclusion of key audit matters or critical audit matters
Table 3.2 Audit Report for Each Condition Requiring
a Departure from a Standard Unmodified Opinion
Report at Different Level of Materiality
* If the auditor does not concur with the appropriateness of the change, the condition is considered a violation of GAAP.
† The auditor has the option of issuing a disclaimer of opinion.
‡ If the auditor can demonstrate that GAAP would be misleading, an unmodified opinion audit report with an explanatory
paragraph is appropriate.
More than One Condition Requiring
a Departure or Modification
• Auditors may encounter situations involving more than one
of the conditions requiring a departure from an unmodified
opinion audit report or revisions to the standard report
wording:
– In these circumstances, the auditor should modify his or
her opinion for each condition unless one has the effect of
neutralizing the others
• What are the three conditions that require a departure from an
unmodified opinion audit report?
– Give an example of each.
• What are the three alternative opinions that may be appropriate
when the client’s financial statements are not in accordance
with GAAP?
– Under what circumstance is each appropriate?
• How does the auditor’s opinion differ between scope
limitations caused by client restrictions and limitations
resulting from conditions beyond the client’s control? Under
which of these two will the auditor be most likely to issue a
disclaimer of opinion? Explain.
• When an auditor discovers more than one condition that
requires departure from or modification of the standard
unmodified opinion audit report, what should the auditor’s
report include?
Understand the use of international accounting and auditing
standards by U.S. companies
International Accounting and
Auditing Standards (1 of 2)
• U.S. public companies are required to prepare financial
statements that are filed with the SEC in accordance with
GAAP in the United States
• Foreign companies listed on U.S. exchanges are allowed
to report under IFRS
International Accounting and
Auditing Standards (2 of 2)
• An auditor may be engaged to report on financial statements
prepared in accordance with IFRS
• When the auditor reports on financial statements prepared in
conformity with IFRS, the auditor refers to those standards
rather than U.S. GAAP
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