CHAPTER TWO

Generally Accepted Auditing Standards (GAAS) and

types of Audit Reports
 Generally Accepted Auditing Standards (GAAS) and types of Audit Reports

• Activity 2.1.
• What is GAAS?
• What is its purpose?
 Auditing standards
Auditing standards are general guidelines to aid
auditors in fulfilling their professional
responsibilities in the audit of historical FSs.
They include consideration of professional
qualities such as competence & independence,
reporting requirements, and evidence.
GAAS-1947 by AICPA.
They are not sufficiently specific to provide any
meaningful guide to practitioners, but they do
represent a framework upon w/c the AICPA can
provide interpretation.
 Auditing Standards….
Auditor is required to plan, perform, and report the results of
a financial statement audit in accordance with generally
accepted auditing standards (GAAS).
 GAAS is concerned with measuring the quality of the audit and
the objectives to be attained during an audit.
Identify necessary qualifications and characteristics of
auditors and guide the conduct of the audit
Purpose of GAAS is to achieve the following objectives of
an audit examination
– Obtain reasonable assurance about whether financial statements
are free of material misstatement
– Report on the financial statements and communicate in
accordance with auditor’s findings.
 Generally Accepted Auditing Standards (GAAS)
• Three categories of GAAS:
 General standards
 Standards of fieldwork
 Standards of reporting
 GAAS…

Generally Accepted
Auditing Standards

Field Work
General performance of Reporting results
qualifications the audit
and conduct

oWhether statements were

 Adequate & Proper
 Adequate technical planning and
training and supervision
proficiency
 Sufficient understanding
 Independence in of the entity, its
mental attitude environment, and its
 Due professional care internal control
 Sufficient competent
evidence
prepared in accordance with
GAAP
oCircumstances when GAAP
not consistently followed
oAdequacy of informative
disclosures
oExpression of opinion on
financial statements
 i. General Standards
The General Standards affect all phases of the
audit, including client acceptance or retention.
General Standards Stress the important personal
qualities that the auditor should possess.
1. The audit must be performed by a person or
persons having adequate technical training and
proficiency as an auditor.
- Experience and expertise
 General Standards…
2. In all matters relating to the assignment, an independence in
mental attitude is to be maintained by the auditor or auditors.
– Independence in fact vs. independence in appearance

– Financial and managerial relationships

3.Due professional care is to be exercised in the performance

of the audit and the preparation of the report.
 level of performance by reasonable auditor in similar
circumstances
 ii. Standards of Fieldwork
 The Fieldwork Standards - guide the planning,
internal control evaluation, and the evidence gathering
phases of the engagement.
 The Fieldwork Standards Concern evidence accumulation
& other activities during the actual conduct of the audit.
1. The auditor must adequately plan the work and must
properly supervise any assistants.
2. The auditor must obtain a sufficient understanding of the
entity and its environment, including its internal control, to
assess the risk of material misstatement of the financial
statements whether due to error or fraud, and to design the
nature, timing, and extent of further audit procedures.
 Standards of Fieldwork…
Materiality
– Influences decisions of financial statement users
– Considered throughout the audit
Risk assessment
– Understand entity and environment (including internal
control)
– Determine necessary effectiveness of substantive tests

3.The auditor must obtain sufficient appropriate audit

evidence through audit procedures performed to afford a
reasonable basis for an opinion regarding the financial
statements under audit.
 Evidence Considerations
The auditor must "obtain sufficient, appropriate
audit evidence” to support opinion.
– Sufficient Evidence
• Enough to support opinion
• Persuasive enough to convince another
person (judge, jury?)
• Essentially a matter of professional judgment
– Appropriate Evidence
• Competent, valid, relevant, reliable
 Characteristics of Appropriate Evidence
 Relevance
 Testing what you want to test (e.g., direction of testing).
 Evidence Source
 Generally an externally generated piece of evidence more
reliable than an internal (client-generated) piece of evidence.
Evidence Hierarchy
Direct personal knowledge
External evidence
External-internal evidence
Internal Evidence
Verbal and written
 Objective v. Subjective Evidence
 iii. Reporting Standards

The Reporting Standards - guide the reporting phase of the audit

engagement. It require the auditor to prepare a report on the FSs
taken as a whole, including informative disclosures.
1. The report shall state whether the financial statements are
presented in accordance with GAAP.
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.
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.
 Types of Audit Report Opinions
1. Unqualified: The financial statements present fairly the
financial condition and operations of the company in
conformity with U.S. GAAP.
2. Qualified: Except for one (limited) item, the financial
statements present fairly ….
3. Adverse: The financial statements do not present fairly ….
4. Disclaimer: The auditors do not express an opinion….
 Quality Control Standards for CPA Firms
 Quality Control Standards guide the performance of
firm-wide audit and attestation practice
– Independence, integrity, objectivity
– Personnel management
– Acceptance and continuance of clients
– Engagement performance
– Monitoring
 STATEMENTS ON AUDITING STANDARDS
The 10 GAAS are too general to provide
meaningful guidance, so auditors turn to the SASs
issued by the ASB for more specific Guidance.
These statements interpret the 10 GAAS & have the
status of GAAS and are often referred to as auditing
standards or GAAS, even though they are not part
of the 10 GAAS.
GAAS and SASs are regarded as authoritative
literature, & every member who performs audits of
historical financial statements is required to follow
them under the AICPA Code of Professional
Conduct.
 STATEMENTS ON AUDITING STANDARDS….
 The ASB issues new statements when an auditing
problem arises of sufficient importance to warrant an
official interpretation.
 Although GAAS and the SASs are the authoritative
auditing guidelines for members of the profession, they
provide less direction to auditors than might be assumed.
 A limited number of specific audit procedures are
required by the standards, and there are no specific
requirements for auditors’ decisions, such as determining
sample size, selecting sample items from the population
for testing, or evaluating results.
 Many practitioners believe that the standards should
provide more clearly defined guidelines for determining
the extent of evidence to be accumulated.
 STATEMENTS ON AUDITING STANDARDS….
 Such specificity would eliminate some difficult audit
decisions and provide a line of defense for a CPA firm
charged with conducting an inadequate audit.
 However, highly specific requirements could turn auditing
into mechanistic evidence gathering, devoid of
professional judgment.
 From the point of view of both the profession and the
users of auditing services, there is probably greater harm
in defining authoritative guidelines too specifically than
too broadly.
GAAS and the SASs should be looked on by
practitioners as minimum standards of performance
rather than as maximum standards or ideals.
 Audit Reports
Review of Audit Process
1. Obtain an understanding of internal control sufficient
to plan the audit.
2. Determine the planned level of control risk.
3. Design and perform additional tests of controls.
4. Reassess control risk and modify planned substantive
tests.
5. Perform substantive tests and complete the audit.
6. Form an opinion and issue the audit report.
 Preparation of Audit Report
* Prepared under the direction of lead auditor
* Distributed to parties as agreed with client
* Addresses topics in audit plan
* Changes should be agreed upon by all parties
* Report should:
* contain the audit findings and/or a summary of the
findings with references to supporting evidence
* contain additional materials as agreed upon by the
lead auditor and the client
* be reviewed and dated by the lead auditor
 GENERAL AUDIT REPORT REQUIREMENTS/BASIC
AUDIT REPORT STRUCTURE
1. Report title…must include the word “independent.”
(Except disclaimers for independence)
2. Audit report address..(BoD, audit committee, SH, management)
3. Introductory paragraph.. States that an audit has been performed; identifies
the financial statements and appropriate dates; states that the financial statements are the
responsibility of the entity’s management & the auditors’ responsibility is to express an opinion..

4. Scope paragraph (except disclaimer). States that auditor followed

GAAS or other standards & indicates that the audit only provides reasonable assurance.

5. Opinion paragraph– Communicates the results of the audit.

6. Name of CPA firm– may be include specific office if a large CPA firm.
7. Audit report date– last day of fieldwork (last day of on-site..
evidence collection). Auditor is held accountable only through this date

If situation warrants, explanatory paragraphs may be included.

 Five Conditions for the Standard Report
All 4 of the basic financial statements are
included.
Three General Standards have been followed.
Sufficient evidence has been accumulated and
three Field Work Standards have been followed.
Financial Statements are in accordance with U.S.
GAAP or UK IFRS.
No circumstances require an explanatory
paragraph or modified wording of the report.
 Types of Opinions
1. Standard unqualified opinion
2. Unqualified opinion with explanatory language

3. Qualified Opinions
4. Adverse Opinion
5. Disclaimer of Opinion
1. Standard Unqualified Opinions
 Used when everything is okay
 Client has followed GAAP
 No scope limitations
 Disclosures are adequate
 Presentation has been consistent
 This is what the client wants
 Conditions Required for Issuance of Standard
Unqualified Audit Report
1. All financial statements are included.
2. The three general standards have been followed in all respects on the
engagement , and there were no significant scope limitations.
3. Sufficient evidence has been accumulated to conclude that the
three standards of field work have been met.
4. The financial statements are presented in accordance with generally
accepted accounting principles, including adequate disclosure.
5. There are no circumstances requiring the addition of an explanatory
paragraph or modification of the wording of the report.
 Examples of The Standard Auditors’ Report
Introductory Paragraph
We have audited the accompanying balance sheet
of XYZ Company as of December 31, 2018, 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.
The above paragraph accomplishes three things:
 Clearly states that an audit was performed.
 States what statements are covered by the opinion.
 Defines each party’s responsibility.
 The Standard Auditors’ Report…
Scope Paragraph
We conducted our audit in accordance with auditing standards
generally accepted in the United States of America. 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 audit
provides a reasonable basis for our opinion.
Paragraph accomplishes three things:
 States what is done in an audit.
Uses words to imply less than absolute assurance. (My underlines are NOT in the
original.)
 Explains the basis of the audit opinion.
 The Standard Auditors’ Report
Opinion Paragraph
In our opinion, the financial statements referred to
above present fairly, in all material respects, the
financial position of XYZ Company as of December
31, 2018, and the results of its operations and its
cash flows for the year then ended in conformity with
accounting principles generally accepted in the
United States of America.

Paragraph accomplishes two things:

 Expresses the auditor’s opinion.
 Introduces the term “present fairly.”
 2. Unqualified – yet Modified!
 Sometimes the financials conform to GAAP,
yet they need special wording
Examples
» Change in GAAP…lack of consistence (eg Fifo to Lifo)
» Going concern.. Customer loss, catastrophes, debts etc
» Emphasis of a matter
» Reports involving other auditors
 First three paragraphs of unqualified opinion remain
the same.
 Fourth paragraph is added to discuss issue
 Exception: Use of another auditor
- All paragraphs are modified, none is added
 3. Qualified Opinions
 Does not mean “Auditor is qualified.”
 Most things are okay
 But Departure from GAAP
» Material enough to mention
» Not material enough to be pervasive
-Material but not “substantially misleading”
 There is Scope limitation
 Introduction and Scope paragraph unchanged
 Third explanatory paragraph added before opinion
 Opinion modified: “except for”
 A qualified opinion report can result from a limitation
on the scope of the audit or failure to follow GAAP.
 4. Adverse Opinion
 Very material departures from GAAP cause financial
statements taken as a whole to be substantially misleading.
 Statements do not conform with GAAP
 F/S should not be relied on for any purpose.
 First two paragraphs (introductory and scope) unchanged
 Third paragraph is explanatory (between the scope& opinion)
 Opinion paragraph is modified.
» Because of…
» do not present fairly
 Not allowed for scope limitation or independence problem
 Adverse opinion is issued very, very rare.
 Example Adverse Opinion

Standard introductory
Standard Scope
Explanatory
In our opinion, because of the effects of the matters
discussed in the preceding paragraph, the financial
statements referred to above do not present fairly, in
conformity with accounting principles generally accepted in
the United States of America, the financial position of XYZ
Company as of December 31, 2018, or the results of its
operations or its cash flows for the year then ended.
 5. Disclaimer of opinion
Used when the auditor is unable to collect sufficient evidence to
support an opinion. Not to be used because the auditor is
unwilling to issue the appropriate opinion. It is not a “chicken
out” opinion. Report includes a modified introductory paragraph.
Scope paragraph is omitted (since an audit was not performed,
at least to a conclusion.)
Explanatory paragraph describes why an opinion could not be
formed.
“Opinion” paragraph states that no opinion was formed.
Disclaimer of opinion issued if:
» Substantial circumstance-imposed scope restrictions.
» Significant client-imposed scope restrictions.
» Significant uncertainties
» Lack of auditor independence
 Disclaimer for Scope Limitation
 Issued for severe Scope limitation
 Different from that issued for Non-independence
 Standard first paragraph
 No scope paragraph
 Explanatory paragraph
 Because..unable to form an opinion, therefore we don’t…
Disclaimer for Non-Independence
 Only one paragraph
 We are not independent
 Accordingly, we do not express an opinion
Materiality audit reporting decisions.
Materiality = magnitude of error or omission that would affect the
decision of an informed person.
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.
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
 Summary on Audit report
Type of Report

Condition Unqualified Qualified Disclaimer Adverse

Limit on audit Highly
scope Material
Immaterial Material
Departure Highly
from GAAP Material
Immaterial Material
Lack of Only
Independence report
=======================

• End of Chapter Two