Misstated or omitted segment information

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  • 1. ACCT 4376 / 7370 Chapter 18 Reporting: Other Information and Special Reports Major Topics: • The auditor’s responsibility for information presented with the financial statements. • “Special reports” issued on financial statements or portions thereof. • Other types of reports issued in conjunction with an audit. Reporting on Information Presented with the Financial Statements The auditor’s opinion is intended to cover only the basic financial statements and footnotes. • But these statements are typically included in an annual report which includes much more (“other” information). • Annual Report readers may (erroneously) assume that the auditor’s opinion applies to the entire annual report. The auditor is obliged to perform certain procedures to determine the reasonableness of this “other information.” 1
  • 2. Reporting on Info Presented with the Financial Statements The auditor’s responsibility for info. accompanying the financial statements depends on the information. We’ll discuss four categories of information: 1. Other info. presented with the financial statements; 2. Segment information; 3. Supplementary info. required by the FASB or GASB; 4. Info. contained in auditor-submitted documents. Other Info. Presented with the Financial Statements (prepared by the client) This information includes: • financial highlights; • financial analyses made by management; • the President’s letter; • other financial data. The auditor is obliged to: 2
  • 3. • read this information; • determine whether it’s consistent with the audited financial statements. 3
  • 4. Other info presented with the financial statements (prepared by the client)(cont.) If this information is not consistent with the financial statements, the auditor should determine whether the following need to be revised: • the financial statements; • the auditor’s opinion, or • both. If the financial statements are fairly presented, the auditor should request that the other information be revised. If the client refuses to revise the other information, the following actions may be appropriate: • Revise the audit report to include an explanatory paragraph about the inconsistency; • Withhold the use of the audit report; • Withdraw from the engagement. 4
  • 5. Reporting on Info. Presented with the Financial Statements (cont.) Segment Information SFAS No. 14 requires companies to provide certain disclosures related to industry segments. The auditor has full audit responsibility for segment information, which is covered by the auditor’s report. • That is, the auditor must apply procedures and gather evidence to determine that segment info. is fairly stated. The auditor’s responsibility for segment info. is exception-based • The auditor’s report doesn’t refer to segment info. unless he/she notices a problem. Perhaps the two most common such problems: • Segment info. is misstated or omitted; • The auditor encounters a scope limitation in examining segment information. 5
  • 6. Segment Information (cont.) Misstated or omitted segment information If material, these problems require the auditor to modify his/her audit opinion due to a departure from GAAP. Normally a qualified (rather than an adverse) opinion is appropriate, given these problems. • This is due to the magnitude of segment info. in relation to the financial statements taken as a whole. • See example of qualified opinion due to misstatement, pg. 18-4. If segment info. is omitted, the auditor need not present the omitted information in his/her report. • However, the auditor should describe the omitted information. 6
  • 7. Segment Information (cont.) Scope Limitations Scope limitations related to segment information include: • Client refusal to provide the auditor with information needed to determine whether the client needs to present segment information. • Client refusal to allow the auditor to apply the necessary audit procedures to segment information. These restrictions are treated in a manner similar to other scope limitations. • Thus, an explanatory paragraph is added to the auditor’s report, identifying the scope limitation. • In addition, the scope and opinion paragraphs refer to the scope limitation. The magnitude of segment information (in relation to the financial statements taken as a whole) would not usually justify a disclaimer of opinion. • Instead, a qualified opinion would usually be appropriate. • See example on pg. 18-5. 7
  • 8. Reporting on Info Presented with the Financial Statements Supplementary Info. Required by the FASB or GASB; Some of this information is industry-specific, while some applies across industries. This information is specifically excluded from audit requirements (see SAS No. 52) The auditor should nevertheless perform limited procedures regarding this information, including: • Asking management whether the information is prepared, measured and presented according to FASB or GASB guidelines. • Comparing supplementary info. required by the FASB to the financial statements for consistency. • Any other procedures deemed appropriate under the circumstances. 8
  • 9. Required Supplementary Information (cont.) The auditor’s report would normally not refer to the supplementary information (SI) or the limited procedures applied to that information. The auditor’s report should only be expanded if one or more of the following circumstances are present: • The required SI has been omitted. • The measurement or presentation of the SI departs materially from FASB or GASB guidelines. • The auditor has not been able to complete the prescribed procedures regarding the SI. In these cases, an explanatory paragraph would be placed after the opinion paragraph, but would not affect the auditor’s overall opinion of the financial statements. 9
  • 10. Reporting on Info. Presented with the Financial Statements (cont.) Information Contained in Auditor-Submitted Documents Financial information presented along with the financial statements is: • usually prepared by the client. • occasionally prepared by the auditor (for example, to help readers interpret the financial statements). Such information, when prepared by the auditor, is referred to as auditor-submitted documents. In these cases: 1. This information is derived from the basic financial statements, and thus is a representation of the client. 2. The auditor must explicitly indicate the extent of responsibility assumed for all information included in the document. • A disclaimer on all or part of this information is an option. 3. This indication can be done by: • expanding on the audit report, or • reporting on this information separately. 4. The auditor’s opinion on this information will indicate whether it “is fairly stated in all material respects in 10
  • 11. relation to the basic financial statements taken as a whole.” 11
  • 12. Summary: The Auditor’s Responsibility for Information Presented with the Financial Statements Audit Reporting Other Responsibility Responsibility Comments Other Exception- Information Limited based - Segment Full Exception- May affect Information Audit based audit opinion Supplemental Info. Req’d Exception- by FASB Limited based - Other Info. Can vary May disclaim in Auditor- from full an opinion Submitted audit to no on all or part 12
  • 13. documents responsibility Explicit of this info. 13
  • 14. Special Reports Five types of “special reports” are identified in SAS no. 62 (discussed in turn): 1. Financial statements prepared using a comprehensive accounting basis other than GAAP. 2. Specified financial statement elements, accounts, or items. 3. Company compliance with contractual or regulatory requirements. 4. Financial presentations intended to comply with contractual or regulatory requirements. 5. Financial information, or the auditor’s report, presented in a prescribed format. 14
  • 15. Special Reports (cont.) Basis other than GAAP Some firms prepare (or are required to prepare) financial statements prepared using a basis of accounting other than GAAP. Examples of these bases: • A basis required by a governmental regulatory agency (such as the Federal Energy Regulatory Commission, or FERC). • The basis used by firms to file income tax returns. • The cash basis, and slight modifications thereof. • Any other basis having substantial support (e.g., price- level adjusted accounting). 15
  • 16. Sample Auditor’s Report Basis Other than GAAP - Cash Basis _______________________________________________________________________________________________________ ______ Independent Auditor’s Report To: the Board of Directors of ABC Company We have audited the accompanying statement of assets and liabilities arising from cash transactions of ABC Company as of December 31, 19X1, and the related statements of income, retained earnings, and cash flows for the year then ended. These financial statements are the responsibility of ABC Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. [standard scope paragraph] As described in Note 4, the Company’s policy is to prepare its financial statements on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles. In our opinion, the financial statements referred to above present fairly, in all material respects, the assets and liabilities arising from cash transactions of ABC Company as of December 31, 19X1, and the revenue collected and expenses paid during the year then ended on the basis of accounting described in Note 4. Hamilton & Company February 20, 19X2 16
  • 17. Basis other than GAAP (cont.) Similarities between this report and the standard audit report: • the scope paragraph is the same. • the opinion is unqualified. Differences between this report and the standard audit report: • The basis of accounting identified is different. • The names of the financial statements audited are different. • There’s an explanatory paragraph which refers to a footnote which explains the basis of accounting used (see example of footnote, pg. 18-12). If the statements are prepared on an accounting basis required by a regulatory agency, • the auditor should add a paragraph to the audit report which specifies that: • the distribution of the report should be limited to that agency and the client. 17
  • 18. Special Reports (cont.) Reports on Specified Elements, Accounts, or Items (of the Financial Statements) Sometimes auditors are engaged to report only on certain elements, accounts, or items contained in the client’s financial statements. • Example: A client wants to sell its accounts receivable, and wants an audit report which indicates that their receivables are fairly stated. It’s acceptable for the auditor to conduct an audit examination of only certain elements, accounts or items. • If he/she does so, his/her report will only address the elements, accounts, or items examined (see pg. 18-14). If the auditor expresses an opinion on elements, accounts or items in the statements, AND he/she has also issued an adverse opinion or disclaimed an opinion on the same statements taken as a whole, he/she should make sure that: • the elements, accounts, or items reported on do not encompass a major portion of the financial statements. 18
  • 19. • the report on the elements, accounts or items is presented separately from the report on the financial statements of the entity. Why? 19
  • 20. Reports on Specified Elements, Accounts, or Items (cont.) Applying Agreed-Upon Procedures Sometimes, when CPAs are engaged to report on certain elements, accounts, or items of the financial statements, the scope of the engagement is less than a GAAS audit. • Why would that be? Such “agreed-upon procedures engagements” are acceptable only under the following circumstances: • The accountant is independent with respect to the client. • The accountant and specified users agree upon the procedures to be performed. • The specified users take responsibility for the sufficiency of the agreed-upon procedures. • Use of the report is restricted to the specified users. 20
  • 21. Applying Agreed-Upon Procedures (cont.) SAS No. 75 provides guidance to the auditor regarding what are considered acceptable “agreed-upon procedures.” The accountant should not use terms of uncertain meaning such as the following to describe the agreed-upon procedures, unless the terms are defined within the agreement: • general review; • limited review; • reconcile; • check; • test. The accountant’s report in an agreed-upon procedures engagement: • does not express an opinion on the elements, accounts, or items examined. • does not provide “standard levels of assurance.” • does provide a summary of the procedures performed by the accountant, and his or her findings. An example of such a report follows… 21
  • 22. Sample Accountant’s Report Independent Accountant’s Report on Applying Agreed-Upon Procedures We have performed the procedures enumerated below, which were agreed to by Third Bank, solely to assist you with respect to the accounts receivable of Allan Company. This engagement to apply agreed-upon procedures was performed in accordance with standards established by the American Institute of Certified Public Accountants. The sufficiency of the procedures is solely the responsibility of the specified users of the report. Consequently, we make no representation regarding the sufficiency of the procedures described below either for the purpose for which this report has been requested or for any other purpose. We confirmed all accounts receivable over $50,000 directly with customers using the positive request method. These accounts receivable totaled $3.2 million of the $4.0 million accounts receivable outstanding at year-end for Allan Company. The results of these confirmations, as well as follow-up of exceptions to these confirmations, indicated one customers’ account was overstated by $400,000. We were not engaged to, and did not, perform an audit, the objective of which would be the expression of an opinion on the specified elements, accounts or items. Accordingly, we do not express such an opinion. Had we performed additional procedures, other matters might have come to our attention that would have been reported to you. This report is intended solely for the use of the specified users listed above and should not be used by those who have not agreed to the procedures and taken responsibility for the sufficiency of the procedures for their purposes. 22
  • 23. Special Reports (cont.) Company Compliance with Contractual Agreements Sometimes auditors are asked to provide assurance to third parties that a client is in compliance with contractual or regulatory requirements. Example: Many lending agreements require the borrowing company to maintain certain financial ratios at minimum specified levels. • ratios like the current ratio and debt-to-equity ratio. CPAs are not allowed to provide such reports unless he/she has also audited that company’s financial statements. • Why not? Such a report can be separate from, or part of, the report on the financial statements. The report should provide “negative” or “limited” assurance. • i.e., “In connection with the audit, nothing came to our attention that caused us to believe that the company was not in compliance with any of the terms or covenents…” Such negative assurance should not be provided if an adverse opinion or disclaimer of opinion is issued on the financial statements. 23
  • 24. Special Reports (cont.) Financial Presentations Intended to Comply with Contractual or Regulatory Requirements This financial information differs from statements prepared on a comprehensive basis other than GAAP as follows: • This financial information comprises less than a full set of financial statements, and/or • This financial information is not prepared using one of the four previously-mentioned “comprehensive bases of accounting other than GAAP.” These “statements” are prepared for parties who establish their form and (in general) their content. The auditor still conducts a GAAS audit, and issues an opinion on whether the statements are presented fairly. The auditor’s report will be similar to the standard report, and will indicate that: • the statements were prepared to comply with contractual or regulatory requirements; • distribution of the report is restricted to the client and the third party involved in the contractual or regulatory requirements. 24
  • 25. Special Reports (cont.) Prescribed Formats These refer to situations in which: • the financial statements are presented in a given format, or • the auditor’s report is preprinted using a prescribed format. These situations usually arise when the client is subject to the requirements of a regulatory (i.e., governmental) agency. The auditor should consider whether the format required (for the statements or the auditor’s report) would force the auditor to make unjustified assertions. • If the prescribed auditor’s report is inappropriate, the auditor should revise it (by inserting or deleting the necessary language). • If the prescribed financial statement form is inappropriate, the auditor should disclaim an opinion on the financial statements. 25
  • 26. Summary Special Reports Items Type of Reported Extent of Opinion or Upon Procedures Assurance Other Basis of Full Financial GAAS Audit Accounting Statements Audit Opinion Audit of Specified Accounts, Items, Limited GAAS Audit or Elements Information Audit Opinion Applying Agreed- Upon Procedures Specified to Specified Items, by client Accounts, or Limited or third Summary Elements Information parties of findings Compliance with Compliance GAAS Audit Negative Contractual with provisions on Financial Assurance Agreements or agreements Statements on Compliance Special Purpose Info. required Financial by agreements GAAS Audit Statements or reg. agency Audit Opinion Prescribed Full Financial GAAS May disclaim Formats Statements Audit if necessary 26
  • 27. 27
  • 28. • Other Types of Reports Issued in Conjunction with Audited Financial Statements These reports fall into four general categories (discussed in turn): • Financial Statements Prepared for Use in Other Countries. • Review of Interim Financial Information. • Letters for Underwriters and Other Third Parties. • Condensed Financial Statements and Selected Financial Data. 28
  • 29. Other Types of Reports (cont.) Financial Statements Prepared for Use in Other Countries When a U.S. firm prepares financial statements for use outside the U.S., • they may need to be prepared in conformity with accounting principles not accepted in the U.S. In these cases, the auditor should comply with the general and field work standards of U.S. GAAS. However, the auditing procedures followed under U.S. GAAS may need to be modified (depending on the GAAP in the other country). • For example, the other country (unlike the U.S.) may require the statements to reflect the effects of inflation. 29
  • 30. Financial Statements Prepared for Use in Other Countries (cont.) When the financial statements audited were prepared under another country’s GAAP for use solely outside the U.S., the auditor may either: • modify the U.S.-style report to adapt it to the other country’s GAAP (see example, pg. 18-21), or • use the report form of the other country. In the latter case, the auditor should comply with the other country’s reporting standards. If the audited financial statements: • will be used in the U.S., and • were prepared in conformity with accounting principles not accepted in the U.S., then: • the auditor should use the U.S. report form, and • the opinion should be qualified or adverse if the statements depart materially from U.S. GAAP. 30
  • 31. Other Types of Reports (cont.) Review of Interim Financial Information Public companies are required by the SEC to provide to the SEC • audited annual financial statements, and • interim financial information. Interim financial information: • covers a period of time less than a full year, or • covers a year that ends on a date other than the company’s fiscal year-end. Interim financial information is normally filed on a quarterly basis using the SEC’s form 10-Q. • Interim information filed using form 10-Q is not required to be audited or subjected to any other type of auditing procedures. However, the SEC also requires public companies to include interim financial information as part of the footnotes accompanying their audited financial statements. • Even though this information is specifically marked as being “unaudited,” the auditor is required to perform certain procedures (known as a review) related to this information. 31
  • 32. Review of Interim Financial Information (cont.) Per SAS No. 71, here are some of the major procedures performed in a review of interim financial information: 1. Obtain knowledge of the client’s internal control policies (affecting preparation of both annual and interim info.). 2. Inquire of client personnel regarding: a. the client’s accounting system; b. changes in internal control; c. changes in accounting principles; d. subsequent events. 3. Read minutes of meetings, interim financial information, and reports prepared by other accountants (if any). 4. Perform analytical procedures and evaluate current interim information in relation to: 32
  • 33. a. the preceding interim period. b. anticipated results. c. any relationships based on predictive patterns. (Many of these procedures will be performed as part of the audit of the annual financial statements). The auditor cannot express an opinion on the fairness of the interim financial information. 33
  • 34. Review of Interim Financial Information (cont.) Interim financial information may be presented: • separately from the audited financial statements, or • along with the audited financial statements. In the latter case, 1. the auditor does not issue a separate report on the interim financial information; 2. the auditor would only modify (due to problems with the interim information) his/her report on the audited statements if problems like the following were encountered: • Interim data required under GAAP are omitted. • Interim data were not reviewed. • Interim data are not marked as “unaudited.” • Interim data contain departures from GAAP. 3. However, the auditor’s opinion on the audited statements would not be modified due solely to problems like the above related only to interim information. Please see pg. 18-24 for an example of an auditor’s report on interim information presented separately from the audited statements. 34
  • 35. Other Types of Reports (cont.) Letters for Underwriters and Other Third Parties The Securities Act of 1933 (“the 1933 Act): • deals with initial public offerings (IPOs) of stock; • requires publicly traded stock to be registered with the SEC; • indicates that anyone involved in the registration process can be held liable if information filed with the SEC contains material false statements or misleading omissions. Underwriters: • guarantee the company issuing shares that the shares will be sold. • are required to perform a “reasonable investigation” of info. contained in the registration statements. • ask accountants to provide them (in the form of a comfort letter from the accountant to the underwriter) with assurance that the financial information filed is accurate and complete. This information includes unaudited financial data. 35
  • 36. Letters for Underwriters and Other Third Parties (cont.) Letters to from auditors to underwriters usually address the following topics: • The independence of the accountants. • An opinion on the conformity of the financial statements and schedules in the registration statement with the 1933 Act requirements. • Negative assurance regarding changes in selected financial statement items since the last financial statement date. • Negative assurance relating to any other information included in the registration statement. What is negative assurance? If the accountant provides negative assurance on unaudited financial information, he/she should perform a review of that information (in accordance with SAS No. 71, previously discussed). 36
  • 37. Letters for Underwriters and Other Third Parties (cont.) Sometimes third parties other than underwriters request similar assurances regarding unaudited information such as: • unaudited condensed financial statements; • proforma financial information • financial forecasts • changes in specified financial statement line items. Such parties include those involved in: • debt or equity offerings or exchanges; • guarantees of debt or other securities. Before issuing such assurances, the accountant must perform a review of the information about which assurances are sought The assurances given by the accountant should be “negative assurances,” in conformity with SAS No. 71. 37
  • 38. Other Types of Reports (cont.) Condensed Financial Statements and Selected Financial Data Sometimes companies wish to present their financial results in abridged form, such as: • condensed financial statements (for example, showing total current assets without the detailed breakdown), or • selected financial data (for example, a schedule of current liabilities only). The client is not permitted to present the auditor’s report on the full set of financial statements alongside: • the condensed financial statements, or • the selected financial data. Why not? However, the auditor is permitted to issue a separate opinion on the condensed statements or selected data. Because he/she has audited the full set of financial statements, he/she merely needs to make sure that the condensed statements or selected data are correctly derived from the audited statements. 38
  • 39. Condensed Financial Statements and Selected Financial Data (cont.) If information not derived from the audited financial statements is presented along with the condensed statements or selected data, • the auditor may only report on information derived from the audited statements, and • the auditor’s report must clearly identify the data being reported on. A sample auditor’s report on condensed statements is shown on pg. 18-26. That report: • indicates that the auditor has examined the full set of financial statements; • notes the type of opinion issued on those statements. • does not conclude that the condensed statements are prepared in accordance with GAAP (why not?) • does state whether the condensed statements are fairly presented based on the full set of financial statements. 39