Chapter 3


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Chapter 3

  1. 1. Audit Reports Chapter 3
  2. 2. Learning Objective 1 <ul><li>Describe the parts of the standard </li></ul><ul><li>unqualified audit report. </li></ul>
  3. 3. 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
  4. 4. Learning Objective 2 <ul><li>Specify the conditions required </li></ul><ul><li>to issue the standard unqualified </li></ul><ul><li>audit report. </li></ul>
  5. 5. Conditions for Standard Unqualified Audit Report 1. All financial statements are included. 2. The three general standards have been followed in all respects on the engagement. 3. Sufficient evidence has been accumulated to conclude that the three standards of field work have been met.
  6. 6. Conditions for Standard Unqualified Audit Report 4. The financial statements are presented in accordance with generally accepted accounting principles . 5. There are no circumstances requiring the addition of an explanatory paragraph or modification of the wording of the report.
  7. 7. Four Categories of Audit Reports 1. Standard unqualified 3. Qualified 2. Unqualified with explanatory paragraph or modified wording 4. Adverse or disclaimer
  8. 8. Learning Objective 3 <ul><li>Understand combined reporting </li></ul><ul><li>on financial statements and </li></ul><ul><li>internal control over financial </li></ul><ul><li>reporting under Section 404 of </li></ul><ul><li>the Sarbanes-Oxley Act. </li></ul>
  9. 9. Sarbanes-Oxley Act This Act requires the auditor of a public company to attest to management’s report on the effectiveness of internal control over financial reporting. PCAOB Auditing Standard 2 requires the audit of internal control to be integrated with the audit of the financial statements.
  10. 10. Sarbanes-Oxley Act Combined 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
  11. 11. Learning Objective 4 <ul><li>Describe the five circumstances </li></ul><ul><li>when an unqualified report with </li></ul><ul><li>an explanatory paragraph or </li></ul><ul><li>modified wording is appropriate. </li></ul>
  12. 12. 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
  13. 13. Substantial Doubt About Going Concern 1. Significant recurring operating losses or working capital deficiencies. 2. Inability of the company to pay its obligations as they come due. 3. Loss of major customers, the occurrence of uninsured catastrophes. 4. Legal proceedings, legislation that might jeopardize the entity’s ability to operate.
  14. 14. Auditor Agrees with a Departure from a Promulgated Principle The auditor must be satisfied and must state and explain, in a separate paragraph or paragraphs in the audit report, that adhering to the principle would have produced a misleading result in that situation.
  15. 15. 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.
  16. 16. Reports Involving Other Auditors 1. Make no reference in the audit report 3. Qualify the opinion 2. Make reference in the report (modified wording report)
  17. 17. Learning Objective 5 <ul><li>Identify the types of audit reports </li></ul><ul><li>that can be issued when an </li></ul><ul><li>unqualified opinion is not justified. </li></ul>
  18. 18. Departures from An Unqualified Opinion 1. Scope limitation 2. GAAP departure 3. Auditor not independent
  19. 19. 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.
  20. 20. Adverse Opinion It is used only when the auditor believes that the overall financial statements are so materially misstated or misleading that they do not present fairly the financial position or results of operations and cash flows in conformity with GAAP.
  21. 21. Disclaimer of Opinion It is issued when the auditor is unable to be satisfied that the overall financial statements are fairly presented.
  22. 22. Learning Objective 6 <ul><li>Explain how materiality affects </li></ul><ul><li>audit reporting decisions. </li></ul>
  23. 23. 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.
  24. 24. 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.
  25. 25. Relationship of Materiality to Type of Opinion Materiality Level Significance in Terms of Reasonable Users’ Decisions Type of Opinion Users’ decisions are unlikely to be affected. Immaterial Unqualified Users’ decisions are likely to be affected. Material Qualified Users’ decisions are likely to be significantly affected. Highly material Disclaimer or adverse
  26. 26. Materiality Decisions Failure to follow GAAP Audit report Unqualified Qualified opinion only Adverse
  27. 27. Materiality Decisions <ul><li>Dollar amount compared with a base </li></ul><ul><li>Measurability </li></ul><ul><li>Nature of the item </li></ul>
  28. 28. Materiality Decisions Scope limitation Audit report Unqualified Qualified scope and opinion Disclaimer
  29. 29. Learning Objective 7 <ul><li>Draft appropriately modified </li></ul><ul><li>audit reports under a variety </li></ul><ul><li>of circumstances. </li></ul>
  30. 30. Discussion of Conditions Requiring Departure <ul><li>Auditor’s scope has been restricted </li></ul><ul><li>Statements are not in conformity with GAAP </li></ul><ul><li>Auditor is not independent </li></ul>
  31. 31. Learning Objective 8 <ul><li>Determine the appropriate audit </li></ul><ul><li>report for a given audit situation. </li></ul>
  32. 32. Auditor’s Decision Process Determine whether any condition exists requiring a departure from a standard unqualified report. <ul><li>Decide the materiality for each condition </li></ul><ul><li>Decide the appropriate type of report </li></ul><ul><li>Write the audit report </li></ul>
  33. 33. More Than One Condition Requiring a Departure or Modification The auditor is not independent. There is a scope limitation. There is a substantial doubt about the company’s ability to continue as a going concern. There is a deviation in the statements’ preparation in accordance to GAAP.
  34. 34. Number of Paragraphs in the Report Standard unqualified 3 Unqualified with explanatory paragraph 4 Unqualified shared report with other auditors 3 Qualified – opinion only 4 Qualified – scope and opinion 4 Disclaimer – scope limitation 3 Adverse 4 Type of Report
  35. 35. Learning Objective 9 <ul><li>Discuss the impact of e-commerce </li></ul><ul><li>on audit reporting. </li></ul>
  36. 36. Impact of E-Commerce on Audit Reporting Under auditing standards, the auditor has no obligation to perform any procedures to corroborate the other information. Most public companies provide access to financial information through their home Web page . Auditing standards note that electronic sites are not considered “documents.”
  37. 37. End of Chapter 3