Ch 3 Audit

An audit of historical financial statements most commonly includes the

balance sheet, income statement, statement of cash flows, and the statement of changes in stockholders' equity.

The standard unmodified opinion audit report for a nonpublic entity must

be dated.

When an auditor is trying to determine how changes can affect consistency and and/or comparability, she should keep in mind that

changes that affect consistency require an explanatory paragraph if they are material.

The first step to be followed when deciding the appropriate audit report in a given set of circumstances is to

determine whether any conditions exist requiring a departure from a standard unmodified opinion audit report.

Whenever the client imposes restrictions on the scope of the audit, the auditor should be concerned that management may be trying to prevent discovery of misstatements. In such cases, the auditor will likely issue a

disclaimer of opinion whenever materiality is in question.

Under AICPA auditing standards, the primary auditor issuing the opinion on the financial statements is called the

group engagement partner.

For departures from GAAP or scope restrictions, the auditor must decide if the potential effect on the financial statements is

immaterial material highly material.

If the auditor lacks independence, a disclaimer of opinion must be issued

in all cases.

A CPA might wish to emphasize specific matters regarding the financial statements even though an unqualified opinion will be issued. Normally, such explanatory information is

included in a separate paragraph in the report.

Under PCAOB rules, a separate report on internal control over financial reporting

includes a paragraph that addresses the inherent limitations of internal controls.

William Gregory, CPA, is the principal auditor for an international corporation. Another CPA has examined and reported on the financial statements of a significant subsidiary of the corporation. Gregory is satisfied with the independence and professional reputation of the other auditor, as well as the quality of the other auditor's examination. With respect to his report on the consolidated financial statements, taken as a whole, Gregory

may refer to the examination of the other auditor

If there is a deviation in the statements' preparation in accordance with GAAP and another accounting principle was applied on a basis that was not consistent with that of the preceding year,

more than one modification should be included in the report.

Misstatements must be compared with some measurement base before a decision can be made about materiality. A commonly accepted measurement base includes

net income total assets working capital

When there is uncertainty about a company's ability to continue as a going concern, the auditor's concern is the possibility that the client may not be able to continue its operations or meet its obligations for a "reasonable period of time." For this purpose, a reasonable period of time is considered not to exceed

one year from the date of the financial statements.

If most or all users' decisions that are based on the financial statements are likely to be significantly affected, the materiality level is

pervasive.

After the balance sheet date but prior to issuance of the auditor's report the auditor learns that the client's facility in a foreign country has been expropriated. Management refuses to disclose this information in a financial statement footnote or present pro-forma data as to the effect of the event. The auditor should

provide the information in the report and modify the opinion

Subsequent to the close of Spacely Sprockets' fiscal year ending October 31, 2016, a major debtor has declared bankruptcy due to a series of events. The receivable is significantly material in relation to the financial statements, and recovery is doubtful. The debtor had confirmed the full amount due to Spacely at the balance sheet date. Because the account was confirmed at the balance sheet date, Spacely refuses to disclose any information in relation to this subsequent event. The CPA believes that all other accounts were stated fairly at the balance sheet date. In addition, Spacely changed their method of inventory valuation from FIFO to LIFO. This change was disclosed in Note X to the financial statements. Accordingly, what type of opinion should be expressed?

qualified due to a GAAP departure

All of the following are causes for the addition of an explanatory paragraph under both AICPA and PCAOB standards except for

reports involving other auditors

The auditor's responsibility section of the standard unmodified opinion audit report states that the auditor is

responsible for the opinion on the financial statements.

When accounting principles are not consistently applied, and the materiality level is immaterial, the auditor will issue a(n)

standard unmodified opinion.

The appropriate audit report date for a standard unmodified opinion audit report for a nonpublic entity should be

the date the auditor completed the auditing procedures in the field.

An adverse opinion is issued when the auditor believes

the overall financial statements are so materially misstated that they do not present fairly the financial position or results of operations and cash flows in conformity with GAAP.

The management's responsibility section of the standard unmodified opinion audit report for a nonpublic company states that the financial statements are

the responsibility of management

Under PCAOB standards

the standard unmodified opinion audit report is referred to as an unqualified opinion audit report.

Financial statement users are normally much more concerned about a disclaimer than an unmodified opinion audit report that contains an additional-emphasis-of-matter paragraph.

true

When there is a justified departure from GAAP that is considered material, the auditor should issue a(n)

unmodified opinion with an explanatory paragraph.

The dollar amount of some misstatements cannot be accurately measured. For example, if the client were unwilling to disclose an existing lawsuit, the auditor must estimate the likely effect on

users of the financial statements

There are four conditions that must be met before an auditor can issue a standard unmodified opinion audit report for the audit of a private company. Please discuss each of these four conditions.

• All statements-balance sheet, income statement, statement of changes in stockholder's equity, and statement of cash flows-are included in the financial statements. • Sufficient appropriate evidence has been accumulated, and the auditor has conducted the engagement in a manner that enables him or her to conclude that the audit was performed in accordance with auditing standards. • The financial statements are presented fairly in all material respects in accordance with U.S. generally accepted accounting principles or other appropriate accounting framework. This also means that adequate disclosures have been included in the footnotes and other parts of the financial statements. • There are no circumstances requiring the addition of an explanatory paragraph or modification of the wording of the report.

When a pervasive scope limitation exists,

- a disclaimer of opinion rather than a qualified opinion is generally required. - the auditor's responsibility paragraph is modified to indicate that the auditor was not able to obtain sufficient appropriate evidence to express an audit opinion. - sections of the auditor's responsibility paragraph are eliminated to avoid stating anything that might lead readers to believe that other parts of the financial statements might be fairly stated.

Which of the following are changes that affect the comparability of financial statements but not the consistency and therefore, do not have to be included in the auditor's report?

- error corrections not involving principles -- changes in accounting estimates - variations in the format and presentation of financial information

When the client fails to include information that is necessary for the fair presentation of financial statements in the body of the statements or in the footnotes,

- it is the auditor's responsibility to present the information in the audit report. - the auditor should issue a qualified or an adverse opinion. - the qualification is put in an added paragraph preceding the opinion.

More than one modification should be included in the audit report when

- the auditor is not independent and the auditor knows that the company has not followed generally accepted accounting principles. - there is substantial doubt about the going concern of the company and information about the causes of the uncertainties is not adequately disclosed in the footnotes. - there is a scope limitation and there is substantial doubt about the company's ability to continue as a going concern

When there is a lack of consistent application in accounting principles

- the nature and impact of the change should be adequately disclosed. - the auditor should discuss the nature of the change and point the reader to the footnote that discusses the change. -the materiality of the change is evaluated based on the current year effect of the change.

When there is a scope restriction, what type of audit report can be issued?

- unmodified opinion - qualification of scope and opinion - disclaimer of opinion

When a client fails to follow GAAP, the audit report can be unmodified, qualified, or adverse depending on the materiality. What factors affect materiality that an auditor should consider?

-the dollar amount in comparison to a base -if the misstatement can be measured -the nature of the item

There are three conditions necessitating a departure from an unqualified audit report. Name, discuss and state the appropriate audit report for each of these three conditions

1. Scope Restrictions. A scope restriction can be imposed by the client or due to circumstances beyond the auditor's or client's control. In either case the scope restriction prevents the auditor from accumulating sufficient evidence to reach a conclusion regarding whether financial statements are stated in accordance with GAAP. The type of opinion, depending upon materiality, would be either a qualified or a disclaimer of opinion report. 2. GAAP Departures. In this situation the financial statements are not prepared in accordance with GAAP. Accordingly, the auditor would issue a qualified opinion if the GAAP violation were moderately material, or an adverse opinion if the GAAP violation were highly material. 3. Auditor lacks independence. Independence is ordinarily determined by the AICPA Code of Professional Conduct. When the auditor is not independent, the only report the auditor can issue is a disclaimer of opinion.

Which of the following modifications of the auditor's report does not include an explanatory paragraph?

A principal auditor accepts the work of another auditor.

Indicate which changes would require an explanatory paragraph in the audit report.

Change in the estimated life of an asset; No Variation in the format of the financial statements ;No

Indicate which changes would require an explanatory paragraph in the audit report

Changes in reporting entities, such as the inclusion of an additional company in the combined financial statements;yes The CPA makes reference to the work of another auditor to indicate shared responsibility in an unqualified opinion;no

To emphasize the fact that the auditor is independent, a typical addressee of the audit report could be

Company Controller; No Shareholders; Yes Board of Directors;Yes

Indicate which changes would require an explanatory paragraph in the audit report

Correction of an error by changing from an accounting principle that is not generally acceptable to one that is generally acceptable; Yes Change from LIFO to FIFO; Yes

An auditor determines the financial statements include at least a material departure from GAAP. Which type of opinion may be issued?

Disclaimer;no Qualified;yes Adverse;yes

Section 404(b) of the Sarbanes Oxley Act requires that the auditor of a public company attest to management's report on the efficiency of internal controls over financial reporting.

FALSE

The standard audit report for nonpublic entities refers to GAAS and GAAP in which sections?

GAAS:Auditor's responsibility GAAP:Management's responsibility and Opinion paragraph

The introductory paragraph of the standard unmodified opinion audit report for a nonpublic company performs which functions? I. It states the CPA has performed an audit. II. It lists the financial statements being audited. III. It states the financial statements are the responsibility of the auditor.

I It states the CPA has performed an audit. II It lists the financial statements being audited

When the auditor concludes that there is substantial doubt about the entity's ability to continue as a going concern, the appropriate audit report could be I. an unmodified opinion audit report with an explanatory paragraph. II. a disclaimer of opinion.

I or II

When an auditor issues an audit report for a public company, the auditor can choose to issue a report in which of the following forms?

I. A combined report on financial statements and internal control over financial reporting II. Separate reports on financial statements and internal control over financial reporting either I or II

Which of the following is not something the principal CPA firm can do when issuing a report based in part on the audit work of another CPA firm?

Issue a joint report signed by both CPA firms.

Which of the following is a correct statement regarding materiality?

Misstatements must be compared with some benchmark before a decision can be made about the materiality level of the failure of a company to follow GAAP

An auditor who issues a qualified opinion because sufficient appropriate evidence was not obtained should describe the limitations in an explanatory paragraph. The auditor should also modify the

Scope paragraph; yes Opinion paragraph; yes Notes to the financial statements;no

Indicate which changes would require an explanatory paragraph in the audit report.

The CPA concludes there is substantial doubt about the entity's ability to continue as a going concern;yes Change from FIFO to LIFO;yes

Which of the following requires a recognition in the auditor's opinion of an inconsistency?

The change from the cost method to the equity method of accounting for investments in common stock.

Which of the following is least likely to cause uncertainty about the ability of an entity to continue as a going concern?

The entity is suing a competitor for a minor patent infringement.

In which of the following circumstances would an auditor most likely express an adverse opinion?

The financial statements are not in conformity with the FASB statement on loss contingencies

In which situation would the auditor be choosing between "except for" qualified opinion and an adverse opinion?

The footnotes include less than sufficient disclosure

Which of the following is a correct statement regarding the standard unmodified opinion audit report?

The scope paragraph includes a statement that the auditor considers internal controls when designing the audit procedures performed.

Of the various types of opinions that the auditor can issue,

a qualified opinion report can be used only when the auditor concludes that the overall financial statements are fairly stated.

Items that materially affect the comparability of financial statements generally require disclosure in the footnotes. If the client refuses to properly disclose the item, the auditor will most likely issue

a qualified opinion.

A restriction on the scope of the auditor's examination requires

a qualifying paragraph that precedes the opinion paragraph.

What category of audit report will be issued if the auditor concludes that the financial statements are not fairly presented?

adverse

The most common case in which conditions beyond the client's and auditor's control cause a scope restriction in an engagement is when the

auditor is not appointed until after the client's year-end.

Discuss each of the five circumstances when an auditor would issue an unmodified opinion audit report with an emphasis-of-matter paragraph or nonstandard report wording.

An unmodified opinion audit report with an emphasis-of-matter paragraph or nonstandard report wordings appropriate in the following circumstances: • Lack of consistent application of GAAP. When the client has not followed generally accepted accounting principles consistently in the current period in relation to the preceding period, an unmodified opinion audit report with an explanatory paragraph following the opinion paragraph is appropriate. • Substantial doubt about continuing as a going concern. When an auditor concludes there is substantial doubt about the client's ability to continue as a going concern, an unmodified opinion audit report with an explanatory paragraph following the opinion paragraph is appropriate. The auditor also has the option of issuing a disclaimer of opinion. • A departure from GAAP with which the auditor concurs. If adherence to GAAP would result in misleading financial statements, an unmodified opinion audit report with an explanatory paragraph is appropriate. • Emphasis of a matter. If the auditor wants to emphasize specific matters in the audit report, an explanatory paragraph discussing those matters may be added to an unmodified report. • Reports involving other auditors. When an auditor relies upon a different CPA firm to perform part of the audit, the auditor can indicate that responsibility for the audit is shared with another CPA firm by modifying the wording of an unmodified report.

Discuss how materiality affects audit reporting decisions.

When determining the appropriate audit report to issue, the auditor considers three levels of materiality for a given condition. These three levels are (1) immaterial, (2) material without overshadowing the financial statements as a whole, and (3) so material and so pervasive that overall fairness of the statements is in question. For conditions involving a GAAP violation, the materiality level of the violation influences whether an unmodified, qualified, or adverse opinion is issued. For conditions involving a scope restriction, the materiality of the restriction influences whether a standard unmodified opinion report, a report with a qualified scope and opinion, or a disclaimer report is issued