Audit Chapter 3 Q&A Questions
Distinguish between a qualified opinion, an adverse opinion, and a disclaimer of opinion, and explain the circumstances under which each is appropriate.
A qualified opinion states that there has been either a limitation on the scope of the audit of material accounts, transactions, or disclosures or a material departure from GAAP in the financial statements, but that the auditor believes that the overall financial statements are fairly presented. This type of opinion may not be used if the auditor believes the exceptions being reported upon are extremely material, in which case a disclaimer or adverse opinion would be used. An adverse opinion states that the auditor believes the overall financial statements are so materially misstated or misleading that they do not present fairly in accordance with GAAP the financial position, results of operations, or cash flows. A disclaimer of opinion states that the auditor has been unable to satisfy himself or herself as to whether or not the overall financial statements are fairly presented because of a significant limitation of the scope of the audit, or a non-independent relationship under the AICPA Code of Professional Conduct between the auditor and the client. Examples of situations that are appropriate for each type of opinion are as follows: Qualified - Inability to confirm the existence of an asset which is material but not extremely material in value. Adverse - A highly material departure from GAAP. Disclaimer - Material physical inventories not observed and the inventory cannot be verified through other procedures. Lack of independence by the auditor.
Distinguish between a report qualified due to a GAAP departure and one qualified due to a scope limitation.
A qualified report due to a scope limitation is issued when the auditor can neither perform procedures that he or she considers necessary nor satisfy himself or herself by using alternative procedures, usually due to the existence of conditions beyond the client's or the auditor's control, but the amount involved in the financial statements is not highly material. An important part of qualified opinion due to a scope limitation is that it results from not accumulating sufficient appropriate audit evidence, either because of the client's request or because of circumstances beyond anyone's control. When the opinion is qualified due to a scope limitation, the auditor modifies both the scope and opinion paragraphs. The scope paragraph is modified to indicate that the auditor's scope has been restricted and the opinion paragraph is modified to include the qualified opinion. A report qualified as to opinion only results when the auditor has accumulated sufficient appropriate evidence but has concluded that the financial statements are not correctly stated. The only circumstance in which an opinion only qualification is appropriate is for material, but not highly material, departures from GAAP. When the opinion is qualified due to a GAAP departure, only the opinion paragraph is modified to include the qualified opinion. The scope paragraph is not modified because there has been no limitation on the auditor's scope.
What four circumstances are required for a standard unmodified opinion audit report to be issued?
A standard unmodified opinion audit report may be issued under the following circumstances: 1. All statements—balance sheet, income statement, statement of retained earnings, and statement of cash flows—are included in the financial statements. 2. 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. 3. The financial statements are presented in accordance with appropriate accounting standards such as U.S. generally accepted accounting principles or IFRS. This also means that adequate disclosures have been included in the footnotes and other parts of the financial statements. 4. There are no circumstances requiring the addition of an explanatory paragraph or modification of the wording of the report.c
Distinguish between an unmodified opinion audit report that contains an emphasis-of-matter explanatory paragraph and a qualified report.
An unmodified opinion audit report with an explanatory paragraph or modified wording is the same as a standard unmodified opinion report except that the auditor believes it is necessary to provide additional information about the audit or the financial statements. For a qualified report, either there is a scope limitation (condition 1) or a failure to follow generally accepted accounting principles (condition 2). Under either condition, the auditor concludes that the overall financial statements are fairly presented. Two examples of an unmodified opinion audit report with an explanatory paragraph or modified wording are: 1. The entity changed from one generally accepted accounting principle to another generally accepted accounting principle. 2. A shared report involving the use of other auditors.
Explain why auditors' reports are important to users of financial statements and why it is desirable to have standard wording.
Auditors' reports are important to users of financial statements because they inform users of the auditor's opinion as to whether or not the financial statements are fairly stated or whether no conclusion can be made with regard to the fairness of their presentation. Users especially look for any deviation from the wording of the standard unmodified report and the reasons and implications of such deviations. Having standard wording improves communications for the benefit of users of the auditor's report. When there are departures from the standard wording, users are more likely to recognize and consider situations requiring a modification or qualification to the auditor's report or opinion.
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.
The auditor's opinion may be qualified by scope limitations caused by client restrictions or by limitations resulting from conditions beyond the client's control. The former occurs when the client will not, for example, permit the auditor to confirm material receivables or physically observe inventories. The latter may occur when the engagement is not agreed upon until after the client's year-end when it may not be possible to physically observe inventories or confirm receivables. A disclaimer of opinion is issued if the scope limitation is so material that the auditor cannot determine if the overall financial statements are fairly presented. If the scope limitation is caused by the client's restriction, the auditor should be aware that the reason for the restriction might be to deceive the auditor. For this reason, a disclaimer is more likely for client restrictions than for conditions beyond anyone's control. When there is a scope restriction that results in the failure to verify material, but not pervasive accounts, a qualified opinion may be issued. This is more likely when the scope limitation is for conditions beyond the client's control than for restrictions by the client.
Define materiality as it is used in audit reporting. What conditions will affect the auditor's determination of materiality?
The common definition of materiality as it applies to accounting and, therefore, to audit reporting is: 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. 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. Conditions that affect the auditor's determination of materiality include: < Potential users of the financial statements < Dollar amounts of the following items: net income before taxes, total assets, current assets, current liabilities, and owners' equity < Nature of the potential misstatements—certain misstatements, such as fraud, are likely to be more important to users of the financial statements than other misstatements.
What are the purposes of the scope paragraph under the auditor's responsibility in the auditor's report? Identify the most important information included in the scope paragraph The purpose of the scope paragraph under the auditor's responsibility is to inform the financial statement users of the nature of the audit procedures performed.
The information in the scope paragraph includes: 1. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. 2. The audit procedures selected depend on the auditor's judgment, and consider the auditor's assessment of the risks of material misstatement, whether due to fraud or error. 3. As part of this risk assessment, the auditor considers internal control over financial reporting in the design of the audit procedures. The assessment is not for the purpose of expressing an opinion on internal control over financial reporting, and the auditor does not express such an opinion. 4. An audit includes evaluating the appropriateness of the accounting policies used, the reasonableness of significant estimates, and the overall presentation of the financial statements.
What are the purposes of the opinion paragraph in the auditor's report? Identify the most important information included in the opinion paragraph.
The purpose of the opinion paragraph is to state the auditor's conclusions based upon the results of the audit evidence. The most important information in the opinion paragraph includes: 1. The words "in our opinion," which indicate that the conclusions are based on professional judgment. 2. A statement about whether the financial statements were presented fairly and in accordance with generally accepted accounting principles along with indication of the fiscal year(s) associated with those statements.
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.
The three conditions requiring a departure from an unqualified report are: • 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. • 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. • 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.
