CH 3

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.

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.

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.

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.

• 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.