Audit 15.1-15.6 Reporting

On January 2, Year 2, the Retail Auto Parts Co. received a notice from its primary suppliers that effective immediately all wholesale prices would be increased 10%. On the basis of the notice, Retail Auto Parts Co. revalued its December 31, Year 1, inventory to reflect the higher costs. The inventory constituted a material proportion of total assets. However, the effect of the revaluation was material to current assets but not to total assets or net income. In reporting on the company's financial statements for the year ended December 31, Year 1, in which inventory is valued at the adjusted amounts, the auditor would most likely

Express a qualified opinion. The auditor should express a qualified opinion when the financial statements are materially misstated, but the effects are not pervasive. Inventory is misstated because it should be recorded at lower of cost or market. Holding gains should not be recognized until realized, i.e., when inventory is sold. Furthermore, the effect on current assets is material. However, it (1) is confined to specific elements, accounts, or items and (2) is not a substantial proportion of the financial statements.

In a financial statement audit of a nonissuer, an auditor would express an unmodified opinion with an emphasis-of-matter paragraph added to the auditor's report for An Unjustified Change in an Accounting Principle A Weakness in Internal Control

No No An unjustified change in an accounting principle requires a modified opinion if it results in a material misstatement. Thus, an unmodified opinion with an emphasis-of-matter paragraph would not be appropriate. A weakness in internal control does not require an emphasis-of-matter paragraph but should be considered in planning the audit.

A limitation on the scope of an audit sufficient to preclude an unmodified opinion is most likely to result when management

Refuses to furnish a management representation letter to the auditor. According to AU-C 580, Written Representations, management's refusal to furnish written representations constitutes a limitation on the scope of the audit. The refusal is often sufficient to preclude an unmodified opinion. Moreover, it may cause an auditor to disclaim an opinion or withdraw from the engagement, especially with regard to representations about (1) fraud, (2) noncompliance, (3) uncorrected misstatements, (4) litigation and claims, (5) estimates, (6) related party transactions, and (7) subsequent events. However, the circumstances may permit a qualified opinion. Furthermore, the auditor should consider the effects of management's refusal on his or her ability to rely on other management representations.

In which of the following circumstances would an auditor not express an unmodified opinion?

The auditor is unable to obtain audited financial statements of a long-term investee. A qualified opinion may be based on a lack of sufficient appropriate evidence. Some common scope limitations relate to the inability to observe inventory, confirm accounts receivable, or obtain audited statements of a long-term investee.

An auditor's report included an additional paragraph disclosing that there is a difference of opinion between the auditor and the client for which the auditor believed an adjustment to the financial statements should be made. The opinion paragraph of the auditor's report most likely expressed

A qualified opinion. The most likely reason for including a separate paragraph disclosing a difference of opinion with the client is that the selection or application of an accounting principle is not in accordance with the applicable reporting framework. Such a disagreement is described in a basis for qualified opinion or basis for adverse opinion paragraph, depending upon the pervasiveness of the material misstatement.

When a certified public accountant who is not independent is associated with financial statements, (s)he is precluded from expressing an opinion because

Any auditing procedures (s)he might perform will not be in accordance with generally accepted auditing standards An auditor is associated with financial information when (s)he applies procedures that suffice to report in accordance with GAAS. The auditor must be independent of the entity when performing an engagement in accordance with GAAS unless (1) GAAS provide otherwise or (2) the auditor is required by law to accept and report on the engagement. Barring one of the exceptions, an auditor who is not independent must not report under GAAS. Independence means independence in fact and appearance (AU-C 200). This crucially important quality gives credibility to the auditor's opinion. If an auditor does not maintain the appearance of independence, however unbiased (s)he may be in fact, the public will be reluctant to believe that (s)he is unbiased.

The accuracy of information included in notes that accompany the audited financial statements of a company whose shares are traded on a stock exchange is the primary responsibility of the

Company's management. The notes are considered part of the basic financial statements. Because management has the primary responsibility for the financial statements, it also has the primary responsibility for the accuracy of information included in notes.

When would an audit report refer to both the auditing standards of the PCAOB and generally accepted auditing standards (GAAS)?

For the audit of a nonissuer in accordance with the standards issued by the PCAOB When conducting an audit of financial statements in accordance with the standards of the PCAOB and the audit is not within the jurisdiction of the PCAOB, the auditor is required to also conduct the audit in accordance with GAAS. In such circumstances, when the auditor refers to the standards of the PCAOB in addition to GAAS in the auditor's report, the auditor should use the form of report required by the standards of the PCAOB, amended to state that the audit was also conducted in accordance with GAAS.

A limitation on the scope of an audit sufficient to preclude an unmodified opinion is most likely to result when management

Is unable to obtain audited financial statements supporting the entity's investment in a foreign subsidiary. An auditor's inability to obtain sufficient appropriate evidence may arise from, among other things, circumstances related to the nature or timing of the auditor's work. An example is an inability, not resulting from a management-imposed limitation, to obtain audited financial statements of a long-term investee. If the possible effects are material, the auditor expresses a qualified opinion or disclaims an opinion, depending on pervasiveness.

An auditor may reasonably express a "subject to" qualified opinion for Lack of Consistency Departure from an Applicable Financial Reporting Framework

No No The phrase "subject to" should not be used in any report. It is not clear or forceful enough (AU-C 705).

When single-year financial statements are presented, an auditor ordinarily expresses an unmodified opinion if the

Prior year's financial statements were audited by another CPA whose report, which expressed an unmodified opinion, is not presented. When single-year financial statements are presented, the auditor's reporting responsibility is limited to those statements. If the prior year's financial statements are not presented for comparative purposes, the current-year auditor should not refer to the prior year's statements and the report thereon. Furthermore, the failure to present comparative statements is not a basis for modifying the opinion.

In which of the following situations will a practitioner disclaim an opinion on an examination of prospective financial statements?

The practitioner was not able to perform certain procedures deemed necessary. If the auditor becomes aware of a management-imposed scope limitation after accepting the engagement, a disclaimer of opinion should be issued.

For a nonissuer that does not receive governmental financial assistance, an auditor's report on financial statements generally would not refer to

The auditor's use of confirmations and analytical procedures. The report does not describe specific auditing procedures performed by the auditor.

When qualifying an opinion because of an insufficiency of appropriate audit evidence, an auditor should refer to the situation in the Auditor's Responsibility Section Notes to the Financial Statements

Yes No An auditor may express a qualified opinion due to an inability to obtain sufficient appropriate audit evidence if the possible effects are material but not pervasive. But the notes to the financial statements are unchanged because they were not drafted by the auditor. Moreover, a sentence in the auditor's responsibility section states, "We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified audit opinion."

When an auditor expresses an adverse opinion, the opinion paragraph should include

A direct reference to a separate paragraph disclosing the basis for the opinion. An adverse opinion states that the financial statements are not fairly presented in accordance with the applicable financial reporting framework. When an adverse opinion is expressed, the opinion paragraph should directly refer to a basis for adverse opinion paragraph that discloses the basis for the adverse opinion. This paragraph should precede the opinion paragraph (AU-C 705).

Restrictions imposed by management prohibit the observation of physical inventories, which account for 35% of all assets. Alternative audit procedures cannot be applied, although the auditor was able to examine satisfactory evidence for all other items in the financial statements. The auditor should express

A disclaimer of opinion. The auditor may become aware of a management-imposed scope limitation after accepting the engagement that is likely to result in a qualified opinion or a disclaimer of opinion. The auditor should request removal of the limitation. If it is not removed, the auditor should communicate with those charged with governance and determine whether alternative procedures can be performed. If the auditor cannot obtain sufficient appropriate evidence because of the limitation, (s)he should determine whether the possible effects of undetected misstatements could be material and pervasive. If they are, the auditor should disclaim an opinion or withdraw from the engagement (AU-C 705).

The auditor is most likely to disclaim an opinion because of

A management-imposed limitation. An inability to obtain sufficient appropriate evidence may result from (1) circumstances beyond the control of the entity, (2) circumstances related to the nature or the timing of the work, or (3) a management-imposed limitation. They result in either a qualified opinion or a disclaimer (AU-C 705).

An auditor expresses an adverse opinion if

A misstatement is material and pervasive. When the effects on the financial statements of a material misstatement are pervasive, the auditor expresses an adverse opinion. Pervasive effects are not confined to specific elements, accounts, or items of the financial statements. If they are confined, they represent a substantial proportion of the statements.

Because an expression of opinion as to certain identified items in financial statements tends to overshadow or contradict a disclaimer of opinion or adverse opinion, it is inappropriate for an auditor to express

A piecemeal opinion. A piecemeal opinion is an opinion on a specific element of the statements when an auditor has disclaimed an opinion or expressed an adverse opinion on the statements as a whole. A piecemeal opinion is not acceptable because it contradicts the disclaimer or adverse opinion.

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 related notes, it is the responsibility of the auditor to present the information, if practicable, in the auditor's report and express

A qualified or an adverse opinion. A material misstatement requires the auditor to express a qualified or an adverse opinion. A material misstatement may result from inappropriate or inadequate disclosure or from omission of required disclosures. If information required to be presented or disclosed is omitted, the auditor describes the nature of the information in the basis paragraph. (S)he also includes the information, if practicable, and discusses the omission with those charged with governance. But an auditor is not expected to prepare a basic statement.

or a particular entity's financial statements to be presented fairly, it is not required that

Accounting policies be applied on a basis consistent with those followed in the prior year. A lack of consistency does not preclude fair presentation in accordance with the applicable reporting framework. For example, if the entity voluntarily changes from one accounting principle in accordance with the framework to another and the auditor concurs with the change, an emphasis-of-matter paragraph is required to be included in the auditor's report. But the financial statements will be in accordance with the framework.

A client using U.S. GAAP has capitalizable leases but refuses to capitalize them in the financial statements. Which of the following reporting options does an auditor have if the effects on the financial statements are material and pervasive?

Adverse opinion. An adverse opinion is expressed when the financial statements are not presented fairly in accordance with the applicable reporting framework. An adverse is appropriate when a material misstatement exists that has pervasive effects on the financial statements.

If financial statements are to meet the requirements of adequate disclosure,

All information believed by the auditor to be essential to the fair presentation of the financial statements must be disclosed, no matter how confidential management believes the data to be. In considering the adequacy of disclosure, the auditor necessarily uses confidential client information. Otherwise, forming an opinion on the statements would be difficult. To the extent required by GAAP or an other appropriate financial reporting framework, such information must be disclosed. But beyond these requirements, the auditor who discloses confidential information without specific consent violates the Code of Professional Conduct.

On August 13, a CPA dated the audit report on financial statements for the year ended June 30. On August 27, an event came to the CPA's attention that should be disclosed in the notes to the financial statements. The event was properly disclosed by the entity, but the CPA decided not to dual-date the auditor's report and dated the report August 27. Under these circumstances, the CPA was taking responsibility for

All subsequent events that occurred through August 27. Subsequent events are material events or transactions that occur after the balance sheet date but prior to the issuance of the financial statements. They require adjustment or disclosure in the financial statements. If the auditor dates the report August 27, the auditor is assuming responsibility for all subsequent events that occurred through August 27.

Kapok Corporation is a substantial user of computer equipment and has used an outside service bureau to process data in years past. During the current year, Kapok adopted the policy of leasing all hardware and expects to continue this arrangement in the future. This change in policy is adequately disclosed in notes to Kapok's financial statements, but uncertainty prohibits either Kapok or its auditor from assessing the impact of this change upon future operations. The audit report should include

An unmodified opinion In the absence of a material misstatement, for example, because of inadequate disclosure or a scope limitation, an uncertainty does not require modification of the opinion.

A note to the financial statements of the First Security Bank indicates that all of the records relating to the bank's business operations are stored on magnetic disks and that no emergency backup systems or duplicate disks are stored because the bank and its auditors consider the occurrence of a catastrophe to be remote. Based upon this note, the auditor's report on the financial statements should express

An unmodified opinion. Failure to provide for backup records does not affect the fairness of the financial statements, regardless of the negative implications for the client's internal control. The auditor should therefore express an unmodified opinion in the absence of other indications to the contrary.

The existence of audit risk is recognized by the statement in the auditor's report that the

Auditor obtains reasonable assurance about whether the financial statements are free of material misstatement. Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated (AU-C 200). The high, but not absolute, level of assurance that is intended to be obtained by the auditor is described in the auditor's responsibility section of the report. Reasonable assurance means that audit risk is reduced to an acceptably low level.

An auditor who is unable to form an opinion on a new client's opening inventory balances may express an unmodified opinion on the current year's

Balance sheet only. An inability to obtain sufficient appropriate audit evidence related to beginning inventory may prevent the auditor from expressing an unmodified opinion on some of the financial statements. Opening inventories enter into the determination of net income and cash flows. Thus, the auditor may disclaim an opinion on results of operations and cash flows. However, the balance sheet reports only the ending inventory balances. Thus, the auditor may express an unmodified opinion on the balance sheet.

The financial statements include a separate statement of changes in equity. This statement should

Be identified in the introductory paragraph of the report but need not be reported on separately in the opinion paragraph. The balance sheet, statement of income, statement of changes in equity, and statement of cash flows are the financial statements upon which the auditor customarily reports. The introductory paragraph identifies the titles of the entity's financial statements. However, the statement of changes in equity and a separate statement of comprehensive income are not separately reported on the opinion paragraph. The reason is that changes in equity and comprehensive income are included in financial position, results of operations, and cash flows.

In the first audit of a client, an auditor was not able to gather sufficient appropriate audit evidence about the consistent application of accounting principles between the current and the prior year, as well as the amounts of assets or liabilities at the beginning of the current year. This was due to the client's record retention policies. If the amounts in question could materially affect current operating results, the auditor most likely would

Be unable to express an opinion on the current year's results of operations and cash flows. According to AU-C 705, in a first audit, the auditor is permitted to (1) express an unmodified opinion on the financial position of the entity and (2) disclaim an opinion on the results of operations and cash flows, if relevant. A disclaimer of opinion is expressed because the auditor is unable to obtain sufficient appropriate audit evidence. This inability may result from (1) circumstances not controlled by the entity, (2) circumstances related to the nature or timing of the auditor's work, or (3) limitations imposed by management.

The auditor's report may be addressed to the company whose financial statements are being audited or to that company's

Board of directors. The auditor's report should be addressed to those for whom the report is prepared. If the client is the auditee, the addressee may be the company whose statements are being audited or to those charged with governance (e.g., the board of directors). If the client is an unincorporated entity, the report should be addressed as circumstances dictate, e.g., to the partners or the proprietor. If the statements audited are not those of the client, the client is the proper addressee (AU-C 700).

A client makes test counts on the basis of a statistical plan. The auditor observes such counts as are deemed necessary and is able to become satisfied as to the reliability of the client's procedures. In reporting on the results of the audit, the auditor

Can express an unmodified opinion. When the client uses statistical sampling to determine inventory quantities, the auditor must become satisfied that the procedures are reliable. The auditor must observe at least some counts and must be satisfied that the sampling plan is reasonable and statistically valid, that it has been properly applied, and that its results are reasonable. Given no significant scope limitation, the report need not refer to failure to observe a year-end physical count or to the alternative procedures employed. The auditor may express an unmodified opinion.

Without affecting the CPA's willingness to express an unmodified opinion on the client's U.S.-GAAP-based financial statements, corporate management may refuse a request to

Change its basis of accounting for inventories from FIFO to LIFO because, in the opinion of the CPA, the FIFO method fails to give adequate recognition to the extraordinary increases in prices of merchandise acquired and held by the company. FIFO (first-in, first-out) and LIFO (last-in, first-out) are both methods of accounting for inventories that are generally accepted in the U.S. LIFO has the advantage during periods of inflation of matching current costs with current revenues. An independent auditor who has requested a change from FIFO to LIFO is likely to express an unmodified opinion even if management refuses to do so because the financial statements would still conform with U.S. GAAP.

A major purpose of the auditor's report on financial statements is to

Clarify for the public the nature of the auditor's responsibility and performance. One of the highest priorities of the AICPA has been to reduce the gap between the nature of the auditor's responsibility and performance and the public's perception of the audit function. The auditor's report issued in accordance with auditing standards clarifies the role of the auditor with the intention of diminishing the gap.

A CPA is considered not associated with unaudited financial statements of a public entity when (s)he

Completed an audit and reported on the financial statements that, without the CPA's consent, were part of a prospectus including unaudited financial statements. PCAOB auditing standards apply to engagements involving issuers. Under these standards, a CPA is associated with unaudited financial statements of a public entity when (s)he prepares or assists in preparing them or consents to the use of his or her name with them. If neither condition is met, the CPA is not associated with the unaudited statements in the prospectus (PCAOB AS 3320).

In which of the following situations would an auditor ordinarily choose between expressing a qualified opinion and an adverse opinion?

Conditions that cause the auditor to have substantial doubt about the entity's ability to continue as a going concern are inadequately disclosed. When the auditor concludes that substantial doubt exists about an entity's ability to continue as a going concern for a reasonable period of time, (s)he should include an emphasis-of-matter paragraph (following the opinion paragraph) in the auditor's report to describe the uncertainty. By itself, this doubt does not require a modification of the opinion. However, if the entity's disclosures about the issue are inadequate, the misstatement may result in a qualified or an adverse opinion.

Patentex developed a new secret formula that is of great value because it resulted in a virtual monopoly. Patentex has capitalized all research and development costs associated with this formula. Greene, CPA, who is auditing this account, will probably

Confer with management regarding transfer of the amount from the balance sheet to the income statement. U.S. GAAP require that R&D costs be expensed as incurred. The auditor should confer with management about this material misstatement. If management refuses to correct the misstatement, the auditor should express a qualified or an adverse opinion if the misstatement is material. The required restatement is to expense the amounts capitalized, i.e., to transfer the amounts from the balance sheet to the income statement.

If an accountant concludes that unaudited financial statements of an issuer on which the accountant is disclaiming an opinion also lack adequate disclosure, the accountant should suggest appropriate revision. If the client does not accept the accountant's suggestion, the accountant should

Describe the appropriate revision to the financial statements in the accountant's disclaimer of opinion. PCAOB auditing standards apply to engagements involving issuers. Under these standards, inadequate disclosure is a departure from U.S. GAAP. When an accountant who is associated with the unaudited statements of an issuer suggests revision because of such a departure and the client declines to provide the necessary disclosures, the disclaimer should be modified to describe the departure. The description should refer specifically to the nature of the departure and, if practicable, state the effects on the financial statements or include the necessary information for adequate disclosure (PCAOB AS 3320).

A CPA concludes that the unaudited financial statements of an issuer on which the CPA is disclaiming an opinion are not in conformity with generally accepted accounting principles (GAAP) because management has failed to capitalize leases. The CPA suggests appropriate revisions to the financial statements, but management refuses to accept the CPA's suggestions. Under these circumstances, the CPA ordinarily would

Describe the nature of the departure from GAAP in the CPA's report and state the effects on the financial statements, if practicable. An accountant planning to disclaim an opinion on an issuer's financial statements may discover a material departure from GAAP. Under PCAOB standards, the accountant should disclose the departure in the disclaimer, including its effects if they have been determined by management or by the accountant's procedures.

Morris, CPA, suspects that a pervasive scheme of illegal bribes exists throughout the operations of Worldwide Import-Export, Inc., a new audit client. Morris notified the audit committee and Worldwide's legal counsel, but neither would assist Morris in determining whether the amounts involved were material to the financial statements or whether senior management was involved in the scheme. Under these circumstances, Morris most likely should

Disclaim an opinion on the financial statements. Bribery is a violation of laws or governmental regulations. If the auditor is precluded by management or those charged with governance (e.g., the audit committee) from obtaining sufficient appropriate evidence to evaluate whether material noncompliance with laws or regulations has (or is likely to have) occurred, the auditor should disclaim an opinion or express a qualified opinion.

Trotman, Inc., a manufacturing company, has engaged a CPA to audit its financial statements for the year ended June 30, Year 2. The CPA observed the physical inventory count at June 30, Year 2, but no physical inventory had been taken at June 30, Year 1. The CPA has not been able to become satisfied as to the value of the inventory at June 30, Year 1. Assuming that the financial statements are fairly presented in all other material respects, the CPA should

Disclaim an opinion on the results of operations and cash flows but express an unmodified opinion on the balance sheet. An inability to obtain sufficient appropriate evidence may result from, among other things, circumstances related to the nature or timing of the work. An example is not being able to observe the counting of physical inventories at the beginning of the year. These inventories enter into the determination of net income and cash flows. If the possible effects of this scope limitation are material and pervasive to the results of operations and cash flows, the auditor cannot express an opinion on them. However, the auditor can express an unmodified opinion on year-end financial position.

John Greenbaum, CPA, provides bookkeeping services to Santa Fe Products Co., an issuer. He also is a director of Santa Fe and performs limited auditing procedures in connection with his preparation of Santa Fe's financial statements. Greenbaum's report accompanying these financial statements should include a

Disclaimer of opinion and each page of the financial statements should be marked as unaudited. When an accountant lacks independence, any procedures (s)he might perform are not in accordance with GAAS. (S)he is therefore precluded from expressing an opinion or any other form of assurance. If the statements are those of an issuer, the accountant should disclaim an opinion. (S)he should also state that (s)he is not independent and did not audit the statements. The reasons for lack of independence and any procedures performed should not be described. Each page of the statements should be clearly and conspicuously marked as unaudited.

When an independent CPA is associated with the financial statements of an issuer but has not audited or reviewed such statements, the appropriate form of report to be issued must include a(n)

Disclaimer of opinion. PCAOB auditing standards apply to engagements involving issuers. Under these standards, a disclaimer should be attached to the financial statements of an issuer when an accountant is associated with those statements and has not audited or reviewed them. Association means that the accountant has consented to the use of his or her name in a report, document, or written communication containing the statements. Association also means that the accountant has prepared or assisted in preparing statements that (s)he submits to a client or others even if his or her name is not used (PCAOB AS 3320).

When an independent CPA is associated with the financial statements of an issuer but has not audited or reviewed such statements, the appropriate form of report to be issued must include a(n)

Disclaimer of opinion. PCAOB auditing standards apply to engagements involving issuers. Under these standards, when an accountant is associated with the financial statements of an issuer but has not audited or reviewed such statements, the report should disclaim an opinion on them (PCAOB AS 3320).

When management will not permit inquiry of outside legal counsel, the audit report will ordinarily contain a(n)

Disclaimer of opinion. The auditor may be unable to determine the legality of certain acts or the amounts associated with them because of an inability to gather sufficient appropriate audit evidence. For example, management may not permit inquiry of external legal counsel. In these circumstances, the scope limitation requires a qualified opinion or a disclaimer. However, if (1) the auditor cannot obtain sufficient appropriate evidence because of a management-imposed limitation, and (2) the possible effects of undetected misstatements are material and pervasive, the auditor should disclaim an opinion or withdraw from the engagement.

Restrictions imposed by management of a retail entity that is a new client prevent an auditor from observing any physical inventories. These inventories account for 40% of the entity's assets. Alternative auditing procedures cannot be applied due to the nature of the entity's records. Under these circumstances, the auditor should express a(n)

Disclaimer of opinion. The auditor may become aware of a management-imposed scope limitation after accepting the engagement that is likely to result in a qualified opinion or a disclaimer of opinion. The auditor should request removal of the limitation. If it is not removed, the auditor should communicate with those charged with governance and determine whether alternative procedures can be performed. If the auditor cannot obtain sufficient appropriate evidence because of the limitation, (s)he should determine whether the possible effects of undetected misstatements could be material and pervasive. If they are, the auditor should disclaim an opinion or withdraw from the engagement (AU-C 705).

An auditor's client has violated a minor requirement of its bond indenture that could result in the trustee requiring immediate payment of the principal amount due. The client refuses to seek a waiver from the bond trustee. Request for immediate payment is not considered likely. Under these circumstances, the auditor should

Disclose the situation in the auditor's report. The auditor should disclose this situation in the report because the violation could have a material effect on financial statement presentation. Even if no basis exists for modifying the opinion, disclosure in an emphasis-of-matter paragraph is appropriate. But U.S. GAAP require such information to be disclosed, for example, when the obligation has been classified as a noncurrent liability although the creditor has not waived or lost its right to demand immediate repayment. Hence, the auditor may also need to modify the opinion because of the misstatement resulting from the omitted disclosure.

A limitation on the scope of an audit sufficient to preclude an unmodified opinion will usually result when management

Does not make the minutes of the board of directors' meetings available to the auditor. An inability to obtain sufficient appropriate evidence may result from limitations imposed by management. Failing to make the minutes of board meetings available is such a limitation. It also raises a question about management's compliance with the preconditions for an audit, e.g., providing access to relevant information and persons within the entity.

Green, CPA, is aware that Green's name is to be included in the interim report of National Company, a publicly held entity. National's quarterly financial statements are contained in the interim report. Green has not audited or reviewed these interim financial statements. Green should request that Green's name not be included in the communication. The financial statements be marked as unaudited, with a notation that no opinion is expressed on them.

Either I or II. The accountant may become aware that his or her name is to be included in a client-prepared written communication of an issuer containing financial statements that have not been audited or reviewed. Under PCAOB standards, which apply to engagements involving issuers, (s)he should request either that (1) his or her name not be included in the communication or (2) the financial statements be marked as unaudited, with a notation included to the effect that (s)he does not express an opinion on them.

When a scope limitation has precluded the auditor from obtaining sufficient appropriate evidence to determine whether certain client acts are illegal, (s)he would most likely express

Either a disclaimer of opinion or a qualified opinion. The auditor may be unable to determine the legality of certain acts or the amounts associated with them because of an inability to gather sufficient appropriate evidence; e.g., the internal control may have been circumvented, resulting in failure to record or properly document the acts, or client's legal counsel may have refused to give advice. In these circumstances, the scope limitation requires a qualified opinion or a disclaimer, although a client-imposed scope limitation ordinarily results in a disclaimer.

When the auditor cannot obtain sufficient appropriate evidence to determine whether certain client acts are not in compliance with laws and regulations, (s)he would most likely express

Either a disclaimer of opinion or a qualified opinion. When the auditor cannot obtain sufficient appropriate evidence, (s)he expresses a qualified opinion if the possible effects are material but not pervasive. If the possible effects are material and pervasive, (s)he disclaims an opinion.

Which of the following phrases will an auditor most likely include in the auditor's report when expressing a qualified opinion because of inadequate disclosure?

Except for the omission of the information. A report qualified for inadequate disclosure includes a basis for qualified opinion paragraph preceding the opinion paragraph. The opinion paragraph states, "In our opinion, except for the omission of information described in the Basis for Qualified Opinion paragraph, the financial statements referred to above present fairly . . ."

Zag Co. presents financial position and results of operations but not the related statement of cash flows. Zag would like to engage Brown, CPA, to audit its financial statements without the statement of cash flows, although Brown's access to all of the information underlying the basic financial statements will not be limited. Under these circumstances, Brown most likely would

Explain to Zag that the omission requires a qualification of the auditor's opinion. An entity that reports financial position and results of operations should provide a statement of cash flows. Thus, the omission of the cash flow statement is normally a basis for modifying the opinion. If the statements fail to disclose required information, the auditor should provide the information in the report, if practicable. However, the auditor is not required to prepare a basic financial statement. Accordingly, (s)he should qualify the opinion and explain the reason in a basis for qualified opinion paragraph.

How are management's responsibility and the auditor's responsibility represented in the auditor's report? Management's responsibility Auditor's responsibility

Explicitly Explicitly The auditor's report explicitly states, "Management is responsible for the preparation and fair presentation of these financial statements . . ." It also states, "Our responsibility is to express an opinion on these financial statements based on our audit" (AU-C 700).

Does an auditor make the following representations explicitly or implicitly in the opinion paragraph when expressing an unmodified opinion? Conformity with the Applicable Financial Reporting Framework Adequacy of Disclosure

Explicitly Implicitly The opinion paragraph of the auditor's report explicitly states whether the financial statements are in accordance with the applicable financial reporting framework, e.g., U.S. GAAP or IFRS. The adequacy of disclosure is implicit in the auditor's report. Adequacy of disclosure is implied if the report does not mention disclosure.

The objective of the audit of GAAP-based financial statements is to

Express an opinion on the fairness with which the statements present financial position, results of operations, and cash flows in accordance with generally accepted accounting principles. Based on an audit, the auditor expresses an opinion (or a disclaimer of opinion) on the fairness, in all material respects, of the presentation of financial statements, i.e., on whether they will be misleading to users.

An auditor's decision concerning whether to dual date the audit report is based upon the auditor's willingness to

Extend auditing procedures. When a subsequent event disclosed in the financial statements occurs after the date of the auditor's report but before the release of the auditor's report, the auditor may use dual dating. (S)he may date the report as of the original report date except for the matters affected by the subsequent event, which would be assigned the appropriate later date. In that case, the auditor's responsibility for events after the original report date would be limited to the specific event. If the auditor is willing to accept responsibility to the later date and accordingly extends subsequent events procedures to that date, the auditor may choose the later date as the date for the entire report.

On February 13, Year 2, Fox, CPA, met with the audit committee of the Gem Corporation to review the draft of Fox's report on the company's financial statements as of and for the year ended December 31, Year 1. On February 16, Year 2, Fox completed all remaining field work and obtained sufficient appropriate evidence to support the opinion on the financial statements. On February 28, Year 2, the final report was mailed to Gem's audit committee. What date most likely would be used on Fox's report?

February 16, Year 2. The report should be dated no earlier than the date on which the auditor has obtained sufficient appropriate audit evidence. February 16, Year 2, is the date that Fox obtained sufficient appropriate evidence to support the opinion on the financial statements. The auditor is not responsible for making any inquiries or carrying out any audit procedures for the period after the date of the report (but see AU-C 925).

The auditor's judgment concerning the overall fairness of the presentation of financial position, results of operations, and cash flows is applied within the framework of

Generally accepted accounting principles. Reporting standards require the auditor to state whether the audited entity's financial statements are presented in conformity with GAAP. Without an applicable reporting framework, the auditor would have no uniform standard for judging fairness of presentation.

In which of the following circumstances would an auditor usually choose between expressing a qualified opinion or disclaiming an opinion?

Inability to obtain sufficient appropriate audit evidence. Scope limitations may require a qualification of the opinion or a disclaimer. The choice depends on whether the possible effects of undetected misstatements are material and pervasive.

The auditor's report refers to the U.S. GAAP-based financial statements, which are customarily considered to include the balance sheet and the statements of

Income, changes in equity, and cash flows. The balance sheet, statement of income, statement of changes in equity, and statement of cash flows are the financial statements upon which the auditor customarily reports. Furthermore, provided that the entity has items of other comprehensive income, U.S. GAAP require that comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements that constitute a full set of financial statements. The format may be (1) one continuous statement consisting of net income and other comprehensive income (OCI) or (2) two separate but consecutive statements. The introductory paragraph identifies the titles of the entity's financial statements. However, the statement of changes in equity and a separate statement of comprehensive income are not separately reported on the opinion paragraph. The reason is that changes in equity and comprehensive income are included in financial position, results of operations, and cash flows.

The evaluation of fairness in determining the appropriate opinion to express should include consideration of the qualitative aspects of the entity's accounting practices, including whether

Indicators of possible bias exist in management's judgments. The auditor should be aware of the potential for management bias. For example, management's judgments may indicate a lack of neutrality that results in selective correction of identified misstatements and bias in making accounting estimates.

A CPA is associated with the financial statements of an issuer but is not independent. With respect to the CPA's lack of independence, which of the following actions by the CPA might confuse a reader of such financial statements?

Issuing a modified auditor's opinion explaining the reason for the auditor's lack of independence. A modified opinion is a qualified opinion, adverse opinion, or disclaimer of opinion. When a CPA lacks independence, (s)he should disclaim an opinion and state specifically that (s)he is not independent. This guidance is in the AICPA's pronouncement on compilations. It does NOT apply to engagements performed for issuers (public companies). Issuing a modified opinion would improperly imply that an audit was performed in accordance with GAAS (PCAOB AS 3320).

An auditor released an audit report that was dual-dated for a subsequently discovered fact occurring after the date of the auditor's report but before issuance of the related financial statements. The auditor's responsibility for events occurring subsequent to the original report date was

Limited to the specific event referenced. Subsequent to the original report date, the auditor is responsible only for the specific subsequently discovered fact for which the report was dual-dated. (S)he is responsible for other events only up to the original report date.

Under which of the following circumstances would a disclaimer of opinion not be appropriate?

Management does not provide reasonable justification for a change in accounting principles. If (1) the new principle and the method of accounting for the effect of the change are in accordance with the applicable reporting framework, (2) disclosures are adequate, and (3) the entity has justified that the principle is preferable, the auditor expresses an unmodified opinion. Otherwise, if the change is material, the misstatement results in expression of a qualified or an adverse opinion in the report for the year of change. A basis for modified opinion paragraph is added preceding the opinion paragraph.

Under which of the following circumstances would the expression of a disclaimer of opinion be inappropriate?

Management does not provide reasonable justification for a change in accounting principles. When management does not provide reasonable justification for a change in accounting principles, a qualified or adverse opinion should be expressed if the effect is a material misstatement.

The primary responsibility for the adequacy of disclosure in the financial statements of an issuer rests with the

Management of the issuer. Management is responsible for the accounting policies and the internal control of an entity, including the accounting system. Accordingly, management has the primary responsibility for the fairness of presentation of the financial statements in accordance with U.S. GAAP.

When financial statements audited by the independent auditor contain notes that are captioned "unaudited" or "not covered by the auditor's report," the auditor

May refer to these notes in the auditor's report. If information included in the basic statements is (1) not required by the applicable reporting framework, (2) not necessary for fair presentation, and (3) clearly differentiated from the statements, the information may be identified as "unaudited" or "not covered by the auditor's report" (AU-C 700). If the auditor wishes to draw attention to such a matter that is appropriately presented or disclosed, (s)he may include an emphasis-of-matter paragraph in the auditor's report (AU-C 705). If (1) the information constitutes other information, (2) the information is materially inconsistent with the audited statements, and (3) management has not revised the information after a request by the auditor, the auditor should (1) include an other-matter paragraph in the report, (2) withhold the report, or (3) withdraw from the engagement. If the information contains a material misstatement of fact that management refuses to correct, the auditor should take further appropriate action (AU-C 720).

An auditor's report includes the following statement: "The financial statements referred to above do not present fairly the financial position, results of operations, or cash flows in conformity with U.S. generally accepted accounting principles." This auditor's report was most likely issued in connection with financial statements that are

Misleading The language quoted states an adverse opinion. The essence of an adverse opinion is that the statements reported on, as a whole, are materially and pervasively misstated. If financial statements fail to meet the standards, they are misleading.

March, CPA, is engaged by Monday Corp., a client, to audit the financial statements of Wall Corp., a company that is not March's client. Monday expects to present Wall's audited financial statements with March's auditor's report to 1st Federal Bank to obtain financing in Monday's attempt to purchase Wall. In these circumstances, March's auditor's report would usually be addressed to

Monday Corp., the client that engaged March. If an auditor is retained to audit the financial statements of an entity that is not his or her client, the report customarily is addressed to the client and not to the board of directors or shareholders of the entity whose financial statements are being audited.

An auditor expresses a qualified opinion because of a material misstatement related to specific amounts in the financial statements. Which of the following phrases should be included in the opinion paragraph? "When Read in Conjunction with Note X" "With the Foregoing Explanation"

No No The auditor should use the phrase "except for" to qualify an opinion, followed by the basis for the qualification and a reference to the basis for qualified opinion paragraph preceding the opinion paragraph. Given a qualification because of a material misstatement related to specific amounts in the financial statements, the basis paragraph should describe the matter resulting in the qualification. It also should include (1) a description and quantification of the financial effects, if practicable; (2) an explanation of how narrative disclosures are misstated; or (3) omitted information, if practicable, and a description of its nature. However, if financial-effects disclosures are made in a note to the statements, the basis paragraph may refer to it. Furthermore, the notes are part of the financial statements, and a phrase such as "when read in conjunction with Note X" in the opinion paragraph is likely to be misunderstood. Also, wording such as "with the foregoing explanation" is neither clear nor forceful enough.

When an auditor qualifies an opinion because of the omission of information required to be disclosed, the auditor should describe the nature of the omission in the basis for qualified opinion paragraph and modify the Introductory Paragraph Auditor's Responsibility Section Opinion Paragraph

No Yes Yes If the material misstatement relates to specific amounts, the basis paragraph should describe and quantify the financial effects, if practicable. If the misstatement relates to narrative disclosures, the auditor should include an explanation. If the misstatement relates to an omission of required information, the auditor should describe the nature of the information and, if practicable, include the information. If the opinion is qualified, (1) the introductory paragraph and management's responsibility for the financial statements paragraph are unchanged, (2) the auditor's responsibility section mentions that the audit opinion is qualified, and (3) the opinion paragraph includes the language ". . ., except for the effects of the matter(s) described in the basis for qualified opinion paragraph, . . ."

Which of the following parts of the auditor's report are changed when an adverse opinion is expressed? Introductory Paragraph Auditor's Responsibility Section Opinion Paragraph

No Yes Yes The opinion should state that, because of the significance of the matter(s) described in the basis for adverse opinion paragraph, the financial statements are not presented fairly in accordance with the framework. The following are other effects on the auditor's report when an adverse opinion is expressed: (1) The introductory paragraph is unchanged; (2) the management's responsibility paragraph is unchanged; and (3) the auditor's responsibility section is changed to state, "We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our adverse audit opinion."

An annual shareholders' report includes audited financial statements and contains a management report asserting that the financial statements are the responsibility of management. Is it permissible for the auditor's report to refer to the management report?

No, because the reference may lead to the belief that the auditor is providing assurances about management's representations. According to AU-C 700, such a reference in the auditor's report may lead users to the erroneous belief that the auditor is giving assurances about management's representations in the separate statement in the annual report.

Due to a scope limitation, an auditor disclaimed an opinion on the financial statements as a whole, but the auditor's report included a statement that the current asset portion of the entity's balance sheet was fairly stated. The inclusion of this statement is

Not appropriate because it may tend to overshadow the auditor's disclaimer of opinion. A piecemeal opinion is an expression of an opinion on a specific element of a financial statement when the auditor has disclaimed an opinion or expressed an adverse opinion on the financial statements as a whole. This type of assurance is inappropriate because it would contradict a disclaimer of opinion or an adverse opinion (AU-C 705).

If the auditor obtains satisfaction with respect to the accounts receivable balance by alternative procedures because it is impracticable to confirm accounts receivable, the auditor's report should be unmodified and could be expected to

Not mention the alternative procedures. External confirmation of receivables is required except when (1) they are immaterial, (2) confirmation would be ineffective, or (3) the assessed risk of material misstatement is low; other substantive procedures address the assessed risk (AU505). Thus, if the auditor is able to obtain sufficient appropriate audit evidence without external confirmation, the opinion is unmodified, and the report should not refer to the omission of the procedures or the use of alternative procedures.

The existence of audit risk is recognized by the statement in the auditor's report that the auditor

Obtains reasonable assurance about whether the financial statements are free of material misstatement. The existence of audit risk is recognized by the statement in the auditor's report that the auditor obtained reasonable assurance about whether the financial statements are free of material misstatement. Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Audit risk exists because the assurance is not absolute. Reasonable assurance is obtained when the auditor has obtained sufficient appropriate evidence to reduce audit risk to an acceptably low level (AU-C 200).

When an auditor expresses an adverse opinion, the matter resulting in the modification should be described in a paragraph

Preceding the opinion paragraph. When an adverse opinion is expressed, the opinion paragraph should refer to a basis for adverse opinion paragraph that precedes the opinion paragraph. This paragraph describes the matter resulting in the modification (AU-C 705).

The auditor's opinion refers to U.S. generally accepted accounting principles (U.S. GAAP). Which of the following best describes U.S. GAAP?

Principles issued by bodies designated by the Council of the AICPA. GAAP are issued by bodies designated by the AICPA Council in accordance with the Compliance with Standards and Accounting Principles Rules of Conduct. For nongovernmental financial accounting purposes, these standards setters include the FASB for U.S. GAAP and the International Accounting Standards Board (IASB) for international financial reporting standards. Moreover, pronouncements of the SEC must be followed by registrants.

An auditor was unable to obtain audited financial statements or other evidence supporting an entity's investment in a foreign subsidiary. Between which of the following reports should the entity's auditor choose?

Qualified and disclaimer. An auditor's inability to obtain sufficient appropriate evidence may arise from, among other things, circumstances related to the nature or timing of the auditor's work. An example is an inability, not resulting from a management-imposed limitation, to obtain audited financial statements of a long-term investee. If the possible effects are material, the auditor expresses a qualified opinion or disclaims an opinion, depending on pervasiveness (AU-C 705).

When an issuer refuses to include in its audited financial statements the segment disclosures that the auditor believes are required, the auditor should express a(n)

Qualified opinion because of inadequate disclosure. If the statements are materially misstated because of the omission of required information, the auditor should modify the opinion for inadequate disclosure and describe the information omitted. The auditor also should include this information in the report, if practicable. But the auditor is not expected to prepare segment information. (S)he need not assume the position of a preparer of financial information.

An auditor concludes that a client's noncompliance with laws and regulations, which has a material effect on the financial statements, has not been properly accounted for or disclosed. Depending on how pervasive the effect is on the financial statements, the auditor should express either a(n)

Qualified opinion or an adverse opinion. When noncompliance with laws and regulations having a material effect on the financial statements has been detected but not properly reported, the auditor should insist upon revision of the financial statements. Failure to revise the statements precludes an unmodified opinion. Depending on the pervasiveness of the misstatement, the auditor should express either a qualified opinion or an adverse opinion.

If an issuer releases financial statements that purport to present its financial position and results of operations but omits the statement of cash flows, the auditor ordinarily will express a(n)

Qualified opinion. An entity that reports financial position and results of operations should provide a statement of cash flows. Thus, the omission of the cash flow statement is normally a basis for modifying the opinion. If the statements fail to disclose required information, the auditor should provide the information in the report, if practicable. However, the auditor is not required to prepare a basic financial statement. Accordingly, (s)he should qualify the opinion and explain the reason in a basis for qualified opinion paragraph.

When the financial statements contain a misstatement, the effect of which is material but not pervasive, the auditor should

Qualify the opinion and include a basis for qualified opinion paragraph that describes the matter resulting in the qualification. When the financial statements are materially misstated, but the effects are not pervasive, the auditor should express a qualified opinion. The report should contain a basis for qualified opinion paragraph preceding the opinion paragraph. If the material misstatement relates to specific amounts, the basis paragraph should describe and quantify the financial effects, if practicable. If the misstatement relates to narrative disclosures, the auditor should include an explanation. If the misstatement relates to an omission of required information, the auditor should describe the nature of the information and, if practicable, include the information. The opinion paragraph should refer to the basis paragraph.

Question: 68 A CPA engaged to audit financial statements observes that the accounting for a certain material but not pervasive item is not in conformity with the applicable financial reporting framework, although the matter is prominently disclosed in a note to the financial statements. The CPA should

Qualify the opinion because of the misstatement. When financial statements are materially misstated, but the effects are not pervasive, the auditor should express a qualified opinion if the audit has been in accordance with GAAS. The basis for the opinion should be stated in the report even if full and prominent note disclosure has been made.

A CPA who is associated with the financial statements of an issuer, but has not audited or reviewed such statements, should

Read them to determine whether there are obvious material misstatements. PCAOB auditing standards apply to engagements involving issuers. Under these standards, the CPA should issue a disclaimer stating that (s)he has not audited the statements and expresses no opinion on them. The CPA has no responsibility to apply any procedures beyond reading the financial statements for obvious material misstatements (PCAOB AS 3320).

When an independent CPA assists in preparing the financial statements of an issuer but has not audited or reviewed them, the CPA should issue a disclaimer of opinion. In such situations, the CPA has no responsibility to apply any procedures beyond

Reading the financial statements for obvious material misstatements. PCAOB standards apply to audit engagements involving issuers. Under the standards, the accountant has no responsibility to apply any procedures beyond reading the financial statements for obvious material misstatements. Any procedures applied should not be described.

A limitation on the scope of the audit sufficient to preclude an unmodified opinion is most likely to result when management

Refuses to permit its lawyer to respond to the letter of audit inquiry. Direct communication with the entity's external legal counsel should be made if actual or potential litigation, claims, or assessments may result in a risk of material misstatement. If management refuses to permit this communication, the auditor should modify the opinion.

A closely held manufacturing company must disclose all of the following information in audited financial statements except

Replacement cost of inventory. A U.S. manufacturer should report inventory at full absorption cost unless the fair value is less than cost. Neither closely nor publicly held companies must report replacement cost of inventory.

On September 30, Year 2, Miller was asked to reissue an auditor's report dated March 31, Year 2, on a client's financial statements for the year ended December 31, Year 1. Miller will submit the reissued report to the client in a document that contains information in addition to the client's basic financial statements. However, Miller discovered that the client suffered substantial losses on receivables resulting from conditions that occurred since March 31, Year 2. Miller should

Request the client to disclose the event in a separate, appropriately labeled note to the financial statements and reissue the original report with its original date. To prevent the financial statements from being misleading, management may disclose an event that arose after the date of the auditor's report. If the event is included in a separate note labeled as unaudited [e.g., a note captioned as "Event (Unaudited) Subsequent to the Date of the Independent Auditor's Report"], the auditor need not perform any procedures on the note. Moreover, the auditor's report should have the same date as the original report (AU-C 560).

Which of the following is an example of a CPA being associated with unaudited financial statements of a public entity?

The CPA analyzes the client's input data before sending the data to an independent computer service company, and the processed financial statements are returned directly to the client. If a CPA helps prepare or consents to the use of his or her name with unaudited financial statements, (s)he is associated with them. A CPA who reviews the client's input data has assisted in the preparation of the statements and is deemed to be associated with them (PCAOB AS 3320).

An auditor's report on audited financial statements is inappropriate if it refers to

The CPA's assessment of sampling risk factors. The auditor's report on audited financial statements states, "An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements." But the auditor's report does not directly refer to sampling. It also does not describe specific procedures.

An auditor has been engaged by the State Bank to audit the XYZ Corporation in conjunction with a loan commitment. The report would most likely be addressed to

The State Bank. Occasionally, an auditor is retained to audit the financial statements of an entity that is not his or her client. In such a case, the report customarily is addressed to the client and not to those charged with governance of the entity whose financial statements are being audited.

The date of the audit report is important because

The auditor cannot date the report earlier than the date on which sufficient appropriate evidence to support the opinion has been obtained. The auditor cannot date the report until sufficient appropriate evidence has been obtained. This date informs users that the auditor has considered the effects of events and transactions occurring up to that date of which the auditor became aware.

Which of the following circumstances would not be considered a departure from the auditor's unmodified report?

The auditor is asked to report only on the balance sheet, and the auditor can comply with relevant standards. The auditor may report on one basic financial statement and not on the others if (1) the auditor complies with all AU-C sections relevant to the audit, (2) the audit is feasible, and (3) the auditor can perform procedures on interrelated items. For example, (1) sales and receivables, (2) inventory and payables, and (3) equipment and depreciation are interrelated.

Under which of the following circumstances might an auditor disclaim an opinion?

The auditor is unable to obtain sufficient appropriate evidence to support management's assertions concerning an uncertainty. Based on the audit evidence that is, or should be, available, the auditor assesses whether the audit evidence is sufficient to support managements' assertions about an uncertainty. When the auditor cannot obtain sufficient appropriate evidence, (s)he expresses a qualified opinion if the possible effects are material but not pervasive. If the possible effects are material and pervasive, (s)he disclaims an opinion.

Under which of the following circumstances would an auditor's expression of an unmodified opinion for a nonissuer be inappropriate?

The auditor is unable to obtain the audited financial statements of a significant subsidiary. An auditor's inability to obtain sufficient appropriate evidence may arise from, among other things, circumstances related to the nature or timing of the auditor's work. An example is an inability, not resulting from a management-imposed limitation, to obtain audited financial statements of a long-term investee. If the possible effects are material, the auditor expresses a qualified opinion or disclaims an opinion, depending on pervasiveness (AU-C 705).

An auditor may not express a qualified opinion when

The auditor lacks independence with respect to the audited entity. An auditor must be independent of the entity when performing an audit in accordance with GAAS unless (1) GAAS provide otherwise or (2) a law or regulation requires the auditor to report on the statements (AU-C 200).

Which of the following statements best describes the distinction between the auditor's responsibilities and management's responsibilities?

The auditor's responsibility is confined to expressing an opinion, but the financial statements remain the responsibility of management. The auditor is responsible for the opinion on financial statements, but management is responsible for the representations made in the financial statements.

An auditor did not observe a client's taking of beginning physical inventory and was unable to become satisfied about the inventory by means of other auditing procedures. The possible effects are material. Assuming no other scope limitations or reporting problems, the auditor could express an unmodified opinion on the current year's financial statements for

The balance sheet only. The auditor did not observe the counting of physical inventories at the beginning of the year and was not able to become satisfied by performing other procedures on those inventories. Because they enter into the determination of net income and cash flows, the auditor could not determine whether any adjustments were needed with respect to profit and net cash flows from operating activities. Moreover, the possible effects of the inability to obtain sufficient appropriate evidence regarding beginning inventories are material. Thus, the auditor should not express an opinion on the results of operations and cash flows. However, because the balance sheet reports only the ending inventory balance, the auditor can express an unmodified opinion on it alone, assuming (s)he is satisfied with the ending balance.

Under which of the following circumstances would the expression of a disclaimer of opinion be inappropriate?

The company issues financial statements that purport to present financial position and results of operations but refuses to include the related statement of cash flows. An entity that reports financial position and results of operations should provide a statement of cash flows. Thus, the omission of the cash flow statement is normally a basis for modifying the opinion. If the statements fail to disclose required information, the auditor should provide the information in the report, if practicable. However, the auditor is not required to prepare a basic financial statement. Accordingly, (s)he should qualify the opinion because of a material misstatement and explain the reason in a basis for qualified opinion paragraph.

A former client requests a predecessor auditor to reissue an audit report on a prior period's financial statements. The financial statements are not restated and the report is not revised. What date(s) should the predecessor auditor use in the reissued report?

The date of the prior-period report. Use of the original date in a predecessor auditor's reissued report removes any implication that records, transactions, or events after such date have been audited or reviewed. However, the predecessor auditor should perform the following procedures to determine whether the report is still appropriate: (1) read the statements of the subsequent period, (2) compare the prior statements with the current statements, and (3) obtain written representations from management and the successor auditor about information obtained or events that occurred subsequent to the original date of the report (also see AU-C 925 regarding filings under the Securities Act of 1933).

Which of the following factors most likely would influence an auditor's determination of the auditability of an entity's financial statements?

The destruction of the accounting records. When the auditor cannot obtain sufficient appropriate evidence, (s)he expresses a qualified opinion if the possible effects are material but not pervasive. If the possible effects are material and pervasive, (s)he disclaims an opinion. An inability to obtain sufficient appropriate evidence may result from (1) circumstances beyond the control of the entity, (2) circumstances related to the nature or the timing of the work, or (3) a management-imposed limitation. They result in either a qualified opinion or a disclaimer. Circumstances beyond the control of the entity include (1) destruction of accounting records or (2) indefinite governmental seizure of accounting records (AU-C 705).

A client decides not to correct misstatements communicated by the auditor that collectively are not material and wants the auditor to issue the report based on the uncorrected numbers. Which of the following statements is correct regarding the financial statement presentation?

The financial statements are free from material misstatement, and no disclosure is required in the notes to the financial statements. If the uncorrected misstatements are immaterial, by definition the financial statements are free from material misstatement, and an unmodified opinion may be expressed. However, the schedule of uncorrected misstatements must be included in the management representation letter, and management must assert that these uncorrected misstatements are individually and collectively immaterial.

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

The financial statements are not in conformity with the FASB Codification's guidance regarding the capitalization of leases. An adverse opinion is expressed when, in the auditor's judgment, the financial statements as a whole are not presented fairly in conformity with GAAP. The FASB Accounting Standards Codification is authoritative with regard to U.S. GAAP.

Under which of the following circumstances would a disclaimer of opinion not be appropriate?

The financial statements fail to contain adequate disclosure concerning related party transactions. A disclaimer is inappropriate when the financial statements contain material departures from the applicable financial reporting framework. Inadequacy of the disclosures required by the applicable financial reporting framework is such a departure. Because U.S. GAAP require certain disclosures about related party transactions, the inadequacy of such disclosures is a basis for expressing a qualified or an adverse opinion.

In which of the following situations would an auditor ordinarily choose between expressing a qualified opinion and an adverse opinion?

The financial statements fail to disclose information that is required by the applicable reporting framework. Misstatements, including inadequate disclosures, may result in either a qualified or an adverse opinion. The auditor should exercise judgment about materiality by considering such factors as (1) benchmarks for dollar amounts, (2) significance to the statements and the entity, and (3) pervasiveness. If the misstatement is not pervasive, the auditor should express a qualified opinion.

Which of the following best describes why an independent auditor is asked to express an opinion on the fair presentation of financial statements?

The opinion of an independent party is needed because a company may not be objective with respect to its own financial statements. The opinion of a suitably qualified, independent, outside party lends credibility to the financial statements and provides some protection to third parties who may rely upon them when making investment decisions. The opinion contained in the audit report, which accompanies audited financial statements, is the result of the auditor's performance of the attest function, that is, the gathering of evidence during the audit and the issuance of an opinion on the fairness of the presentation of the statements.

When an auditor qualifies an opinion because of a scope limitation, which part(s) of the auditor's report should indicate that the qualification pertains to the possible effects on the financial statements and not to the scope limitation itself?

The opinion paragraph only. When a qualified opinion results from an inability to obtain sufficient appropriate evidence, the auditor describes the matter in the basis for qualified opinion paragraph, not in a note to the statement. The description of the audit scope is the responsibility of the auditor, not management. The opinion paragraph should indicate that the qualification pertains to the possible effects on the financial statements, not to the scope limitation itself. The wording ". . . except for the possible effects of the matter described in the basis for qualified opinion paragraph . . ." is appropriate. The following are the other effects on the auditor's report when the opinion is qualified due to an inability to obtain sufficient appropriate evidence with possible effects that are material but not pervasive: (1) The introductory paragraph is unchanged; (2) the management's responsibility paragraph is unchanged; and (3) the auditor's responsibility section ends with the sentence, "We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified audit opinion."

An auditor decides to express a qualified opinion on an entity's financial statements because a major inadequacy in its computerized accounting records prevents the auditor from applying necessary procedures. The opinion paragraph of the auditor's report should state that the qualification pertains to

The possible effects on the financial statements. When an auditor qualifies his or her opinion because of a scope limitation, the wording in the opinion paragraph should indicate that the qualification pertains to the possible effects on the financial statements and not to the scope limitation itself.

Which of the following statements is a basic element of the auditor's report for a nonissuer?

The procedures used depend on the auditor's judgment. The auditor's responsibility section states, "The procedures selected depend on the auditor's judgment . . ."

Limitation on the scope of the audit may require the auditor to express a qualified opinion or to disclaim an opinion. Which of the following is a limitation on the scope of the audit?

The unavailability of sufficient appropriate evidence. A limitation on the scope of the audit is defined as an auditor's inability to obtain sufficient appropriate audit evidence. It may result from (1) circumstances not controlled by the entity, (2) circumstances related to the nature or timing of audit work, or (3) limitations imposed by management. An auditor's inability to obtain sufficient appropriate audit evidence results in a qualified opinion (disclaimer of opinion) when the possible effects of undetected misstatements are material but not pervasive (material and pervasive) (AU-C 705).

Under which of the following circumstances might an auditor disclaim an opinion?

There are significant uncertainties affecting the financial statements for which the auditor is unable to obtain sufficient evidence to support management's assertions If the auditor is unable to obtain sufficient evidential matter to support management's assertions about a matter, a qualified opinion or disclaimer of opinion should be expressed.

An auditor's opinion reads as follows: "In our opinion, except for the above-mentioned limitation on the scope of our audit..." This is an example of an

Unacceptable reporting practice. When an opinion is qualified because of a scope limitation, the opinion paragraph should indicate that the qualification pertains to the possible effects on the statements of undetected misstatements (AU-C 705). The language given in the question bases the qualification on the restriction itself and is unacceptable.

Park, CPA, was engaged to audit the financial statements of Tech Co., a new client, for the year ended December 31, Year 1. Park obtained sufficient appropriate audit evidence for all of Tech's financial statement items except Tech's opening inventory. Due to inadequate financial records, Park could not verify Tech's January 1, Year 1, inventory balances. Park's opinion on Tech's Year 1 financial statements most likely will be Balance Sheet Income Statement

Unmodified Disclaimer The auditor may report on one basic financial statement and not on the others. Because the balance sheet presents information at a specific moment in time, the auditor should be able to become satisfied regarding the balances presented at year end. However, beginning inventory is included in the determination of the results of operations and cash flows. Thus, the auditor will probably not be able to form an opinion as to the fairness of these statements and should disclaim an opinion on them.

Eagle Company's financial statements contain a departure from generally accepted accounting principles because, due to unusual circumstances, the statements would otherwise be misleading. The auditor should express an opinion that is

Unmodified and describe the departure in an other-matter paragraph. A material departure from GAAP prohibits expression of an opinion that financial statements are in conformity with GAAP. However, an exception is permitted when the auditor can demonstrate that because of unusual circumstances the statements would otherwise have been misleading. Given these circumstances, and if no other basis for modifying the opinion exists, the auditor may express an unmodified opinion, provided that (s)he describes in an other-matter paragraph of the report the departure, its effects, and the reasons compliance with GAAP would have been misleading.

Fact Pattern: An audit was performed by Leo Gonzales, CPA, of the financial statements of Lectronic Leasing Company for the year ended December 31. A cash advance to Computer Credit Corporation is material to the presentation of Lectronic's financial position. Computer Credit's unaudited financial statements show negative working capital, negative equity, and losses in each of the 5 preceding years. Mr. Gonzales has suggested an allowance for the uncollectibility of the advance to Computer Credit. All of the stock of both Lectronic and Computer Credit is owned by Paul McRae and his family. Mr. McRae adamantly refuses to consider an allowance for uncollectibility. He insists that Computer Credit eventually will be profitable and be able to repay the advance. Mr. McRae proposes the following note to Lectronic's statements: Note to Financial Statements At December 31, the Company had advanced $500,000 to Computer Credit Corporation. We obtained written confirmation of this debt from Computer Credit Corporation and reviewed unaudited financial statements of Computer Credit Corporation. Computer Credit Corporation is not in a position to repay this advance at this time, but the Company has informed us that it is optimistic as to the future of Computer Credit Corporation. Computer Credit Corporation's stock is wholly owned by Lectronic Leasing Company's common shareholders. Assume that subsequent to the date of the auditor's report (but prior to issuance of the related financial statements) Mr. McRae and his family sell all of their stock in Computer Credit and the new owners repay the advance from Lectronic. Mr. Gonzales' opinion as to Lectronic's financial statements will be

Unmodified because the issue of collectibility is now settled. The subsequent event provides additional evidence with respect to conditions existing at the balance sheet date. Such an event may require adjustment of the financial statements and consequently may affect the audit report (AU-C 560). Here, the auditor can now express an unmodified opinion, assuming no other basis exists for modifying the opinion. The subsequent event has eliminated the issue of collectibility of the receivable.

Green, CPA, was engaged to audit the financial statements of Essex Co. after its fiscal year had ended. The timing of Green's appointment as auditor and the start of field work made confirmation of accounts receivable by direct communication with the debtors ineffective. However, Green applied other procedures and was satisfied as to the reasonableness of the account balances. Green's auditor's report most likely contained a(n)

Unmodified opinion. Because the CPA is satisfied as to the amounts of receivables, no scope limitation exists. Accordingly, the report need not refer to the omission of the procedures or the use of alternative procedures, and the CPA may express an unmodified opinion.

Billie J. King, CPA, was engaged to audit the financial statements of Newton Co. after its fiscal year had ended. King neither observed the inventory count nor confirmed the receivables by direct communication with debtors, but was satisfied concerning both after applying alternative procedures. King's auditor's report most likely contained a(n)

Unmodified opinion. Because the auditor is satisfied as to inventory quantities and the amounts of receivables, she obtained sufficient appropriate evidence. Accordingly, the opinion is not modified.

An external auditor discovers that a payroll supervisor of the firm being audited has misappropriated $10,000. The firm's total assets and before-tax net income are $14 million and $3 million, respectively. Assuming no other issues affect the report, the external auditor's report will most likely contain a(n)

Unmodified opinion. The auditor is likely to express an unmodified opinion for two reasons. First, the misappropriated amount is immaterial relative to assets and income. Second, as long as the misappropriation is accounted for properly, the financial statements will be fairly presented.

In May Year 3, an auditor reissues the auditor's report on the Year 1 financial statements at a former client's request. The Year 1 financial statements are to be presented comparatively with subsequent audited statements. They are not restated, and the auditor does not revise the wording of the report. The auditor should

Use the original report date on the reissued report. Use of the original date in a reissued report removes any implication that records, transactions, or events after such date have been audited or reviewed. However, the predecessor auditor should perform the following procedures to determine whether the report is still appropriate: (1) read the statements of the subsequent period, (2) compare the prior statements with the current statements, and (3) obtain written representations from management and the successor auditor about information obtained or events that occurred subsequent to the original date of the report.

Adequate disclosure means that sufficient information is presented so that financial statements are not misleading. The decisions about adequate disclosure should reflect the needs of

Users with a reasonable knowledge of business. The auditor considers the needs of users of the financial statements. However, it is reasonable for the auditor to assume that users (1) have reasonable knowledge of business and accounting, (2) are willing to study financial information with reasonable diligence, (3) understand the materiality limits of audited statements, (4) recognize that many amounts in the statements are based on estimates and judgments, and (5) make reasonable decisions based on the statements.

Under which of the following circumstances may audited financial statements contain a note that is labeled "unaudited," disclosing an event occurring after the balance sheet date?

When the event occurs after the date of the auditor's original report To prevent the financial statements from being misleading, management may disclose an event that arose after the date of the auditor's report. If the event is included in a separate note labeled as unaudited [e.g., a note captioned as "Event (Unaudited) Subsequent to the Date of the Independent Auditor's Report"], the auditor need not perform any procedures on the note. Moreover, the auditor's report should have the same date as the original report (AU-C 560).

When financial statements are materially but not pervasively misstated, an auditor may express a Qualified Opinion Disclaimer of an Opinion

Yes No A material misstatement results in either a qualified or an adverse opinion. The auditor must exercise judgment as to whether the misstatement is pervasive. If the misstatement is not pervasive, the auditor should express a qualified opinion.

An auditor may reasonably express an "except for" qualified opinion for a(n) Scope Limitation Unjustified Change in an Accounting Principle

Yes Yes A qualified opinion should be expressed if the auditor (1) has obtained sufficient appropriate audit evidence and concludes that misstatements, individually or combined, are material but not pervasive to the financial statements or (2) is unable to obtain sufficient appropriate audit evidence but concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive. A misstatement results from, for example, an inappropriate selection or application of an accounting principle. Among other things, the auditor evaluates whether the entity has justified that the alternative principle is preferable. An inability to obtain sufficient appropriate evidence is a scope limitation. Thus, an unjustified change in principle or a scope limitation may require expression of a qualified opinion. NOTE: All qualified opinions are "except for" opinions.

An auditor may express a qualified opinion for which of the following reasons? Circumstances Related to the Work Limitations Imposed by Management

Yes Yes An auditor may express a qualified opinion due to an inability to obtain sufficient appropriate audit evidence if the possible effects are material but not pervasive. The inability to obtain sufficient audit evidence (also called a scope limitation) may result from (1) circumstances not controlled by the entity, such as destruction or government seizure of accounting records; (2) circumstances related to the nature or timing of the work, such as not being able to (a) observe inventory due to the late appointment of the auditor, (b) obtain an investee's financial information, or (c) determine that controls are ineffective; or (3) limitations imposed by management, such as preventing the auditor from observing inventory or confirming receivables (AU-C 705).

An auditor of a nonissuer was engaged by the client to use PCAOB auditing standards to conduct the audit. The auditor should refer in the report to PCAOB Auditing Standards Generally Accepted Auditing Standards

Yes Yes When conducting an audit of financial statements in accordance with the standards of the PCAOB and the audit is not within the jurisdiction of the PCAOB, the auditor is required to also conduct the audit in accordance with GAAS. In such circumstances, when the auditor refers to the standards of the PCAOB in addition to GAAS in the auditor's report, the auditor should use the form of report required by the standards of the PCAOB, amended to state that the audit was also conducted in accordance with GAAS.

The auditor's report most likely is addressed to the following: Board of Directors Audited Entity Internal Auditors

Yes Yes No According to AU-C 700, the auditor's report ordinarily is addressed to those for whom the report is prepared. It may be addressed to the entity whose statements are being audited or to those charged with governance (e.g., the board or the audit committee). If the client is an unincorporated entity, the addressee depends on the circumstances, e.g., to the partners or the proprietor.