AUDIT Chapter 3 - Audit Reports (Textbook Questions)

What four circumstances are required for a standard unmodified opinion audit report to be issued? (Objective 3-2)

1. All statements are included in the financial statements 2. Sufficient appropriate evidence has been accumulated 3. Financial statements are presented with GAAP or IFRS 4. There are no circumstances requiring addition of an explanatory paragraph or modification of the wording of the report.

What are the three levels of materiality and what type of opinion is needed?

1. Immaterial (Unmodified) 2. Material (Qualified) 3. Highly Material (Disclaimer or Adverse)

What are the eight parts of a standard unmodified opinion audit report for a nonpublic entity and what is the main content provided in each part?

1. Report Title 2. Audit report Address 3. Intro Paragraph 4. Management's Responsibility 5. Auditor's Responsibility 6. Opinion paragraph 7. Signature and address of CPA Firm 8. Audit report date

Explain how materiality differs for failure to follow GAAP and for lack of independence (3-6)

Materiality for lack of independence in audit reporting is easiest to define. If the auditor lacks independence as defined by the Code of Professional Conduct, it is always considered highly material and therefore a disclaimer of opinion is always necessary. That is, either the CPA is independent or not independent. For failure to follow GAAP, there are three levels of materiality: immaterial, material, and highly material.

The client changed from FIFO to LIFO inventory valuation in the current year and reflected this change in their financials. If auditor does not concur with the appropriateness of this change, How should this be reflected in the auditor's report? (3-4)

Qualified Opinion

What is a disclaimer of opinion? (3-7)

A disclaimer of opinion states that the auditor has been unable to satisfy him or herself as to whether or not the overall financial statements are fairly presented because of a significant limitation of the scope of the audit, or a nonindependent relationship under the Code of Professional Conduct between the auditor and the client.

What is an emphasis-of-matter paragraph?

A paragraph in auditor's report that refers to a matter appropriately presented or disclosed in the financial statements that, in the auditor's judgment, is of such importance that it is fundamental to users' understanding of the financial statements

Distinguish between a qualified opinion, an adverse opinion, and a disclaimer of opinion, and explain the circumstances under which each is appropriate (3-5)

A qualified opinion states that there has been either a limitation on the scope of the audit or a departure from GAAP in the financial statements, but that the auditor believes that the overall financial statements are fairly presented. This type of opinion may not be used if the auditor believes the exceptions being reported upon are extremely material, in which case a disclaimer or adverse opinion would be used. An adverse opinion states that the auditor believes the overall financial statements are so materially misstated or misleading that they do not present fairly in accordance with GAAP the financial position, results of operations, or cash flows. A disclaimer of opinion states that the auditor has been unable to satisfy him or herself as to whether or not the overall financial statements are fairly presented because of a significant limitation of the scope of the audit, or a nonindependent relationship under the Code of Professional Conduct between the auditor and the client. Examples: Disclaimer - Material physical inventories not observed and the inventory cannot be verified through other procedures. Lack of indepdence by the auditor Adverse - A highly material departure from GAAP. Qualified - Inability to confirm the existence of an asset which is material but not extremely material in value.

DIstinguish between a report qualified due to a GAAP departure and one qualified due to a scope limitation. (3-5)

A qualified report due to a scope limitation is issued when the auditor can neither perform procedures that he or she considers necessary nor satisfy himself or herself by using alternative procedures, usually due to the existence of conditions beyond the client's or the auditor's control, but the amount involved in the financial statements is not highly material. An important part of qualified opinion due to a scope limitation is that it results from not accumulating sufficient appropriate audit evidence, either because of the client's request or because of circumstances beyond anyone's control. When the opinion is qualified due to a scope limitation, the auditor modifies both the scope and opinion paragraphs. The scope paragraph is modified to indicate that the auditor's scope has been restricted and the opinion paragraph is modified to include the qualified opinion. A report qualified as to opinion only results when the auditor has accumulated sufficient appropriate evidence but has concluded that the financial statements are not correctly stated. The only circumstance in which an opinion only qualification is appropriate is for material, but not highly material, departures from GAAP. When the opinion is qualified due to a GAAP departure, only the opinion paragraph is modified to include the qualified opinion. The scope paragraph is not modified because there has been no limitation on the auditor's scope.

What is a scope limitation? (3-7)

A scope limitation is a restriction on an audit that is caused by the client, issues beyond the control of the client, or other events that do not allow the auditor to complete all aspects of his or her audit procedures. Examples of events causing a scope limitation are the disappearance of relevant evidentiary matter and the client's restriction on contact with customers to confirm the existence of accounts receivable.

What is an unmodified opinion? (3-1)

Auditor's opinion about financials contains no material exceptions or qualifications.

Explain why auditor's reports are important to users of financial statements and why it is desirable to have standard wording (Objective 3-1)

Auditor's reports increase trust in financial statements. Standard wording makes it easier / more uniform to understand. Long answer: Auditor's reports are important to users of financial statements because they inform users of the auditor's opinion as to whether or not the statements are fairly stated or whether no conclusion can be made with regard to the fairness of their presentation. Users especially look for any deviation from the wording of the standard unqualified report and the reasons and implications of such deviations. Having standard wording improves communications for the benefit of users of the auditor's report. When there are departures from the standard wording, users are more likely to recognize and consider situations requiring a modification or qualification to the auditor's report or opinion.

Discuss why the adoption of international accounting and auditing standards might be beneficial to investors and auditors? (3-9)

Because audits of U.S. financial statements are only prepared with GAAP, preparing the audits using IFRS and ISAs can help international investors make decisions.

Distinguish between changes that affect consistency and those that may affect comparability but not consistency. Give an example of each. (3-4)

Changes that affect the consistency of the financial statements may involve any of the following: a. Change in accounting principle b. Change in reporting entity c. Corrections of errors involving accounting principles. An example of a change that affects consistency would be a change in the method of computing depreciation from straight line to an accelerated method. A separate explanatory paragraph is required if the amounts are material. Comparability refers to items such as changes in estimates, presentation, and events rather than changes in accounting principles. For example, a change in the estimated life of a depreciable asset will affect the comparability of the statements. In that case, no explanatory paragraph for lack of consistency is needed, but the information may require disclosure in the statements.

Compare standard unmodified opinion audit report for a nonpublic entity under AICPA auditing standards (p. 48) with the wording for a public company audit under PCAOB auditing standards in (p. 52) How are they similar? How are they different? (Objectives 3-1, 3-3)

Nonpublic: - Heading - Report Title - Audit Report Address - Introductory Pargraph - Management's Responsiblity - Auditor's Responsibility - Scope paragraph - Auditor's Opinion - Signature and Address of CPA firm - Audit Report Date Public: - Introductory Paragraph - Scope paragraph - Opinion paragraph Public (separate report): - Introductory Paragraph - Scope Paragraph - Definition Paragraph - Inherent Limitations Paragraph - Opinion Paragraph - Cross Reference Paragraph

How does the auditor's opinion differ between scope limiations caused by client restrictions and limitations resulting from conditions beyond the client's control? Under which of these two will the auditor be most likely to issue a disclaimer of opinion? Explain. (3-7)

The auditor's opinion may be qualified by scope limitations caused by client restrictions or by limitations resulting from conditions beyond the client's control. The former occurs when the client will not, for example, permit the auditor to confirm material receivables or physically observe inventories. The latter may occur when the engagement is not agreed upon until after the client's year-end when it may not be possible to physically observe inventories or confirm receivables. A disclaimer of opinion is issued if the scope limitation is so material that the auditor cannot determine if the overall financial statements are fairly presented. If the scope limitation is caused by the client's restriction the auditor should be aware that the reason for the restriction might be to deceive the auditor. For this reason, a disclaimer is more likely for client restrictions than for conditions beyond anyone's control. When there is a scope restriction that results in the failure to verify material, but not pervasive accounts, a qualified opinion may be issued. This is more likely when the scope limitation is for conditions beyond the client's control than for restrictions by the client.

On February 17, 2017, a CPA completed all the evidence gathering procedures on the audit of financial statements for the Buckheizer Technology Corporation for the year ended December 31, 2016. The audit is satisfactory in all respects except for the existence of a change in accounting principles from FIFO to LIFO inventory valuation, which results in an explanatory paragraph on consistency. On February 26, the auditor completed the tax return and the draft of the audit report. The final audit report was completed, attached to the financial statements, and delivered to the client on March 7. What is the appropriate date of the auditor's report? (Objective 3-1)

The auditor's report should be dated February 17, 2017.

Define materiality as it is used in audit reporting. What conditions will affect the auditor's determination of materiality? (3-6)

The common definition of materiality as it applies to accounting and, therefore, to audit reporting is: A misstatement in the financial statements can be considered material if knowledge of the misstatement would affect a decision of a reasonable user of the statements. Conditions that affect the auditor's determination of materiality include: Potential users of the financial statements Dollar amounts of the following items: net income before taxes, total assets, current assets, current liabilities, and owners' equity Nature of the potential misstatements—certain misstatements, such as fraud, are likely to be more important to users of the financial statements than other misstatements.

Describe the information included in the introductory, scope, and opinion paragraphs in a separate audit report on the effectiveness of internal control over financial reporting. What is the nature of the additional paragraphs in the audit report? (Objective 3-3)

The introductory, scope and opinion paragraphs are modified to include reference to management's report on internal control over financial reporting and the scope of the auditor's work and opinion on internal control over financial reporting. The introductory and opinion paragraphs also refer to the framework used to evaluate internal control. he additional paragraphs are added between the scope and opinion paragraphs that define internal control and describe the inherent limitations of internal control.

What are are the purposes of the opinion paragraph in the auditor's report? Identify the most important information included in the opinion paragraph. (Objective 3-1)

The purpose of the opinion paragraph is to state the auditor's conclusions based upon the results of the audit evidence. The most important information in the opinion paragraph includes: 1. The words "in our opinion" which indicate that the conclusions are based on professional judgment. 2. A restatement of the financial statements that have been audited and the dates thereof or a reference to the introductory paragraph. 3. A statement about whether the financial statements were presented fairly and in accordance with generally accepted accounting principles.

What are the purposes of the scope paragraph under the auditor's responsibility in the auditor's report? Identify the most important information in the scope paragraph. (Objective 3-1)

The purpose of the scope paragraph is to inform the reader that audit was conducted with GAAS, and whether audit provides a reasonable basis for an opinion. - Auditor followed GAAS (reasonable assurance) - Statements are free of material misstatement - Discussion of audit evidence - Statement that the auditor believes the evidence accumulated was appropriate for the circumstances to express the opinion presented.

What are three alternative opinions that may be appropriate when the client's financial statements are not in accordance with GAAP? Under what circumstance is each appropriate?

The three alternative opinions that may be appropriate when the client's financial statements are not in accordance with GAAP are an unqualified opinion, qualified as to opinion only and adverse opinion. Determining which is appropriate depends entirely upon materiality. An unqualified opinion is appropriate if the GAAP departure is immaterial (standard unqualified) or if the auditor agrees with the client's departure from GAAP (unqualified with explanatory paragraph). A qualified opinion is appropriate when the deviation from GAAP is material but not highly material; the adverse opinion is appropriate when the deviation is highly material.

What are the three conditions that require a departure from an unmodified opinion audit report? Give an example of each

The three conditions requiring a departure from an unqualified opinion are: 1. The scope of the audit has been restricted. One example is when the client will not permit the auditor to confirm material receivables. Another example is when the engagement is not agreed upon until after the client's year-end when it may be impossible to physically observe inventories. 2. The financial statements have not been prepared in accordance with generally accepted accounting principles. An example is when the client insists upon using replacement costs for fixed assets. 3. The auditor is not independent. An example is when the auditor owns stock in the client's business.

Distinguish between an unmodified opinion audit report that contains an emphasis-of-matter explanatory paragraph and a qualified report (Objective 3-4, 3-5)

Unmodified: Complete audit took place with satisfactory results & financial statements fairly represented, but author believes additional information required Qualified: Auditor concludes overall financial statements are fairly presented, but scope has been materially restricted or accounting standards not followed when preparing financial statements

Describe what is meant by reports involving the use of other auditors. What are the three options available to the primary auditor responsible for the opinion, and when should each be used? (3-4)

When another CPA has performed part of the audit, the primary auditor issues one of the following types of reports based on the circumstances. 1. No reference is made to the other auditor. This will occur if the other auditor audited an immaterial portion of the statement, the other auditor is known or closely supervised, or if the principal auditor has thoroughly reviewed the other auditor's work. 2. Issue a shared opinion in which reference is made to the other auditor. This type of report is issued when it is impractical to review the work of the other auditor or when a portion of the financial statements audited by the other CPA is material in relation to the total. 3. The report may be qualified if the principal auditor is not willing to assume any responsibility for the work of the other auditor. A disclaimer may be issued if the segment audited by the other CPA is highly material.

When an auditor discovers more than one condition that requires departure from or modification of the standard unmodified opinion audit report, what should the auditor's report include? (3-8)

When the auditor discovers more than one condition that requires a departure from or a modification of a standard unqualified report, the report should be modified for each condition. An exception is when one condition neutralizes the other condition. An example would be when the auditor is not independent and there is also a scope limitation. In this situation the lack of independence overshadows the scope limitation. Accordingly, the scope limitation should not be mentioned.