ACC 406 16

what explanatory paragraphs can you include in financial statement opinions

Other auditors, going concern, lack of consistency, additional emphasis, refer to audit of ICFR, Change in estimate

o Steve Rackwill, CPA has been asked by his audit entity, Petry Plumbing Supply, to help implement a new control system. Rackwill will arrange interviews for Petry's hiring and instruct and oversee training of current entity personnel. PP is a privately held company. Petry will make all hiring decisions and supervise employees once they are trained

Not Impaired

The WSJ article titled "When you're Most Vulnerable to Fraud" indicates that small businesses often are most vulnerable to fraud when times are hard and thus sales and profits are down. True False

False

True or False. An engagement partner for an audit client could directly own shares of stock in the client if the amount was clearly immaterial to the partner.

False

Use of service organizations

"Many companies use service organizations to process transactions. If the service organiza-tion's services make up part of an entity's information system, then they are considered part of the information and communication component of the entity's ICFR. Thus, both management and the auditor must consider the activities of the service organization.Management and the auditor should perform the following procedures with respect to the activities performed by the service organization: (1) obtain an understanding of the nature and significance of the services provided by the service organization and their effect on the user entity's internal control relevant to the audit, sufficient to identify and assess the risks of material misstatement and (2) design and perform audit procedures responsive to those risks.Evidence about the operating effectiveness of controls that are relevant to management's assessment and the auditor's opinion may be obtained by performing tests of the user organiza-tion's controls over the activities of the service organization, performing tests of controls at the service organization, or obtaining a service auditor's report on the design and operating effective-ness of controls placed in operation at the service organization (referred to as a Service Organ-ization Control (SOC) 1 "Type 2" report discussed in Chapter 6). If the service organization outsources some of its functions to another service organization, consideration of controls at the "sub-service" organizations must be included as well. If a service auditor's report on controls placed in operation and tests of operating effectiveness is available, management and the auditor separately evaluate whether this report provides sufficient evidence to support the assessment and opinion. Important factors that management and the auditor should consider include the scope of the examination, the controls tested, the results of those tests of controls, and the service auditor's opinion on the operating effectiveness of the controls. Management and the auditor should also make inquiries concerning the service auditor's reputation, competence, and independence.When a significant period of time has elapsed between the time period covered by the tests of controls in the service auditor's report and the date of management's assessment, additional procedures should be performed."

disclaimer

"The auditor disclaims an opinion on the financial statements either because there is insufficient appropriate evidence to form an opinion on the overall financial statements or because there is a lack of independence. In a disclaimer the auditor explains the reasons for withholding an opinion and explicitly indicates that no opinion is expressed"

Adverse opinion

"The auditor issues an adverse opinion when the financial statements do not present fairly due to a GAAP departure that materially and pervasively affects the financial statements overall. In an adverse report the auditor explains the nature and size of the misstatement and states the opinion that the financial statements do not present fairly in accordance with GAAP."

Auditor documentation requirements

"The auditor should document the processes, procedures, judgments, and results relating to the audit of internal control consistent with the PCAOB's documentation standards. The auditor's documentation must include the auditor's understanding and evaluation of the design of each of the components of the entity's ICFR, documentation of the process used to determine the points at which misstatements could occur within significant accounts and disclosures, the extent to which he or she relied on work performed by others, and the scope of testing. Finally, the audi-tor must describe the evaluation of any deficiencies discovered, as well as any other findings, that could result in a modification to the auditor's report. PCAOB standards require the auditor to retain audit documentation for the ICFR audit and for the financial statement audit for seven years from the date of the auditor's report, unless a longer period of time is required by law."

Two common third party liability sources from statutory law

1933 act and 1934 act

In which of the following situations would a CPA's independence be considered impaired according to the Code of Professional Conduct? 1. The CPA has a car loan from a bank that is an audit entity. The loan was made under the same terms available to all customers. 2. The CPA has a direct financial interest in an audit entity, but the interest is maintained in a blind trust. 3. The CPA owns a commercial building and leases it to an audit entity. The rental income is material to the CPA.

2 & 3

o Julia Roberto, a sole practitioner, has provided extensive advisory services for her audit entity, Leather Ltd. She has interpreted the financial statements, provided forecasts and other analyses, counseled on potential expansion plans, and counseled on banking relationships but has not made any management decisions. Leather is a privately held entity.

A CPA may provide such advisory services to an audit client and NOT IMPAIRED INDEPENDENCE because the member's role in advisory in nature and because the CLIENT IS PRIVATE

emphasis of matter paragraph

A paragraph added to an auditors' report that provides information fundamental to users' understanding of the financial statements (such as consistency or going-concern uncertainties).

You are auditing Diverse Carbon, a manufacturer of nerve gas for the military, for the year ended September 30. On September 1, one of its manufacturing plants caught fire, releasing nerve gas into the surrounding area. Two thousand people were killed and numerous others paralyzed. The company's legal counsel indicates that the company is liable and that the amount of the liability can be reasonably estimated, but the company refuses to disclose this information in the financial statements.

Adverse

Unmodified Opinion

An opinion issued when the auditors conclude that the financial statements present the financial condition, results of operations, and cash flows in accordance with GAAP (until recently, known as an unqualified opinion).

During the audit of Moon Co., the auditor disagrees with management's estimation of collectible accounts receivable. The possible misstatement amount is material. Which of the statements below should weigh more heavily for the auditor in this instance? A. Moon management has the right to make company estimates. B. Requiring an adjustment to the allowance for doubtful accounts would give stockholders access to fair and adequate information. C. Accounts Receivable as stated by Moon Co., might turn out to be fully collectible. D. The interests of Moon Co., the auditor, and the public should be weighed equally in the decision.

B. Requiring an adjustment to the allowance for doubtful accounts would give stockholders access to fair and adequate information. The auditor's duty is to assess whether the financial statements present fairly. Thus, the auditor must recommend an adjustment and, if the proposed adjustment is not made, indicate a material misstatement of accounts receivable in her/his qualified audit opinion. Yes, it really is that simple.

An audited entity company has not paid its 2018 audit fees. According to the AICPA Code of Professional Conduct, for the auditor to be considered independent with respect to the 2019 audit, the 2018 audit fees must be paid before the A. 2018 report is issued. B. 2019 fieldwork is started. C. 2019 report is issued. D. 2020 fieldwork is started.

C. 2019 report is issued. Ethical ruling #52, Unpaid Fees, states that independence is impaired if, by the date an audit report is issued, fees remain unpaid for services provided more than one year prior to the date of the audit report.

Which of the following legal situations would be considered to impair the auditor's independence? A. An expressed intention by the present management to commence Litigation against the auditor, alleging deficiencies in audit work for the entity, although the auditor considers that there is only a remote possibility that such a claim will be filed. B. Actual litigation by the auditor against the entity for an amount not material to the auditor or to the financial statements of the entity arising out of disputes as to billings for management advisory services. C. Actual litigation by the auditor against the present management, alleging management fraud or deceit. D. Actual litigation by the entity against the auditor for an amount not material to the auditor or to the financial statements of the entity arising out of a dispute as to billings for tax services.

C. Actual litigation by the auditor against the present management, alleging management fraud or deceit.

gross negligence

Conduct that constitutes a willful or reckless disregard for a duty or standard of care.

What are the types of reports that an auditor can issue for an audit ICFR? Brief identify the circumstances justifying each type of report.

Control/significant deficiency --> unqualified opinion Material weakness --> adverse opinion Minor effect --> unqualified opinion More than minor effect --> adverse opinion Unqualified report:--reasonable assurance that entity's controls designed & operating effectively as of the BS date, "in all material respects" (free of mat weakness)--combined report = unqualified opinion on both the FS and the ICFR audit, can be many periods for FS but only most recent period for ICFR Adverse report:--when there's a material weakness--includes definition of mat weakness, description of the mat weakness found, auditor's opinion, & disclosure (when FS opinion is affected by adverse ICFR opinion)

All of the following non-audit services are identified by the SEC as generally impairing an auditor's independence except A. Information systems design and implementation. B. Human resource services. C. Management functions. D. Some specific tax services. E. All of the above are seen by the SEC as impairing independence.

D. Some specific tax services. While still a subject of debate, some specific tax services are allowed by the SECs rules.

o Dip it paint corp requires an audit for the current year. However, Dip it hasn't apid Allen & Allen th fees due for tax related sercied performed 2 years ago. Dip it issued Allen & Allen a note for the unpaid fees, and Allen & Allen proceeded with the audit services.

IMPAIRED

o Jimmy Salad, a sole practitioner, audited Dallas Conduit Inc's financial statements for the year ended June 30 and was issued stock by the entity as payment for the audit fee. Salad disposed of the stock before commencing fieldwork planning for the audit of the next year's June 30th financial statements

IMPAIRED

o Kraemeer & Kraemeer recently won the audit of Gavin Clothiers, a large manufacturer of women's clothing. Jock Kraemeer had a substantial investment in Gavin prior to bidding on the engagement. In anticipation of winning the engagement, Kraemeer placed his shares of Gavin stock in a blind trust.

IMPAIRED

o ZEKE & ASSOCIATES audits a condo association in which parents of a member of the firm own a unit and reside. The unit is material to the parent's and the member participatins in the engagement.

IMPAIRED

"Management's Report Incomplete or Improperly Presented

If the auditor determines that elements of management's annual report on ICFR are incom-plete or improperly presented, the auditor should modify his or her report to include an explanatory paragraph describing the reasons for this determination."

punitive damages

Monetary damages that may be awarded to a plaintiff to punish the defendant and deter similar conduct in the future.

During your audit of Cuccia Coal Company, the controller, Tracy Tricks, refuses to allow you to confirm accounts receivable because she is concerned about complaints from her customers. You are unable to satisfy yourself about accounts receivable by other audit procedures and you are concerned about Tracy's true motives.

Qualified

Gelato Bros., Inc., leases its manufacturing facility from a partnership controlled by the chief executive officer and major shareholder of Gelato. Your review of the lease indicates that the rental terms are in excess of rental terms for similar buildings in the area. The company refuses to disclose this related-party transaction in the footnotes.

Qualified

The management of Bonner Corporation has decided to exclude the statement of cash flows from its financial statements because it believes that its bankers do not find the statement to be very useful.

Qualified

Which of the following is not a principle of professional conduct as defined by the Code of Professional Conduct?-Integrity-Due care-Reporting-Scope and nature of services

Reporting

"Safeguarding of Assets

Safeguarding of assets is defined in AS 2201 as policies and procedures that "provide reason-able assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the entity's assets that could have a material effect on the financial statements." This definition is consistent with the definition in the COSO Framework. For example, an entity could have safeguarding controls over inventory tags (preventive controls) and per-form timely periodic physical inventory counts (detective control) for its quarterly and annual financial reporting dates. Given that the definitions of material weakness and significant defi-ciency relate to the likelihood of misstatement of the financial statements, the failure of the inventory tag control will not result in a significant deficiency or material weakness if the physical inventory count prevents a misstatement of the financial statements. Therefore, the COSO definition indicates that although losses might occur, controls over financial reporting are effective if they provide reasonable assurance that those losses are properly reflected in the financial statements"

The PCAOB specifies two areas that require special consideration by management and the auditor during an audit of ICFR

Service organizations and safeguarding assets

"Subsequent Events

The auditor has a responsibility to report on any changes in internal control that might affect financial reporting between the end of the reporting period and the date of the auditor's report. Chapter 17 describes the types of procedures the auditor undertakes to search for subsequent events affecting an entity's financial statements and affecting the entity's ICFR. As noted in Chapter 17, the auditor's treatment of a subsequent event depends on whether the event reveals information about a material weakness that existed as of the end of the reporting per-iod or whether the event creates or reveals information about a new condition that did not exist as of the end of the reporting period."

Prob 7-40 For each of the following independent situations, indicate the type of report on ICFR you would issue. Justify your report choice. (LO 7-10, 7-14) b. Meryll Company's management identified a material weakness prior to the "as of" date and implemented controls to correct it. Management believes that the new controls have been operating for a sufficient period of time to determine that they are designed and operating effectively. However, Meryll's auditor disagrees with the sufficiency of the time period for testing the operating effectiveness of the controls.

The auditor should issue an adverse opinion if he or she does not believe sufficient time has passed to gather sufficient, competent evidence that the control deficiencies have been corrected. However, after the auditor completes testing in the following year and if controls were found to be operating effectively, an interim report on the effectiveness of internal controls could be issued.

Prob 7-38 For each of the following independent situations, indicate the type of report on ICFR you would issue. Justify your report choice. (LO 7-4, 7-10, 7-14) c. Kim Semiconductor has an ineffective audit committee

The auditor would most likely issue an adverse opinion because of the importance of the audit committee in the control process.

The Liability Crisis in the United Sates: Impact on the Accounting Profession

The present liability system has produced an epidemic of litigation that is spreading throughout the accounting profession and business community. It is threatening the independent audit function and the financial reporting system, the strength of the U.S. capital markets, and the competitiveness of the U.S. economy. The principle causes of the accounting profession's liability problems are unwarranted litigation and coerced settlements. Congress responded in the 1990's by passing litigation reform acts that provided some limits on auditor liability. However, in the wake of several major accounting scandals, auditor liability has continued to be a central focus in the profession

Prob 7-38 For each of the following independent situations, indicate the type of report on ICFR you would issue. Justify your report choice. (LO 7-4, 7-10, 7-14) b. Shu & Han Engineering does not have effective oversight of the entity's external financial reporting.

This would indicate the presence of a material weakness which necessitates an adverse assessment by management and an adverse opinion by the auditor.

The WSJ article titled "When you're Most Vulnerable to Fraud," posted to Canvas, indicates that for some entrepreneurs a factor that makes them a prime target for fraud is that overseeing finances often doesn't come naturally to them because many don't have a background in business or accounting. True False

True

What elements must a plaintiff prove in order to win action under Rule 10b-5 of the Securities Exchange Act of 1934?

Under Rule 10b-5 of the Securities Exchange Act of 1934, the following elements must be proved by a plaintiff: (1) the existence of a material, factual misrepresentation or omission, (2) reliance by the plaintiff on the financial statements, (3) damages suffered as a result of reliance on the financial statements, and (4) scienter.

Johnstone Manufacturing Company has used the double-declining balance method to depreciate its machinery. During the current year, management switched to the straight-line method because it held that it better represented the utilization of the assets. You concur with its decision. All information is adequately disclosed in the financial statements.

Unqualified - Paragraph for change in accounting principle

Prob 7-38 For each of the following independent situations, indicate the type of report on ICFR you would issue. Justify your report choice. (LO 7-4, 7-10, 7-14) g. Edwards & Eddins, CPAs, communicated significant deficiencies to Waste Disposal's management and the audit committee for the last two years. At the end of the current year, these significant deficiencies remain uncorrected.

Unqualified w/ a disclaimer/ disclosure? Given the lack of management's concern for internal control, which can be considered a control environment issue, an adverse opinion would most likely be issued, depending on the nature and severity and the combined effect of the significant deficiencies that were left uncorrected.

Prob 7-38 For each of the following independent situations, indicate the type of report on ICFR you would issue. Justify your report choice. (LO 7-4, 7-10, 7-14) a. Hansen, Inc., has restated previously issued financial statements to reflect the correction of a misstatement.

Unqualified w/ a disclosure

Barefield Corporation, a wholly owned subsidiary of Sandy, Inc., is audited by another CPA firm. As the auditor of Sandy, Inc., you have assured yourself of the other CPA firm's independence and professional reputation. However, you are unwilling to take complete responsibility for its audit work.

Unqualified, modified wording to recognize other auditor

On January 31, Asare Toy Manufacturing hired your firm you audit the company's financial statements for the prior year. You were unable to observe the client's inventory on December 31. However, you were able to satisfy yourself about the inventory balance using other auditing procedures.

Unqualified, standard wording

18-2 Distinguish between accounting changes that affect consistency and changes that do not. To what does the word consistency refer? How is it possible for an accounting change to affect comparability but not consistency?

a consistent and comparable financial statement is the outcome of proper maintenance of fundamental principles of accounting. the auditor categorizes accounting changes into changes that affect consistency and those that do not affect consistence.A change that affects comparability and consistency is explained in the explanatory paragraph of the audit statement. this change has material effect. accounting changes affect comparability and consistency. these changes include changes in accounting principles, changes in reporting entity, and correction of errors. some changes affect comparability, but do not affect consistency. the changes include change in accounting estimate, changes occurred in the classification and reclassification, and all other changes that have a material effect in the future periodall the changes that do not affect materiality are disclosed in the foot notes of the financial statements

qualified opinion

a report issued when the auditor believes that the overall financial statements are fairly stated but that either the scope of the audit was limited or the financial data indicated a failure to follow GAAP

Eagle Company, a public company, had a computer failure and lost part of its financial data. As a result, the auditor was unable to obtain sufficient audit evidence relating to Eagle's inventory account. Assuming the inventory account is at least material, the auditor would most likely choose either a. A qualified opinion or a disclaimer of opinion. b. A qualified opinion or an adverse opinion. c. An unqualified opinion with no explanatory paragraph or an unqualified opinion with an explanatory paragraph. d. A qualified opinion with no explanatory paragraph or a qualified opinion with an explanatory paragraph.

a. A qualified opinion or a disclaimer of opinion.

MC 7-28 In auditing a public company, Natalie, an auditor for N. M. Neal & Associates, identifies four deficiencies in ICFR. Three of the deficiencies are unlikely to result in financial misstatements that are material. One of the deficiencies is reasonably likely to result in misstatements that are not material but significant. What type of audit report should Natalie issue? (LO 7-14) a. An unqualified report. b. An adverse report. c. A disclaimer of opinion. d. An exculpatory opinion.

a. An unqualified report. significant deficiency

An auditor includes a separate paragraph in an otherwise unmodified financial statement audit report to emphasize that the entity being reported upon had significant transactions with related parties. The inclusion of this separate paragraph a. Is appropriate and would not negate the unmodified opinion. b. Is considered an "except for" qualification of the opinion. c. Violates generally accepted auditing standards if this information is already disclosedin footnotes to the financial statements. d. Necessitates a revision of the opinion paragraph to include the phrase "with their going explanation."

a. Is appropriate and would not negate the unmodified opinion.

MC 7-30 Which of the following statements concerning control deficiencies is true? (LO 7-15) a. The auditor should communicate to management, in writing, all control deficiencies in internal control identified during the audit. b. All significant deficiencies are material weaknesses. c. All control deficiencies are significant deficiencies. d. An auditor must immediately report material weaknesses and significant deficiencies discovered during an audit to the PCAOB.

a. The auditor should communicate to management, in writing, all control deficiencies in internal control identified during the audit.

If there is a material weakness, the auditor should issue a(n)

adverse opinion

"It is possible for the auditor to issue an adverse opinion on internal control while at the same time issuing an unqualified opinion on the financial statement audit. Such a conclusion is reached when

an entity's internal control is not effective at preventing or detecting material errors, but the auditor concludes (based on substantive procedures) that the entity's finan-cial statements do not contain material misstatements. Such circumstances can arise when an identified material weakness does not actually result in a misstatement in the financial statements or when a material weakness does result in a material misstatement but the entity corrects the misstatement prior to issuing the financial statements."

"When auditing ICFR, the auditor may become aware of fraud or other possible illegal acts. If the matter involves fraud, it must be brought to the attention of the appropriate level of management. If the fraud involves senior management, the auditor must communicate the matter directly to the

audit committee. If the matter involves other possible illegal acts, the auditor must be assured that the audit committee is adequately informed, unless the matter is clearly inconsequential. When timely communication is important, the auditor communicates such matters during the course of the audit rather than at the end of the engagement"

1934 act

audited financial statements issued to the public or filed with the SEC. Section 10 and rule 10b5 are known as antifraud provisions. Damages include actual losses (i.e. no punitive damages are permitted).

Common law

consists of the legal precedents (i.e., prior court rulings) established by court decisions in legal jurisdictions, either federal or state. Common law often differs from state-to-state.

In which of the following situations would an auditor ordinarily issue an unqualified/unmodified financial statement audit opinion with no explanatory (or emphasis-of-matter/other-matter) paragraph? a. The auditor wishes to emphasize that the entity had significant related-party transactions. b. The auditor decides to refer to the report of another auditor as a basis, in part, for the auditor's opinion. c. The entity issues financial statements that present financial position and results of operations but omits the statement of cash flows. d. The auditor has substantial doubt about the entity's ability to continue as a going concern, but the circumstances are fully disclosed in the financial statements.

b. The auditor decides to refer to the report of another auditor as a basis, in part, for the auditor's opinion.

MC 7-27 AnnaLisa, an auditor for N. M. Neal & Associates, is prevented by the management of Lileah Company from auditing controls over inventory. Lileah is a public company. Management explains that controls over inventory were recently implemented by a highly regarded public accounting firm that the entity hired as a consultant and insists that it is a waste of time for AnnaLisa to evaluate these controls. Inventory is a material account, but procedures performed as part of the financial statement audit indicate the account is fairly stated. AnnaLisa found no material weaknesses in any other area of the entity's internal control relating to financial reporting. What kind of report should AnnaLisa issue on the effectiveness of Lileah's internal control? (LO 7-14) a. An unqualified report. b. An adverse report. c. A disclaimer of opinion. d. An exculpatory opinion.

c. A disclaimer of opinion. relying on the audit of another auditor

MC 7-29 In auditing ICFR for a public company, Emily finds that the entity has a significant subsidiary located in a foreign country. Emily's accounting firm has no offices in that country, and the entity has thus engaged another reputable firm to conduct the audit of internal control for that subsidiary. The other auditor's report indicates that there are no material weaknesses in the foreign subsidiary's ICFR. What should Emily do? (LO 7-14) a. Disclaim an opinion because she cannot rely on the opinion of another auditor in dealing with a significant subsidiary. b. Accept the other auditor's opinion and express an unqualified opinion, making no reference to the other auditor's report in her audit opinion. c. Accept the other auditor's opinion after evaluating the auditor's work and make reference to the other auditor's report in her audit opinion. d. Qualify the opinion because she is unable to conduct the testing herself, and this constitutes a significant scope limitation

c. Accept the other auditor's opinion after evaluating the auditor's work and make reference to the other auditor's report in her audit opinion.

MC 7-31 Significant deficiencies and material weaknesses must be communicated to an entity's audit committee because they represent (LO 7-15) a. Material fraud or illegal acts perpetrated by high-level management. b. Disclosures of information that significantly contradict the auditor's going concern assumption. c. Significant deficiencies in the design or operation of internal control. d. Potential manipulation or falsification of accounting records

c. Significant deficiencies in the design or operation of internal control.

King, CPA, was engaged to audit the financial statements of Chang Company, a private company, after its fiscal year had ended. King neither observed the inventory count nor confirmed the receivables by direct communication with debtors but was satisfied that both were fairly stated after applying appropriate alternative procedures. King's financial statement audit report most likely contained a(n) a. Qualified opinion. b. Disclaimer of opinion. c. Unmodified opinion. d. Unmodified opinion with an emphasis-of-matter paragraph.

c. Unmodified opinion.

A public entity changed from the straight-line method to the declining balance method of depreciation for all newly acquired assets. This change has no material effect on the current year's financial statements but is reasonably certain to have a substantial effect in later years. The client's financial statements contain no material misstatements and the auditor concurs with this change. If the change is disclosed in the notes to the financial statements, the auditor should issue a report with a(n) a. "Except for," qualified opinion. b. Explanatory paragraph. c. Unqualified opinion. d. Consistency modification

c. Unqualified opinion.

Which of the following best describes whether a CPA has met the required standard of care in auditing an entity's financial statements? a. Whether the client's expectations are met with regard to the accuracy of audited financial statements. b. Whether the statements conform to generally accepted accounting principles. c. Whether the CPA conducted the audit with the same skill and care expected of an ordinarily prudent CPA under the circumstances. d. Whether the audit was conducted to investigate and discover all acts of fraud.

c. Whether the CPA conducted the audit with the same skill and care expected of an ordinarily prudent CPA under the circumstances.

18-3 Give examples of a client-imposed and a condition-imposed scope limitation. Why is a client-imposed limitation generally considered more serious?

client - imposed scope limitationwhen a client requests the auditor not to disclose the accounts receivable because of adverse effect over customer relations, the auditor issues a qualified opinion depending on the materiality of accounts recievablecondition - imposed scope of limitationwhen the auditor is not engaged to perform the audit until the year end of the period, they may not be able to observe inventorythe auditor should be seriously alert when the client requests to place limit on the scope of engagement, because the client may be trying to prevent the auditor from ascertaining the material misstatements. according to accounting standards if any limitations are forced by the client, then the auditor should refuse that opinion on the financial statements

Auditors can be held liable to clients and third parties through two primary legal frameworks:

common and statutory law.

Qualified for scope limitation and qualified for departure from GAAP are

material but not pervasive

To be successful in a civil action under Section 11 of the Securities Act of 1933 concerning liability for a misleading registration statement, the plaintiff must prove:a. Defendant's Intent to Deceive: Yes. Plaintiff's Reliance on the Registration Statement: Yes.b. Defendant's Intent to Deceive: Yes. Plaintiff's Reliance on the Registration Statement: No.c. Defendant's Intent to Deceive: No. Plaintiff's Reliance on the Registration Statement: Yes.d. Defendant's Intent to Deceive: No. Plaintiff's Reliance on the Registration Statement: No.

d. Defendant's Intent to Deceive: No. Plaintiff's Reliance on the Registration Statement: No.

scienter

deliberately or knowingly

An auditor issues an unqulaified opinion on ICFR if the entity's internal control is

designed and operating in all material respects.

"If the scope of the auditor's work is limited because of circumstances beyond the control of management or the auditor, the auditor should

disclaim an opinion or withdraw from the engagement. The auditor's decision depends on an assessment of the importance of the omitted procedure(s) to his or her ability to form an opinion."

Prob 7-38 For each of the following independent situations, indicate the type of report on ICFR you would issue. Justify your report choice. (LO 7-4, 7-10, 7-14) f. Conroy Trucking Company has an ineffective control environment.

disclaimer for scope limitation?auditor must communicate that specific sign.def/ mat wkness in wrtg to the board of directorsDepending on the amount of risk of material misstatement due to the ineffective control environment, the auditor will issue an adverse opinion or an unqualified opinion. In most cases, an ineffective control environment will result in an adverse opinion because it is considered a pervasive entity-level control.

If the scope of the auditor's work is limited, a

disclaimer of opinion is issued on the effectiveness of ICFR.

1933 act

financial/registration statements associated with NEW securities (IPOs, new issues, bonds, stocks) Damages are limited to the amount of the loss

Suits under the 1933 act impose a

higher burden of proof on auditors than suits under the 1934 act (guilty until proven innocent). However, there are more users, more financial statements and more lawsuits under the 1934 act.

Prob 7-38 For each of the following independent situations, indicate the type of report on ICFR you would issue. Justify your report choice. (LO 7-4, 7-10, 7-14) d. The internal audit function at Smith Components, a very large manufacturing company, was ineffective. The entity's auditor has determined that the internal audit function needed to be effective in order for the entity to have an effective monitoring component.

if the ineffective monitoring component is a material deficiency, then an adverse opinion should be issued. Otherwise, an unqualified opinion may be given. Because the auditor determined that an effective internal audit function was critical to effective monitoring, an adverse opinion would most likely be considered appropriate

Unqualified is

immaterial misstatements

Elements of the auditor's report on the effectiveness of internal control

include the title "Report of Independent Registered Public Accounting Firm" and addressed to the shareholders and the board of directors of the company Opinion on whether the entity maintained in all material respects, effective ICFR as of the specified date. Auditor's basis for the opinion. Limitations and defines ICFR. Signature of the auditors, office location and date.

"If management remediates a material weakness after the "as of" date, the auditor can provide an

interim opinion rather than making the entity wait 12 months to receive a clean opinion regarding its ICFR in the next year-end report. Thus, the auditor can attest on a timely basis as to whether an entity has eliminated the cause of a previously issued adverse opinion regarding its ICFR."

Statutory law

is established by legislative bodies such as the U.S. Congress or state legislatures, and can be found in the form of statutes, regulations, and legislative acts. Primary examples of statutory law pertaining to auditor liability are the Securities and Exchange Acts of 1933 and 1934 (i.e., SEC Acts of 1933 & 1934) along with the Sarbanes-Oxley Act of 2002. Our focus is on the basics of auditor liability under the SEC Acts of 1933 and 1934.

In contrast to suits filed under common law, the plaintiff does not have to prove

negligence or fraud, reliance on the auditor's opinion, a causal relationship, or a contractual relationship; the plaintiff need only prove that a loss was suffered by investing in the security and that the audited financial statements contained a material omission or misstatement. This statute favors plaintiffs because under the statute the auditor must prove that he or she was not negligent. Thus, the burden of proof is on the defendant auditor to prove the absence of negligence.

Damages are limited to the amount

of the loss.

Disclaimer and adverse opinions are

pervasively material

To be successful with a 1934 act lawsuit, plaintiff must prove

s/he 1) suffered a loss, 2) there was a material misstatement or omission, 3) s/he relied on the audited financial statements, 4) and the auditor was guilty of scienter or gross negligence

To be successful with a 1933 act lawsuit, plaintiff must prove

s/he 1) sustained losses and 2) the financial statements were misleading due to materials misstatements or omissions. If the plaintiff shows these two things then the burden of proof rests on the auditor to prove due diligence (ie, non-negligence).

Conditions for departure from unqualified opinions on financial statement audits

scope limitation, departure from GAAP, lack of independence of the auditor

PCAOB standards require the auditor to retain audit documentation for the ICFR audit and for the financial statement audit for

seven years from the date of the auditor's report, unless a longer period of time is required by law.

Dart corp. engaged Jay assoc., CPA to assist in a public stock offering. Jay audited Dart's financial statements gave an unqualified opinion, despite knowing that the financial statements contained misstatements. Jay's opinion was included in Dart's registration statement. Hansen purchase shares in offering and suffered a loss when the stock declined in value after the misstatements became known. In a suit against Jay and Dart under the section 11 liability provisions of the securities act of 1933, Hansen must prove that

the misstatements contained in Dart's financial statements were material.

"The auditor may choose to issue separate reports on the entity's financial statements and ICFR or may issue a combined report. Under either approach, the date of the two reports should be

the same. "

Significant deficiencies do not require a departure from an unqualified opinion because,

though they are deemed to be significant to be brought to attention of audit committee they relate to possible financial statement misstatements that are less than material.

Prob 7-38 For each of the following independent situations, indicate the type of report on ICFR you would issue. Justify your report choice. (LO 7-4, 7-10, 7-14)e. The auditors of Benron identified significant financial statement fraud by the entity's chief financial officer.

written communication to audit committee. The significance of financial fraud by the CFO is a material weakness and an adverse opinion should be issued.

"Pervasive effects on the financial statements are those that

∙are not confined to specific elements, accounts, or items of the financial statements; ∙if so confined, represent or could represent a substantial proportion of the financial statements; or ∙with regard to disclosures, are fundamental to users' understanding of the financial statements (¶ 6)"