Audit Reports Chapter 3 2012 Prentice Hall Business

Learning Objective 1 Describe the parts of the standard unqualified audit report. © 2012

Parts of the Standard Unqualified Audit Report 1. Report title 2. Audit report address 3. Introductory paragraph 4. Scope paragraph 5. Opinion paragraph 6. Name of CPA firm 7. Audit report date © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 -3

Parts of the Standard Unqualified Audit Report © 2012 Prentice Hall Business Publishing, Auditing

Learning Objective 2 Specify the conditions required to issue the standard unqualified audit report.

Conditions for Standard Unqualified Audit Report 1. Includes all financial statements 2. Three general standards are met 3. Complies with the three standards of field work © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 -6

Conditions for Standard Unqualified Audit Report 4. Financial statements comply with GAAP 5. No circumstances require an explanatory paragraph or report modification © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 -7

Four Categories of Audit Reports © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Learning Objective 3 Understand reporting on financial statements and internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act. © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 -9

Reporting on Internal Control over Financial Reporting Auditors of public companies subject to Section 404 of the Sarbanes-Oxley Act must report on the effectiveness of internal control over financial reporting. PCAOB Auditing Standard 5 requires the audit of internal control to be integrated with the audit of the financial statements. © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 10

Reporting on Internal Control over Financial Reporting Sarbanes. Oxley Sec. 404 2010 Legislation Accelerated Filer Non-accelerated Filer © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley ICFR Effectiveness Audits Permanent Exemption 3 - 11

Sarbanes-Oxley Act Separate Report on Financial Statements and Internal Control Over Financial Reporting 1. 2. 3. 4. 5. 6. Introductory paragraph Scope paragraph Definition paragraph Inherent limitations paragraph Opinion paragraph Cross-Reference Paragraph © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 12

Separate Report on ICFR © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3

Learning Objective 4 Describe the five circumstances when an unqualified report with an explanatory paragraph or modified wording is appropriate. © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 14

Unqualified Report with Explanatory Paragraph 1. Lack of consistent application of generally accepted accounting principles 2. Substantial doubt about going concern 3. Auditor agrees with a departure from promulgated accounting principles 4. Emphasis of a matter 5. Reports involving other auditors © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 15

Lack of Consistent Application of GAAP Auditors must note circumstances in which accounting principles are not consistently applied Auditor should modify the report when a material change occurs by adding an explanatory paragraph in the report © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 16

Substantial Doubt About Going Concern Ø Significant recurring operating losses or working capital deficiencies. Ø Inability of the company to pay its obligations as they come due. Ø Loss of major customers, the occurrence of uninsured catastrophes. Ø Legal proceedings, legislation that might jeopardize the entity’s ability to operate. © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 17

Auditor Agrees with a Departure from a Promulgated Principle Departure may not require a qualified or adverse opinion The auditor must separately explain in the audit report that adhering to the principle would have produced a misleading result. Circumstances are most unusual © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 18

Emphasis of a Matter Under certain circumstances, the CPA may want to emphasize specific matters regarding the financial statements, even though the CPA intends to express an unqualified opinion. Subsequent Events Related Party Transactions Financial Statement Comparability © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Material Uncertainties 3 - 19

Reports Involving Other Auditors 1. Make no reference in the audit report 2. Make reference in the report (modified wording report) 3. Qualify the opinion © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 20

Reports Involving Other Auditors © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3

Learning Objective 5 Identify the types of audit reports that can be issued when an unqualified opinion is not justified. © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 22

Departures from an Unqualified Opinion 1. Scope limitation 2. GAAP departure 3. Auditor not

Qualified Opinion A qualified opinion report can result from a limitation on the scope of the audit or failure to follow generally accepted accounting principles. © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 24

Qualified Opinion © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 25

Adverse Opinion Auditor believes the financial statements are not presented fairly in conformity with

Adverse Opinion © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 27

Disclaimer of Opinion It is issued when the auditor is unable to be satisfied that the overall financial statements are fairly presented. It can arise only from a lack of knowledge by the auditor. © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 28

Disclaimer of Opinion © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 -

Learning Objective 6 Explain how materiality affects audit reporting decisions. © 2012 Prentice Hall

Materiality 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. © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 31

Levels of Materiality Amounts are immaterial. Amounts are material but do not overshadow the financial statements as a whole. Amounts are so material or so pervasive that overall fairness of the statements is in question. © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 32

Materiality Decisions Failure to follow GAAP Audit report Unqualified Qualified opinion only © 2012

Relationship of Materiality to Type of Opinion Materiality Significance in Terms of Level Reasonable Users’ Decisions Type of Opinion Users’ decisions are unlikely Immaterial to be affected. Unqualified Material Users’ decisions are likely to be affected. Qualified Highly material Users’ decisions are likely to be significantly affected. Disclaimer or adverse © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 34

Materiality Decisions Ø Dollar amount compared with a base Ø Measurability ØNature of the

Materiality Decisions Scope limitation Audit report Unqualified Qualified scope and opinion © 2012 Prentice

Learning Objective 7 Draft appropriately modified audit reports under a variety of circumstances. ©

Discussion of Conditions Requiring Departure Ø Auditor’s scope has been restricted ØStatements are not in conformity with GAAP ØAuditor is not independent © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 38

Learning Objective 8 Determine the appropriate audit report for a given audit situation. ©

Auditor’s Decision Process Determine whether any condition exists requiring a departure from a standard unqualified report. Decide Materiality Decide appropriate type of report © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley Write Audit Report 3 - 40

More Than One Condition Requiring a Departure or Modification The auditor is not independent. There is a scope limitation. Going concern uncertainty exists. Statements are not prepared in accordance with GAAP. © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 41

Number of Paragraphs in the Report Type of Report © 2012 Prentice Hall Business

Learning Objective 9 Understand proposed use of international accounting and auditing standards by U.

Proposed Use of International Accounting and Auditing Standards by U. S. companies Globalization of world’s capital markets are leading to calls for a single set of accounting standards to be used around the world. SEC Developing Workplan If plan is approved? © 2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 2015 Implementation of IFRS into U. S. 3 - 44