Audit Reports PAs Professional Responsibilities When associated with

Audit Reports

PA’s Professional Responsibilities When associated with information, responsibilities include the following: • Applicable standards in the CPA Canada Handbook must be met. The PA complies with • There is appropriate communication • 2

Association with Financial Statements A PA is associated with financial statements when: • they consent to • they have prepared or performed some other services with respect to the statements 3

The concept of association is far reaching. • Statements are produced • Statements result from • A document containing financial statements 4

Levels of Assurance Level of assurance 5

Type of Assurance High assurance Middle assurance No assurance Audit Positive Assurance “In our opinion. . . ” Negative Assurance Review Compilation “Nothing has come to our attention. ” “No attempt to verify accuracy or completeness of information. ” 6

Standard Unqualified Report The standard unqualified report contains five basic segments: • • • Opinion Basis for Opinion Key Audit matters Responsibilities of Management Auditor’s Responsibilities 7

INDEPENDENT AUDITOR'S REPORT – Taken from CAS 700 To the Shareholders of ABC Company [or Other Appropriate Addressee] Report on the Audit of the Financial Statements Opinion We have audited the financial statements of ABC Company (the Company), which comprise the statement of financial position as at December 31, 20 X 1, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies. In our opinion, the accompanying financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 20 X 1, and its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards (IFRSs). Basis for Opinion We conducted our audit in accordance with Canadian generally accepted auditing standards. Our responsibilities under those standards are further described in the Auditor's Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the financial statements in Canada, and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Key Audit Matters Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the financial statements of the current period. These matters were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. [Description of each key audit matter in accordance with CAS 701. ] Responsibilities of Management and Those Charged with Governance for the Financial Statements Management is responsible for the preparation and fair presentation of the financial statements in accordance with IFRSs, 3 and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. In preparing the financial statements, management is responsible for assessing the Company's ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Company or to cease operations, or has no realistic alternative but to do so. Those charged with governance are responsible for overseeing the Company's financial reporting process. Auditor's Responsibilities for the Audit of the Financial Statements (Also called scope paragraph) Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor's report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Canadian generally accepted auditing standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements. Auditor Signature Auditor Address Date

Reservation in the Audit Report 1. Financial statements contain a departure from GAAP including inadequate disclosure. Qualified Opinion Materiality Adverse Opinion 9

A GAAP departure requires a qualified report: • A material departure from GAAP in the statements • A basis for modification paragraph is added • Follows Opinion paragraph • “Except for” opinion. • The introductory, management responsibility and auditor responsibility paragraphs are the same as in the unmodified report 10

Qualified Opinion – GAAP Departure CAS 705 – Modifications to the Opinion Auditor’s Report To the Shareholders of ……………. Qualified Opinion We have audited the financial statements of ABC Company (the Company), which comprise the statement of financial position as at December 31, …. . , and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies. In our opinion, except for the effect of the failure to record depreciation as described in the Basis for Qualified Opinion paragraph, these financial statements present fairly, in all material respects, the financial position of the company as at ……………. , and the results of its operations and the cash flows for the year then ended in accordance with International Financial reporting Standards. Basis for Qualified Opinion Note ……. . describes the depreciation policy with respect to the company’s manufacturing plants and equipment. The note also indicates that the company is not depreciating its head office building, which it acquired 5 years ago, on the grounds that it is not a producing asset and is maintaining its value as a potential rental or resale property. In this respect, the financial statements are not in accordance with generally accepted accounting principles. The estimated useful life of similar building is usually considered to be between 30 and 40 years. If depreciation had been provided on the basis of an estimated useful life of , say, 35 years, depreciation for the current year would have increased by $. . (20…. $. . ), net income after taxes would have decreased by $. . (20…. . $. . ), accumulated depreciation would have increased by $. . . . (20…. . ), and the balance of deferred income taxes and the closing balance of retained earnings would have been reduced by $. . . (20…. . $. . . ) and $. . . (20…. . $. . . ), respectively.

GAAP departure is material and pervasive result in an: Adverse report: • Departures from GAAP in the statements are: • A basis for modification paragraph added to provide more details. • Follows Opinion paragraph. • The introductory, management responsibility and auditor responsibility paragraphs are the same as in the unmodified report 12

Adverse Opinion – GAAP Departure CAS 705 – Modifications to the Opinion Auditor’s Report To the Shareholders of ……………. Adverse Opinion We have audited the financial statements of ABC Company (the Company), which comprise the statement of financial position as at December 31, …. . , and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies. In our opinion, because the write-down has not been made for the significant decline in value of the investment described in the preceding paragraph, these financial statements do not present fairly the financial position of the company as at ……………. , and the results of its operations and the cash flows for the year then ended in accordance with International Financial reporting Standards. Basis for Adverse Opinion The company’s investment in X Company Ltd. , its only asset, which is carried at a cost of $10, 000, has declined in value to an amount of $5, 850, 000. The loss in value of this investment, in our opinion, is other than a temporary decline and in such circumstances generally accepted accounting principles require that the investment be written down to recognize the loss. If this decline in value had been recognized, the investment, net income for the year, and retained earnings would have been reduced by $4, 150, 000.

2. Scope limitation (extent of audit work has been limited) inability to obtain sufficient evidence Qualified Opinion Materiality Denial or Disclaimer of Opinion 14

Scope limitation: The introductory and management paragraphs are the same as the unmodified report The Opinion and the Basis for Opinion have been changed. The auditor’s responsibilities paragraph is modified because the audit was not completed entirely in accordance with GAAS. 15

Qualified Opinion – Scope Limitation CAS 705 – Modifications to the Opinion INDEPENDENT AUDITOR'S REPORT To the Shareholders of ABC Qualified Opinion We have audited the financial statements of ABC Company (the Company), which comprise the statement of financial position as at December 31, 20 X 1, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies. In our opinion, except for the effects of the matter described in the Basis for Qualified Opinion section of our report, the accompanying financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 20 X 1, and its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards (IFRSs). Basis for Qualified Opinion The Company's inventories are carried in the statement of financial position at xxx. Management has not stated the inventories at the lower of cost and net realizable value but has stated them solely at cost, which constitutes a departure from IFRSs. The Company's records indicate that, had management stated the inventories at the lower of cost and net realizable value, an amount of xxx would have been required to write the inventories down to their net realizable value. Accordingly, cost of sales would have been increased by xxx, and income tax, net income and shareholders' equity would have been reduced by xxx, xxx and xxx, respectively. We conducted our audit in accordance with Canadian generally accepted auditing standards. Our responsibilities under those standards are further described in the Auditor's Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the financial statements in Canada, and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified opinion. 16

Denial of Opinion – Scope Limitation CAS 705 – Modifications to the Opinion INDEPENDENT AUDITOR'S REPORT To the Shareholders of ABC Company Adverse Opinion We have audited the financial statements of ABC Company and its subsidiaries (the Group), which comprise the consolidated statement of financial position as at December 31, 20 X 1, and the consolidated statement of comprehensive income, consolidated statement of changes in equity and consolidated statement of cash flows for the year then ended, and notes to the consolidated financial statements, including a summary of significant accounting policies. In our opinion, because of the significance of the matter discussed in the Basis for Adverse Opinion section of our report, the accompanying consolidated financial statements do not present fairly the consolidated financial position of the Group as at December 31, 20 X 1, and its consolidated financial performance and its consolidated cash flows for the year then ended in accordance with International Financial Reporting Standards (IFRSs). Basis for Adverse Opinion As explained in Note X, the Group has not consolidated subsidiary XYZ Company that the Group acquired during 20 X 1 because it has not yet been able to determine the fair values of certain of the subsidiary's material assets and liabilities at the acquisition date. This investment is therefore accounted for on a cost basis. Under IFRSs, the Company should have consolidated this subsidiary and accounted for the acquisition based on provisional amounts. Had XYZ Company been consolidated, many elements in the accompanying consolidated financial statements would have been materially affected. The effects on the consolidated financial statements of the failure to consolidate have not been determined. We conducted our audit in accordance with Canadian generally accepted auditing standards. Our responsibilities under those standards are further described in the Auditor's Responsibilities for the Audit of the Consolidated Financial Statements section of our report. We are independent of the Group in accordance with the ethical requirements that are relevant to our audit of the consolidated financial statements in Canada, and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our adverse opinion. 17

Influence of Materiality Report type required Circumstance Lesser materiality Greater materiality Departure from GAAP Scope limitation Qualified Adverse Qualified Denial of opinion Unqualified Uncertainty 18

Effects of Lack of Independence If the auditor feels that they are not independent: Auditor should resign or not accept the engagement. 19

Problem 4 -3, Page 116 Scope Limitation, Auditor Independence Crow Corporation, a public company, has set up a number of limited partnerships to pursue some risky development projects. The limited partnerships borrow money form various financial intuitions to support the development projects, and Crow guarantees these loans. Crow’s interest in each limited partnership is set at a level just below the percentage that would require the partnerships, and their debts to be included in Crow’s consolidated financial statements. Theses percentages are set specifically in the professional accounting recommendations that form the basis of GAAP for the purpose of Crow’s financial reporting. Zilch Zulch, LLP (ZZ) has been the auditor of Crow since its incorporation thirty years ago. The current CFO of Crow was formerly and audit partner in ZZ and was in charge of the Crow audit for five years before Crow hired her as its CFO. Because of her familiarity with ZZ’s approach to setting materiality for its audits, the CFO was able to suggest the amount of a loan that could be guaranteed in each limited partnership without being material. If an individual loan was material, it would need to be disclosed as a contingency in Crow’s consolidated financial statements even if the partnership was not required to be consolidated. Approximately 1000 limited partnerships were set up, since a large sum of money was required to fund Crow’s development activities. Because of the way the limited partnerships were structured, none of them was consolidated and no disclosure of Crow’s loan guarantees to the partnerships was made in Crow’s 2000 financial statements, despite the fact that in total they exceeded the reported long-term debt and shareholder’s equity of Crow. Zero Mustbe, the audit partner in charge of the audit of Crow’s 2000 consolidated financial statements, was somewhat puzzled as to why there were so many limited partnerships, since only one development project was being undertaken. However, he was assured by Crow’s CFO that the structure was appropriate and in accordance with GAAP because, in her words, “It was all set up by financial engineers with Ph. D. s in ZZ’s accounting group. These people know all about GAAP and are much smarter that you are, Zero, so there is nothing to be concerned about. ” As a result of his audit work, Zero provided a clean audit opinion on Crow’s 20 X 0 consolidated financial statements, During 20 X 1, adverse events resulted in Crow’s being unable to meet its obligations under loan guarantees and it went bankrupt. Required: Comment on the adequacy of Zero’s audit, the independence and scope issues raised, and the appropriateness of issuing a clean audit report in this scenario. 20

Problem 4 -6, Page 117 Scope Limitation, Auditor Independence The following audit report was drafted by an assistant at the completion of the audit of Cramdon Inc. , on March 1, 20 X 5. The partner in charge of the engagement has decided the opinion on the 20 X 4 financial statements should be modified only with reference to the change in method of computing sales. Also, because of a litigation uncertainty, an uncertainty paragraph was included in the audit report on the 20 X 3 financial statements, which are included for comparative purposes. The 20 X 3 audit report (same audit firm) was dated March 5, 20 X 4, and on October 15, 20 X 4, the litigation was resolved in favour of Cramdon Inc. Auditor’s Report To the Board of Directors of Cramdon Inc. ; We have audited the accompanying financial statements of Cramdon Inc. , as of December 31, 20 X 4 and 20 X 3. These financial statements are the responsibility of the Company’s Management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. As discussed in Note 7 to the financial statements, our previous report on the 20 X 3 financial statements contained an explanatory paragraph regarding a particular litigation uncertainty. Because of our lawyer’s meritorious defence in this litigation, our current report on these financial statements does not include such an explanatory paragraph. In our opinion, based on the preceding, the financial statements referred to above present fairly, in all material respects, the financial position of Cramdon Inc. , as of December 31, 20 X 4, and the results of its operations and its cash flows for the period then ended in conformity with generally accepted accounting principles consistently applied, except for the changes in the method of computing sales as described in Note 14 to the financial statements. /s/ PA Firm March 5, 20 X 5 Required: Identify the deficiencies and errors in the draft report and write an explanation of the reasons they are errors and deficiencies. Do 21 not write the report.

Problem 4 -18, Page 118 Going Concern Issue: PA is the auditor of Jayhawk Inc. Jayhawk’s revenues and profitability have decreased in each of the past three years and, as of this year end, 20 X 3, its retained earnings will fall into a deficit balance. Jayhawk's long-term debt comes due in 20 X 4, and its management is currently renegotiating the repayment date and terms with its bondholders. According to PA’s discussions with management, the renegotiation is not going well and there is a significant risk that the bondholders will put Jayhawk into receivership and liquidate its assets. Jayhawk’s CFO has provided draft 20 X 3 financial statements to PA that are prepared in accordance with GAAP. Required: a) Discuss the audit reporting implications of the preceding situation. b) Assume the long-term debt repayment date was not until 20 X 5. Would your response differ? 22