2 LEARNING OBJECTIVES Describe the parts of the standard unqualified audit report.Specify the conditions required toissue the standard unqualified audit report.Describe the five circumstances whenan unqualified report with an explanatoryparagraph or modified wording isappropriate.Identify the types of audit reports thatcan be issued when an unqualified opinionis not justified.Explain how materiality affects auditreporting decisions.Draft appropriately modified audit reportsunder a variety of circumstance.Determine the appropriate audit reportfor a given audit situation.
3 1. Report Title2. Audit Report Address3. Introductory Paragraph4. Scope Paragraph5. Opinion Paragraph6. Name of CPA Firm7. Audit Report Date
4 Certified Public Accountants FIGURE Standard Unqualified Report onComparative StatementsANDERSON and ZINDER, P.C.Certified Public AccountantsSuite 100Park Plazza EastDenver, Colorado303/Independent auditor’s ReportTo the StockholdersGeneral Ring corporationWe have audited the accompanying balance sheets of General Ring Corporation as of December 31, 1999 and 1998, and the related statements of income, retained earnings, and cash flows for the years then ended. 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 evidence supporting the amounts and disclosures in the financial statements. 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 the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of General Ring Corporation as of December 31, 1999 and 1998 and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.ANDERSON AND ZINDER, P.C., CPAsMarch 5, 2000Report TitleAudit ReportAddressIntroductoryParagraph(factual Statement)Scope Paragraph(Factual Statement)Opinion Paragraph(Conclusions)Name of CPA Firm)Audit Report Date(Date Audit FieldWork is completed)
5 The standard unqualified audit report is issued when the following conditions have been met:1. All statements - balance sheet, income statement, statement ofretained earnings, and statement of cash flows - are included in thefinancial statements.2. The three general standards have been followed in all respects on theengagement. (General, FW, Reptg.)Continued on next slide
6 3. Sufficient evidence has been accumulated to conclude that the three standards of field work have been met – “audit documentation”4. The financial statements are presented in accordance with generallyaccepted accounting principles.5. There are no circumstances requiring the addition of an explanatoryparagraph or modification of the wording of the report.
8 UNQUALIFIED AUDIT REPORT WITH EXPLANATORY PARAGRAPH OR MODIFIED WORDINGThe most important causes of the addition of an explanatoryparagraph or modification in the wording of standardunqualified report are listed below1 Lack of consistent application of generally accepted accounting principles2 Substantial doubt about going concern3 Auditor agrees with a departure from promulgated accounting principles4 Emphasis of a matter5 Reports involving other auditors
9 Consistency versus Comparability The auditor must be able to distinguish betweenchanges that affect consistency and those that mayaffect comparability but do not affect consistency.Changes that affect consistency and require an explanatoryparagraph if they are material:1. Changes in accounting principles2. Changes in reporting entities3. Corrections of errors involving principlesChanges that affect comparability but not consistency (NO EX. P):1. Changes in an estimate2. Error corrections not involving principles (PY math error)3. Variations in format and presentation of financial informationChanges because of substantially different transactions or events(sale of a material sub)
10 Substantial Doubt about Going Concern (UNQUAL W/ EX. P.) The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern.1. Significant recurring operating losses or working capital deficiencies.2. Inability of the company to pay its obligations as they come due.3. Loss of major customers, the occurrence of uninsured catastrophes.4. Legal proceedings, legislation, or similar matters that have occurredthat might jeopardize the entity’s ability to operate.
11 Auditor Agrees with a Departure from a Promulgated Principle (UNQUAL W/ EX. P.)The auditor must be satisfied and must stateand explain, in a separate paragraph orparagraphs in the audit report, thatadhering to the principlewould have produced amisleading result inthat situation
12 Under certain circumstances, the Emphasis of a Matter(UNQUAL W/ EX. P.)Under certain circumstances, theCPA may want to emphasize specific matters regarding the financial statements, even though he or she intends to express anunqualified opinion.EX: RPT’s, Sub Events.
13 Reports Involving Other Auditors (UNQUAL W/ EX. P.)When the CPA relies on a different CPA firm to perform part of theaudit, which is common when the client has several widespreadbranches or subdivisions the principal CPA firm has three (3) alternatives.Only the second is an unqualified report with modified wording.1. Make No Reference in the Audit Report2. Make Reference in the Report (Modified Wording Report)3. Qualify the Opinion
14 DEPARTURES FROM AN UNQUALIFIED AUDIT REPORT Three conditions requiring a departure are as follows:1. The Scope of the Audit Has Been Restricted( Scope Limitation)2. The Financial Statements Have Not Been Preparedin Accordance with Generally Accepted AccountingPrinciples (GAAP Departure)3. The Auditor Is Not Independent
15 Qualified OpinionA limitation on the scope of the audit or failure to follow GAAP can cause a qualified opinion report
16 Adverse OpinionIs used only when the auditor believesthat the overall financial statements areso materially misstated or misleading thatthey do not present fairly the financial positionor results of operations and cash flows inconformity with GAAP.A disclaimer is used when the auditor is unable to be satisfied that the FS’s are fairly presentedThe adverse opinion report can arise only whenthe auditor has knowledge, after an adequateinvestigation, of the absence of conformity. This isuncommon and thus the adverse opinion is rarely used.
17 essential consideration MaterialityMateriality is anessential considerationin determining theappropriate type ofreport for agiven set ofcircumstances.Level of Materiality:The common definition applies to accounting and audit reportingA misstatement in the financial statements can be consideredmaterial if knowledge of the misstatement would affect an InvestmentDecision of a reasonable user of the statements.
18 In applying the definition, three levels of materiality are used Amounts Are Immaterial.Amounts Are Material but Do NotOvershadow the Financial Statementsas a Whole.Amounts Are So Material or So PervasiveThat Overall Fairness of the StatementsIs in Question.
19 Materiality Decisions - Non GAAP Conditions When a client has failed to follow GAAP, theaudit report will be unqualified, qualified opiniononly, or adverse, depending on the materiality ofthe departure. Several aspects of materiality mustbe considered.
20 Nature of the Item Transactions are illegal or fraudulent. An item may materially affect some future period eventhough it is immaterial when only the current period isconsidered.An item has a “psychic” effect ( for example, small profitversus small loss or cash balance versus overdraft).An item may be important in terms of possible consequencesarising from contractual obligations.
21 Determine Whether Any Condition Exists Requiring a Departure from a Standard Unqualified ReportDecide the Materiality for Each ConditionDecide the Appropriate Type of Report for the Condition,Given the Materiality LevelWrite the Audit Report
22 Number of Paragraphs in the Report TABLE 3-4Number of Paragraphs in the ReportStandardUnqualified with explanatory paragraph 4Unqualified shared report with other auditors 3Qualified - opinion only 4Qualified - scope and opinion 4Disclaimer - scope limitation 3Adverse
23 Material Misstatement Adverse OpinionQualified OpinionDisclaimer of OpinionMaterial MisstatementStandard Unqualified Audit ReportUnqualified Audit Report withExplanatory Paragraph orModified Wording
24 Relationship of Materiality to Type of Opinion TABLE 3-1Relationship of Materiality to Type of OpinionMateriality Level Significance in Term of Reasonable User’s Decisions Type of OpinionImmaterial User’s decisions are unlikely to be affected UnqualifiedMaterial Users’ decisions are likely to be affected only if theis question is important to the specific decisions being Qualifiedmade. The overall financial statements are presentedfairly.Highly material Most or all user’s decisions based on the financialstatements are likely to be significantly affected Disclaimer orAdverseNote: Lack of independence requires a disclaimer regardless of materiality.