1. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 1 Audit Reports Chapter 3

2. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 2 Learning Objective 1 Describe the parts of the standard unqualified audit report. Describe the parts of the standard unqualified audit report.

3. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 3 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

4. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 4 Learning Objective 2 Specify the conditions required to issue the standard unqualified audit report. Specify the conditions required to issue the standard unqualified audit report.

5. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 5 Conditions for Standard Unqualified Audit Report 1. All financial statements are included. 2. The three general standards have been followed in all respects on the engagement. 3. Sufficient evidence has been accumulated to conclude that the three standards of field work have been met.

6. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 6 Conditions for Standard Unqualified Audit Report 4. The financial statements are presented in accordance with generally accepted accounting principles. 5. There are no circumstances requiring the addition of an explanatory paragraph or modification of the wording of the report.

7. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 7 Four Categories of Audit Reports Standard unqualified Unqualified with explanatory paragraph or modified wording Qualified Adverse or disclaimer

8. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 8 Learning Objective 3 Describe the five circumstances when an unqualified report with an explanatory paragraph or modified wording is appropriate. Describe the five circumstances when an unqualified report with an explanatory paragraph or modified wording is appropriate.

9. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 9 Unqualified Report with Explanation 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.

10. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 10 Consistency versus Comparability Changes that affect consistency and require an explanatory paragraph if they are material: 1. Changes in accounting principles 2. Changes in reporting entities 3. Corrections of errors involving principles

11. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 11 Consistency versus Comparability Changes that affect comparability but not consistency: 1. Changes in an estimate 2. Error corrections not involving principles 3. Variations in format and presentation of financial information 4. Changes because of substantially different transactions or events

12. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 12 Substantial Doubt about 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, that might jeopardize the entity’s ability to operate

13. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 13 Auditor Agrees with a Departure from a Promulgated Principle The auditor must be satisfied and must state and explain, in a separate paragraph or paragraphs in the audit report, that adhering to the principle would have produced a misleading result in that situation.

14. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 14 Emphasis on 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.

15. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 15 Reports Involving Other Auditors 1. Make no reference in the audit report. 3. Qualify the opinion. 2. Make reference in the report (modified wording report).

16. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 16 Learning Objective 4 Identify the types of audit reports that can be issued when an unqualified opinion is not justified. Identify the types of audit reports that can be issued when an unqualified opinion is not justified.

17. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 17 Departures from an Unqualified Opinion 1. Scope limitation 2. GAAP departure 3. Auditor not independent

18. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 18 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.

19. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 19 Adverse Opinion It is used only when the auditor believes that the overall financial statements are so materially misstated or misleading that they do not present fairly the financial position or results of operations and cash. flows in conformity with GAAP.

20. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 20 Disclaimer of Opinion It is issued when the auditor is unable to be satisfied that the overall financial statements are fairly presented.

21. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 21 Learning Objective 5 Explain how materiality affects audit reporting decisions. Explain how materiality affects audit reporting decisions.

22. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 22 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.

23. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 23 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.

24. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 24 Relationship of Materiality to Type of Opinion Materiality Level Significance in Terms of Reasonable Users’ Decisions Type of Opinion Users’ decisions are unlikely to be affected. Users’ decisions are likely to be affected. Users’ decisions are likely to be significantly affected. Immaterial Material Highly Material Unqualified Qualified Disclaimer or Adverse

25. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 25 Materiality Decisions Failure to follow GAAP Audit report Unqualified Qualified opinion only Adverse

26. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 26 Materiality Decisions Scope limitation Audit report Unqualified Qualified scope and opinion Disclaimer

27. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 27 Materiality Decisions Dollar amount compared with a base Measurability Nature of the item

28. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 28 Learning Objective 6 Draft appropriately modified audit reports under a variety of circumstances. Draft appropriately modified audit reports under a variety of circumstances.

29. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 29 Discussion of Conditions Requiring Departure Auditor’s scope has been restricted. Statements are not in conformity with GAAP. Auditor is not independent.

30. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 30 Scope Restricted by Client or Conditions ImmaterialMaterial Level of Materiality Extremely Material Unqualified report Qualified scope, additional paragraph, and qualified opinion (except for) Disclaimer of opinion

31. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 31 Statements Not Prepared in Accordance With GAAP ImmaterialMaterial Level of Materiality Extremely Material Unqualified report Additional paragraph and qualified opinion (except for) Adverse opinion

32. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 32 The Auditor Is Not Independent ImmaterialMaterial Level of Materiality Extremely Material Disclaimer of opinion (regardless of materiality)

33. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 33 Learning Objective 7 Determine the appropriate audit report for a given audit situation. Determine the appropriate audit report for a given audit situation.

34. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 34 Auditor’s Decision Process Determine whether any condition exists requiring a departure from a standard unqualified report. Decide the materiality for each condition. Decide the appropriate type of report. Write the audit report.

35. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 35 Number of Paragraphs in the Report Standard3 Unqualified with explanatory paragraph4 Unqualified shared report with other auditors3 Qualified – opinion only4 Qualified – scope and opinion4 Disclaimer – scope limitation3 Adverse4

36. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 36 Learning Objective 8 Discuss the impact of e-commerce on audit reporting. Discuss the impact of e-commerce on audit reporting.

37. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 37 Impact of E-Commerce on Audit Reporting Auditors are not required to read information contained in electronic sites. Most companies provide access to financial information through their home Web page. Auditing standards note that electronic sites are not considered “documents.”

38. ©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 3 - 38 End of Chapter 3