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Chapter 12
Reports on Audited
Financial Statements
“The very existence of the accounting profession depends on public confidence in the determination of certified public accountants to safeguard the public interest.”
--J.L Carey (Professional Ethics of Public Accounting)
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Chapter 12 Objectives
List three general functions of the auditor's report
Explain the significance of the three paragraphs in a standard audit report.
Write an audit report with an unqualified opinion, but containing additional explanation for a given description of accounting facts and audit circumstances.
Describe the type of reports that may be written if the client's financial statements contain a departure from generally accepted accounting principles.
Describe the type of reports that may be written if the conduct of the audit involves a departure from generally accepted auditing standards.
Describe how other circumstances may affect the audit report.
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3. The Purpose of the Audit Report
Definition of Auditing: "... communicating results to interested users."
Indicate whether the FS are in accordance with GAAP
Provide indication of what the FS would be like if GAAP were followed
Provide any client-omitted disclosures
Indicate any unusual aspects of the audit examination
Scope limitations
Division of responsibility
Indicate any unusual matters related to the client
Going concern uncertainty
Consistency
Emphasize a matter
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Types of Audit Reports
Standard (Unqualified, "Clean")
Standard with Explanatory Language (Standard "Plus")
Qualified ("Except for ...")
Adverse
Disclaimer - Severe scope limitation
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5. The STANDARD ("CLEAN") audit report
Introductory Paragraph
FS and years examined
Responsibility of auditor - what they did
Management responsibility emphasized with SAS 58
Scope Paragraph
GAAS audit conducted
Description of an audit (specific references to "test basis," "materiality," and "significant estimates")
Audit provides reasonable basis for opinion
Opinion Paragraph - "fairly presented, in all material respects, in accordance with accounting principles generally accepted in the United States.”
Other Matters
Title of report ("independence" emphasized)
Addressee (Board of Directors usually)
Date (end of fieldwork)
Signed by partner (CPA firm name)
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Independent Auditor’s Report
Report Title
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Apollo Shoes, Inc.
We have audited the accompanying balance sheets of Apollo Shoes, Inc. as of December 31,2004 and 2003, 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 auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of 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 the overall financial statement presentation. We believe that our audit provides 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 Apollo Shoes, Inc. as of December 31, 2004 and 2003, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.
Smith & Smith, CPAs
February 22, 2005
Report Address
Introductory Paragraph:
Notice of audit,
F/S Examined
Auditor, Management responsibilities
Scope Paragraph:
Description of an audit
Opinion
Paragraph
Signature
Report Date
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7. Reasons to Issue an Other than Clean Report
Departure from Generally Accepted Accounting Practices (GAAP)
Justified (Rule 203 Report)
Unjustified (Qualified or Adverse report)
Unusual Aspects of Audit
Division of responsibility
Scope limitation (Qualified or Disclaimer)
Unusual Client Matters (Unqualified with Additional Explanation)
Consistency
Going concern uncertainty
Emphasize a matter
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8. Unqualified Opinion with Additional Explanation
Consistency
Going Concern Uncertainties
Emphasis of a matter
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Lack of Consistency
Relating to Change in Principle, Change in Entity, Prior Period Adjustment.
No Paragraph -- Not Consistency Standard
Change in Accounting Estimate
Correction of Error Not Involving Principle
Changes in Classification
Variation in Statement of Cash Flows
Changes not Material to Current but may affect Future F/S
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10. Going Concern Uncertainties
The auditor has an active responsibility to evaluate, on all audit engagements, whether there is substantial doubt about the entity remaining a going concern for a reasonable time after year-end, not to exceed one year beyond F/S date.
Apply procedures and evaluate:
negative trends
defaults on debt obligations, restructuring of debt, arrearages of dividends
internal matters - work stoppages, dependence on one project
external matters - legal proceedings, changes in governmental regulations, natural disasters, etc.
If going concern problem, auditor may disclaim (e.g., if liquidation values unknown), else add explanatory paragraph after opinion. No standard language, but must include the words substantial doubt and going concern.
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Emphasis of a matter
Add explanatory paragraph after opinion paragraph discussing the matter (e.g., a subsequent event not affecting year-end F/S's)
Usually items that are difficult to disclose in the financial statements
Often non-quantitative matters
Often subsequent events
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12. GAAP Departure Reports
Unjustified GAAP Departures
Qualified opinions
Adverse opinions
Justified GAAP Departures
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GAAP Departures
GAAP departure
identified
Standard
Report No
Is the departure
material?
Yes
Rule 203
Report
Yes
Is the departure
justified? No
Yes
Qualified
Report
Can it be
“compartmentalized”? No
Adverse
Report
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14. Qualified ("Except for ...") Opinion
GAAP departures can cause adverse opinions or qualified opinions -- depends upon severity and materiality.
Key question: “Is the GAAP departure relatively contained (“compartmentalized”) or does it permeate the financial statements?
Report Modifications:
Intro and scope paragraphs remain the same
Add middle paragraph explaining problem and detailing $ amounts involved
Change opinion paragraph (“In our opinion, except for the matter discussed in the preceding paragraph,….”)
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Adverse Opinion
Issued when statements are "so lacking in fairness" that a qualified opinion would be misleading (i.e., a serious departure from GAAP that permeates the financial statements).
Report Modifications:
Intro and scope paragraphs remain the same
Add middle paragraph explaining problem and detailing $ amounts involved
Change opinion paragraph (add "do not" and "because of ...", omit "in all material respects")
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Rule 203 Report
Rule 203 allows for non-GAAP solutions to fairly present the company’s financial situation.
Rule 203 of the AICPA Code of Professional Conduct recognizes that adherence to certain accounting principles may create situations in which a company’s financial condition may not be fairly presented.
Solution: Insert an additional middle paragraph (between scope and opinion paragraphs) stating the deviation from GAAP, but still issue an unqualified report.
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17. Reporting on Unusual Aspects of the Audit
Scope limitation
Qualified opinion
Disclaimer of opinion
Lack of independence
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GAAS Departures
Scope limitation
identified
Is the scope limitation
material? No
Standard
Report
Yes
Alternative procedures
available?
Yes
Standard
Report No
Can it be
“compartmentalized”?
Yes
Qualified
Report No
Disclaimer of
Opinion
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19. Qualified ("Except for ...") Opinions
Scope limitations can cause disclaimers or qualified opinions depending upon severity and materiality.
Key question: “Is the scope limitation limited, or does it permeate the financial statements?
If alternative procedures are available, the auditor may still be able to issue an unqualified opinion.
Report Modifications:
Intro paragraph remain the same
Scope paragraph: “Except for the problem noted, the audit was conducted in accordance with auditing standards generally accepted in the United States.
Add middle paragraph explaining problem
Change opinion paragraph (“In our opinion, except for the matter discussed in the preceding paragraph,….”)
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20. Disclaimer of Opinion (No opinion issued)
Significant scope limitation, usually client-imposed (e.g., no physical inventory taken, confirming A/R not allowed by client (and auditor cannot get satisfaction otherwise), significant subsidiary not examined, etc.)
The problem is that the auditor cannot gather sufficient competent evidence to form an opinion, even an adverse one.
Lack of independence
Report Modifications:
Intro paragraph: (“We were engaged to audit ….”; omit auditor responsibility)
Omit scope paragraph
Add middle paragraph explaining problem
Change opinion paragraph (“…we do not express an opinion….”)
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21. Reporting when CPA is NOT Independent
Should state that CPA is not independent but need not state the reason why
I (WE) are not independent with respect to the XYZ Company and the accompanying balance sheet as of December 32, 19X1, and the related statements of income retained earnings, and cash flows for the year then ended were not audited by me (us) and, accordingly, we do not express and opinion on them.
No heading on report
Do not describe procedures performed
BUT must describe material departures from GAAP
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22. Choosing the Right Report
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23. Other Issues Affecting the Auditor’s Report
Reference to other auditors
Circumstances concerning comparative financial statements
Previous year audited by other auditors
First year audit
Reporting on other information accompanying the financial statements
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24. Reference to Other Auditors
Another Auditor has performed a significant portion of the audit (e.g., a partially-owned subsidiary or a branch located elsewhere).
Choice 1 - make no reference to other auditors and just issue Standard Report -- principal auditor assumes responsibility for other auditor's work.
Choice 2 - Make reference to Other Auditors in all three paragraphs.
Requirements - In either case, principal auditor must be satisfied that the quality of the other auditor's work is good enough to be relied upon.
Inquiries of Professional Reputation
Obtain representation that other auditor is independent
Communicate with other auditor about GAAP/GAAS matters, awareness that statements will be consolidated (i.e., inter-company transfers, etc.), maybe visit and review other auditor's work if taking full responsibility.
If unable to rely on other auditor’s work, consider scope limitation.
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25. Circumstances Concerning Comparative Financial Statements
Different opinions on the financial statements
Most often occurs in first year audit with disclaimer on income statement and unqualified on balance sheet
Updating an opinion
Opinion or report may be different than previously reported (on comparative financial statements) and auditor must explain the change in the report. Add paragraph just before opinion paragraph explaining the change.
In our report dated March 1, 20x5, we expressed an opinion that the 20x1 financial statements did not present the financial position, results of operations, and cash flows in conformity with generally accepted accounting principles because of two departures from such principles: 1) the Company carried its property, plant, and equipment at appraisal values, and provided for depreciation on the basis of such values, and 2) the Company did not provide for deferred income taxes with respect to differences between income for financial reporting purposes and taxable income. As described in Note X, the Company has restated its 20x4 financial statement to conform with generally accepted accounting principles. Accordingly, our present opinion on the 20x4 financial statements, as presented herein, is different from that expressed in our previous report.
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26. Other Information Accompanying The Financial Statements
Other information provided by the client
Review, make sure that it is consistent with F/S
Supplemental information required by FASB/GASB
Exception based (similar to consistency)
Information contained in an AUDITOR-SUBMITTED document
Typing or reproducing Financial Statements
Presenting Financial Statements to third parties
Attach report stating relationship with the submitted document.
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