1. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 1 Audit Reports Chapter 3

2. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 2 Learning Objective 1 Describe the parts of the standard unqualified audit report. unqualified audit report.

3. ©2012 Prentice Hall Business Publishing, Auditing 14/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. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 4 Parts of the Standard Unqualified Audit Report

5. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 5 Learning Objective 2 Specify the conditions required to issue the standard unqualified audit report.

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

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

8. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 8 Four Categories of Audit Reports

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

10. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 10 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.

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

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

13. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 13 Separate Report on ICFR

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

15. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 15 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

16. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 16 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

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

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

19. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 19 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 Financial Statement Comparability Material Uncertainties Related Party Transactions

20. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 20 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

21. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 21 Reports Involving Other Auditors

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

23. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 23 Departures from an Unqualified Opinion 1. Scope limitation 2. GAAP departure 3. Auditor not independent

24. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 24 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.

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

26. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 26 Adverse Opinion Auditor believes the financial statements are not presented fairly in conformity with GAAP.

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

28. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 28 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.

29. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 29 Disclaimer of Opinion

30. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 30 Learning Objective 6 Explain how materiality affects audit reporting decisions.

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

32. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 32 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.

33. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 33 Materiality Decisions Failure to follow GAAP Audit report Unqualified Qualified opinion only Adverse

34. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 34 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. ImmaterialUnqualified Users’ decisions are likely to be affected. MaterialQualified Users’ decisions are likely to be significantly affected. Highly material Disclaimer or adverse

35. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 35 Materiality Decisions  Dollar amount compared with a base  Measurability  Nature of the item

36. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 36 Materiality Decisions Scope limitation Audit report Unqualified Qualified scope and opinion Disclaimer

37. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 37 Learning Objective 7 Draft appropriately modified audit reports under a variety of circumstances.

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

39. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 39 Learning Objective 8 Determine the appropriate audit report for a given audit situation.

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

41. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 41 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.

42. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 42 Number of Paragraphs in the Report Type of Report

43. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 43 Learning Objective 9 Understand proposed use of international accounting and auditing standards by U.S. companies.

44. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 44 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 2015 Implementation of IFRS into U.S. If plan is approved?

45. ©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 3 - 45 End of Chapter 3