Chapter 17 - Auditors’ Reports
CHAPTER 17
Auditors' Reports
Review Questions
17-1
The sectio sections ns of of the standard standard audit audit report report for a nonpubl nonpublic ic compa company ny are: are: (1) introd introducto uctory ry sectio section n (which does not hae a section title)! (") mana#ement’s responsibility for the financial statements! ($) auditor’s responsibility! and (%) opinion&
17-"
The function function of notes notes to to financial financial statement statementss is to to proide proide ade'uate disclosure disclosure when when information information in the financial statements is insufficient to attain this obectie&
17-$
The primary differences are that the CA*+ report ($ re'uired): ,ncludes the words Re#istered in the title& References standards of the CA*+ rather than #enerally accepted auditin# standards& ,ncludes less detailed discussions of mana#ement and auditor responsibilities& ,ncludes an additional para#raph indicatin# that the auditors hae also issued a report on the client.s internal control oer financial reportin#& /oes not include section titles&
• •
• •
•
17-%
/isa#ree /isa#ree&& 0hile 0hile AA AA is a fre'ue fre'uentl ntly y used used financ financial ial report reportin# in# framewo framewor2! r2! AA3 AA3 is a set of of auditin# standards! not a financial reportin# framewor2&
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Chapter 17 - Auditors’ Reports
17-4
The typ types of unmodified and modified opinions include: (1) (1) (") ($) ($) (%) (4) (8) (7)
5nmodified op opinion 6st 6stan and dard ard& 5nmo 5nmodi difi fied ed opin opinio ion n with with an emph emphasi asiss of of matte matterr para# para#raph raph&& 5nmo 5nmodi difi fied ed opin opinio ion n wit with h an othe otherr mat matte terr para# para#rap raph& h& 5nmo 5nmodif dified ied opinio opinion n with with dii diide ded d respons responsibi ibilit lity y on on #roup #roup financi financial al statem statements ents&& ualified opinion& Aderse opinion& /isclaimer of of op opinion&
17-8
The report report should should be dated dated as of the date reen reen obtained obtained ssuffic ufficient ient appropriate audit audit eiden eidence ce to support the opinion! 9ebruary "& (The financial statements and the reiew of the audit both must be complete completed&) d&)
17-7
;o& Referen Reference ce to a compon component ent auditor auditor in in a #roup #roup audit audit report! report! in itself! itself! does does not represen representt a 'ualification& Rather! this form of opinion merely diides diides the auditors. oerall responsibility for the en#a#ement between two or more CA firms& ;ote! howeer! that factors other than the diision of responsibility may lead to a 'ualified report (i&e&! departures from AA and scope limitations)&
17-<
The wordin# wordin# of a report report with an unmodifi unmodified ed opinion opinion mi#ht mi#ht depart depart from the wordin# wordin# of the the standard standard report when 3ubstantial doubt about an entity’s ability to continue as a #oin# concern e=ists& rinciples of accountin# hae not been consistently applied in relation to the prior year& The auditors wish to emphasi>e some matter in the financial statements (e&#&! si#nificant related party transactions! si#nificant eents! uncertainties)& A #roup auditor ma2es reference to a component auditor& (only three re'uired) • • •
•
17-?
The audit audit report should include include an emphasis emphasis of matter matter section section that describes describes the chan#e and ma2es ma2es reference to the financial statement note e=plainin# the nature of and ustification for the chan#e in the method of aluin# the inentories and the effect of such chan#e upon the financial statements&
17-1 The two circumstan circumstances ces resultin# resultin# in mod modified ified opinions opinions are (a) materially materially misstated misstated financial financial statements (a @departure from AA) and (b) inability to obtain sufficient appropriate audit eidence (a @scope limitation)& 17-11 The statement statement is incorrect& incorrect& ,f the misstatem misstatement ent is immaterial! immaterial! an unmodifi unmodified ed opinion opinion may be issued& ,f it is material! the auditors issue either a 'ualified opinion or an aderse opinion dependin# upon whether they beliee the misstatement is perasie&
17-"
Chapter 17 - Auditors’ Reports
17-1" Bffects of misstatements become perasie when! in the auditor’s ud#ment! they meet one or more of the followin# three criteria: They are not confined to specific elements! accounts! or items of the financial statements ,f confined! they represent or could represent a substantial proportion of the financial statements or ,n relation to disclosures! they are fundamental to users’ understandin# of the financial statements& • •
•
17-1$ A client can aoid an opinion 'ualified because of inade'uate disclosure merely by ma2in# the appropriate disclosure in the financial statements& 17-1% ,n such a circumstance a +asis for ualified *pinion section is added to the report and the opinion para#raph is modified& 17-14 3ince the auditors hae not been able to form an opinion on the financial statements ta2en as a whole! they must disclaim an opinion& Doweer! they should set forth their reserations about the accountin# treatment of the deferred income ta=es in an e=planatory para#raph to their disclaimer& 17-18 *rdinarily! aderse opinions do the client no #ood& resumably! creditors and stoc2holders would not proide debt or e'uity capital and! if the client is under 3BC urisdiction! the 3BC mi#ht launch an inesti#ation of mana#ement for iolations of the federal securities acts& Thus! the client usually will ma2e whateer chan#es in the financial statements that the auditors re'uire in order to aoid receiin# an aderse opinion& ,n fact! in the few cases in which the client and its auditors cannot a#ree! the client would probably dischar#e the auditors instead of hain# them complete an audit that culminates in an aderse opinion& 17-17 The statement is not correct& A basis for modification para#raph is of three possible types: (1) basis for 'ualified opinion para#raph! (") basis for aderse opinion para#raph! and ($) basis for disclaimer of opinion para#raph& 0hile AA3 (and international standards) refer to a basis for modification para#raph! that term is not used in an audit report6one of the three more descriptie terms is used when an audit opinion is modified& 17-1< Ees& Bach year’s financial statements stand alone& Thus! the CAs may issue different types of opinions on the financial statements of successie years when reportin# on comparatie statements& 17-1? Ees& 0hen reportin# on comparatie statements! CAs should update their report on the prior year.s statements to determine whether it is still the proper type of report to accompany those statements& 9or e=ample! a departure from AA that e=isted last year! resultin# in a report 'ualification! mi#ht hae been corrected& ,n this case! it is appropriate for the auditors to reise their report on the prior year.s statements to a standard un'ualified report&
17-$
Chapter 17 - Auditors’ Reports
17-" The reports containin# audited financial statements filed by a company subect to the reportin# re'uirements of the 3BC may include: Forms S-l throu#h S-11& These are the re#istration statements for clients plannin# to issue securities to the public they are accompanied by comparatie audited financial statements& Forms SB-1 and SB-2. These forms are more simplified re#istration forms for small businesses& Form 8-K & A report filed upon the occurrence of a specified si#nificant eent& ,f the eent is a si#nificant ac'uisition or disposal of assets! Form 8-K will be accompanied with pro forma financial information& An <-F report is used to report a chan#e in auditors& Form 10-Q. This form includes 'uarterly financial statements reiewed by the company’s auditors& Form 10-K & This report is filed annually by publicly owned companies and includes audited financial statements! reports on internal control oer financial reportin#! and other detailed financial information& Questions Requiring Analysis
17-"1
(")
($)
(b)
(") ($)
(%)
(a) (1) The first sentence of the statement is partially true& ,t is important to read the notes to financial statements because they proide important supplementary information& ;otes often pertain to comple= matters and are presented in technical lan#ua#e& Certainly it must be ac2nowled#ed that sometimes they could be presented in a clearer form& To the e=tent the notes supplement disclosures in the body of the financial statements! they could reduce the auditors. e=posure to third-party liability& The disclosure must be supplementary! not contradictory& (1) The second statement is wron# in assertin# that the notes can be used to correct or contradict financial statement presentation& ;otes are an inte#ral part of the financial statements& ,f there is contradiction or if the presentation is incomprehensible! this constitutes inade'uate reportin# and re'uires 'ualification of the audit report& The statement fails to reco#ni>e that while there is a need for accuracy and completeness! those notes should also be comprehensible& The statement incorrectly assi#ns mana#ement.s primary responsibility for the financial statements and notes to the auditors& The auditors. relationship to the notes is the same as their relationship to the balance sheet and other financial statements their actions are #oerned by the same reportin# responsibilities and liabilities to interested parties& +ecause notes are prepared by mana#ement! the auditors cannot control their content& *ther adisers! e&#&! le#al counsel! will influence the wordin# of notes& The auditors properly should recommend improements in presentation! but they will modify their report’s opinion only if disclosure is inade'uate or so unclear as to be misleadin#&
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Chapter 17 - Auditors’ Reports
17-""
(a) The #roup auditors are not re'uired to ma2e reference to the component auditors& Ga2in# reference merely diides the auditors. collectie responsibility for the en#a#ement between the two CA firms& ,f the #roup auditors are willin# to assume full responsibility for the en#a#ement (which they often will do if they retained the component auditors)! they need ma2e no reference to the other auditors in their report& ;ote! howeer! as is discussed in the chapter! when no reference is made the #roup auditors must perform additional audit procedures! the scope of which is based upon the si#nificance of the subsidiary audited by the component auditors& (b)
Althou#h Hones I Abbot issued a 'ualified report on the Canadian subsidiary! Rowe I Gyers do not necessarily hae to 'ualify their report& Rowe I Gyers will be ealuate issues in li#ht of what is material to the consolidated entity! whereas Hones I Abbot ealuated them in relation to what was material for the Canadian subsidiary& As the consolidated entity is lar#er than the subsidiary! the problem at the subsidiary may be immaterial to /unbar Blectronics&
0hen a component auditor e=ists! the #roup en#a#ement partner should determine whether sufficient appropriate audit eidence can reasonably be e=pected to be obtained re#ardin# the consolidation process and the financial information on the components& ,n addition! the #roup auditor should obtain an understandin# of 0hether the component auditor is competent and understands and will comply with all ethical re'uirements! particularly independence& The e=tent to which the #roup en#a#ement team will be inoled with the component auditor& 0hether the #roup en#a#ement team will be able to obtain necessary information on the consolidation process from the component auditor& 0hether the component auditor operates in a re#ulatory enironment that actiely oersees auditors&
17-"$
(a)
•
•
•
•
(b)
17-"%
,f Gichaels decides to ma2e reference to the audit of Thomas! Gichaels. report should indicate clearly! in the auditor’s responsibility section of the audit report the diision of responsibility between that portion of the financial statements coered by Gichaels. audit and that coered by the audit of Thomas& ,n the opinion para#raph! after @,n our opinion! the followin# should be added @based on our audit and the report of the other auditors& (a) ,nformation contrary to an assumption that a client will remain a #oin# concern usually relates to the company.s ability to meet its financial obli#ations& Conditions that indicate such a problem include recurrin# operatin# losses! wor2in# capital deficiencies! aderse financial ratios! defaults on loans! and arreara#es in diidends& *ther conditions such as wor2 stoppa#es! le#al matters! le#islation! and loss of principal customers may also indicate a 'uestion as to a client.s ability to remain a #oin# concern&
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Chapter 17 - Auditors’ Reports
(b)
After discoerin# conditions and eents that mi#ht indicate substantial doubt as to whether a firm can continue as a #oin# concern! the auditors must obtain and ealuate mana#ement.s plans for dealin# with the conditions and eents& After reiewin# the feasibility of mana#ement.s plans! if the auditors still beliee that there is substantial doubt as to ability to continue as a #oin# concern! they should determine that the matters are properly disclosed in the financial statements and also should modify the audit report to reflect that conclusion&
Obe!tive Questions
17-"4
Gultiple Choice (a) ($) 0hen the auditors ta2e e=ception to the application of accountin# principles in the client.s financial statements! they will issue either a 'ualified or aderse opinion! dependin# on whether the misstatement is considered perasie& (b)
(") The audit report should be dated no earlier than when the auditors hae accumulated sufficient appropriate eidence& This date is often the last day of fieldwor2&
(c)
(1) Reference to the wor2 of a component auditor is not! in itself! a 'ualification of the #roup audit report& This reference does not lessen the auditors. collectie responsibility& Rather! it merely diides this responsibility amon# two or more CA firms&
(d)
(%) This phrase iolates the fourth standard of reportin#! because it does not #ie the reader of the report a clear-cut indication of the auditors. opinion& The phrase appears to modify the standard opinion para#raph! but is not forceful enou#h to constitute 'ualifyin# lan#ua#e&
(e)
(1) The auditor communicates throu#h the auditors. report! and therefore only answer (1) is correct& ;ote that the client will include a discussion of the related party transactions in a note to the financial statements&
(f)
($)
(#)
(1) A consistency modification results in an emphasis of matter para#raph& ualified and aderse opinions include a basis for modification para#raph& 0hen a report refers to component auditors no additional para#raph is added&
(h)
(") An audit report of a public client indicates that the audit was performed in accordance with standards of the ublic Company Accountin# *ersi#ht +oard (5nited 3tates)&
0hen a misstatement is perasie! an aderse opinion is appropriate&
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Chapter 17 - Auditors’ Reports
(i)
($) An audit report for a public client indicates that the financial statements are presented in conformity with #enerally accepted accountin# principles (5nited 3tates)& The CA*+ does not issue accountin# standards&
()
($) 3ubstantial doubt about a client’s ability to continue as a #oin# concern results in either an un'ualified report with e=planatory lan#ua#e or a disclaimer of opinion& Accordin#ly answer ($) is correct since a 'ualified report is not appropriate&
(2)
(") 0hen an unustified chan#e in accountin# principles occurs! either a 'ualified or aderse opinion is appropriate as this represents a departure from #enerally accepted accountin# principles& Accordin#ly! answer (") is correct since an aderse opinion! but not a disclaimer of opinion is appropriate&
(l)
($) An emphasis of matter para#raph is appropriate when an auditor wishes to emphasi>e a matter concernin# the financial statements! but not a matter concernin# the scope of the audit en#a#ement& Accordin#ly! answer ($) is not a situation in which an emphasis of a matter para#raph is appropriate since confirmin# accounts receiable relates to the scope of the audit&
17-"8 (a) (b)
(c)
(d) (e)
17-"7 (b) (c) (d) (e)
1& An unmodified (standard report) should be issued& 8& Bither a 'ualified or an aderse opinion is re'uired& Jaluation of properties at appraised alues is not in accordance with #enerally accepted accountin# principles& 3ince the difference between appraised alue and cost is si#nificant! an un'ualified opinion would not be appropriate& 7& A scope restriction results in either a 'ualified opinion or a disclaimer of opinion& +ecause we hae no information on whether a possible misstatement could perasiely misstatement the financial statements! either type of opinion is possibly appropriate& $& +ecause the misstatements could be material! but could not perasiely misstate the financial statements! a 'ualified opinion is appropriate& 8& A 'ualified or an aderse opinion is necessary& The CA firm has ac'uired sufficient appropriate eidence to the effect that the inestments in stoc2 of subsidiary companies are oerstated& ;ote disclosure does not compensate for improper balance sheet presentation&
(a) 4& +ecause the possible effects on the financial statements of undetected misstatements! if any! could be both material and perasie! a disclaimer is appropriate& 1& 0hen no reference is made to the component auditors a standard unmodified report is issued& $& A lac2 of disclosure leads to either a 'ualified opinion or an aderse opinion& 3ince the effect is material! but not perasie! a 'ualified opinion is appropriate& "& 3ince the auditor concurs that the chan#e is desirable! an unmodified opinion with an emphasis of a matter para#raph is appropriate& %& +ecause the auditor does not concur with the chan#e it is a departure from AA& +ecause the amount is material and perasie! an aderse opinion is appropriate&
17-7
Chapter 17 - Auditors’ Reports
17-"< ,tem ;o&
3hould Auditors. Report be GodifiedK
Type of Chan#e
1&
An accountin# chan#e inolin# a chan#e from one #enerally accepted accountin# principle to another #enerally accepted accountin# principle&
Ees
"&
An accountin# chan#e inolin# a chan#e in an accountin# estimate&
;o
$&
An error correction not inolin# an accountin# principle&
Ees
%&
An accountin# chan#e inolin# a correction of an error in principle that is accounted for as a correction of an error&
Ees
4&
A chan#e in accountin# estimate effected by a chan#e in accountin# principle&
Ees
8&
;ot an accountin# chan#e but rather a chan#e in classification&
7&
An accountin# chan#e from one #enerally accepted accountin# principle to another #enerally accepted accountin# principle&
17-"? 3imulation 1&
;o
Ees
(9!H) A situation in which an auditor is unable to obtain audited financial statements for an inestee represents a scope restriction& 3cope restrictions lead to either a 'ualified opinion or a disclaimer of opinion& A decision as to whether the auditors should 'ualify or disclaim the opinion is dependent upon whether perasie misstatements are possible&
"&
(A!,) 3ubstantial doubt about an entity.s ability to continue as a #oin# concern leads to either an un'ualified opinion with an emphasis of matter para#raph! or a disclaimer& +ecause the problem indicates a disclaimer will not be issued! only an un'ualified opinion with an emphasis of matter para#raph is appropriate&
$&
(A!G) A standard unmodified opinion is appropriate in circumstances in which a #roup auditor ta2es responsibility for the wor2 of a component auditor&
%&
(A!,) 0hen an auditor a#rees with a chan#e in accountin# principles! a lac2 of consistency results in an unmodified opinion with an emphasis of matter para#raph followin# the opinion para#raph&
17-<
Chapter 17 - Auditors’ Reports
4&
(+!H) /epartures from #enerally accepted accountin# principles result in either a 'ualified opinion or an aderse opinion! based on the perasieness of misstatements& ien that the situation su##ests that the misstatement cannot be perasie! a 'ualified opinion is appropriate&
17-$ 3imulation Re# port
"ituation
Co$$ent
1& A company has not followed #enerally accepted accountin# principl es in the recordin# of its leases&
7
This is a departure from AA&
"& A company has not followed #enerally accepted accountin# principl es in the recordin# of its leases& The amounts inoled are immaterial&
1
+ecause the amounts inoled are immaterial! no audit report modification is necessary&
$& A company alued its inentory at current replacement cost& 0hile the auditor beliees that the inentory costs do appro=imate replacement costs! these costs do not appro=imate any AA inentory aluation method&
7
Althou#h the auditor beliees that the costs appro=imate replacement costs! they depart from AA&
%& A client chan#ed its depreciat ion method for production e'uipment from the strai#ht-line method to the units-of-production method based on hours of utili>ation& The auditor concurs with the chan#e&
"
This situation inoles a lac2 of consistency&
4& A client chan#ed its depreciat ion method for production e'uipment from the strai#ht-line to a units-of-production method based on hours of utili>atio n& The auditor does not concur with the chan#e&
7
+ecause the auditor does not concur with the chan#e! it is treated as a departure from AA&
8& A client chan#ed the depreciab le life of certain assets from 1 years to 1" years& The auditor concurs with the chan#e&
1
A proper chan#e in estimate does not re'uire an emphasis of matter para#raph&
7& A client chan#ed the depreciab le life of certain assets from 1 years to 1" years& The auditor does not concur with the chan#e& Confined to fi=ed assets and accumulated depreciation! the misstatements inoled are not considered perasie&
$
+ecause the auditor does not concur with the chan#e in estimate! it is treated as a departure from AA& A 'ualified report is appropriate because the misstatements are not considered perasie&
<& A client chan#ed from the method it uses to calculate post employment benefits from one acceptable method to another one& The effect of the chan#e is immaterial this year! but e=pected to be material in the future&
1
A chan#e in accountin# principles with an immaterial effect (een if e=pected to become material in the future) does not result in addition of an emphasis of matter para#raph on consistency&
?& A client chan#ed the sala#e alue of certain asset s from 4L to 1L of ori#inal cost& The auditor concurs with the chan#e&
1
This is a chan#e in estimate that does not result in addition of an emphasis of matter para#raph on consistency&
1& A client uses the speci fic identificatio n method of accountin# for aluable items in inentory! and M,9* for less aluable items& The auditor concurs that this is a reasonable practice&
1
Consistency is a between periods concept usin# different inentory aluation methods such as here is acceptable and does not result in an emphasis of matter para#raph on consistency&
17-?
Chapter 17 - Auditors’ Reports
11& /ue to recurrin# operatin# losses and wor2in# capital deficiencies! an auditor has substantial doubt about an entity.s ability to continue as a #oin# concern for a reasonable period of time& The notes to the financial statements ade'uately disclose the situation&
8
This is a situation in which there is substantial doubt about a client’s #oin# concern&
1"& /ue to recurrin# operatin# losses and wor2in# capital deficiencies! an auditor has substantial doubt about an entity.s ability to continue as a #oin# concern for a reasonable period of time& The notes to the financial statements do not ade'uately disclose the substantial doubt situation and the auditor beliees the omission fundamentally affects the users’ understandin# of the financial statements&
%
The lac2 of disclosure creates a departure from AA& +ecause effects are perasie (fundamental to users’ understandin# of the financial statements is a characteristic of perasieness)! an aderse opinion is appropriate&
1$& An auditor reportin# on #roup financial statements decides to ta2e responsibility for the wor2 of a component auditor who audited a 7L owned subsidiary and issued an unmodified opinion& The total assets and reenues of the subsidiary are 4L and
1
+ecause the auditor ta2es responsibility for the wor2 of the component auditor! there is no mention of the component auditor&
1%& An auditor reportin# on #roup financial statements decides not to ta2e responsibility for the wor2 of a component auditor who audited a 7L owned subsidiary and issued an un'ualified opinion& The total assets and reenues of the subsidiary are 4L and
1
,n this situation the auditor’s responsibility section and the opinion sections hae additional wordin# added! but there is no emphasis of matter para#raph in what remains a report with an unmodified opinion&
14& An auditor was hired after year-end and was unable to obsere the countin# of the year-end inentory& 3he is unable to apply other procedures to determine whether endin# inentory and related information are properly stated&
<
This is a scope limitation&
18& An auditor was hired after year-end and was unable to obsere the countin# of the year-end inentory& Doweer! she was able to apply other procedures and determined that endin# inentory and related information is properly stated&
1
+ecause the auditor has satisfied herself throu#h performin# other procedures! a standard report is appropriate&
17& An auditor discoered that a client made ille#al political payoffs to a candidate for president of the 5nited 3tates& The auditor was unable to determine that amounts associated with the payoffs because of the client.s inade'uate record retention policies& The client has added a note to the financial statements to describe the ille#al payments and has stated that the amounts of the payments are not determinable&
<
This is a scope limitation because of the inade'uate record retention policies and the auditor’s inability to perform other procedures&
1<& An auditor discoered that a client made ille#al political payoffs to a candidate for president of the 5nited 3tates& The auditor was unable to determine that amounts associated with the payoffs because of the client.s inade'uate record retention policies! althou#h there is no li2elihood that the financial statements are perasiely misstated! they may be materially misstated& The client refuses to disclose the payoffs in a note to the financial statements&
$
The lac2 of disclosure results in a departure from AA& +ecause the effect is less than perasie! a 'ualified opinion is appropriate&
17-1
Chapter 17 - Auditors’ Reports
1?& ,n auditin# the lon#-term inestments account of a new client! an auditor finds that a lar#e contin#ent liability e=ists that is material to the consolidated company& ,t is probable that this contin#ent liabil ity will be resoled with a material loss in the future! but the amount is not estimable& Althou#h no adustin# entry has been made! the client has proided a note to the financial statements that describes the matter in detail&
1
+ecause the amount is not estimable! no adustin# entry can be recorded& The auditor mi#ht choose to emphasi>e this matter! but the problem’s bac2#round rules out this treatment&
"& ,n auditin# the lon#-term inestments account of a new client! an auditor finds that a lar#e contin#ent liability e=ists that is material to the consolidated company& ,t is probable that this contin#ent liabil ity will be resoled with a material loss in the future! and this amount is reasonably estimable as N"!!& Althou#h no adustin# entry has been made! the client has proided a note to the financial statements that describes the matter in detail and includes the N"!! estimate in that note&
7
+ecause the amount is estimable! an adustin# entry should be recorded since it was not! a departure from AA e=ists&
"1& A client is issuin# " years of comparatie financial statements& The first year was audited by another auditor who is not bein# as2ed to reissue her audit report& (Reply as to the successor auditor’s report&)
1
The successor auditor reports on year "& +ut an other matter para#raph is added indicatin# (1) the prior-period statements were audited by other auditors! (") the date and type of report issued and! ($) if the report was other than standard! the reasons therefore&
""& A client is issuin# " years of comparatie financial statements& The first year was audited by another auditor who is bein# as2ed to reissue her audit report& (Reply as to the successor auditor’s report&)
1
A standard report is issued on the second year& The other auditor’s report on the first year is reissued and included&
"$& A client.s financial statements follow AA! but the auditor wishes to emphasi>e in his audit report a si#nificant related-party transaction that is ade'uately described in the notes to the financial statements&
"
This is an emphasis of a matter situation&
"%& A client.s financial statements follow AA e=cept that they do not include a note on a si#nificant related party transaction&
7
This is a departure from AA& ;o information is proided on whether the omission is considered perasie&
17-$1 3imulation 1&
Correct& The title should include the word @independent&
"&
Correct& The report should include an addressee&
$&
Correct& There should be a section on mana#ement’s responsibility for the financial statements&
%&
,ncorrect& The report has the proper wordin#&
4&
,ncorrect& +ecause Hohnson I +ar2ley wish to assume responsibility for the wor2 of Mar2in I Ma2e! no mention of Mar2in I Ma2e should be made in the report&
8&
,ncorrect& The para#raph is re'uired&
7&
Correct& The emphasis of matter para#raph should follow the opinion para#raph&
<&
,ncorrect& The opinion section should not mention consistency&
17-11
Chapter 17 - Auditors’ Reports
?&
Correct& The date should be the date on which sufficient appropriate audit eidence has been #athered&
1&
,ncorrect& The titles of the financial statements are not repeated in the opinion para#raph&
Proble$s
17-$" 3*M5T,*;: 0illiams I Co&! CAs (Bstimated time " minutes) The auditors. report contains the followin# deficiencies: ,ntroductory section 1&
The financial statements audited should indiidually be named&
Auditor’s responsibility section "& $&
%&
0hat should be the second sentence is missin# (@0e conducted our audit in accordance with auditin# standards #enerally accepted in the 5nited 3tates of America&) An auditor obtains reasonable assurance about whether the financial statements are free of material misstatement! not in conformity with #enerally accepted accountin# principles (final sentence in first para#raph)& The one sentence final para#raph (0e beliee that the audit proides a reasonable basis for our opinion&) is omitted&
Bmphasis of matter section 4& 8&
The section should follow the opinion para#raph& The auditors should not #ie an opinion concernin# the entity.s surial beyond a reasonable period of time&
*pinion section 7& <& ?&
A 'ualified opinion is inappropriate (it should be unmodified)& The date of the financial statements audited is omitted& There should be no reference to consistency&
17-1"
Chapter 17 - Auditors’ Reports
17-$$ 3*M5T*;: Menses Co& (Bstimated time: " minutes) The auditors. report contains the followin# deficiencies: 1& The title should include the word @,ndependent "& The address ordinarily should not be mana#ement (it should be the board of directors! the audit committee! or the shareholders! etc&) ,ntroductory para#raph $& ,t should be#in with @0e hae auditedO& rather than @0e hae e=aminedO&& %& The final sentence concernin# CA*+ re'uirements should not be included& 3cope para#raph 4& The audit should be conducted in accordance with ublic Company Accountin# *ersi#ht +oard standards rather than #enerally accepted auditin# standards& 8& The auditor obtains reasonable assurance! not positie assurance& 7& The assurance relates to the financial statements bein# free of @material misstatements not @all misstatements& *pinion para#raph <& The term @present should be @present fairly& ?& @Applied on a consistent basis at the end of the para#raph is inappropriate and should be deleted& ,nternal control para#raph 1& @0e also hae reiewed at the be#innin# of the para#raph should be @0e hae audited&
17-1$
Chapter 17 - Auditors’ Reports
17-$% 3*M5T,*;: 3turdy Corporation (Bstimated time: " minutes) (a)
A separate basis for modification section (titled @+asis for Aderse *pinion) should set forth reasons for the e=pression of an aderse opinion and the principal effects of the subect matter of the aderse opinion& The section should state the followin#! proidin# dollar amounts where practicable: The company carries its buildin# accounts at appraisal alues and proides for depreciation on the basis of such alues& +uildin#s! accumulated depreciation! and e'uity (attributed to appraisals) are oerstated& ;et income is understated& /epreciation e=pense is oerstated& •
•
• •
(b)
The opinion para#raph should contain a reference to the separate para#raph and state the financial statements do not present fairly the financial position! results of operations! and cash flows& ,t should be worded as follows:
Aderse *pinion ,n our opinion! because of the si#nificance of the matter discussed in the +asis for Aderse *pinion para#raph! the consolidated financial statements referred to aboe do not e=press fairly the financial position of 3turdy Corporation as of /ecember $1! 1?P$! and the results of its operations and its cash flows for the year then ended&
17-1%
Chapter 17 - Auditors’ Reports
17-$4 3*M5T,*;: B=celsior Corporation (Bstimated time: "4 minutes) %ndependent Auditor&s Report
To the +oard of /irectors and 3toc2holders of B=celsior Corporation 0e hae audited the accompanyin# consolidated financial statements of B=celsior Corporation and its subsidiaries! which comprise the consolidated balance sheet as of /ecember $1! "P1! and the related consolidated statements of income! chan#es in stoc2holders’ e'uity and cash flows for the year then ended! and the related notes to the financial statements& Management’s Responsibility or the Finan!ial Statement Gana#ement is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accountin# principles #enerally accepted in the 5nited 3tates of America this includes the desi#n! implementation and maintenance of internal control releant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement! whether due to fraud or error& "#ditor’s Responsibility *ur responsibility is to e=press an opinion on these consolidated financial statements based on our audit& 0e conducted our audit in accordance with auditin# standar ds #enerally accepted in the 5nited 3tates of America& Those standards re'uire that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement&
An audit inoles performin# procedures to obtain audit eidence about the amounts and disclosures in the consolidated financial statement& The procedures selected depend on the auditor’s ud#ment! includin# the assessment of the ris2s of material misstatement of the consolidated financial statements! whether due to fraud or error& ,n ma2in# those ris2 assessments! the auditor considers internal control releant to the entity’s preparation and fair presentation of the consolidated financial statements in order to desi#n audit procedures that are appropriate in the circumstances! but not for the purpose of e=pressin# an opinion on the effectieness of the entity’s internal control& Accordin#ly! we e=press no such opinion& An audit also includes ealuatin# the appropriateness of accountin# policies used and the reasonableness of si#nificant accountin# estimates made by mana#ement! as well as ealuatin# the oerall presentation of the consolidated financial statements& 0e beliee that the audit eidence we hae obtained is sufficient and appropriate to proide a basis for our audit opinion& Basis or Q#aliied $pinion The corporation declined to disclose that the a#reement e=ecuted in conunction with the issuance of the debentures of Hanuary $1! "P1! for the purpose of financin# e=pansion of plant facilities! restricts the payment of future cash diidends to earnin#s after /ecember $1! "P1& Q#aliied $pinion ,n our opinion! e=cept for the effects of omittin# the information on the debentures discussed in the +asis for ualified *pinion ara#raph! the financial statements referred to aboe present fairly! in all material respects! the financial position of B=celsior Corporation and its subsidiaries as of /ecember $1! "P1! and the results of their operations and their cash flows for the year then ended in accordance with accountin# principles #enerally accepted in the 5nited 3tates of America& %mphasis o Matters As discussed in note 11 to the financial statements! the corporation is the defendant in a lawsuit relatin# to (state type of liti#ation)& The ultimate outcome of the lawsuit cannot presently be determined! and no proision for any liability that may result has been made in the financial statements& *ur opinion is not modified with respect to this matter&
As discussed in note 1" to the financial statements! the corporation chan#ed its method of accountin# for lon#-term construction contracts& *ur opinion is not modified with respect to this matter&
Roscoe & Jones, Ltd
3iler! +ell! Ari>ona 9ebruary 1! "P"
17-14
Chapter 17 - Auditors’ Reports
The only item of other information that is not part of the aboe report is Roscoe.s failure to confirm accounts receiable& 0hen alternate procedures are performed and proide sufficient appropriate audit eidence! the auditors need not refer to the omission of the normal procedures in the report& This and the ne=t problem are similar! althou#h this problem is for a nonpublic company and includes a departure from AA& 17-$8 3*M5T,*;: B=chec2er Corporation Report o %ndependent Registered Publi! A!!ounting (ir$ T)e *oard o +ire!tors and "to!,)olders E-!)e!,er Corporation
0e hae audited the accompanyin# consolidated balance sheets of B=chec2er Corporation as of /ecember $1! "P1 and "P! and the related consolidated statement of income! stoc2holders’ e'uity! and cash flows for each of the three years in the period ended /ecember $1! "P1& These financial statements are the responsibility of the Company’s mana#ement& *ur responsibility is to e=press an opinion on these financial statements based on our audits& 0e conducted our audits in accordance with the standards of the ublic Company Accountin# *ersi#ht +oard (5nited 3tates)& Those standards re'uire that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement& An audit includes e=aminin#! on a test basis! eid ence supporti n# the amounts and di sclosures in the fin ancial statements& An audit al so includes assessin# the accountin# principles used and si#nificant estimates made by mana#ement! as well as ealuatin# the oerall financial statement presentation& 0e beliee that our audits proide a reasonable basis for our opinion& ,n our opinion! the financial statements referred to aboe present fairly! in all material respects! the consolidated financial position of B=chec2er Corporation at /ecember $1! "P1 and "P! and the consolidated results of its operations and its cash flows for each of the three years in the period ended /ecember $1! "P1! in conformity with 5&3& #enerally accepted accountin# principles& 0e also hae audited! in accordance with the standards of the ublic Company Accountin# *ersi#ht +oard (5nited 3tates)! B=chec2er Corporation’s internal control oer financial reportin# as of /ecember $1! "P1! based on criteria established in ,nternal Control-,nte#rated 9ramewor2 issued by the Committee of 3ponsorin# *r#ani>ations of the Treadway Commission and our report dated 9ebruary 1! "P" e=pressed an un'ualified opinion thereon& As discussed in note 11 to the financial statements! the corporation is the defendant in a lawsuit relatin# to (state type of liti#ation)& The ultimate outcome of the lawsuit cannot presen tly be determined! and no proision for any liability that may result has been made in the financial statements& As discussed in note 1" to the financial statements! the corporation chan#ed its method of accountin# for lon#-term construction contracts&
Rotter & Co, Ltd 3iler +ell! Ari>ona 9ebruary 1! "P"
The only item of other information that is not part of the aboe report is Roscoe.s failure to confirm accounts receiable& 0hen alternate procedures are performed and proide sufficient appropriate audit eidence! the auditors need not refer to the omission of the normal procedures in the report&
17-18
Chapter 17 - Auditors’ Reports
This and the precedin# problem are similar! althou#h this is for a public company& Also! we omitted the departure from AA since the 3BC will ordinarily not allow 'ualified reports& %n#Class Tea$ Case 17-$7 Reportin# 3cenarios (Bstimated Time: 4 Ginutes) Cir!u$stan!e
1
AA
Type opinion.s/
Report Alteration
+9G
A
+9G
"
BGD
5
B*G
$
3C*B
+9G
/
+9G
5
B*G
/
+9G
%
C
4
R*5
5
*TDBR
8
R*5
5
;*
7
C*; or ;*;B
5
;*
<
C*;
5
;*
?
BGD
5
B*G
1
C*G
5
*G
;ote on placement of para#raphs: B*G6After opinion section & *G6After opinion section (also after any B*G) +9G6rior to opinion para#raph&
17-17
Chapter 17 - Auditors’ Reports
17-$< "ituation 1& A company in its first year of e=istence alues its inentory at current replacement cost& 0hile you beliee that the inentory costs do appro=imate replacement costs! these costs do not appro=imate any AA inentory aluation method& The difference inoled is material! but not perasiely material to the financial statements& "& /ue to recurrin# operatin# losses and wor2in# capital deficiencies! you hae substantial doubt about an entity’s ability to continue as a #oin# concern for a reasonable period of time& The notes to the financial statements ade'uately disclose the substantial doubt situation& $& Eou hae discoered that a client made ille#al payoffs to a candidate for president of the 5nited 3tates& Eou are unable to determine the amounts associated with the payoffs because of the client’s inade'uate record retention policies& The client has added a note to the financial statements to describe this all! and has stated that the amounts of the payments are not determinable& 4. ,n auditin# the lon#-term inestments account of a new client! you find that a N"!! contin#ent liability e=ists that is material to the consolidated company& ,t is a probable this contin#ent liability will be resoled with a material loss in the future& Althou#h no adustin# entry has been made! the client has proided a note to the financial statements that describes the matter in detail and includes the N" million estimate in that note& 4& A client is issuin# " years of comparatie financial statements& The first year was audited by another auditor who is not bein# as2ed to reissue her audit report& 8& An entity chan#es its depreciation method for production e'uipment from the strai#ht-line to the units-of-production method based on hours of utili>ation& Eou concur with the chan#e& 7& A client has chan#ed from the method it uses to calculate post employment benefits from one acceptable method to another one& The effect of the chan#e is immaterial this year! but e=pected to be material in the future& <& A component auditor has audited a subsidiary of your client as a part of a #roup audit& Eou hae decided to rely upon the component auditor’s wor2& ?& A client omits a note disclosure related to si#nificant accountin# policies which the auditor beliees to be fundamental to users’ understandin# of the financial statements& 1& A client does not count its year-end inentory& The auditors are unable to obtain sufficient appropriate audit eidence related to inentory and they consider inentory as representin# an e=tremely substantial proportion of the financial statements&
17-1<
Opinion
Opinion
5
/
/
A
5
5
3
3
A
/
Chapter 17 - Auditors’ Reports
Resear!) and +is!ussion Case
17-$? Getropolitan ower 3upply (Bstimated Time: 44 minutes) (a)
Ar#uments for auditors insistin# that some portion of construction costs be e=pensed: The concept that an asset should not be carried at a alue #reater than its serice potential is F"SB "S& '(0-10. This statement re'uires that the carryin# amount of an asset be reduced wheneer the sum of the e=pected future cash flows is less than the carryin# amount& ,t appears that Ba#le Gountain ultimately will cost far more than G3 can e=pect to recoer throu#h operations& Therefore! some of the total cost should be re#arded as a loss! not as a productie asset& The asset should be written down to its fair alue& The fair alue is probably best measured as the present alue of the e=pected future cash flows from the plant& ranted! the computation of the loss is somewhat subectie! but it must be done to fairly present the asset&
•
•
Ar#ument a#ainst insistin# that some construction costs be e=pensed: •
As G3’s auditors! we do not 2now what the future cash flows from operations will be& resumably! the @recoerable costs are whateer the state utilities commission ultimately allows G3 to pass on to its ratepayers& 5ntil this determination is made! or until G3 abandons the proect! any #uesses as to the recoerable cost would be sheer speculation&
*ur opinion on part a: 0e beliee that the carryin# alue of the plant should be reduced to its estimated fair alue measured as the discounted e=pected future cash flows from the plant in accordance with F"SB "S& '(0-10-'). Gana#ement of G3 should be able to reasonably estimate the amount of the cost that the utility commission will allow the company to recoer based on their e=perience in the industry& (b)
,t appears that there is considerable ris2 that continuin# with the Ba#le Gountain proect may ultimately cause G3 to become insolent& The 'uestion! therefore! is whether this ris2 is sufficient for the auditors to modify their report as to G3.s ability to remain a #oin# concern&
17-1?
Chapter 17 - Auditors’ Reports
Althou#h the case does not ma2e it alto#ether clear when the company would be li2ely to become insolent! there is no indication that it will within a one-year period as indicated in A,CA A5 47 (CA*+ $%1) relatin# to #oin# concern 'uestions& Thus! the facts do not su##est that auditors should issue a #oin# concern modification merely because they anticipate problems years down the road& ,n the opinion of the authors! the client should receie the benefit of the doubt& An opinion should not be modified with respect to a #oin# concern 'uestion unless there is substantial doubt that the client will become insolent within one year from the date of the balance sheet& To speculate oer lon#er periods of time simply inoles too much conecture to be consistent with the attest function& Althou#h we would not modify our opinion as to G3.s ability to remain a #oin# concern! we would consider includin# an emphasis of a matter para#raph describin# the uncertainty surroundin# the ultimate reali>ation of the capitali>ed construction costs& Therefore! we would consider includin# an emphasis of a matter para#raph discussin# the company.s ability to finance the completion of the Ba#le Gountain facility and to recoer the capitali>ed construction costs&
17-"
