Problem EP 16-4, Page 882 At the end of her audit of Jolie Angelique Inc., Emma concludes that there are material misstatements affecting many accounts, with the result that the financial statements as a whole are misleading. The company’s management refuses to adjust the financial statements, however. REQUIRED: List the four forms of modified opinions set out in CAS 705. Explain which form of audit opinion would be appropriate in this situation.

Solution to problem EP 16-4 Form of opinion, misleading financial statements Disclaimer Adverse qualified (scope limitation) Qualified (GAAP departure)   Emma would probably resign from the audit without reporting since the integrity of management is questionable. If she is unable to resign for some reason, she would issue an adverse opinion in this case since the overall impact of the misstatements has a pervasive effect and results in the financial statements being misleading.

Problem DC 16-3, Page 883 The auditors of CRX Inc. financial statements for the year ended December 31, 20X7, have decided that there is substantial doubt that CRX can continue to exist as a going concern because the company has experienced significant operating losses since 20X5 and has had to get permission from its lenders to postpone its debt payment requirements. CRX’s management has agreed to describe the problems in the president’s message to the shareholders in their annual report but has decided not to reflect this situation in the notes to the financial statements. REQUIRED: Discuss fully the type of audit opinion to be issued in this situation, including a description of any information that would be necessary to the standard report. Describe what change(s) would be necessary for CRX to obtain an unmodified opinion in this case.

Solution to problem DC 16-3 Failure to properly disclose the going concern is a non-compliance with GAAP situation. Most likely it would be considered so material and pervasive that an adverse opinion is warranted. An added paragraph between the scope and opinion paragraph explaining the impact on the financial statements is required. The opinion paragraph would say “except for” and reference to the reservation paragraph and state the opinion that “these financial statements do not present fairly.” If the auditee was persuaded by the auditor to provide adequate disclosure of the uncertainty, a clean opinion could have be provided under Canadian GAAS prior to the CAS coming into effect. The CAS require an emphasis of matter paragraph to be added drawing attention to the going concern disclosure, eliminating what had been a difference between Canadian GAAS, and US or International GAAS. If management agrees that the going concern assumption is no longer valid, GAAP financial statements are no longer appropriate. Management would be required to present the company’s financial position based on its liquidation values.

Problem DC 16-4, Page 883 Yue is auditing the accounts receivable for Slawson & Slawson, LLP, a large law partnership. The managing partner of the law firm has prohibited the auditor from confirming any of the law firm’s accounts receivable. The lawyers are concerned that their clients would consider it a breach of confidentiality for the auditor to know that they had engaged the lawyer’s services and would not understand that the auditor is also operating under strict rules that require confidentiality. The accounts receivable balance is highly material. Yue is not able to satisfy himself as to the receivable balance by alternative means. REQUIRED: Describe the type and format of audit opinion that should be issued in this case. Explain the type of evidence that Yue was trying to obtain by confirming the law firm’s accounts receivable balances, and then explain the assertion(s) and specific audit objectives that this evidence relates to. Why do you think it was not possible to obtain evidence by alternative means?

Solution to problem DC 16-4 Type - Audit report should contain a qualified opinion, modified for a scope limitation because the balance is MATERIAL. If the assumption was made that the amounts were so material they are pervasive throughout the financial statements then disclaimer would also be an acceptable answer. Format - Scope paragraph would start with “Except as explained in the following paragraph,…” Additional paragraph between scope and opinion paragraph would be added explaining that the company has restricted the scope of the auditor and the auditor was not able to satisfy him or herself by alternative procedures. Opinion paragraph contains modification: “In my opinion, except for the effects of adjustments, if any, which I might have determined to be necessary had I been able to confirm the accounts receivable specified in the preceding paragraph,…” If disclaimer is recommended, scope and additional paragraph would be modified as above, opinion paragraph would be worded as : “In view of the possible material effects on the financial statements of the matters described in the preceding paragraph, I am unable to express an opinion whether these financial statements are presented fairly…”   Confirmation with outside parties provides highly reliable evidence regarding assertions: existence, valuation and completeness of accounts receivable. Specific audit objectives include: - are receivables valid debts owed by real customers? - are all receivables outstanding included in company’s records? - does the net realizable value of the receivable reflect likelihood that customers will actually pay? Alternative procedures such as verifying subsequent receipts or examining client documents cannot prove the customer or the debt is real with a high degree of reliability because confirmation is highly objective, independent evidence, and it is not easily to falsify because auditors can control the confirmation process. So failure to obtain confirmations in this case means an essential piece of evidence is missing.