Chapter Two Audit Reports Auditing 81.3550 Chapter Two Audit Reports

Highlights Describe basic contents of Audit Report Identify the 4 basic types of Audit Reports What conditions apply to each type of report Materiality - what is it? Process involved in determining which report is appropriate

Audit Report - Standard Sections 1. Report Title - required by section 5400.07 2. Addressee - 5400.31 - to whom report is address to often to Shareholders 3. Introduction Paragraph - identifies audit has been done, clarifies what an audit means, lists statements audited, discusses parties’ responsibilities 4. Scope Paragraph - reasonable assurance and free from material misstatement - but not guarantee

Report title: Auditor’s Report Address: To the Shareholders of Ace Company: Introductory paragraph: We have audited the balance sheets of Ace Company as at December 31, 2004 and the statements of income, retained earnings, and changes in financial position for the year 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.

Scope paragraph: We conducted our audits in accordance with generally accepted auditing standards. 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.

Opinion paragraph: Audit report date: Name of firm: February 27, 2005 In our opinion, these financial statements present fairly, in all material respects, the financial position of Ace Company as at December 31, 2004 and the results of its operations and the changes in its financial position for the years then ended in accordance with generally accepted accounting principles. Name of firm: Taylor & Tower, CAs City: Anywhere, any province Audit report date: February 27, 2005

Audit Report - Standard Sections 5. Opinion Paragraph - states auditor’s conclusion based on evidence obtained during audit 6. Name of Firm - one responsible for the audit 7. Place of issue - often indicated at foot of report 8. Auditor’s Report Date - one by which most audit procedures were completed by - indicates last date of responsibility

Audit Report - Standard Sections - Double dating of Audit report used when material even occurs after the completion of the field work but before report is issued

Audit Report Categories Standard Unqualified Unqualified with explanatory paragraph Qualified Adverse or Denial of Opinion

Most Common Type of Audit Report - Unqualified Often called “Standards Audit Report” All conditions of the standard audit have been meet Auditors feel comfortable with rendering unqualified opinion on FS

Unqualified Opinion with Explanatory Paragraph Audit completed but auditor believes additional information is required or of great importance Statements still believed to present fairly all regular conditions have been met For example - audit may have been conducted with basis of accounting different from GAAP Explanation section/disclosure of additional information in the audit report follows in a new paragraph after the opinion one

Qualified Opinion Can also be called a “reserved” opinion can result from a scope limitation (auditor’s field work restricted but only in one area) - often imposed by client or beyond client or auditors control or failure to follow GAAP (small area of departure and effect can be quantified)

Qualified Opinion Examples include: inappropriate accounting treatment, valuation or failure to disclose essential info satisfied with overall financial statements as presenting fairly should use terms - except for or except that or except as in opinion paragraph to outline exceptions very rare to have this type of report

Adverse Opinion Used only when auditor concludes that statements do not present fairly i.e.. Materially misstated or misleading normally due to GAAP departures

Denial of Opinion Auditor does not feel confident that financial statements present fairly - unable to express an opinion could be result of severe scope limitation or severe GAAP noncompliance lack of knowledge - unable to give opinion differs from adverse where there is knowledge of significant departure and can identify misstatements

Denial – Scope Restriction Same introductory paragraph Except as explained in the following paragraph, we conducted our audit in accordance with generally accepted auditing standards... Explanatory third paragraph including $-effect In view of the possible material effects on the financial statements of the matters described in the preceding paragraph, we are unable to express an opinion whether these financial statements are presented fairly in accordance with generally accepted accounting principles.

Materiality Defn (5130.05) - misstatement in financial statements is considered to be material if the decision of a person who is relying on the financial statements would be changed requires professional judgement to determine effect

Materiality Items to consider in determining materiality compare dollar amount to base common ones include: income B4 taxes, total assets, current assets, and working capital note need to add up all errors found to consider total plus look at pervasiveness Measurability can we accurately measure the effects of this error Nature of Item does this affect users decision for example is it fraud, may have future effects, send incorrect message, or may have other consequences (such as debt call or convent failure)

Materiality Immaterial - misstatement in F/S unlikely to affect decision of user - can issue unqualified opinion (example bank balance is found to be in error $10 on a million dollar balance) Pervasive - extent to which exception/error affects different parts of F/S

Materiality Material item - not pervasive = would affect users decision need since not pervasive likely overall statements still useful. If use overall still useful issue qualified opinion using “except for” Material item - pervasive = affects decision plus other parts of the statement likely will overall statements increased level of pervasiveness = adverse opinion more likely

Reliance on Specialists or Another Auditor Primarily auditor responsible for audit regardless of personnel or specialists hired Primary- responsible to check credentials, competence and integrity of specialist/auditor

Reliance on Specialists or Another Auditor Normally use of a specialist or another auditor is not mentioned in audit report Scope limitation = find out cannot rely on another auditor/specialist if unqualified opinion appropriate- name of secondary auditor/specialist not mentioned qualified or denial opinion - may mention name and explain reason(s) for qualification

Type of Audit Report Level Materiality Immaterial Material Material & Pervasive Scope Restriction Not GAAP Standard Report Standard Report Qualified report Qualified Report Denial of Opinion Adverse Opinion