Auditing & Assurance Services, 6e

Chapter 12 Reports on Audited Financial Statements In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Enron Corp. and subsidiaries as of December 31, 2000 and 1999, and the results of their operations, cash flows, and changes in shareholders’ equity for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Opinion paragraph from Arthur Andersen’s final audit of Enron Corp. (dated February 23, 2001)

Chapter 12 Objectives Understand the types of reports that accompany an entity’s financial statements and the content of the auditors’ standard (unmodified) report. Identify situations in which the language in the standard (unmodified) report is modified and the type of opinion issued in those circumstances. Identify situations in which auditors add explanatory language to an unmodified opinion. Identify other circumstances affecting auditors’ reporting responsibilities and explain how they affect auditors’ reports on an entity’s financial statements.

Major Topics Overview of Reporting The Standard (Unmodified) Report Reasons for Departing from Standard (Unmodified) Report Departures from GAAP Scope limitations Audit of group financial statements Other Matters Encountered During the Audit Other Issues and Reporting

Reports Accompanying Financial Statements Nonpublic entities Public entities Auditor Fairness of financial statements and related disclosures Effectiveness of internal control over financial reporting Management

Major Topics Overview of Reporting The Standard (Unmodified) Report Reasons for Departing from Standard (Unmodified) Report Departures from GAAP Scope limitations Audit of group financial statements Other Matters Encountered During the Audit Other Issues and Reporting

Components of the Standard (Unmodified) Report Introductory paragraph F/S and years examined Management’s Responsibility section Management responsible for financial statements Management responsible for internal control Auditor’s Responsibility section Auditor responsible for issuing opinion on financial statements Audit conducted in accordance with GAAS Audit provides reasonable assurance Opinion Are F/S presented in accordance with applicable financial reporting framework (GAAP)?

The Standard (Unmodified) Report (Other Elements) Title includes the word “independent” Addressed to the client (normally, shareholders and board) Dated when auditors have obtained sufficient appropriate evidence (date of the auditors’ report) Signed by the accounting firm

Types of Opinions Unmodified opinion Qualified opinion Adverse opinion F/S are in accordance with GAAP Standard report may be modified to disclose additional matters Qualified opinion “Except for” some matter, F/S are in accordance with GAAP Adverse opinion F/S are not in accordance with GAAP Disclaimer of opinion No opinion is issued by auditors

Major Topics Overview of Reporting The Standard (Unmodified) Report Reasons for Departing from Standard (Unmodified) Report Departures from GAAP Scope limitations Audit of group financial statements Other Matters Encountered During the Audit Other Issues and Reporting

Departures from GAAP NO YES NO Qualified Opinion YES Adverse Opinion Is the Departure Material? NO Standard Report (Unmodified Opinion) YES NO Is the Departure Pervasive? Qualified Opinion YES Adverse Opinion

Qualified Opinion Issued when departure is material, yet not pervasive Report Modifications: Add paragraph preceding the opinion paragraph explaining departure and detailing $ amounts involved Modify opinion paragraph (“In our opinion, except for the matter discussed in the preceding paragraph,….”) Report Example

Adverse Opinion Issued when F/S do not present fairly according to GAAP (i.e., a serious, pervasive departure from GAAP). Report Modifications: Add paragraph preceding the opinion paragraph explaining the departure and detailing $ amounts involved Change opinion paragraph (“financial statements do not present fairly”) Report Example

Major Topics Overview of Reporting The Standard (Unmodified) Report Reasons for Departing from Standard (Unmodified) Report Departures from GAAP Scope limitations Audit of group financial statements Other Matters Encountered During the Audit Other Issues and Reporting

Scope Limitations NO YES YES NO NO Qualified Opinion YES Is the Limitation Material? NO Standard Report (Unmodified Opinion) YES Alternative Procedures Available? YES Standard Report (Unmodified Opinion) NO Is the Limitation Pervasive? NO Qualified Opinion YES Disclaimer of Opinion

Type of Scope Limitations Circumstance-Imposed Situation in which matters beyond auditors’ and client’s control limit procedures performed by auditors Example: inability to observe year-end inventory because of late appointment Client-Imposed Situation in which client specifically limits auditors’ procedures Should be viewed as a significant restriction and a disclaimer is ordinarily issued

Scope Limitation: Qualified Opinion Issued when scope limitations are material, but not pervasive Report Modifications: Add paragraph preceding the opinion paragraph describing the scope limitation Modify opinion paragraph (“In our opinion, except for”) Report Example

Scope Limitation: Disclaimer of Opinion Pervasive scope limitation, usually client-imposed Significance of the limitation is such that auditors cannot gather sufficient appropriate evidence to form an opinion Report Modifications: Introductory paragraph: (“We were engaged to audit ….”) Modify Auditor’s Responsibility section: Note that auditors were not able to obtain sufficient appropriate evidence Delete paragraphs describing an audit and indicating that the audit provides a basis for the opinion Add paragraph preceding the opinion paragraph describing the scope limitation Modify opinion paragraph (“…we do not express an opinion….”) Report Example

Major Topics Overview of Reporting The Standard (Unmodified) Report Reasons for Departing from Standard (Unmodified) Report Departures from GAAP Scope limitations Audit of group financial statements Other Matters Encountered During the Audit Other Issues and Reporting

Audit of Group Financial Statements Group financial statements: Financial statements comprised of more than one division/subsidiary/segment/component Group auditors: Conduct audit of material portion of the entity Component auditors: May be engaged by group auditors to audit divisions, subsidiaries, or components

Audit of Group F/S Standard Report (Unmodified Opinion) YES NO Take Responsibility for Component Auditors’ Work? Standard Report (Unmodified Opinion) YES NO Obtain permission and present component auditors’ report Refer to Component Auditors by Name? YES NO Indicate Division of Responsibility in Unmodified Opinion

Effect on Report Report Example Group auditors should Options Verify component auditors’ reputation and independence Communicate and coordinate with component auditors Options Take responsibility for work: Standard (unmodified) report Name component auditors Present report of component auditors, only with their permission Refer to component auditors Modify Auditor’s Responsibility section Modify opinion paragraph Still express unmodified opinion, if appropriate Report Example

Summary Standard Report Unmodified Opinion Qualified Opinion Adverse Opinion Disclaimer of Opinion Departures from GAAP Not Material Material, but Not Pervasive Material and Pervasive Scope Limitations Material but Not Pervasive Audit of Group Financial Statements Assume Responsibility for Work of Component Auditors Do Not Assume Responsibility for Work of Component Auditors

Major Topics Overview of Reporting The Standard (Unmodified) Report Reasons for Departing from Standard (Unmodified) Report Departures from GAAP Scope limitations Audit of group financial statements Other Matters Encountered During the Audit Other Issues and Reporting

General Approach for Other Matters Issue unmodified opinion but add paragraph to report to discuss the matter Emphasis-of-matter paragraphs provide information related to users’ understanding of F/S Other-matter paragraphs provide information related to users’ understanding of audit, auditors’ responsibility, or auditors’ report Situations Consistency Going-concern Other Information Required Supplementary Information Emphasis of a matter

Consistency Relates to: Type of changes in accounting principles: Change in accounting principles Adjustments to correct misstatements in previously issued F/S Type of changes in accounting principles: Accounting principles (GAAP to GAAP) Form of reporting entity Accounting principles (non-GAAP to GAAP) Accounting principle inseparable from changes in estimates

Consistency: Effect on Report Add emphasis-of-matter paragraph following the opinion paragraph May issue a qualified opinion (GAAP departure) if: Change is not justified Change is not accounted for in accordance with GAAP

Going-Concern Uncertainties Auditors are responsible to evaluate whether substantial doubt exists about ability of entity to continue in existence for one year beyond date of F/S Options Add emphasis-of-matter paragraph following opinion paragraph (still unmodified opinion) If serious uncertainty, may issue disclaimer of opinion Modified language must include the words substantial doubt and going concern

Non-F/S Information Other Information Accompanying F/S Auditors required to ensure information consistent with F/S If not consistent, either revise opinion on F/S or add emphasis-of-matter paragraph Required Supplementary Information Auditors required to perform limited procedures and expand report on F/S to address Add other-matter paragraph to identify information, describe procedures performed, and identify any issues

Emphasis of a matter Call user attention to important matters Add emphasis-of-matter paragraph after opinion paragraph discussing the matter

Major Topics Overview of Reporting The Standard (Unmodified) Report Reasons for Departing from Standard (Unmodified) Report Departures from GAAP Scope limitations Audit of group financial statements Other Matters Encountered During the Audit Other Issues and Reporting

Comparative F/S Continuing auditors Predecessor auditors Report should address all years presented in comparative form Update opinion by considering if previously issued opinions still appropriate If previously issued opinions not appropriate, revise opinion in current report (other-matter paragraph) Predecessor auditors With permission, auditors may present reissued report from predecessor on prior- years’ F/S along with successor’s report on current F/S If predecessors’ report not presented, successor auditors’ report must reference predecessors’ report and opinion on prior-years’ F/S (other-matter paragraph)

Summary Financial Statements Derived from the full set of financial statements Auditor can only examine and report if audited full financial statements Report Refers to auditors’ report on full financial statements Indicates whether information in summary financial statements is consistent in relation to the full financial statements

Association with Unaudited F/S Auditors permit use of name in communication including F/S Issue disclaimer of opinion (one paragraph) Do not mention auditing procedures performed Must identify any known departures from GAAP in the report Should cover all unaudited prior-years’ financial statements

Lack of Independence Scenario: Auditors begin engagement but independence subsequently compromised Report Single paragraph Indicates auditors are not independent Does not indicate why independence lacking

Components modified/added Reporting Summary Opinion Components modified/added Material Pervasive Intro Auditor’s Respons Add’l Departure from GAAP Qualified Adverse X Scope Limitation Disclaimer X (Disclaimer) Audit of Group F/S Unmodified Other matters (Consistency, Going-concern, Required Supplementary, Emphasis of Matter, etc.) May issue disclaimer if: Lack of independence Associated with financial statements Material and pervasive going-concern uncertainty

Report Examples

We have audited the accompanying financial statements of Dunder-Mifflin, Inc., which comprise the balance sheet as of December 31, 2014, and the related statements of income, changes in shareholders’ equity, and cash flows for the year then ended, and the related notes to the financial statements. Management’s Responsibility for the Financial Statements Auditor’s Responsibility Opinion Paragraph Return to Overview

Management’s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s Responsibility Opinion Paragraph Return to Overview

Management’s Responsibility for the Financial Statements Auditor’s Responsibility Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion Opinion Paragraph Return to Overview

Management’s Responsibility for the Financial Statements Auditor’s Responsibility Opinion Paragraph In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Dunder-Mifflin, Inc. as of December 31, 2014, and the results of its operations and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America. Return to Overview

Management’s Responsibility for the Financial Statements Auditor’s Responsibility Basis for Qualified Opinion   As discussed in Note 16, an additional provision In the amount of $30,000,000 for possible uncollectible receivables at December 31, 2013, was charged to operations during the year ended December 31, 2014, which, in our opinion, should have been reflected In the financial statements for 2013. Had this provision been properly recorded in the 2013 financial statements, Dunder-Mifflin, Inc. would have reported net earnings of $700,000 for the year ended December 31, 2014, rather than the net loss of $29,300,000 as reflected in the statements of income, changes in shareholders’ equity, and cash flows for that period. Qualified Opinion In our opinion, except for the effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements referred to above present fairly, in all material respects, the financial position of Dunder-Mifflin, Inc. as of December 31, 2014, and the results of its operations and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America. Return to Overview

Management’s Responsibility for the Financial Statements Auditor’s Responsibility Basis for Adverse Opinion   As discussed in Note 16, an additional provision In the amount of $30,000,000 for possible uncollectible receivables at December 31, 2013, was charged to operations during the year ended December 31, 2014, which, in our opinion, should have been reflected In the financial statements for 2013. Had this provision been properly recorded in the 2013 financial statements, Dunder-Mifflin, Inc. would have reported net earnings of $700,000 for the year ended December 31, 2014, rather than the net loss of $29,300,000 as reflected in the statements of income, changes in shareholders’ equity, and cash flows for that period. Adverse Opinion In our opinion, because of the significance of the matter discussed In the Basis for Adverse Opinion paragraph, the financial statements referred to above do not present fairly the financial position of Dunder-Mifflin, Inc. as of December 31, 2014, or the results of its operations or its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America. Return to Overview

Introductory Paragraph Management’s Responsibility for the Financial Statements Auditor’s Responsibility Basis for Qualified Opinion   Dunder-Mifflin, Inc. did not make a count of their physical inventory in 2014, stated in the accompanying financial statements at $10,000,000 at December 31, 2014, and we were unable to observe the physical quantities on hand. Dunder-Mifflin, Inc.'s records do not permit the application of other auditing procedures to the audit of inventories. Qualified Opinion In our opinion, except for the possible effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements referred to above present fairly, in all material respects, the financial position of Dunder-Mifflin, Inc. as of December 31, 2014, and the results of its operations and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America. Return to Overview

We were engaged to audit the accompanying financial statements of Dunder-Mifflin, Inc., which comprise the balance sheet as of December 31, 2014, and the related statements of income, stockholders' equity, and cash flows for the year then ended, and the related notes to the financial statements. Management's Responsibility for the Financial Statements Auditor's Responsibility Our responsibility is to express an opinion on these financial statements based on conducting the audit in accordance with auditing standards generally accepted In the United States of America. Because of the matter described in the Basis for Disclaimer of Opinion paragraph, however, we were not able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion. [Remainder of section deleted] Basis for Disclaimer of Opinion Dunder-Mifflin, Inc. did not make a count of their physical inventory in 2014 , stated in the accompanying financial statements at $10,000,000 at December 31, 2014, and we were unable to observe the physical quantities on hand. Dunder-Mifflin, Inc.'s records do not permit the application of other auditing procedures to the audit of inventories. Disclaimer of Opinion Because of the significance of the matter described in the Basis for Disclaimer of Opinion paragraph, we have not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion. Accordingly, we do not express an opinion on these financial statements. Return to Overview

Management's Responsibility for the Financial Statements   Auditor's Responsibility Our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the financial statements of B Company, a wholly-owned subsidiary, which statements reflect total assets constituting 20 percent of total assets at December 31, 2014 and total revenues constituting 18 percent of total revenues for the year then ended. Those statements were audited by other auditors, whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for B Company, is based solely on the report of the other auditors. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. (No revisions to remainder of the section) Opinion In our opinion, based on our audit and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of Dunder-Mifflin, Inc. as of December 31, 2014 and the results of its operations and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America. Return to Overview