GENERAL TYPES OF AUDIT REPORTS Fourth standard of reporting = express opinion. Five general types: Unqualified opinion: “The F/S present fairly IAW GAAP.” Unqualified opinion with explanatory language: “The F/S present fairly IAW GAAP but …” Qualified opinion: “The F/S present fairly IAW GAAP except for….” Adverse opinion: “The F/S do not present fairly IAW GAAP.” Disclaimer: “Unable to determine if the F/S present fairly IAW GAAP.”

DEFINITION OF MATERIALITY Materiality = magnitude of error or omission that would affect the decision of an informed person. Immaterial = no one cares. ↓------- ↓------- F/S changes required ------- ↓ ------- ↓ Material = affects the decision of those using a specific set of accounts but not someone using the entire set of financial statements. Highly (or pervasively) material = misstatement is so large or affects so many accounts that any decision using the financial statements would be affected.

ADDITIONAL CONCERNS ABOUT MATERIALITY Materiality is subjectively defined. Requires professional judgment. Must consider BOTH quantitative and qualitative factors. Qualitative factors: Actions not measurable but important in implication. Nature of misstatements. Scope limitations. Covenant violations and changes in trends.

GENERAL AUDIT REPORT REQUIREMENTS Report title which must include the word “independent.” (Except disclaimers for independence) Report addressed (B of D, audit committee, SH, management) Introductory paragraph. Scope paragraph (except disclaimer). Opinion paragraph. Name of CPA firm – may be include specific office if a large CPA firm. Audit report date – last day of fieldwork (last day of on-site evidence collection). If situation warrants, explanatory paragraphs may be included.

STANDARD UNQUALIFIED OPINIONS “Qualified” – used in the context of a statement being with or without qualifications to the basic opinion. (hedging on the opinion?) Issuance of a “clean” or standard unqualified opinion implies or expresses: All major statements are included. Generally accepted auditing standards have been followed. Sufficient evidence has been accumulated. F/S are in accordance with GAAP. No additional circumstances that require explanation. Most common type of audit report. Why?

INTRODUCTORY PARAGRAPH We have audited the accompanying balance sheets of the Dewey, Cheatum, & Howe Company as of December 31, 2007 and December 31, 2006 and the related statements of income, stockholder’s equity, and cash flows for each of the three years in the period ended on December 31, 2007. These financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on those financial statements based on our audits. The paragraph accomplishes three things: Clearly states that an audit was performed. States what statements are covered by the opinion. Defines each party’s responsibility.

Paragraph accomplishes three things: States what is done in an audit. SCOPE PARAGRAPH We conducted our audits in accordance with auditing standards generally accepted in the United States. 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. We believe that our audits provide a reasonable basis for our opinion. Paragraph accomplishes three things: States what is done in an audit. Uses words to imply less than absolute assurance. (My underlines are NOT in the original.) Explains the basis of the audit opinion.

Paragraph accomplishes two things: Expresses the auditor’s opinion. OPINION PARAGRAPH In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Dewey, Cheatum, & Howe Company at December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States. Paragraph accomplishes two things: Expresses the auditor’s opinion. Introduces the term “present fairly.”

UNQUALIFIED OPINION WITH EXPLANATORY LANGUAGE Situation: Part of the audit is performed by another auditor. Option 1: If the auditor is willing to be responsible for the other’s work (no reference needs to be made). Must be satisfied with respect to the other auditor’s independence, reputation, quality, and scope of work performed. May require a comprehensive review of the other auditor’s work. The audited work is immaterial to the entire F/S. Option 2: If the auditor is unwilling to be responsible for the other’s work (then make reference to other auditor). Introductory paragraph describes portions audited by the other auditor. Scope paragraph refers to the other auditor. Opinion paragraph states opinion is based in part on the work of another auditor.

UNQUALIFIED OPINION WITH EXPLANATORY LANGUAGE Situation: Departure from a promulgated accounting principle (Rule 203). Client doesn’t use GAAP because its use would lead to misleading results due to unusual circumstances. Auditor agrees with client position. As a practical rule, strong evidence is needed to support the client’s position. By its nature, this situation should rarely occur. All three paragraphs of the audit opinion are unmodified but an additional explanatory paragraph is added following the opinion paragraph.

UNQUALIFIED OPINION WITH EXPLANATORY LANGUAGE Situation: Lack of consistency. Consistency = consistent application of accounting principles and reporting entity. Change in either can trigger a consistency problem. According to SAS #1, these are NOT consistency problems: Changes in accounting estimates. Error corrections (not involving changes in accounting principles). Changes in F/S classifications.

UNQUALIFIED OPINION WITH EXPLANATORY LANGUAGE Situation: Going-concern considerations. If there is substantial doubt about whether an entity will continue to exist during the upcoming year, an explanatory paragraph is included (SAS #59). Other reporting option: disclaimer if (and only if) determination cannot be made. Emphasis is provided by the auditor’s report. F/S are fairly stated IAW GAAP. Auditor’s opinion implies that future of client is uncertain. Often resisted by client.

UNQUALIFIED OPINION WITH EXPLANATORY LANGUAGE Situation: Emphasis of a matter. Used by the auditor to call the attention of the reader of the F/S to some important issue. F/S are fairly stated IAW GAAP = no problem with F/S. But the reader should know this: Significant events occurring after year-end. Existence of significant contingencies, particularly those that cannot be reasonably estimated. Inconsistencies between the audited F/S and other information in the annual report. Other issues deemed important by auditor. Should not be used to explain immaterial misstatements.

Qualified opinion result from two conditions: Scope limitation Used when the overall F/S are fairly stated but some component of the F/S has a material misstatement or omission. Qualified opinion result from two conditions: Scope limitation Caused by the circumstances. Imposed by the client (generally more serious). Violations of GAAP Use of accounting principles that are not GAAP. Inadequate disclosure. Accounting changes with which the auditor does not agree. Materiality for this opinion = affects some specific decisions using the misstated accounts but not decisions using the overall F/S.

ADVERSE OPINION Used when the F/S are not presented fairly IAW GAAP. This is used when the misstatement or omission is highly (or pervasively) material. F/S should not be relied on for any purpose. Adverse opinions have the same introductory and scope paragraphs as an unqualified opinion. Opinion paragraph is modified. An explanatory paragraph is included between the scope and opinion paragraph. Very, very rare.

DISCLAIMER OF OPINION Used when the auditor is unable to collect sufficient evidence to support an opinion. Not to be used because the auditor is unwilling to issue the appropriate opinion. It is not a “chicken out” opinion. Report includes a modified introductory paragraph. Scope paragraph is omitted (since an audit was not performed, at least to a conclusion.) Explanatory paragraph describes why an opinion could not be formed. “Opinion” paragraph states that no opinion was formed.