1. Audit Reports
Dr. Donald McConnell Jr,
11/17/2018

2. There Are Four Fundamental Types of Audit Reports
Unqualified (the standard report)
Qualified, due to material:
Improper GAAP (the numbers or notes)
Scope restriction:
Imposed by circumstances
Client imposed
Adverse: extremely material GAAP impropriety
Disclaimer: technically not an opinion
11/17/2018

3. The Unqualified Report (AU 508.08)
The standard report (clean opinion)
Issued when:
Full and fair disclosure of all material facts
No material scope restrictions
Auditor is independent
Has three paragraphs:
Introductory paragraph
Scope paragraph
Opinion paragraph
Analysis of the report: AU
11/17/2018

4. Very Common Types of CPA Exam Questions:
identify the deficiencies in a presented audit report
Less commonly, write an audit report based on a given set of circumstances
Multiple-choice questions on reports tend to be extremely “picky”
What does this suggest?
11/17/2018

5. Departures from Unqualified Opinions: Qualified, Adverse, and Disclaimer
Know how they differ from one another and the standard report
Know the conditions for issuing each type of report
11/17/2018

6. Qualified Opinions (AU 508.20)
Expressed when there is a material
GAAP departure
Scope restrictions imposed by client or circumstances
These are the “except for” opinions
Must include a separate explanatory paragraph (s) preceding opinion paragraph:
Explaining all substantive reasons for qualification
Financial statement effects, if practicably determinable
11/17/2018

7. GAAP Departure Qualifications (AU 508.39)
Note explanatory paragraph indicating reasons for qualification and effects
Explanatory paragraph must precede the opinion paragraph
“except for…” stated only once: in opinion paragraph
11/17/2018

8. Scope Restriction Qualifications (AU 508.26)
“except for…” stated twice: once in scope paragraph and once in opinion paragraph
“except for” wording in opinion paragraph should base qualification on possible effects to the F.S.’s, and not on the scope limitation itself
Example: “in our opinion, except for the above mentioned limitation on scope…” is unacceptable
11/17/2018

9. What Is the Difference between Material and Extremely Material
What Is the Difference between Material and Extremely Material? Some Examples:
Assume client has $10 million total assets
Client has capitalized $1 million of R & D expenditures. What opinion would auditor render?
Material: qualified for GAAP departure
$5 million?
Extremely material: adverse opinion
What if R & D expenditures are $10,000?
Immaterial: unqualified opinion
11/17/2018

10. Adverse Opinions (AU )
Only used for extremely material GAAP departures: F.S.’s rendered meaningless
Extremely rare
State that the financial statements do not present fairly
Characterized by knowledge of F.S. effect
Substantive reasons and effects (if determinable) must be in a paragraph(s) preceding opinion paragraph
11/17/2018

11. Disclaimer of Opinion (AU 508.63)
Required for:
Extremely material scope limitation, whether imposed by client or circumstances
Auditor lacking independence
Optional for extremely material uncertainty (AU , fn 4)
Scope issues:
Have not obtained sufficient competent evidential matter
Substantive reasons for disclaimer must be in a paragraph preceding opinion paragraph
11/17/2018

12. Disclaimer of Opinion (AU 508.63) (con.)
Report must disclose any other reservations concerning fair presentation in accordance with GAAP
AU : note many significant differences from standard report
A common “real world” cause for disclaimers: new audit client with material inventories (AU )
11/17/2018

13. Various Audit Report Issues
What happens if there is an immaterial GAAP problem and/or immaterial scope problem?
Unqualified report is issued
In “real world,”nonstandard opinions are unusual. Why?
Client imposed scope: what if F.S. effects potentially borderline between material and extremely material?
Disclaimer.
What’s a piecemeal opinion? (AU )
11/17/2018

14. Modified Unqualified Opinions (AU 508.11)
A subset of unqualified opinions
“Clean opinions” with modifying language or, more typically, modifying paragraph(s)
Modifying paragraph(s) can precede or follow opinion paragraph except in case of:
Substantial doubt about going concern status
Material change in accounting principles (fn 8)
Discussion of examples in AU
11/17/2018

15. Comparative Financial Statements (Au508.65)
Usual convention is to report comparatively
Fourth standard of reporting requires an opinion on all presented financial statements, unless clearly labeled unaudited
Prior Period Financial statements may have been:
Audited by our CPA firm
Audited by another CPA firm
11/17/2018

16. Comparative F.S.’s Audited by Our CPA Firm (AU 508.67)
The auditor may express a different opinion for one or more periods
AU shows an example of an unqualified opinion last year with a qualified opinion on the current year’s financial statements
11/17/2018

17. Comparative F.S.’s Audited by Our CPA Firm (Con.) (AU 508.68)
The auditor might also change a previously issued opinion on a prior period.
In such cases, auditor must:
Indicate that the F.S.’s have been restated from last year
Include an explanatory paragraph preceding the opinion paragraph indicating (508.69):
Substantive reasons for opinion change and prior report date
Type of opinion previously expressed
Indicate updated opinion is different from the previous opinion
11/17/2018

18. Previous Year Financial Statements Audited by Another CPA Firm
Predecessor auditor’s prior audit report usually not presented
Less commonly, predecessor auditor reissues the previous report [SEC audits require this.]
11/17/2018

19. Predecessor Auditor Consents to Reissue Prior Report (Au 508.71)
Usually only done for audits of public companies
Predecessor auditor must:
Determine that the prior opinion is still appropriate
Read current period comparative F.S. presentation; compare with last year F.S.’s that prior CPA had reported upon
Obtain rep letter from successor: no current matters effect last year’s F.S.’s
Reissued report date would ordinarily be same as last year (Au )
There will be two audit reports in the registration (IPO) filed with SEC
11/17/2018

20. Predecessor Auditor’s Report Not Presented (AU 508.74)
This is more common: we simply make reference to the prior audit
Note only current year F.S.’s opined upon in opinion paragraph
Introductory paragraph of audit report is modified to:
Indicate the prior F.S.’s were audited by another auditor
The date and type of report which was issued
Substantive reasons, if prior report was not standard
11/17/2018

21. Predecessor Auditor’s Report Not Presented (Con.) (AU 508.74)
Introductory paragraph would be modified as follows:
… our responsibility is to express an opinion on these financial statements based on our audit. [Note: not audits-only opining on current year F.S.’s] The financial statements of ABC as of December 31, 19x1 were audited by other auditors whose report dated March 1, 19x2 [was unqualified or] included an explanatory paragraph that described the change in the Company’s method of computing depreciation discussed in Note xx to the financial statements.
11/17/2018

22. Consistency of Application of GAAP ( AU 420)
Second standard of reporting implies that comparability has not been affected by a change in accounting principles
Accounting changes can:
Affect consistency, or
Affect comparability, but not consistency
11/17/2018

23. Accounting Changes Affecting Consistency (AU 420.06)
Require an additional explanatory paragraph which must follow the opinion paragraph
Examples requiring paragraph ( ):
Material change in accounting principle
Change in reporting entity (presenting consolidated vs. individual F.S.’s, change in component subsidiaries)
Change from an incorrect principle to a correct accounting principle
Principle change inseparable from a change in estimate
Change in definition of cash equivalents
11/17/2018

24. Accounting Changes Not Affecting Consistency (AU 420.06)
Do not require an additional paragraph
Will require footnote disclosure if material
Examples include ( ):
Change in accounting estimate
Error correction not involving principle (math mistake, misuse of facts)
Changes in F.S.classifications
First-time adoption of a new principle
A change in principle not having a current material effect, but which is expected to become material
11/17/2018

25. Consistency of Application of GAAP: Other Considerations
Inadequate client disclosure of accounting changes requires a qualified or adverse opinion (420.21)
If auditor reports only on current period, must obtain sufficient, competent evidence about consistency of current GAAP with prior periods, even though prior period F.S.’s not presented (.22)
Same is true concerning first-year audits. Must verify consistency of principles with prior year (420.24)
If cannot (inadequate records or client limitations), would be unable to express opinion on current year’s financial statements: disclaimer (420.25)
11/17/2018