1. Chapter 3
Audit Reports 1

2. Learning Objectives
Describe the parts of the standard unqualified audit report for non-public entities under AICPA auditing standards.
Specify the conditions required to issue the standard unqualified audit report.
Understand reporting on financial statements and internal control under PCAOB auditing standards.

3. Learning Objectives
Describe the five circumstances when an unqualified report with an emphasis-of-matter explanatory paragraph or modified wording is appropriate.
Identify the types of audit reports that can be issued when an unqualified opinion is not justified.
Explain how materiality affects audit reporting decisions.

4. Learning Objectives
Draft appropriately modified audit reports under a variety of circumstances.
Determine the appropriate audit report for a given audit situation.
Understand use of international accounting and auditing standards by U.S. companies.

5. Describe the parts of the standard1
Describe the parts of the standard
unqualified audit report for non-public entities under AICPA auditing standards.

6. Parts of the Standard Unqualified Audit Report
1. Report title
2. Audit report address
3. Introductory paragraph
4. Management’s Responsibility
5. Auditor’s Responsibility
6. Opinion Paragraph
7. Name and Address of CPA firm
8. Audit report date
Title should include the word independent (e.g., independent audit report)
Report is usually addressed to the company, its stockholders or board of directors.
The intro paragraph does 3 things:
1. States the CPA firm has done an audit
2. It lists the financial statements that were audited
3. It defines responsibilities between management and the auditor
The scope paragraph is a factual statement about what the auditor did in the audit and sets the expectation about reasonable assurance.
The opinion paragraph states the auditor’s conclusions.
The name identifies the CPA firm who performed the audit.
The report date indicates the last day audit procedures were performed in the field.

7. Parts of the Standard Unqualified Audit Report

8. 2
Specify the conditions required to issue the standard unqualified audit report.

9. Conditions for Standard Unqualified Audit Report
1. Includes all financial statements
2. Sufficient appropriate evidence
3. Financial statements present in accordance with U.S.GAAP
4. No circumstances require an explanatory
paragraph or report modification
All financial statements are included
The three general standards have been
followed in all respects on the engagement
Sufficient evidence has been accumulated
to conclude that the three standards of
field work have been met.

10. Four Categories of Audit Reports

11. 3
Understand reporting on financial statements and internal control under PCAOB auditing standards.

12. Reporting on Internal Control over Financial Reporting
Auditors of public companies subject to Section 404 of the Sarbanes-Oxley Act must
report on the effectiveness of internal
control over financial reporting.
PCAOB Auditing Standard 5 requires
the audit of internal control to be integrated
with the audit of the financial statements.
As noted in Chapter 1, non-accelerated filers have been exempt from this requirement and the passage by Congress of the 2010 financial reform legislation made that exemption permanent for non-accelerated filers.

13. Reporting on Internal Control over Financial Reporting
Sarbanes-
Oxley
Sec.404
ICFR
Effectiveness
Audits
Accelerated Filer
Auditors of public companies subject to Section 404 of the Sarbanes-Oxley Act must
report on the effectiveness of internal control over financial reporting.
Non-accelerated filers have been exempt from this requirement and the passage by Congress
of the 2010 financial reform legislation made that exemption permanent.
2010
Legislation
Permanent
Exemption
Non-accelerated
Filer

14. Sarbanes-Oxley Act Separate Report on Financial Statements and
Internal Control Over Financial Reporting
1. Introductory paragraph
2. Scope paragraph
3. Definition paragraph
4. Inherent limitations paragraph
5. Opinion paragraph
6. Cross-Reference Paragraph
The introductory scope and opinion paragraphs describe that the scope of the auditor’s work and opinion is on internal control over financial reporting .
The introductory and opinion paragraphs also refer to the framework used to evaluate internal control.
The report includes a paragraph after the scope paragraph defining internal control over financial reporting.
An additional paragraph addresses the inherent limitations of internal control.
The opinion about the effectiveness of internal control is as of the end of the most recent fiscal year.
The last paragraph includes a cross-reference to the auditor’s separate report on the financial statements.

15. Separate Report on ICFR
The introductory scope and opinion paragraphs describe that the scope of the auditor’s work and opinion is on internal control over financial reporting .
The introductory and opinion paragraphs also refer to the framework used to evaluate internal control.
The report includes a paragraph after the scope paragraph defining internal control over financial reporting.
An additional paragraph addresses the inherent limitations of internal control.
The opinion about the effectiveness of internal control is as of the end of the most recent fiscal year.
The last paragraph includes a cross-reference to the auditor’s separate report on the financial statements.

16. 4
Describe the five circumstances when an unqualified report with an emphasis-of-matter explanatory paragraph or modified wording is appropriate.

17. Unqualified Report with Explanatory Paragraph
1. Lack of consistent application of generally
accepted accounting principles
2. Substantial doubt about going concern
3. Auditor agrees with a departure from
promulgated accounting principles
4. Emphasis of a matter
5. Reports involving other auditors

18. Lack of Consistent Application of GAAP
Auditors must note circumstances in which accounting principles are not consistently applied
Auditor should modify the report when a material change occurs by adding an explanatory paragraph in the report
Auditors are required to call attention to circumstances in which accounting principles have not been consistently observed in the current period in relation to the preceding period.
GAAP requires that changes in accounting principles or their method of application be to a preferable principle and that the nature and impact of the change be adequately disclosed. When a material change occurs, the auditor should modify the report by adding an explanatory paragraph after the opinion paragraph that discussed the nature of the change and points the reader to the footnote that discussed the change.

19. Substantial Doubt About Going Concern
Significant recurring operating
losses or working capital deficiencies.
Inability of the company to pay its
obligations as they come due.
Loss of major customers, the
occurrence of uninsured catastrophes.
Legal proceedings, legislation that
might jeopardize the entity’s ability to operate.

20. Auditor Agrees with a Departure from a Promulgated Principle
Departure may not require a qualified or
adverse opinion
The auditor must separately explain in the
audit report that adhering to the principle
would have produced a misleading result.
The auditor must be satisfied and must state and explain, in a separate paragraph or paragraphs in the audit report, that adhering to the principle would have produced a misleading result in that situation.
Circumstances are unusual

21. Emphasis of a Matter Under certain circumstances, the CPA may
want to emphasize specific matters regarding
the financial statements, even though the
CPA intends to express an unqualified opinion.
Subsequent
Events
Related Party
Transactions
Significant related party transactions
Material subsequent events
Accounting matters affecting comparability of the financial statements
Material uncertainties disclosed in the footnotes
Financial
Statement
Comparability
Material
Uncertainties

22. Reports Involving Other Auditors
Make no reference in the audit report
2. Make reference in the report
(modified wording report)
3. Qualify the opinion
A shared unqualified report is appropriate when it is impractical to review the work of the other auditor or when the portion of the financial statements audited by the other CPA is material in relation to the whole.

23. Reports Involving Other Auditors

24. 5
Identify the types of audit reports that can be issued when an unqualified opinion is not justified.

25. Departures from an Unqualified Opinion
1. Scope limitation
2. GAAP departure
3. Auditor not independent
Scope limitations are when the auditor has not accumulated sufficient appropriate evidence to conclude whether the financial statements are stated in accordance with GAAP.
Client insists on using a method that is not consistent with GAAP.
Independence ordinarily is determined by Rule 101 of the rules of the Code of Professional Conduct.

26. Qualified Opinion A qualified opinion report can result from
a limitation on the scope of the audit or
failure to follow generally accepted
accounting principles.
A qualified report can take the form of a qualification of both the scope and the opinion or of the opinion alone.

27. Qualified Opinion

28. Adverse Opinion Auditor believes the financial statements are
not presented fairly in conformity with GAAP.
It is used only when the auditor believes that the overall financial statements are so materially misstated or misleading that they do not present fairly the financial position or results of operations and cash flows in conformity with GAAP.

29. Adverse Opinion

30. Disclaimer of Opinion Issued when the auditor is unable
to be satisfied that the overall financial
statements are fairly presented.
Can arise only from a lack of
knowledge by the auditor.
The necessity for disclaiming an opinion may arise because of a severe limitation on the scope of the audit or a nonindependent relationship under the Code of Professional Conduct between the auditor and the client.

31. Disclaimer of Opinion

32. Explain how materiality affects audit reporting decisions.6
Explain how materiality affects audit reporting decisions.

33. Materiality A misstatement in the financial statements
can be considered material if knowledge of
the misstatement would affect a decision
of a reasonable user of the statements.
Materiality is an essential consideration in determining the appropriate type of report for a given set of circumstances.

34. Levels of Materiality Amounts are immaterial.
Amounts are material but do not overshadow
the financial statements as a whole.
Amounts are so material or so pervasive that
overall fairness of the statements is in question.
Immaterial is when a misstatement in the financial statements is unlikely to affect the decisions of a reasonable user.
A misstatement in the financial statements would affect a user’s decision, but the overall statements are still fairly stated and therefore useful.
The highest level of materiality exists when users are likely to make incorrect decisions if they rely on the overall financial statements.

35. Materiality Decisions
Failure to
follow GAAP
Audit report
Unqualified
Qualified
opinion only
Adverse

36. Relationship of Materiality to Type of Opinion
Level
Significance in Terms of
Reasonable Users’ Decisions
Type of
Opinion
Immaterial
Users’ decisions are unlikely
to be affected.
Unqualified
Material
Users’ decisions are likely
to be affected.
Qualified
Highly
material
Users’ decisions are likely
to be significantly affected.
Disclaimer
or adverse

37. Materiality Decisions Non-GAAP Conditions
Dollar amount compared with a base
Measurability
Nature of the item
Common bases include net income, total assets, current assets, and working capital.
Some misstatements cannot be accurately measured (e.g., existing lawsuit, acquisition of a new company subsequent to the balance sheet date).
The decision of a user may also be affected by the kind of misstatement:
illegal or fraudulent transaction,
an item that may be material in some future period but immaterial in the current period,
an item changing a small loss to a small profit,
an item that may be important in terms of possible consequences arising from contractual obligations.

38. Materiality Decisions Scope Limitations Condition
Audit report
It is more difficult to evaluate the materiality of potential misstatements resulting form a scope limitation than for a failure to follow GAAP.
Unqualified
Qualified scope
and opinion
Disclaimer

39. 7
Draft appropriately modified audit reports under a variety of circumstances.

40. Discussion of Conditions Requiring Departure
Auditor’s scope has been restricted
Statements are not in conformity with GAAP
Auditor is not independent
Two major categories of scope restrictions:
those caused by a client
those caused by conditions beyond the control of either the client or the auditor

41. Determine the appropriate audit report for a given audit situation.8
Determine the appropriate audit report for a given audit situation.

42. Auditor’s Decision Process
Determine whether any conditions exists
requiring a departure from a standard
unqualified report.
Decide
Materiality
Decide appropriate
type of report
Write
Audit
Report

43. More Than One Condition Requiring a Departure or Modification
The auditor is not independent.
There is a scope limitation.
Going concern uncertainty exists.
Report should be modified for each condition unless one has the effect of neutralizing others.
Statements are not prepared in
accordance with GAAP.

44. 9
Understand proposed use of international accounting and auditing standards by U.S. companies.

45. Proposed Use of International Accounting and Auditing Standards by U.S. companies
Globalization of world’s capital markets are leading to calls for a single set of accounting standards to be used around the world.
SEC
Developing
Workplan
2015
Implementation
of IFRS
into U.S.
When the auditor reports on financial statements prepared in conformity with IFRS, the auditor refers to those standards rather than U.S. GAAP.
If plan is approved?

46. Do you have any questions?

47. Copyright
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