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Chapter 3 audit reports, Lecture notes of Accounting

Audit Reports

Typology: Lecture notes

2015/2016

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Chapter 3--Audit Reports
3-1 Audit Reports
A good place to start in your study of auditing is at the end. The end result of an audit
is the audit report. An "unqualified" report suggests that the auditee (the company
being audited) satisfactorily met all audit requirements, and is the most common
result. Thus, an "unqualified" report is good news for the auditee. If the report is
"qualified", this means that there were issues present that must be documented by the
auditor.
A standard unqualified report contains seven parts, as illustrated in Figure 3-1:
1. Report Title
2. Audit Report Address
3. Introductory Paragraph indicating the scope of the CPA's work (i.e., audit or
compilation or review), the financial statements that were audited, and a
statement to the effect that the statements were the responsibility of
management, with the auditor responsible for rendering an opinion.
4. Scope Paragraph--what the auditors did, with reference to Generally Accepted
Auditing Principles, or with reference to PCAOB standards for a public
company. The country of origin is also indicated, as well as the nature of what
the auditors are striving for--"to obtain reasonable assurance that the statements
are free of material misstatement." The auditor may further indicate that
evidence may have been selected on a "test basis", that is by sample, in making
this determination.
5. The Opinion Paragraph, which presents the auditor's conclusions regarding the
audit. Note that there is no guarantee of reliability claimed. Additionally, note
that the opinion relates to Generally Accepted Auditing reporting Standards 1
and 4 as to whether the statements follow GAAP and the necessity to render an
opinion. (Follow link to GAAS).
6. Name of the CPA firm.
7. Audit Report Date--sets the limit of the auditor's responsibility--which is likely
to be some period of time after the auditee published the financial statements.
3-2 Conditions Meriting a Standard Unqualified Report
The conditions that would result in an unqualified (or "clean") report are as follows:
1. All statements are included in the financial statements, including income
statement, retained earnings statement, balance sheet and cash flow statement;
2. The three general standards (adequate training, independence and due
professional care) have been followed during the audit engagement;
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Chapter 3--Audit Reports

3-1 Audit Reports

A good place to start in your study of auditing is at the end. The end result of an audit is the audit report. An "unqualified" report suggests that the auditee (the company being audited) satisfactorily met all audit requirements, and is the most common result. Thus, an "unqualified" report is good news for the auditee. If the report is "qualified", this means that there were issues present that must be documented by the auditor.

A standard unqualified report contains seven parts, as illustrated in Figure 3-1:

  1. Report Title
  2. Audit Report Address
  3. Introductory Paragraph indicating the scope of the CPA's work (i.e., audit or compilation or review), the financial statements that were audited, and a statement to the effect that the statements were the responsibility of management, with the auditor responsible for rendering an opinion.
  4. Scope Paragraph--what the auditors did, with reference to Generally Accepted Auditing Principles, or with reference to PCAOB standards for a public company. The country of origin is also indicated, as well as the nature of what the auditors are striving for--"to obtain reasonable assurance that the statements are free of material misstatement." The auditor may further indicate that evidence may have been selected on a "test basis", that is by sample, in making this determination.
  5. The Opinion Paragraph, which presents the auditor's conclusions regarding the audit. Note that there is no guarantee of reliability claimed. Additionally, note that the opinion relates to Generally Accepted Auditing reporting Standards 1 and 4 as to whether the statements follow GAAP and the necessity to render an opinion. (Follow link to GAAS).
  6. Name of the CPA firm.
  7. Audit Report Date--sets the limit of the auditor's responsibility--which is likely to be some period of time after the auditee published the financial statements.

3-2 Conditions Meriting a Standard Unqualified Report

The conditions that would result in an unqualified (or "clean") report are as follows:

  1. All statements are included in the financial statements, including income statement, retained earnings statement, balance sheet and cash flow statement;
  2. The three general standards (adequate training, independence and due professional care) have been followed during the audit engagement;
  1. there is sufficient evidence to conclude that the three standards of field work (planning and supervision, understanding of internal control and competent evidentiary matter) have been met;
  2. The financial statements have been presented in accordance with U.S. GAAP;
  3. There are no circumstances warranting an explanatory paragraph or rewording of the report.

If all of these conditions are met, then an unqualified report is rendered. However, not every report will meet these five conditions and there is a continuum of possibilities for the report:

  1. Standard Unqualified Report: meets all five conditions listed above;
  2. Unqualified Report with Explanatory Paragraph or Modified Wording--the audit was complete, with satisfactory results, but the auditor feels compelled to provide additional information;
  3. A Qualified Report--indicates that the financial statements are fairly presented, but the scope of the audit has been materially restricted, or the financial statements were not prepared according to GAAP;
  4. An Adverse Report, or Disclaimer--the financial statements were not fairly presented (adverse), or the auditor is unable to form an opinion as to whether the statements are fairly presented (disclaimer). A disclaimer would also be appropriate if the auditor is not independent.

Take note that the opinion gets increasingly unfavorable as you progress from 1-2, 2-3, and so on, in the list above.

3-3 Combined Reports on Financial Statements and Internal

Control over Financial Reporting

According to the Sarbanes Oxley Act, the auditor must attest to the effectiveness of internal control over financial reporting; additionally, PCAOB Standard 2 requires integration of the internal control audit with the audit of the financial statements. These two efforts can be done in separate or combined reports. An example of a combined report is illustrated in Figure 3.3.

3-4 Unqualified Report with Explanatory Paragraph or

Modified Wording

The auditor may choose to add an explanatory paragraph to the report, or modify the wording of the report, depending on circumstances that might exist. This is in spite of an otherwise unqualified report. Such conditions might be:

  1. A lack of consistent application of GAAP;
  2. A doubt about the going concern assumption is valid;
  1. If the amount of the misstatement is so material as to destroy the fairness of the entire financial statement, the auditor must consider an adverse opinion or a disclaimer of opinion.

Your text suggests consideration of pervasiveness --in which the auditor considers how an error in one part of the accounting system affects other areas of the accounting system.

3-7 Further Discussion of Conditions Requiring a Departure

from an Unqualified Opinion

This section amplifies the considerations of several issues:

  1. Scope limitation--imposed by the client, versus those that are outside the control of either auditor or client;
  2. GAAP departure--and the effect of Rule 203 of the Code of Professional Conduct;
  3. Lack of a Statement of Cash Flows

3-8 The Auditor's Decision Process for Audit Reports

A procedure for writing the audit report has been developed, and consists of the following steps:

  1. (^) Determine whether any conditions exist requiring a departure from a standard unqualified report;
  2. (^) Decide the level of materiality for each condition;
  3. (^) Decide the appropriate type of report for the condition, given the materiality level;
  4. (^) Write the audit report.

A decision table for unqualified reports with modified wording or explanatory paragraph is illustrated in table 3-2, and is briefly reproduced below:

Item If

Immaterial

If Material

GAAP Departure Unqualified Report

Unqualified Report with explanatory paragraph Substantial Going Concern Doubt

Unqualified Report

Unqualified Report with explanatory paragraph Justified GAAP Departure

Unqualified Report

Unqualified Report with explanatory paragraph Emphasis of a Matter Unqualified Report

Unqualified Report with explanatory paragraph

Use of Another Auditor Unqualified Report

Unqualified Report with modified wording

A decision table for conditions requiring departure from an unqualified report, also adapted from Table 3-2, is shown below:

Item If

Immaterial

Material but

Overall FS

OK

Material,

Fairness

Compromised

Scope Restriction

Unqualified Qualified Scope and Qualified Opinion ("except for")

Disclaimer

Statements Not Following GAAP

Unqualified Additional paragraph and Qualified Opinion ("except for")

Adverse Opinion

Auditor Not Independent

Disclaimer Disclaimer Disclaimer

Table 3-3 in your text specifies the number of paragraphs, and locations of paragraphs in various types of reports.

3-9 e-commerce Effects on Audit Reporting

Your text makes the point that internet annual reports are currently not subject to the scrutiny of auditors, as they are not considered documents.