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Chapter 3

Audit Reports

Review Questions

3-1 Auditor's reports are important to users of financial statements becausethey inform users of the auditor's opinion as to whether or not the statements arefairly stated or whether no conclusion can be made with regard to the fairness oftheir presentation. Users especially look for any deviation from the wording of thestandard unqualified report and the reasons and implications of such deviations.Having standard wording improves communications for the benefit of users of theauditor’s report. When there are departures from the standard wording users aremore likely to recogni!e and consider situations requiring a modification orqualification to the auditor’s report or opinion.

3-2 "he unqualified audit report consists of#

$. Report title Auditing standards require that the report be titled andthat the title includes the word independent .

%. Audit report address "he report is usually addressed to the companyits stockholders or the board of directors.

&. Introductory paragraph "he first paragraph of the report does threethings# first it makes the simple statement that the (A firm hasdone an audit . )econd it lists the financial statements that wereaudited including the balance sheet dates and the accounting

periods for the income statement and statement of cash flows."hird it states that the statements are the responsibility ofmanagement and that the auditor's responsibility is to e*press anopinion on the statements based on an audit.

+. Scope paragraph. "he scope paragraph is a factual statement aboutwhat the auditor did in the audit. "he remainder briefly describesimportant aspects of an audit.

,. Opinion paragraph. "he final paragraph in the standard reportstates the auditor's conclusions based on the results of the audit.

-. Name of CPA firm. "he name identifies the (A firm or practitionerwho performed the audit.

. Audit report date. "he appropriate date for the report is the end offieldwork when the auditor has gathered sufficient appropriateevidence to support the opinion.

"he same seven parts are found in a qualified report as in an unqualifiedreport. "here are also often one or more additional paragraphs e*plaining reasonsfor the qualifications.

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3-3 "he purposes of the scope paragraph in the auditor's report are to informthe financial statement users that the audit was conducted in accordance withgenerally accepted auditing standards in general terms what those standardsmean and whether the audit provides a reasonable basis for an opinion.

"he information in the scope paragraph includes#

$. "he auditor followed generally accepted auditing standards.%. "he audit is designed to obtain reasonable assurance about whether the

statements are free of material misstatement.&. 0iscussion of the audit evidence accumulated.+. )tatement that the auditor believes the evidence accumulated was

appropriate for the circumstances to e*press the opinion presented.

3-4 "he purpose of the opinion paragraph is to state the auditor's conclusionsbased upon the results of the audit evidence. "he most important information inthe opinion paragraph includes#

$. "he words 1in our opinion1 which indicate that the conclusions arebased on professional 2udgment.

%. A restatement of the financial statements that have been audited andthe dates thereof or a reference to the introductory paragraph.

&. A statement about whether the financial statements were presentedfairly and in accordance with generally accepted accountingprinciples.

3-5 "he auditor's report should be dated 3ebruary $ %4$4 the date on whichthe auditor concluded that he or she had sufficient appropriate evidence to supportthe auditor’s opinion.

3-6 An unqualified report may be issued under the following five circumstances#

$. All statements5balance sheet income statement statement ofretained earnings and statement of cash flows5are included in thefinancial statements.

%. "he three general standards have been followed in all respects on theengagement.

&. )ufficient evidence has been accumulated and the auditor hasconducted the engagement in a manner that enables him or her toconclude that the three standards of field work have been met.

+. "he financial statements are presented in accordance with generallyaccepted accounting principles. "his also means that adequatedisclosures have been included in the footnotes and other parts ofthe financial statements.

,. "here are no circumstances requiring the addition of an e*planatoryparagraph or modification of the wording of the report.

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3-7 "he introductory scope and opinion paragraphs are modified to includereference to management’s report on internal control over financial reporting andthe scope of the auditor’s work and opinion on internal control over financialreporting. "he introductory and opinion paragraphs also refer to the frameworkused to evaluate internal control. "wo additional paragraphs are added betweenthe scope and opinion paragraphs that define internal control and describe the

inherent limitations of internal control.

3-8 When adherence to generally accepted accounting principles would resultin misleading financial statements there should be a complete e*planation in aseparate paragraph. "he separate paragraph should fully e*plain the departureand the reason why generally accepted accounting principles would haveresulted in misleading statements. "he opinion should be unqualified but itshould refer to the separate paragraph during the portion of the opinion in whichgenerally accepted accounting principles are mentioned.

3-9 An unqualified report with an e*planatory paragraph or modified wording is

the same as a standard unqualified report except that the auditor believes it isnecessary to provide additional information about the audit or the financialstatements. 3or a qualified report either there is a scope limitation 6condition $7or a failure to follow generally accepted accounting principles 6condition %7.Under either condition the auditor concludes that the overall financial statementsare fairly presented.

"wo e*amples of an unqualified report with an e*planatory paragraphor modified wording are#

$. "he entity changed from one generally accepted accounting principleto another generally accepted accounting principle.

%. A shared report involving the use of other auditors.

3-10 When another (A has performed part of the audit the primary auditorissues one of the following types of reports based on the circumstances.

$. 8o reference is made to the other auditor. "his will occur if theother auditor audited an immaterial portion of the statement theother auditor is known or closely supervised or if the principalauditor has thoroughly reviewed the other auditor's work.

%. 9ssue a shared opinion in which reference is made to the otherauditor. "his type of report is issued when it is impractical to review

the work of the other auditor or when a portion of the financialstatements audited by the other (A is material in relation to thetotal.

&. "he report may be qualified if the principal auditor is not willing toassume any responsibility for the work of the other auditor. Adisclaimer may be issued if the segment audited by the other (Ais highly material.

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3-11 :ven though the prior year statements have been restated to enhancecomparability a separate e*planatory paragraph is required to e*plain thechange in generally accepted accounting principles in the first year in which thechange took place.

3-12 hanges that affect the consistency of the financial statements may

involve any of the following#

a. hange in accounting principleb. hange in reporting entityc. orrections of errors involving accounting principles.

An e*ample of a change that affects consistency would be a change in themethod of computing depreciation from straight line to an accelerated method. Aseparate e*planatory paragraph is required if the amounts are material.

omparability refers to items such as changes in estimates presentationand events rather than changes in accounting principles. 3or e*ample a change

in the estimated life of a depreciable asset will affect the comparability of thestatements. 9n that case no e*planatory paragraph for lack of consistency isneeded but the information may require disclosure in the statements.

3-13 "he three conditions requiring a departure from an unqualified opinion are#

$. The scope of the audit has been restricted . ;ne e*ample is whenthe client will not permit the auditor to confirm material receivables.

Another e*ample is when the engagement is not agreed upon untilafter the client's year/end when it may be impossible to physicallyobserve inventories.

%. The financial statements have not been prepared in accordanceith generally accepted accounting principles. An e*ample is whenthe client insists upon using replacement costs for fi*ed assets.

&. The auditor is not independent . An e*ample is when the auditorowns stock in the client's business.

3-14 A !ualified opinion states that there has been either a limitation on thescope of the audit or a departure from <AA( in the financial statements but thatthe auditor believes that the overall financial statements are fairly presented. "histype of opinion may not be used if the auditor believes the e*ceptions beingreported upon are e*tremely material in which case a disclaimer or adverse

opinion would be used. An adverse opinion states that the auditor believes the overall financial

statements are so materially misstated or misleading that they do not presentfairly in accordance with <AA( the financial position results of operations orcash flows.

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3-14 (ontinued!

A disclaimer of opinion states that the auditor has been unable to satisfyhim or herself as to whether or not the overall financial statements are fairlypresented because of a significant limitation of the scope of the audit or anonindependent relationship under the Code of Professional Conduct between

the auditor and the client.:*amples of situations that are appropriate for each type of opinion are as

follows#

"#$%$"% &'# )A*#+ ,$&A&$"%

0isclaimer =aterial physical inventories notobserved and the inventory cannot beverified through other procedures.

>ack of independence by the auditor.

Adverse A highly material departure from <AA(.

?ualified 9nability to confirm the e*istence of anasset which is material but not e*tremelymaterial in value.

3-15 "he common definition of materiality as it applies to accounting andtherefore to audit reporting is#

A misstatement in the financial statements can be considered material ifknowledge of the misstatement would affect a decision of a reasonable

user of the statements.

onditions that affect the auditor's determination of materiality include#

(otential users of the financial statements 0ollar amounts of the following items# net income before ta*es

total assets current assets current liabilities and owners' equity 8ature of the potential misstatements5certain misstatements such

as fraud are likely to be more important to users of the financialstatements than other misstatements.

3-16 =ateriality for lack of independence in audit reporting is easiest to define.9f the auditor lacks independence as defined by the Code of ProfessionalConduct it is always considered highly material and therefore a disclaimer ofopinion is always necessary. "hat is either the (A is independent or notindependent. 3or failure to follow <AA( there are three levels of materiality#immaterial material and highly material.

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3-17 "he auditor's opinion may be qualified by scope limitations caused byclient restrictions or by limitations resulting from conditions beyond the client'scontrol. "he former occurs when the client will not for e*ample permit theauditor to confirm material receivables or physically observe inventories. "helatter may occur when the engagement is not agreed upon until after the client'syear/end when it may not be possible to physically observe inventories or confirm

receivables. A disclaimer of opinion is issued if the scope limitation is so material that

the auditor cannot determine if the overall financial statements are fairlypresented. 9f the scope limitation is caused by the client's restriction the auditorshould be aware that the reason for the restriction might be to deceive theauditor. 3or this reason a disclaimer is more likely for client restrictions than forconditions beyond anyone's control.

When there is a scope restriction that results in the failure to verifymaterial but not pervasive accounts a qualified opinion may be issued. "his ismore likely when the scope limitation is for conditions beyond the client's controlthan for restrictions by the client.

3-18 A report with a scope and an opinion qualification is issued when theauditor can neither perform procedures that he or she considers necessary norsatisfy him or herself by using alternative procedures usually due to thee*istence of conditions beyond the client's or the auditor's control but theamount involved in the financial statements is not highly material. An importantpart of a scope and opinion qualification is that it results from not accumulatingsufficient audit evidence either because of the client's request or because ofcircumstances beyond anyone's control.

A report qualified as to opinion only results when the auditor hasaccumulated sufficient appropriate evidence but has concluded that the financial

statements are not correctly stated. "he only circumstance in which an opiniononly qualification is appropriate is for material but not highly material departuresfrom <AA(.

3-19 "he three alternative opinions that may be appropriate when the client'sfinancial statements are not in accordance with <AA( are an unqualified opinionqualified as to opinion only and adverse opinion. 0etermining which isappropriate depends entirely upon materiality. An unqualified opinion isappropriate if the <AA( departure is immaterial 6standard unqualified7 or if theauditor agrees with the client's departure from <AA( 6unqualified withe*planatory paragraph7. A qualified opinion is appropriate when the deviation

from <AA( is material but not highly material@ the adverse opinion is appropriatewhen the deviation is highly material.

3-20 "he A9(A has such strict requirements on audit opinions when theauditor is not independent because it is important that stockholders and otherthird parties be absolutely assured that the auditor is unbiased throughout theentire engagement. 9f users develop the attitude that auditors are notindependent of management the value of the audit function will be greatlyreduced if not eliminated.

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3-21 When the auditor discovers more than one condition that requires adeparture from or a modification of a standard unqualified report the reportshould be modified for each condition. An e*ception is when one conditionneutrali!es the other condition. An e*ample would be when the auditor is notindependent and there is also a scope limitation. 9n this situation the lack ofindependence overshadows the scope limitation. Accordingly the scope

limitation should not be mentioned.

3-22 <iven the global nature of the financial markets investors both in the U.).and abroad are frequently making investments in companies that are located allover the world. While many companies located outside the U. ). already preparefinancial statements in accordance with 9nternational 3inancial eporting)tandards 693)7 financial statements of U.)./based entities are based on U.).generally accepted accounting principles 0ifferences in the basis of presentationmakes the analysis of U.). and non/U.)./based company financial statementsdifficult. )imilarly differences e*ist in auditing standards issued across the globeso the adoption of 9nternational )tatements on Auditing 69)As7 would mean

auditors from around the globe are conducting their audits using the same set ofstandards. "he embrace of 93) and 9)As will help investors in their analysis ofaudited financial statements prepared across the globe.

*u.tip.e Choie Questions /ro C#A ainations

3-23 a. 6%7 b. 6&7 c. 6&7

3-24 a. 6&7 b. 6+7 c. 6$7

3-25 a. 6%7 b. 6&7 c. 6&7

isussion Questions and #ro.es

3-26 a. 1orrectly stated1 implies absolute accuracy whereas the alternativereport states that no material misstatements e*ist.

b. "he reference to generally accepted accounting principles specifiesrules that were followed in accounting for the transactions to date@whereas 1the true economic conditions1 does not identify the specificaccounting procedures applied.

c. "he opinion paragraph is not intended to be a certification or aguarantee of the accuracy and correctness of the financial statementsbut rather is intended to be an e*pression of professional 2udgmentbased upon a reasonable audit of the statements and underlyingrecords.

d. "he name of the (A firm rather than that of the individual practitionershould appear on the accountant's report because it is the entirefirm that accepts responsibility for the report issued.

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3-26 (ontinued!

e. 1;ur audit was performed to detect material misstatements in thefinancial statements1 is flawed because the purpose of the audit isto determine whether financial statements are fairly stated not tospecifically search for material errors and fraud. 9t also fails to

recogni!e the audit standards followed by the auditor.1We conducted our audit in accordance with auditing

standards generally accepted in the United )tates of America1identifies the auditor's responsibilities for conduct of the auditaccumulation of evidence and reporting requirements. 9t is a muchbroader statement than the alternative clause. 9t also implies that ifthe auditor has conducted the audit in accordance with generallyaccepted auditing standards but does not uncover certain materialerrors or fraud the auditor is unlikely to have responsibility forfailing to do so.

3-27 a. 9tems that need not be included in the auditor's report are#

$. "hat ;ptima is presenting comparative financial statements.6Both years' statements will be referred to in the audit report.7

%. )pecific description of the change in method of accountingfor long/term construction contracts need not be included inthe report since it is discussed in the footnotes. But theauditor's report must state that there is a change in accountingprinciples and refer to the footnote.

&. "he fact that normal receivable confirmation procedures werenot used should not be disclosed since the auditor was able

to satisfy him or herself through alternate audit procedures.+. "he lawsuit need not be discussed in the report since it has

been included in a footnote.

b. "he following deficiencies are in Allison's report#

$. "he audit report is neither addressed nor dated and it doesnot contain a title. "he audit report date should be the lastday of field work.

%. "he balance sheet is as of a specific date whereas the incomestatement and the statement of retained earnings are for a

period of time. "he scope paragraph should identify the periodof time 6usually one year7.

&. "here are comparative statements but the audit reportidentifies and deals with only the current year's financialstatements. An opinion must also be included for the priorperiod financial statements.

+. "here is no separate introductory paragraph that states thefinancial statements audited dates and the responsibilitiesof management and the auditor.

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3-27 (ontinued!

,. "here is no separate scope paragraph that describes whatan audit is. "wo required sentences are completely omitted#1An audit includes e*amining on a test basis evidencesupporting the amounts and disclosures in the financial

statements. An audit also includes assessing the accountingprinciples used and significant estimates made by managementas well as evaluating the overall financial statement presentation.1

-. "he audit was made in accordance with auditing standardsgenerally accepted in the "nited States of America ratherthan generally accepted accounting standards.

. "he word material is e*cluded from the scope paragraph6free of material misstatement7.

C. An additional paragraph should be included which describesthe dividend restrictions and the refusal of the client topresent a statement of cash flows.

D. "he opinion paragraph states that accounting principles wereconsistent with those used in the prior year. "he opinionparagraph should make no reference to consistency.

$4. "he opinion paragraph e*cludes the required phrase 1in allmaterial respects.1

$$. "he opinion paragraph includes the words 1generally acceptedauditing standards1 rather than the phrase 1accountingprinciples generally accepted in the United )tates of America.1

$%. A separate paragraph should be included stating that generallyaccepted accounting principles were not consistently applied.

$&. "he opinion should be qualified rather than being unqualified.

?ualifications are caused by the#6a7 failure to present a statement of cash flows.6b7 failure to disclose the dividend restrictions.

3-28

(a!

C"%$&$"%

(!*A&R$A+$&'

++

(!&'# "/R#"R& C"**%&,

$. )cope ofthe audithas beenrestricted

Highly material 0isclaimer Because the clientrefuses to allow theauditor to e*pand thescope of his audit adisclaimer of opinion isappropriate rather thana qualified as to scopeand opinion.

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3-28 (ontinued!

(a!

C"%$&$"%

(!

*A&R$A+$&'++

(!

&'# "/R#"R& C"**%&,

%. 3ailure tofollow <AA(

Highly material ormaterial. We needadditionalinformationregarding theauditor'spreliminary

2udgment aboutmateriality

Adverse6if highlymaterial7

or

?ualified6if material7

"he materiality of twentypercent of net earningsbefore ta*es would besufficient for manyauditors to require anadverse opinion. "hatmateriality question is amatter of auditor

2udgment.

&. >ack ofindependence

8ot applicable 0isclaimer >ack of independence byaudit personnel on the

engagement mandatesa disclaimer for lack ofindependence.

+ 8one 8ot applicable Unqualified "he company has madea decision to follow adifferent financingmethod which isadequately disclosed."here is no change ofaccounting principle.

,. )cope of

the audithas beenrestricted

Highly material 0isclaimer "he auditor cannot issue

an unqualified opinion onthe income statement orthe statement of cashflows because adisclaimer of opinion isnecessary for thebeginning balance sheet."he auditor may issue anunqualified opinion on theending balance sheet anda disclaimer of opinion onthe income statementstatement of cash flowsand the beginningbalance sheet.

-. )cope ofthe audithas beenrestricted

Highly material Unqualified "he auditor is able tosatisfy him or herself thatwith the use of alternativeprocedures a qualifiedopinion is not necessary.

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3-29

(a!

C"%$&$"%

(!

*A&R$A+$&'++

(!

&'# "/R#"R&

(d! *"$/$ "R$%

A$&$"%A+ #ARARA#,( "&R C"**%&,!

$. )cope of theaudit has been

restricted

Highly material 6-7 0isclaimer "he client has restricted thescope of the audit and the

auditor was not able to satisfyhim or herself by alternative

procedures. Because it was aclient restriction rather than acondition beyond the client’s

control causing the limitationand because the limitation is

highly material a disclaimer isappropriate. 9ntroductory

paragraph is modified secondparagraph is added describing

the scope restriction scopeparagraph is omitted and

opinion paragraph is adisclaimer of opinion.

%. 8one 8ot applicable 6$7 Unqualified5

standardwording

"here is no indication

questioning the ability of thebusiness to continue operations.

"he auditor does notautomatically add an e*planatory

paragraph simply because thereis a risky business.

&. 8one 9mmaterial 6$7 Unqualified5standardwording

"he amount is immaterial. "hefacts are adequately disclosedin the footnote.

+. 3ailure tofollow <AA(

=aterial 6+7 ?ualifiedopinion only

5e*cept for

"he standards require the useof a qualified opinion for the

failure to include a statement ofcash flows. "hird paragraph

must be added stating the

omission.

,. )ubstantial

doubt aboutgoing concern

=aterial 6%7 Unqualified5

e*planatoryparagraph

"here is a question about the

ability of the company tocontinue as a going concern.

"he auditor therefore mustissue an unqualified report with

an e*planatory paragraphfollowing the opinion.

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3-29 (ontinued!

(a!

C"%$&$"%

(!

*A&R$A+$&'++

(!

&'# "/R#"R&

(d! *"$/$ "R$%

A$&$"%A+ #ARARA#,( "&R C"**%&,!

-. eportinvolving otherauditors

=aterial 6&7 Unqualified5modifiedwording

"his is a shared audit report inwhich the auditor will identifythe portion of work done by theother auditor in the introductoryparagraph and still issue anunqualified opinion. "heabsolute dollar amounts ofassets and revenues orpercentages must be stated inthe introductory paragraph.9ntroductory paragraph scopeparagraph and opinionparagraph are all modified.

3-30

(a!

C"%$&$"%

(!*A&R$A+$&'

++

( !&'# "/

R#"R& C"**%&

$. 3ailure tofollow <AA(.

Highly material ormaterial dependingupon the amount ofthe loss and theauditor's preliminary

2udgment aboutmateriality

67 Adverse 6ifhighly material7

or6+7 ?ualified

opinion only 5e*cept for6if material7

0isclosure of this informationis required in a footnote.3ailure to do so is a violationof <AA( and is likely to resultin a qualified opinion or itcould be so material that itrequires an adverse opinion.

%. 3ailure tofollow <AA(.

9mmaterial 6$7 Unqualified5standardwording

"he amount is immaterial.

&. )cope of theaudit hasbeenrestricted.

Highly material ormaterial dependingupon the auditor’spreliminary 2udgmentabout materiality.

6-7 0isclaimer6if highlymaterial7

or 6,7 ?ualified

scope andopinion6if material7

Because the auditor wasunable to satisfy himselfabout beginning inventories itwould be necessary to issueeither a qualified or disclaimerof opinion on the incomestatement and statement ofcash flows as well as thebeginning balance sheet. "heuse of a qualified ordisclaimer would dependupon materiality. Anunqualified opinion could beissued for the current periodbalance sheet.

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3-30 (ontinued!

(a!

C"%$&$"%

(!*A&R$A+$&'

++

( !&'# "/

R#"R& C"**%&

+. )cope of theaudit hasbeen

restricted.

Highly material 6-7 0isclaimer 3ailure of the client to allowthe auditor to inspect theminutes book would be a

material client/imposedrestriction. 0ue to the

importance of the minutesbook a disclaimer would be

necessary. "he certifiedcopy of all resolutions and

actions would not be asatisfactory alternative

procedure.

,. )cope of theaudit has

beenrestricted.

8ot applicable 6$7 Unqualified5standard

wording

Because the auditor wasable to obtain alternative

evidence no scopequalification is necessary. 9f

there were such aqualification it would be a

qualified scope and opinionor a disclaimer depending

on materiality.

-. 3ailure tofollow <AA(.

=aterial 6+7 ?ualifiedopinion only5

e*cept for

etail Auto (arts has useda replacement cost

inventory rather than lowerof cost or market. 9t is not

sufficiently material torequire an adverse opinion.

. 8one 8ot applicable 6$7 Unqualified5

standardwording

"he change of estimated life

is a change of condition andnot a change in accounting

principles. "herefore anunqualified opinion is

appropriate since there isadequate disclosure.

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3-31

$&*%": &'# "/ CA%

,"+A$&"R;,R#"R& <*"$/$=

$ An error correction not involving an accountingprinciple.

8o

% An accounting change involving a correction of anerror in principle which is accounted for as acorrection of an error.

Ees

& An accounting change involving a change in thereporting entity which is a special type of change inaccounting principles.

Ees

+

An accounting change involving both a change inaccounting principle and a change in accountingestimate. Although the effect of the change in eachmay be inseparable and the accounting for such achange is the same as that for a change in estimateonly an accounting principle is involved.

Ees

, An accounting change involving a change from onegenerally accepted accounting principle to anothergenerally accepted accounting principle.

Ees

- An accounting change involving a change in anaccounting estimate. 8o

8ot an accounting change but rather a change inclassification.

8o

C An accounting change from one generally acceptedaccounting principle to another generally acceptedaccounting principle.

Ees

3-32 0eficiencies in the staff accountant's tentative report include the following#

$. eport title must include the word Findependent.G%. "he report should generally be addressed to the board of directors

or stockholders not to the audit committee.&. "he introductory paragraph should state 1we have audited1 not

1we have e*amined.1

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3-32 (ontinued!

+. When the principal auditor decides to make reference to the auditof another auditor the report should indicate clearly in theintroductory paragraph the division of responsibility regarding theportions of the financial statements audited by each. Also the

opinion paragraph should state that the opinion is based in part onthe reports of other auditors. 8either of these was done.

,. When the principal auditor decides to make reference to the auditof the other auditor the report should disclose the dollar amountsor percentages of the portion of the financial statements audited bythe other auditor. "his was not done.

-. "he second paragraph is an inappropriately worded scope paragraph.9t should be stated as follows#

We conducted our audits in accordance with auditingstandards generally accepted in the United )tates of

America. "hose standards require that we plan andperform the audit to obtain reasonable assuranceabout whether the financial statements are free ofmaterial misstatement. An audit includes e*aminingon a test basis evidence supporting the amountsand disclosures in the financial statements. An auditalso includes assessing the accounting principlesused and significant estimates made by managementas well as evaluating the overall financial statementpresentation. We believe that our audits and thereport of other auditors provide a reasonable basis for

our opinion.

. Although the introductory paragraph referred to an audit of thefinancial statements for the years ended 0ecember &$ %44D and%44C an opinion was e*pressed only on the %44D financialstatements.

C. "he statement of cash flows was not identified in the opinionparagraph and financial statements were not referred to in theopinion paragraph as 1consolidated.1

D. "he e*planatory sentence for consistency should follow the opinionparagraph not precede it. Also the second sentence in the third

paragraph should be omitted.$4. "here is no inclusion of the phrase 1in all material respects1 in the

opinion paragraph.

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3-33 "he table presented below describes the seven distinct parts of thestandard unqualified report and describes both similarities 6part a.7 anddifferences 6part of b.7 between the standard audit report and the audit report onthe >es =eridian 9nc. financial statements.

,even istint #arts o>,tandard Audit Report

a:

esription o> ,ii.ar .eents

in the +es *eridianAuditor?s Report

:i>>erent .eents

in +es *eridianAuditor?s Report

$. Report title Auditingstandards require thatthe report be titled andthat the title includes theword independent .

"he report is titledF9ndependent Auditor’seport.

%. Audit report address

"he report is usuallyaddressed to thecompany itsstockholders or theboard of directors.

"he report is addressed

to the )hareholders of>es =eridian 9nc.

&. Introductory paragraph "he first paragraph of thereport does three things#first it makes the simplestatement that the (Afirm has done an audit .

)econd it lists thefinancial statements thatwere audited includingthe balance sheet datesand the accountingperiods for the incomestatement and statementof cash flows. "hird itstates that thestatements are theresponsibility ofmanagement and thatthe auditor'sresponsibility is toe*press an opinion onthe statements based onan audit.

"he report begins withthe statement that the(A firm has done anaudit .

"he introductory para/

graph lists the financialstatements auditedincluding the time periodof those statements.

"he second paragraphstates thatmanagement isresponsible for thepreparation and fairpresentation of thefinancial statements.

"he third paragraphdescribes the auditor’sresponsibility toe*press an opinion thefinancial statements.

"he introductory paragraphalso references thesummary of significantaccounting principles andother e*planatory reportsas being a part of the

scope of the audit. Asimilar reference is notincluded in the U.).standard audit report.

"he discussion of manage/ment’s responsibility for thefinancial statementscontained in the secondparagraph is moree*tensive than thediscussion in the standard

audit report. 9t specificallynotes that the financialstatements are prepared inaccordance with 93) andit describes management’sresponsibility for internalcontrol application ofaccounting principles andmaking estimates.

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3-33 (ontinued!

,even istint #arts o>

,tandard Audit Report

a:esription o>

,ii.ar .eentsin the +es *eridian

Auditor?s Report

:i>>erent .eents

in +es *eridian

Auditor?s Report

+. Scope paragraph. "hescope paragraph is afactual statement aboutwhat the auditor did inthe audit. "he remainderbriefly describesimportant aspects of anaudit.

"he third paragraphidentifies the auditingstandards used toconduct the auditsimilar to the standardaudit report.

>ike the standard auditreport the thirdparagraph notes that

the auditor obtainsreasonable assuranceabout whether thefinancial statements arefree of materialmisstatements.

"he fourth paragraphalso containsinformation related toother elements in thescope paragraph in the

standard audit report.3or e*ample the fourthparagraph describesthe auditor’s evaluationof accounting principlespolicies used estimatesmade and the overallpresentation similar tothe scope paragraph inthe standard audit report.

"he fifth paragraph

acknowledges that theauditor believes theevidence obtainedprovides a sufficientbasis for the opinionsimilar to the lastsentence of the scopeparagraph of thestandard audit report.

"he third paragraph notesthat the auditor conductedthe audit in accordancewith 9)As rather thanU.). <AA).

"he third paragraph notesthat the auditor is requiredto comply with ethical

requirements.

"he fourth paragraphcontains more informationthan the standard auditreport about the auditor’sneed to make 2udgments

the auditor’s considerationof risks and internalcontrol and the fact thatthe risk and controlassessments are notsufficient to e*press anopinion on internalcontrol. "he fourthparagraph also e*plicitlynotes that risks of materialmisstatements due toerror or fraud are

considered.

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3-33 (ontinued!

,even istint #arts o>

,tandard Audit Report

a:esription o>

,ii.ar .eentsin the +es *eridian

Auditor?s Report

:i>>erent .eents

in +es *eridian

Auditor?s Report

,. Opinion paragraph. "hefinal paragraph in thestandard report statesthe auditor's conclusionsbased on the results ofthe audit.

"he last paragraphincludes the auditor’sopinion about thefinancial statementsand acknowledges theaccounting principlesused as the basis ofpresentation.

"he wording associatedwith the opinion notes thatthe auditor’s opinion isabout the Ftrue and fairviewG of the financialstatements rather thanthe financial statementsFpresent fairlyG as statedin the standard auditreport.

-. Name of CPA firm. "hename identifies the (Afirm or practitioner whoperformed the audit.

"he name of the (Ais included.

. Audit report date. "heappropriate date for thereport is the end offieldwork when theauditor has gatheredsufficient appropriate

evidence to support theopinion.

"he date that the auditis completed isprovided below thefirm’s signature.

$nternet #ro.e ,o.ution@ Researh Annua. Reports

3-1 "he U.). )ecurities and :*change ommission 6):7 makes available inelectronic form via the 9nternet most of the forms and reports it receives frompublicly traded companies through :0<A. "his problem e*plores informationavailable on the ):’s Web site.

$. "he :0<A Web site describes many ):/required forms. 3ind anddescribe the following ): forms#

Answer@ 3orm C/I / "his is the form that must be filed whenever a

registrant encounters a significant event 6e.g. a change incontrol of ownership disposition or acquisition of a significant

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amount of assets filing for bankruptcy change in independentauditors7.

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$nternet #ro.e 3-1 (ontinued!

3orm $4/I / "his is the annual report that most reportingcompanies file with the ommission. 9t provides acomprehensive overview of the registrant's business. "hereport must be filed within -4/D4 days after the end of the

company's fiscal year. "his form is required by the )ecurities:*change Act of $D&+.

3orm $4/I)B / "his is the annual report filed by reporting1small business issuers.1 9t provides a comprehensive overviewof the company's business although its requirements call forslightly less detailed information than required by 3orm $4/I."he report must be filed within D4 days after the end of thecompany's fiscal year.

%. )earch :0<A for the $4/I filings of the three companies listedbelow. Within the $4/I filings locate the independent auditor's

report and identify what type of opinion it is 6e.g. unqualifiedqualified disclaimer adverse7 and what type of e*planatoryparagraph if any the opinion contains 6e.g. consistency goingconcern emphasis7. 6Hint# Eou may be able to search the company’s$4/I by using the 9nternet browser's 13ind1 command typicallylocated in the 1:dit1 menu.7

Answer@ American Airlines 9nc. 6$4/I filed %/%4/%44C7 / nua.i>ied audit

report with an ep.anatorB pararaph due to a hane inaountin prinip.e

Report o> $ndependent Reistered #u.i Aountin /ir

"he Board of 0irectors and )tockholder American Airlines 9nc.

We have audited the accompanying consolidated balance sheets of American Airlines 9nc. as of 0ecember &$ %44 and %44- and therelated consolidated statements of operations stockholder’s equity6deficit7 and cash flows for each of the three years in the periodended 0ecember &$ %44. ;ur audits also included the financial

statement schedule listed in the 9nde* at 9tem $,6a76%7. "heseconsolidated financial statements and schedule are the responsibilityof the ompany’s management. ;ur responsibility is to e*press anopinion on these financial statements and schedule based on ouraudits.

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We conducted our audits in accordance with the standards of the(ublic ompany Accounting ;versight Board 6United )tates7. "hosestandards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are

free of material misstatement. An audit includes e*amining on a testbasis evidence supporting the amounts and disclosures in thefinancial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management aswell as evaluating the overall financial statement presentation. Webelieve that our audits provide a reasonable basis for our opinion.

9n our opinion the financial statements referred to above presentfairly in all material respects the consolidated financial position of

American Airlines 9nc. at 0ecember &$ %44 and %44- and theconsolidated results of their operations and their cash flows for

each of the three years in the period ended 0ecember &$ %44 inconformity with U.). generally accepted accounting principles. Alsoin our opinion the related financial statement schedule whenconsidered in relation to the basic financial statements taken as awhole present fairly in all material respects the information set forththerein.

As discussed in 8otes D and $4 to the consolidated financialstatements in %44- the ompany changed its method of accountingfor share/based compensation as required by )tatement of 3inancial

Accounting )tandards 8o. $%&67 F)hare/Based (aymentG and

changed its method of accounting for retirement benefits asrequired by )tatement of 3inancial Accounting )tandards 8o. $,CF:mployer’s Accounting for 0efined Benefit (ension and ;ther(ostretirement (lans.G

We also have audited in accordance with the standards of the(ublic ompany Accounting ;versight Board 6United )tates7

American Airlines 9nc.’s internal control over financial reporting asof 0ecember &$ %44 based on criteria established in 9nternalontrol59ntegrated 3ramework issued by the ommittee of)ponsoring ;rgani!ations of the "readway ommission and our

report dated 3ebruary %4 %44C e*pressed an unqualified opinionthereon.

s :rnst J Eoung >>(

0allas "e*as3ebruary %4 %44C

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3ord =otor ompany 6$4/I filed %/%/%44C7 / nua.i>iedoined audit report on the >inania. stateents andinterna. ontro. over >inania. reportin with an ep.anatorBpararaph due to a hane in aountin prinip.e (%ote@

the report is not in the standard 3 pararaph >orat!

Report o> $ndependent Reistered #u.i Aountin /ir

"o the Board of 0irectors and )tockholders3ord =otor ompany#

9n our opinion the consolidated financial statements listed in theinde* appearing under 9tem $,6a76$7 present fairly in all materialrespects the financial position of 3ord =otor ompany and itssubsidiaries at 0ecember &$ %44 and 0ecember &$ %44- andthe results of their operations and their cash flows for each of thethree years in the period ended 0ecember &$ %44 in conformitywith accounting principles generally accepted in the United )tatesof America. 9n addition in our opinion the financial statementschedule listed in the inde* appearing under 9tem $,6a76%7 presentsfairly in all material respects the information set forth therein whenread in con2unction with the related consolidated financial statements.

Also in our opinion the ompany maintained in all material respectseffective internal control over financial reporting as of 0ecember &$%44 based on criteria established in Internal Control # Integrated$rameor% issued by the ommittee of )ponsoring ;rgani!ationsof the "readway ommission 6;);7. "he ompany'smanagement is responsible for these financial statements and

financial statement schedule for maintaining effective internalcontrol over financial reporting and for its assessment of theeffectiveness of internal control over financial reporting included in=anagement's eport on 9nternal ontrol ;ver 3inancial eportingappearing under 9tem DA. ;ur responsibility is to e*press opinionson these financial statements on the financial statementschedule and on the ompany's internal control over financialreporting based on our integrated audits. We conducted our auditsin accordance with the standards of the (ublic ompany

Accounting ;versight Board 6United )tates7. "hose standardsrequire that we plan and perform the audits to obtain reasonableassurance about whether the financial statements are free of

material misstatement and whether effective internal control overfinancial reporting was maintained in all material respects. ;uraudits of the financial statements included e*amining on a testbasis evidence supporting the amounts and disclosures in thefinancial statements assessing the accounting principles usedand significant estimates made by management and evaluating theoverall financial statement presentation. ;ur audit of internal controlover financial reporting included obtaining

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an understanding of internal control over financial reporting assessingthe risk that a material weakness e*ists and testing and evaluatingthe design and operating effectiveness of internal control based onthe assessed risk. ;ur audits also included performing such other

procedures as we considered necessary in the circumstances. Webelieve that our audits provide a reasonable basis for our opinions.

;ur audits were conducted for the purpose of forming an opinion onthe basic financial statements taken as a whole. "he accompanyingsector balance sheets and the related sector statements of incomeand of cash flows are presented for purposes of additional analysisand are not a required part of the basic financial statements. )uchinformation has been sub2ected to the auditing procedures appliedin the audit of the basic financial statements and in our opinion arefairly stated in all material respects in relation to the basic financial

statements taken as a whole.

As discussed in 8ote $D to the consolidated financial statements theompany changed the manner in which it accounts for uncertain ta*positions in %44. As discussed in 8ote %+ the ompany changedthe manner in which it accounts for defined benefit pension andother postretirement plans and as discussed in 8ote % theompany changed the timing of its annual goodwill and otherintangible assets impairment testing and its amorti!ation method forspecial tools in %44-. As discussed in 8ote %C the ompanychanged the manner in which it accounts for conditional asset

retirement obligations in %44,.

A company’s internal control over financial reporting is a processdesigned to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements fore*ternal purposes in accordance with generally accepted accountingprinciples. A company’s internal control over financial reportingincludes those policies and procedures that 6i7 pertain to themaintenance of records that in reasonable detail accurately andfairly reflect the transactions and dispositions of the assets of thecompany@ 6ii7 provide reasonable assurance that transactions are

recorded as necessary to permit preparation of financial statementsin accordance with generally accepted accounting principles andthat receipts and e*penditures of the company are being made onlyin accordance with authori!ations of management and directors ofthe company@ and 6iii7 provide reasonable assurance regardingprevention or timely detection of unauthori!ed acquisition use ordisposition of the company’s assets that could have a materialeffect on the financial statements.

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Because of its inherent limitations internal control over financialreporting may not prevent or detect misstatements. Also pro2ectionsof any evaluation of effectiveness to future periods are sub2ect tothe risk that controls may become inadequate because of changes

in conditions or that the degree of compliance with the policies orprocedures may deteriorate.

s (ricewaterhouseoopers >>(

(ricewaterhouseoopers >>(0etroit =ichigan3ebruary % %44C

"he Home 0epot 6$4/I filed +/&/%44C7 K Coined nua.i>iedaudit report on the >inania. stateents and interna. ontro.

over >inania. reportinReport o> $ndependent Reistered #u.i Aountin /ir

"he Board of 0irectors and )tockholders"he Home 0epot 9nc.#

We have audited "he Home 0epot 9nc.'s internal control overfinancial reporting as of 3ebruary & %44C based on criteriaestablished in Internal Control & Integrated $rameor% issued bythe ommittee of )ponsoring ;rgani!ations of the "readwayommission 6;);7. "he Home 0epot 9nc.'s management is

responsible for maintaining effective internal control over financialreporting and for its assessment of the effectiveness of internalcontrol over financial reporting included in the accompanying=anagement's eport on 9nternal ontrol ;ver 3inancial eporting.;ur responsibility is to e*press an opinion on the ompany'sinternal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the(ublic ompany Accounting ;versight Board 6United )tates7."hose standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internalcontrol over financial reporting was maintained in all materialrespects. ;ur audit included obtaining an understanding of internalcontrol over financial reporting assessing the risk that a materialweakness e*ists and testing and evaluating the design andoperating effectiveness of internal control based on the assessedrisk. ;ur audit also included performing such other procedures aswe considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

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A company's internal control over financial reporting is a processdesigned to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements fore*ternal purposes in accordance with generally accepted accountingprinciples. A company's internal control over financial reportingincludes those policies and procedures that 6$7 pertain to themaintenance of records that in reasonable detail accurately andfairly reflect the transactions and dispositions of the assets of thecompany@ 6%7 provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statementsin accordance with generally accepted accounting principles andthat receipts and e*penditures of the company are being made onlyin accordance with authori!ations of management and directors ofthe company@ and 6&7 provide reasonable assurance regardingprevention or timely detection of unauthori!ed acquisition use ordisposition of the company's assets that could have a material

effect on the financial statements.Because of its inherent limitations internal control over financialreporting may not prevent or detect misstatements. Also pro2ectionsof any evaluation of effectiveness to future periods are sub2ect tothe risk that controls may become inadequate because of changesin conditions or that the degree of compliance with the policies orprocedures may deteriorate.

9n our opinion "he Home 0epot 9nc. maintained in all materialrespects effective internal control over financial reporting as of3ebruary & %44C based on criteria established in Internal Control

& Integrated $rameor% issued by the ommittee of )ponsoring;rgani!ations of the "readway ommission.

We also have audited in accordance with the standards of the(ublic ompany Accounting ;versight Board 6United )tates7 theonsolidated Balance )heets of "he Home 0epot 9nc. andsubsidiaries as of 3ebruary & %44C and Lanuary %C %44 and therelated onsolidated )tatements of :arnings )tockholders' :quityand omprehensive 9ncome and ash 3lows for each of the fiscalyears in the three/year period ended 3ebruary & %44C and ourreport dated =arch %C %44C e*pressed an unqualified opinion onthose consolidated financial statements.

I(=< >>( Atlanta <eorgia=arch %C %44C

6%ote# 9nternet problems address current issues using 9nternet sources. Because9nternet sites are sub2ect to change 9nternet problems and solutions may change. urrentinformation on 9nternet problems is available at www.pearsonhighered.comarens7.

Documents

AEB_SM_CH03_1.pdf