CHAPTER 3anderson/Password/16eChapter... · Web viewCHAPTER 17 Auditors' Reports Review Questions 17-1 The three paragraphs of the standard audit report for a nonpublic company are

Chapter 17 - Auditors' Reports

CHAPTER 17

Auditors' Reports

Review Questions

17-1 The three paragraphs of the standard audit report for a nonpublic company are (1) introductory paragraph, (2) scope paragraph, and (3) opinion paragraph.

17-2 The function of notes to financial statements is to provide adequate disclosure when information in the financial statements is insufficient to attain this objective.

17-3 Auditors may issue unqualified reports when the following conditions have been met:

(1) The financial statements are presented in conformity with generally accepted accounting principles, including adequate disclosure.

(2) The audit was performed in accordance with generally accepted auditing standards, including no significant scope limitations preventing the auditors from gathering the evidence necessary to support their opinion.

17-4 The audit report for a public company differs from the audit report of a nonpublic company in the following ways:

The title of the public company report includes a reference to the “registered” audit firm.

The public company report references standards of the PCAOB rather than generally accepted auditing standards.

The public company report must include the city and state—or city and country in the case of non-U.S. auditors—where the auditors' report has been issued. There is no similar requirement for nonpublic reports.

The public company report includes an additional paragraph indicating that the auditors have also issued a report on the client’s internal control over financial reporting.

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17-5 (1) Unqualified opinion—standard report. This report represents a "clean bill of health" and may be issued when there are no material departures from generally accepted accounting principles, no significant scope limitations preventing the gathering of necessary evidence, and when no conditions requiring explanatory language exist.

(2) Unqualified opinion—with explanatory language added to report. This is an audit report with an unqualified opinion, but with circumstances that result in the auditors adding certain explanatory language to the report. Examples of such circumstances are those in which other auditors have performed a portion of the audit, or when a question concerning an entity’s ability to continue as a going concern exist.

(3) Qualified opinion. A qualified opinion is issued when the auditors' examination is restricted as to its scope or the financial statements depart from generally accepted accounting principles. A qualified opinion is still a positive opinion; it asserts that the presentation in the financial statements, viewed as a whole, is fair.

(4) Adverse opinion. This is a negative opinion, asserting that the financial statements are not a fair presentation. It is issued when the auditors' exceptions to the presentation in the financial statements are so significant that a qualified opinion would be an inadequate warning to users of those statements.

(5) Disclaimer of opinion. A disclaimer of opinion means that the auditors were unable to form an opinion. It is issued whenever there are such significant scope limitations that the auditors were unable to obtain sufficient evidence to form an opinion of the statements viewed as a whole, or a significant scope limitation imposed by the client.

17-6 Green should sign the report with the firm name—Cary, Loeb, & Co. The report should be dated as of the date Green obtained sufficient evidence to support the opinion, February 20.

17-7 No. A shared responsibility opinion, in itself, does not represent a qualification. Rather, this form of opinion merely divides the auditors' overall responsibility for the engagement between two or more CPA firms. Note, however, that factors other than the division of responsibility may lead to a qualified report (i.e., departures from GAAP and scope limitations).

17-8 The wording of an unqualified opinion might depart from the wording of the standard report when (a) the principal auditors make reference to other auditors, (b) the auditors wish to emphasize some matter in the financial statements, (c) the auditors believe that it is appropriate that the financial statements depart from an officially recognized accounting principle in order to achieve the higher objective of a fair presentation, (d) when principles of accounting have not been consistently applied in relation to the prior year, or (e) when substantial doubt about an entity’s ability to continue as a going concern exists (only three required).

17-9 The audit report should include a fourth paragraph that describes the change and makes reference to the financial statement note explaining the nature of and justification for the change in the method of valuing the inventories and the effect of such change upon the financial statements.

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17-10 Qualifying language is wording inserted in an auditors' report designed to lessen the auditors' responsibility for the presentation in the client's statements. The qualifying language uses the phrase "except for ..." to identify those elements of the statements for which the auditors do not accept responsibility for the fairness of presentation.

17-11 The statement is incorrect. While an explanatory paragraph will be added to the audit report for the departure from generally accepted accounting principles, the opinion will be either qualified or adverse.

17-12 If the client's failure to comply with generally accepted accounting principles is immaterial, the auditors may still issue an unqualified opinion. If the problem is material, they must qualify their report as to the accounting principles in question, using the "except for" qualifying language. If the problem is sufficiently material to overshadow the fairness of the financial statements ("very material"), the auditors must issue an adverse opinion.

17-13 A client can avoid an opinion qualified because of inadequate disclosure merely by making the appropriate disclosure in the financial statements.

17-14 Only an opinion qualified because of a scope limitation has qualifying language in both the scope and opinion paragraphs. When there is a material scope limitation, the audit does not conform, in all respects, to generally accepted auditing standards. Hence, the scope paragraph must be modified. Also, the auditors will not have gathered enough evidence to have an opinion on some element of the financial statements. Thus, the opinion paragraph also must be qualified.

17-15 Since the auditors have not been able to form an opinion on the financial statements taken as a whole, they must disclaim an opinion. However, they should set forth their reservations about the accounting treatment of the deferred income taxes in an explanatory paragraph to their disclaimer.

17-16 Adverse opinions do the client no good. Presumably, creditors and stockholders would not provide debt or equity capital and, if the client were under SEC jurisdiction, the SEC might launch an investigation of management for violations of the federal securities acts. Thus, the client usually will make whatever changes in the financial statements that the auditors require in order to avoid receiving an adverse opinion. In fact, in the few cases in which the client and its auditors cannot agree, the client would probably discharge the auditors instead of having them complete an audit that culminates in an adverse opinion.

17-17 When significant scope limitations are imposed by the client, the auditors generally should issue a disclaimer of opinion. As a disclaimer is of little value to the client, this potential strong action by the auditors serves as a deterrent to clients imposing scope limitations.

17-18 Yes. Each financial statement "stands alone." Thus, the CPAs may issue different types of opinions on the financial statements of successive years when reporting on comparative statements. The CPAs may even issue different opinions on the different financial statements for a single year.

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17-19 Yes. When reporting on comparative statements, CPAs should update their report on the prior year's statements to determine whether it is still the proper type of report to accompany those statements. For example, a departure from GAAP that existed last year, resulting in a report qualification, might have been corrected. In this case, it is appropriate for the auditors to revise their report on the prior year's statements to a standard unqualified report.

17-20 The reports containing audited financial statements filed by a company subject to the reporting requirements of the SEC may include:

Forms S-l through S-11. These are the "registration statements" for clients planning to issue securities to the public; they are accompanied by comparative audited financial statements.

Forms SB-1 and SB-2. These forms are more simplified registration forms for small businesses.

Form 8-K. A report filed upon the occurrence of a specified significant event. If the event is a significant acquisition or disposal of assets, Form 8-K will be accompanied with pro forma financial information. An 8-K report is used to report a change in auditors.

Form 10-Q. This form includes quarterly financial statements reviewed by the company’s auditors.

Form 10-K. This report is filed annually by publicly owned companies and includes audited financial statements, reports on internal control over financial reporting, and other detailed financial information.

Questions Requiring Analysis

17-21 (a) Generally, the independent auditors must issue a disclaimer of opinion when client imposed restrictions limit significantly the scope of the audit, because such restrictions lead to questions concerning whether the client is withholding important information.

(b) Generally, the principal auditors issue an unqualified opinion when they decide to make reference to the report of another CPA firm as a basis, in part, for their opinion. Such a reference indicates a sharing of responsibility for the scope of the audit; it does not represent a qualification of the auditors' report.

(c) A lack of disclosure leads to either a qualified opinion or an adverse opinion. Since it is a note disclosure—with no income effect—that is being omitted, one would generally expect issuance of a qualified opinion.

17-22 (a) (1) The first sentence of the statement is partially true. It is important to read the notes to financial statements because they provide important supplementary information.

(2) Notes often pertain to complex matters and are presented in technical language. Certainly it must be acknowledged that sometimes they could be presented in a clearer form.

(3) To the extent the notes supplement disclosures in the body of the financial statements, they could reduce the auditors' exposure to third-party liability. The disclosure must be supplementary, not contradictory.

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(b) (1) The second statement is wrong in asserting that the notes can be used to correct or contradict financial statement presentation. Notes are an integral part of the financial statements. If there is contradiction or if the presentation is incomprehensible, this constitutes inadequate reporting and requires qualification of the audit report.

(2) The statement fails to recognize that the need for accuracy and completeness sometimes overrides the desire for clarity.

(3) The statement incorrectly assigns management's primary responsibility for the financial statements and notes to the auditors. The auditors' relationship to the notes is the same as their relationship to the balance sheet and other financial statements; their actions are governed by the same reporting responsibilities and liabilities to interested parties.

(4) Because notes are prepared by management, the auditors cannot control their content. Other advisers, e.g., legal counsel, will influence the wording of notes. The auditors properly should recommend improvements in presentation, but they will make an opinion exception only if disclosure is inadequate or so unclear as to be misleading.

17-23 (a) The principal auditors are not required to make reference to the other auditors. Making reference merely divides the auditors' collective responsibility for the engagement between the two CPA firms. If the principal auditors are willing to assume full responsibility for the engagement (which they will normally do if they retained the other auditors), they need make no reference to the other auditors in their report.

(b) Although Jones & Abbot issued a qualified report on the Canadian subsidiary, Rowe & Myers do not necessarily have to qualify their report. Rowe & Myers will be evaluating problems in light of what is material to the consolidated entity, whereas Jones & Abbot were evaluating problems in relation to what was material for the Canadian subsidiary. As the consolidated entity is larger than the subsidiary, the problem at the subsidiary may be immaterial to Dunbar Electronics.

17-24 (a) Whether or not Michaels, the principal auditor, decides to make reference to the audit of Thomas, Michaels should perform the following procedures:

(1) Make inquiries concerning the professional reputation and standing of Thomas through: The American Institute of Certified Public Accountants (AICPA), the

applicable state society of certified public accountants, and/or the local chapter.

Other practitioners. Other appropriate sources.

(2) Obtain representations from Thomas regarding the CPA firm's independence with respect to the client, and knowledge as to the use of the firm's report.

(3) Adopt appropriate measures to assure the coordination of activities with those of Thomas in order to achieve a proper review of matters affecting the consolidating accounts in the financial statements.

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(b) If Michaels decides to make reference to the audit of Thomas, Michaels' report should indicate clearly, in the introductory scope and opinion paragraphs, the division of responsibility between that portion of the financial statements covered by Michaels' audit and that covered by the audit of Thomas. The report should disclose the magnitude of the portion of the financial statements examined by Thomas. This may be done by stating the dollar amounts of total assets, total revenues, and/or other appropriate criteria, whichever most clearly reveals the portion of the financial statements examined by Thomas.

17-25 (a) Information contrary to an assumption that a client will remain a going concern usually relates to the company's ability to meet its financial obligations. Conditions that indicate such a problem include recurring operating losses, working capital deficiencies, adverse financial ratios, defaults on loans, and arrearages in dividends. Other conditions such as work stoppages, legal matters, legislation, and loss of principal customers may also indicate a question as to a client's ability to remain a going concern.

(b) After discovering conditions and events that might indicate substantial doubt as to whether a firm can continue as a going concern, the auditors must obtain and evaluate management's plans for dealing with the conditions and events. After reviewing the feasibility of management's plans, if the auditors still believe that there is substantial doubt as to ability to continue as a going concern, they should determine that the matters are properly disclosed in the financial statements and also should modify the audit report to reflect that conclusion.

Multiple Choice Questions

17-26 (a) (3) When the auditors take exception to the application of accounting principles in the client's financial statements, they will issue either an "except for" qualified, or adverse opinion, depending on the materiality of the problem.

(b) (2) The audit report should be dated no earlier than when the auditors have accumulated

sufficient competent evidence. This date is often the last day of fieldwork.

(c) (1) Reference to the work of another auditor is not, in itself, a qualification of the auditors' report. This reference does not lessen the auditors' collective responsibility. Rather, it merely divides this responsibility among two or more CPA firms.

(d) (4) This phrase violates the fourth standard of reporting, because it does not give the reader of the report a clear-cut indication of the auditors' opinion. The phrase appears to modify the standard opinion paragraph, but is not forceful enough to constitute qualifying language.

(e) (1) The auditor communicates through the auditors' report, and therefore only answer (1) is correct. Note that the client will include a discussion of the related party transactions in a note to the financial statements.

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(f) (2) A disclaimer is appropriate because auditors must generally disclaim an opinion when a significant client imposed scope limitation is involved. Note here that if the limitation were circumstance imposed the auditors would have to decide between an "except for" qualified and disclaimer of opinion.

(g) (3) No explanatory paragraph is added when part of the audit is performed by other auditors. If the CPA wishes to take responsibility for the work of the other auditors, no modification is necessary. If the CPA does not wish to take such responsibility, each of the existing three paragraphs of the report are modified.

(h) (2) An audit report of a public client indicates that the audit was performed in accordance with standards of the Public Company Accounting Oversight Board (United States).

(i) (3) An audit report for a public client indicates that the financial statements were prepared in conformity with generally accepted accounting principles (United States). The PCAOB does not issue accounting standards.

(j) (3) Substantial doubt about a client’s ability to continue as a going concern results in either an unqualified report with explanatory language or a disclaimer of opinion. Accordingly answer (3) is correct since a qualified report is not appropriate.

(k) (2) When an unjustified change in accounting principles occurs, either a qualified or adverse opinion is appropriate as this represents a departure from generally accepted accounting principles. Accordingly, answer (2) is correct since an adverse opinion, but not a disclaimer of opinion is appropriate.

(l) (3) An emphasis of a matter paragraph is appropriate when an auditor wishes to emphasize a matter concerning the financial statements, but not a matter concerning the scope of the audit engagement. Accordingly, answer (3) is not a situation in which an emphasis of a matter paragraph is appropriate since confirming accounts receivable relates to the scope of the audit.

Problems

17-27 SOLUTION: Williams & Co., CPAs (Estimated time 20 minutes)

The auditors' report contains the following deficiencies:

Introductory paragraph

1. All the financial statements audited are not identified. 2. Management's responsibility for the financial statements is omitted.

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Scope paragraph

3. Reference to "auditing standards generally accepted in the United States of America" is omitted.

4. An auditor obtains reasonable assurance about whether the financial statements are "free of material misstatement," not "in conformity with generally accepted accounting principles."

5. The statement that an audit includes "evaluating the overall financial statement presentation" is omitted.

6. The statement that the auditors "believe that the audit provides a reasonable basis for our opinion" is omitted.

Explanatory paragraph

7. The explanatory paragraph should follow the opinion paragraph. 8. The auditors should not give an opinion concerning the entity's survival "beyond a

reasonable period of time."

Opinion paragraph

9. A qualified ("subject to") opinion is inappropriate.10. The date of the financial statements audited is omitted.11. There should be no reference to consistency unless the accounting principles have not

been applied consistently.12. There is no reference to accounting principles generally accepted in the United States

of America.

17-28 SOLUTION: Sturdy Corporation (Estimated time: 20 minutes)

(a) A separate explanatory paragraph should set forth reasons for the expression of an adverse opinion and the principal effects of the subject matter of the adverse opinion. The separate paragraph should state the following, providing dollar amounts where practicable: The company carries its building accounts at appraisal values and provides for

depreciation on the basis of such values. Buildings, accumulated depreciation, and equity (attributed to appraisals) are

overstated. Net income is understated. Depreciation expense is overstated.

(b) The opinion paragraph should contain a reference to the separate paragraph and state the financial statements do not present fairly the financial position, results of operations, and cash flows. It should be worded as follows:

In our opinion, because of the effects of the matters discussed in the preceding paragraph, the financial statements referred to above do not present fairly, in all material respects, the financial position of Sturdy Corporation as of December 31, 19X3, or the results of its operations or its cash flows for the year then ended.

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17-29 SOLUTION: Types of Auditors' Reports (Estimated time: 20 minutes) (a) A standard unqualified audit report should be issued. Possible losses from future

catastrophes not ordinarily insured against are "general risk" contingencies that need not be reflected in the financial statements or notes thereto.

(b) An adverse or a qualified opinion is required. Valuation of assets at appraised values is not in accordance with generally accepted accounting principles. Since the difference between appraised value and cost is significant, an unqualified opinion would not be appropriate.

(c) The report should be qualified for the departures from generally accepted accounting principles necessitated by compliance with regulatory agency requirements.

(d) A qualified opinion (or possibly a disclaimer) should be issued. The material restriction upon the scope of the CPA firm's audit has prevented it from obtaining sufficient competent evidential matter with respect to investments in stocks of subsidiaries.

(e) An adverse or a qualified opinion is necessary. The CPA firm has acquired sufficient competent evidence to the effect that the investments in stock of subsidiary companies are overstated. Note disclosure does not compensate for improper balance sheet presentation.

17-30 SOLUTION: Excelsior Corporation (Estimated time: 25 minutes)

Independent Auditors' Report

To the Board of Directors and StockholdersExcelsior Company

We have audited the accompanying balance sheets of Excelsior Corporation as of December 31, 20X4 and December 31, 20X3, and the related statements of income and retained earnings for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance as to 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 opinions.

The corporation declined to disclose that the agreement executed in conjunction with the issuance of the debentures of January 31, 20X3, for the purpose of financing expansion of plant facilities, restricts the payment of future cash dividends to earnings after December 31, 20X3.

The corporation declined to present statements of cash flows for the years ended December 31, 20X4 and December 31, 20X3. Presentation of such statements summarizing the corporation's cash flows from operating, investing and financing activities is required by Statement No. 95 of the Financial Accounting Standards Board.

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In our opinion, except for the omission of the debenture information discussed in the third paragraph and except for the omission of the statements of cash flows that result in an incomplete presentation as explained in the fourth paragraph, the financial statements referred to above present fairly, in all material respects, the financial position of Excelsior Corporation as of December 31, 20X4 and 20X3, and the results of its operations for the years then ended in conformity with accounting principles generally accepted in the United States of America.

As discussed in note 12 to the financial statements, the corporation changed its method of accounting for long-term construction contracts.

As discussed in note 11 to the financial statements, the corporation is the defendant in a lawsuit relating to (state type of litigation). The ultimate outcome of the lawsuit cannot presently be determined, and no provision for any liability that may result has been made in the financial statements.

Roscoe, CPAMarch 15, 20X5

The only item of other information that is not part of the above report is Roscoe's failure to confirm accounts receivable. Such procedures are required unless circumstances indicate that they are not necessary. In such cases the auditors can use alternate procedures to obtain satisfaction as to the validity of the accounts. If alternate procedures are performed, the auditors need not refer to the omission of the normal procedures in the report.

17-31 SOLUTION: (Estimated time: 25 minutes)

Item No. Type of Change

Should Auditors'Report beModified?

Should PriorYear's StatementsBe Restated?

1. An accounting change involving a change from one generally accepted accounting principle to another generally accepted accounting principle.

Yes Yes

2. An accounting change involving a change in an accounting estimate.

No No

3. An error correction not involving an accounting principle.

No Yes

4. An accounting change involving a correction of an error in principle that is accounted for as a correction of an error.

Yes Yes

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5. An accounting change involving a change in the reporting entity that is a special type of change in accounting principle.

Yes Yes

6. An accounting change involving both a change in accounting principle and a change in accounting estimate. Although the effect of the change in each may be inseparable and the accounting for such a change is the same as that accorded a change in estimate only, an accounting principle is involved.

Yes No

7. Not an accounting change but rather a change in classification.

No Yes

8. An accounting change from one generally accepted accounting principle to another generally accepted accounting principle.

Yes No

-32 SOLUTION: Brown & Brown (Estimated time: 25 minutes)

Deficiencies in the audit assistant's draft include the following:

(1) There is no heading such as "Independent Auditors' Report."

(2) The report is improperly addressed to the president.

(3) Reference to "Note K" pertaining to a subsequent event is inappropriate in the introductory paragraph. If the auditor wishes to emphasize this matter, such explanatory information should be presented in a separate paragraph of the auditors' report.

(4) There is no reference to the predecessor auditors in the introductory paragraph as required when the statements are in comparative form.

(5) There is no indication that an adverse opinion was expressed by the predecessor auditors.

(6) The separate explanatory paragraph does not make reference to the requirements of generally accepted accounting principles, i.e., property and equipment should be stated at an amount not in excess of cost and deferred income taxes should be provided. Therefore, all of the substantive reasons for the qualified opinion have not been disclosed. Also, this paragraph should precede the opinion paragraph.

(7) The separate explanatory paragraph does not disclose either the monetary effects of the violations of generally accepted accounting principles or that the effects are not reasonably determinable.

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(8) The opinion paragraph does not include a direct reference to the separate explanatory paragraph that discloses the basis for the adverse opinion.

(9) No reference to consistency in the application of accounting principles should be made.

(10) The auditors' report is not properly dual dated.

17-33 SOLUTION: Quaid Company (Estimated time: 25 minutes)

Note 6

Indentures relating to the long-term debt require that the company (1) will maintain working capital at not less than $4,500,000, and (2) will not pay cash dividends or purchase its common stock except to the extent of 70 percent of net earnings since January 1, 20X0, plus $250,000, or if working capital would be reduced by such action to less than $5,000,000. At December 31, 20X1, $2,441,291 of retained earnings was not restricted under the indentures.

17-34 SOLUTION: White & Co. (Estimated time: 25 minutes)

Independent Auditors' Report

To the Board of Directors of National Motors, Inc.

We have audited the accompanying balance sheet of National Motors, Inc., as of December 31, 20X1, and the related consolidated statements of income, retained earnings, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the financial statements of Rapid Parts Company, a consolidated subsidiary, which statements reflect total assets of $7,000,000 as of December 31, 20X1, and total revenues of $8,000,000 for the year then ended. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Rapid Parts Company, is based solely on the report of the other auditors.

Except as explained in the following paragraph, we conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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 audit and the report of other auditors provide a reasonable basis for our opinion.

We did not observe the taking of the physical inventory as of December 31, 20X0, since that date was prior to our appointment as auditors for the Company, and the Company's records do not permit adequate retroactive tests of those inventory quantities. Accordingly, the scope of our work was not sufficient to enable us to express, and we do not express, an opinion on the statements of income, retained earnings, and cash flows for the year ended December 31, 20X1.

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In our opinion, based on our audit and the report of other auditors, the consolidated balance sheet as of December 31, 20X1 presents fairly, in all material respects, the financial position of National Motors, Inc. as of December 31, 20X1, in conformity with accounting principles generally accepted in the United States of America.

White and CompanyMarch 28, 20X2

17-35 SOLUTION: Audit Report Modifications (Estimated time: 25 minutes)

1. (F,L) A situation in which an auditor is unable to obtain audited financial statements for an investee represents a scope limitation. Scope limitations lead to either a qualified opinion or a disclaimer of opinion. A decision as to whether the auditors should qualify or disclaim the opinion is dependent upon their assessment of the importance of the scope limitation.

2. (B,I) Substantial doubt about an entity's ability to continue as a going concern leads to either an unqualified opinion with an explanatory paragraph, or a disclaimer. Because the combination of either an unqualified opinion or a disclaimer is not included in list A, an unqualified opinion is best. Given a situation in which an unqualified opinion is to be provided, the appropriate modification of the report is an explanatory paragraph following the opinion paragraph.

3. (B,Q) A standard unqualified opinion is appropriate in circumstances in which a principal auditor takes responsibility for the work of another auditor.

4. (A,J) When a company issues financial statements that purport to present financial position and results of operations, but omit the related statement of cash flows, the auditor will normally conclude that the omission requires a qualified opinion. Qualified opinions for departures from generally accepted accounting principles require an explanatory paragraph preceding the opinion paragraph and a modified opinion paragraph.

5. (B,I) When an auditor agrees with a change in accounting principles, a lack of consistency results in an unqualified opinion with an explanatory paragraph following the opinion paragraph, with no modification of the three standard paragraphs.

6. (E,J) Departures from generally accepted accounting principles result in either a qualified opinion or an adverse opinion, based on the materiality of the departures. In deciding whether a qualified or an adverse opinion should be issued, the auditors consider the materiality of the departures. Regardless of whether a qualified opinion or an adverse opinion is issued, an explanatory paragraph precedes the opinion paragraph, and the opinion paragraph is modified.

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17-36 Jordan Company (Estimated Time: 25 minutes)

1. Correct. The title should include the word “independent.”

2. Incorrect. The introductory paragraph does properly identify the basic financial statements.

3. Incorrect. The AICPA is not, and should not be, identified in the introductory paragraph.

4. Incorrect. Because Johnson & Barkley wish to assume responsibility for the work of Larkin & Lake, no mention of Larkin & Lake should be made in the report.

5. Incorrect. The report properly does not identify the subsidiary.

6. Incorrect. The audit report properly does not include mention of analytical procedures.

7. Incorrect. The audit report properly does not indicate that an audit includes assessing internal control.

8. Correct. The report should include a statement that an audit includes assessing significant estimates made by management.

9. Correct. The date of the previous report should be disclosed.

10. Incorrect. The reason for the different opinion should be disclosed.

11. Correct. The opinion paragraph should begin with the term “In our opinion.”

12. Correct. The auditor’s concurrence with a change should be implicit. If the auditor takes exceptions to the change the report should so indicate.

13, Incorrect. The auditor may chose to add a paragraph on uncertainties through the emphasis of a matter report modification.

14. Incorrect. The letter of audit inquiry need not be referred to.

15. Incorrect. The report should not be dual dated.

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In-Class Team Case17-37 Reporting Scenarios (Estimated Time: 50 Minutes)

Circumstance Type opinion(s)

Report Modifications

Paragraph(s) Modified

1 Justified Departure from GAAP

U E

2 Emphasis of a Matter U E

3 Scope Limitation Q S, O, E

D I, S, O, E

4 Going Concern U E

5 Other Auditors U I, S, O

6 None S N

7 None S N

8 Emphasis of a Matter* U E

9 Unjustified Departure from GAP

Q O, E

A O, E

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10 Other Auditors S N

*“Uncertainty” is not listed as a choice. If this matter were considered serious enough, a disclaimer for an uncertainty might be considered appropriate.

17-38

Situation Opinion Opinion1. A company in its first year of existence is valuing

inventory at current replacement cost. While you believe that the inventory costs do approximate replacement costs, these costs doe not approximate any GAAP inventory valuation method.

Q A

2. Due to recurring operating losses and working capital deficiencies, you have substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time. The notes to the financial statements adequately disclose the substantial doubt situation.

U U

3. You have discovered that a client has made illegal payoffs to a candidate for president of the United States. You are unable to determine the amounts associated with the payoffs because of the client’s inadequate record retention policies. The client has added a note to the financial statements to describe this all, and has stated that the amounts of the payments are not determinable.

Q D

4. In auditing the long-term investments account of a new client, you find that a large contingent liability exists that is material to the consolidated company. It is probable that this contingent liability will be resolved with a material loss in the future, and this amount is reasonably estimable as $2 million. Although no adjusting entry has been made, the client has provided a note to the financial statements that describes the matter in detail and includes the $2 million estimate in that note.

Q A

5. A client is issuing 2 years of comparative financial statements. The first year was audited by another auditor who is not being asked to reissue her audit report.

U U

6. An entity changes its depreciation method for production equipment from the straight-line to the units-of-production method based on hours of utilization. You concur with the change.

U U

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7. A client has changed from the method it uses to calculate post employment benefits from one acceptable method to another one. The effect of the change is immaterial this year, but expected to be material in the future.

S NotApplicable

8. A client has departed from GAAP, because both the client and you believe that because of relatively unique circumstances following GAAP would lead to misleading results.

U U

Research and Discussion Case

17-39 Metropolitan Power Supply (Estimated Time: 55 minutes)

(a) Arguments for auditors insisting that some portion of construction costs be expensed: The concept that an asset should not be carried at a value greater than its "service

potential" is established by FASB Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” This statement requires that the carrying amount of an asset be reduced whenever the sum of the expected future cash flows is less than the carrying amount.

It appears that Eagle Mountain ultimately will cost far more than MPS can expect to recover through operations. Therefore, some of the total cost should be regarded as a loss, not as a productive asset. The asset should be written down to the present value of the expected future cash flows from the plant. Granted, the computation of the loss is highly subjective, but it must be done to fairly present the asset.

Argument against insisting that some construction costs be expensed:

As MPS’s auditors, we do not know what the future cash flows from operations will be. Presumably, the “recoverable costs” are whatever the state utilities commission ultimately allows MPS to pass on to its ratepayers. Until this determination is made, or until MPS abandons the project, any guesses as to the recoverable cost would be sheer speculation.

Our opinion on part a: We believe that the carrying value of the plant should be reduced to the discounted expected future cash flows from the plan in accordance with FASB Statement No. 121. Management of MPS should be able to reasonably estimate the amount of the cost that the utility commission will allow the company to recover based on their experience in the industry.

(b) It appears that there is considerable risk that continuing with the Eagle Mountain project may ultimately cause MPS to become insolvent. The question, therefore, is whether this risk is sufficient for the auditors to modify their report as to MPS's ability to remain a going concern.

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Although the case does not make it altogether clear when the company would be likely to become insolvent, there is no indication that it will within a one-year period as indicated in SAS 59 relating to going concern questions. Thus, the facts do not suggest that auditors should issue a going concern modification merely because they anticipate problems years down the road.

In the opinion of the authors, the client should receive the benefit of the doubt. An opinion should not be modified with respect to a going concern question unless there is substantial doubt that the client will become insolvent within one year from the date of the balance sheet. To speculate over longer periods of time simply involves too much conjecture to be consistent with the attest function.

Although we would not modify our opinion as to MPS's ability to remain a going concern, we would consider including an emphasis of a matter paragraph describing the uncertainty surrounding the ultimate realization of the capitalized construction costs. Therefore, we would consider including an emphasis of a matter paragraph discussing the company's ability to finance the completion of the Eagle Mountain facility and to recover the capitalized construction costs.

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CHAPTER 3anderson/Password/16eChapter... · Web viewCHAPTER 17 Auditors' Reports Review Questions 17-1 The three paragraphs of the standard audit report for a nonpublic company are