Chapter 3

©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 3 - 1

Audit Reports

Chapter 3

©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 3 - 3 - 22

Learning Objective 1

Describe the parts of the standard

unqualified audit report.


Parts of the StandardUnqualified Audit Report1. Report title

2. Audit report address

3. Introductory paragraph

4. Scope paragraph

5. Opinion paragraph

6. Name of CPA firm

7. Audit report date



Specify the conditions required

to issue the standard unqualified

audit report.


Conditions for StandardUnqualified Audit Report

1. All financial statements are included.

2. The three general standards have beenfollowed in all respects on the engagement.

3. Sufficient evidence has been accumulatedto conclude that the three standards offield work have been met.


Conditions for StandardUnqualified Audit Report

4. The financial statements are presented inaccordance with generally acceptedaccounting principles.

5. There are no circumstances requiring theaddition of an explanatory paragraph ormodification of the wording of the report.


Four Categories of Audit Reports

1. Standard unqualified

3. Qualified

2. Unqualified with explanatory paragraphor modified wording

4. Adverse or disclaimer



Understand combined reporting

on financial statements and

internal control over financial

reporting under Section 404 of

the Sarbanes-Oxley Act.


Sarbanes-Oxley Act

This Act requires the auditor of a publiccompany to attest to management’sreport on the effectiveness of internalcontrol over financial reporting.

PCAOB Auditing Standard 2 requiresthe audit of internal control to be integratedwith the audit of the financial statements.


Sarbanes-Oxley Act

Combined Report on Financial Statements andInternal Control Over Financial Reporting

1. Introductory paragraph

2. Scope paragraph

3. Definition paragraph

4. Inherent limitations paragraph

5. Opinion paragraph



Describe the five circumstances

when an unqualified report with

an explanatory paragraph or

modified wording is appropriate.


Unqualified Report with Explanatory Paragraph

1. Lack of consistent application of generallyaccepted accounting principles

2. Substantial doubt about going concern

3. Auditor agrees with a departure frompromulgated accounting principles

4. Emphasis of a matter

5. Reports involving other auditors


Substantial Doubt AboutGoing Concern

1. Significant recurring operating lossesor working capital deficiencies.

2. Inability of the company to pay itsobligations as they come due.

3. Loss of major customers, the occurrenceof uninsured catastrophes.

4. Legal proceedings, legislation that mightjeopardize the entity’s ability to operate.


Auditor Agrees with a Departurefrom a Promulgated Principle

The auditor must be satisfied and must stateand explain, in a separate paragraph orparagraphs in the audit report, that adheringto the principle would have produced amisleading result in that situation.


Emphasis of a Matter

Under certain circumstances, the CPA maywant to emphasize specific matters regardingthe financial statements, even though theCPA intends to express an unqualified opinion.


Reports Involving Other Auditors

1. Make no reference in the audit report

3. Qualify the opinion

2. Make reference in the report(modified wording report)



Identify the types of audit reports

that can be issued when an

unqualified opinion is not justified.


Departures from AnUnqualified Opinion

1. Scope limitation

2. GAAP departure

3. Auditor not independent


Qualified Opinion

A qualified opinion report can result froma limitation on the scope of the audit orfailure to follow generally acceptedaccounting principles.


Adverse Opinion

It is used only when the auditor believesthat the overall financial statements areso materially misstated or misleading thatthey do not present fairly the financialposition or results of operations and cashflows in conformity with GAAP.


Disclaimer of Opinion

It is issued when the auditor is unableto be satisfied that the overall financialstatements are fairly presented.



Explain how materiality affects

audit reporting decisions.


Materiality

A misstatement in the financial statementscan be considered material if knowledge ofthe misstatement would affect a decisionof a reasonable user of the statements.


Levels of Materiality

Amounts are immaterial.

Amounts are material but do not overshadowthe financial statements as a whole.

Amounts are so material or so pervasive thatoverall fairness of the statements is in question.


Relationship of Materiality toType of Opinion

MaterialityLevel

Significance in Terms ofReasonable Users’ Decisions

Type ofOpinion

Users’ decisions are unlikelyto be affected.Immaterial Unqualified

Users’ decisions are likelyto be affected.Material Qualified

Users’ decisions are likelyto be significantly affected.

Highlymaterial

Disclaimeror adverse


Materiality Decisions

Failure tofollow GAAP

Audit report

UnqualifiedQualified

opinion onlyAdverse



Dollar amount compared with a base

Measurability

Nature of the item



Scopelimitation

Audit report

UnqualifiedQualified scope

and opinionDisclaimer



Draft appropriately modified

audit reports under a variety

of circumstances.


Discussion of ConditionsRequiring Departure

Auditor’s scope has been restricted

Statements are not in conformity with GAAP

Auditor is not independent



Determine the appropriate audit

report for a given audit situation.


Auditor’s Decision Process

Determine whether any condition existsrequiring a departure from a standardunqualified report.

Decide the materiality for each condition

Decide the appropriate type of report

Write the audit report


More Than One Condition Requiringa Departure or Modification

The auditor is not independent.

There is a scope limitation.

There is a substantial doubt aboutthe company’s ability to continueas a going concern.

There is a deviation in the statements’preparation in accordance to GAAP.


Number of Paragraphsin the Report

Standard unqualified 3Unqualified with explanatory paragraph 4Unqualified shared report with other auditors 3Qualified – opinion only 4Qualified – scope and opinion 4Disclaimer – scope limitation 3Adverse 4

Type of Report



Discuss the impact of e-commerce

on audit reporting.


Impact of E-Commerce onAudit Reporting

Under auditing standards, the auditor has noobligation to perform any procedures tocorroborate the other information.

Most public companies provide access to financialinformation through their home Web page.

Auditing standards note that electronic sitesare not considered “documents.”

©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 3 - 37

End of Chapter 3

Education

Chapter 3