Reports on audited financial statements

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AUDITING CHAPTER 3Audit Reports

• TOPICS
• Reports on audited financial statements
• Audit report opinions
• Modifications to audit reports
• Updated reports reports for foreign countries
• Reports on attest assurance services

ACCT450 AUDITING WKU
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AUDIT REPORT DEFINED
Topic 1 Reports on audited financial statements

• Audit report is a letter communicating
• What was audited
• Managements responsibilities
• Auditors responsibilities
• What an audit entails
• Auditors opinion

• 1. In most all financial statement audits,
  independent auditors deliver a (an)
• Unqualified opinion
• Qualified opinion
• Adverse opinion
• Standard audit report

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STANDARD AUDIT REPORT OPINION - UNQUALIFIED
OPINION

• Unqualified opinion is independent auditors
  opinion that managements financial statements
  present fairly in all material respects the
  financial position, results of operations, cash
  flows in conformity with GAAP
• Applies to quality of financial statements not to
  quality of entity as investment or credit risk

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SARBANES-OXLEY

• Managements responsibilities
• Reviewed entire annual/quarterly report
• Report does not contain untrue statement of
  material fact or omit material fact
• Financial statements present fairly financial
  condition results of operations
• Establish, maintain, evaluate effectiveness of
  internal controls
• Disclosed to auditors significant deficiencies,
  fraud

• 2. In all financial statements produced to the
  SEC, the chief executive and chief financial
  officers are required to certify in writing that
  they
• Approved appointment of the independent auditor
• Reported to the audit committee any material
  fraud
• Evaluated disclosure controls and procedures
• Approved the companys policy on ethics

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ELEMENTS OF REPORT

• What are the components of an independent
  auditors report?
• Title Independent Auditors Report
• Addressee shareholders, board of directors
• Introductory paragraph
• Scope paragraph
• Opinion paragraph
• Firm signature
• Date of report

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INTRODUCTORY PARAGRAPH

• Statement that
• Financial statements were audited
• Financial statements are managements
  responsibility
• Auditors responsibility is to issue opinion
• We have audited the accompanying consolidated
  balance sheets of The Procter Gamble Company
  and subsidiaries as of June 30, 2004 and 2003,
  and the related consolidated statements of
  earnings, retained earnings, and cash flows for
  each of the three years in the period ended June
  30, 2004. These financial statements are the
  responsibility of the companys management. Our
  responsibility is to express an opinion on these
  statements based on our audits.

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SCOPE PARAGRAPH

• Statement that
• Audit conducted in accordance with U.S. GAAS
• GAAS requires planning, performing audit to
  obtain reasonable assurance financial statements
  free from material misstatements
• Audit includes
• Examining evidence on test basis
• Evaluating accounting principles estimates
• Evaluating overall financial presentation
• We conducted our audits in accordance with the
  standards of the Public Company Accounting
  Oversight Board (United States). Those standards
  require that we plan and perform the audits 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 audits provide a reasonable basis for our
  opinion.

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MEANING OF SCOPE PARAGRAPH

• Reasonable not absolute assurance implies auditor
  may
• Overlook immaterial misstatements
• Test samples rather than all transactions
  events
• Implies auditor complied with all general
  standards
• Adequately trained proficient
• Independent in mental attitude
• Exercised due professional care
• Implies auditor complied with all fieldworks
  standards
• Planned engagement supervised assistants
• Obtained understanding of internal control
• Obtained sufficient, competent evidential matter

• 3. An independent auditors report on the
  financial statements of a public company would
  likely include a statement that the
• Auditor was appointed by the audit committee of
  the board of directors.
• Audit was conducted in accordance with the
  standards of the Public Company Accounting
  Oversight Board.
• Auditor did or did not detect fraud.
• Audit was conducted in accordance with generally
  accepted auditing standards.

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OPINION PARAGRAPH

• Statement of opinion
• Whether financial statements present fairly in
  all material respects
• Financial position
• Results of operations
• Cash flows
• In conformity with GAAP
• In our opinion, the financial statements referred
  to above present fairly, in all material
  respects, the financial position of the companies
  at June 30, 2004 and 2003, and the results of
  their operations and their cash flows for each of
  the three years in the period ended June 30,
  2004, in conformity with accounting principles
  generally accepted in the United States of
  America.

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USE OF STANDARD OPINION PARAGRAPH

• Implies compliance with reporting standards
• Financial statements presented in accordance with
  U.S. GAAP
• Principles are applied consistently
• Disclosures are reasonably adequate
• Opinion applies to statements taken as a whole

• 6. Does an auditor make the following
  representation explicitly or implicitly in an
  unqualified audit report? (AICPA Adapted)
• Consistent Application of Examined Evidence
• Accounting Principles on a Test Basis .
• Implicitly Explicitly
• Implicitly Implicitly
• Explicitly Explicitly
• Explicitly Implicitly

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SIGNIFICANCE OF AUDIT REPORT DATE

• Last day of fieldwork
• Last day responsible for detecting subsequent
  events
• Dual dating financial statements revised for
  subsequent event after fieldwork date but before
  report release
• Event date date to which all responsibilities
  extended

• 19. The last day of audit field work is January
  21, 2007, for the audit of ExPro Inc., which will
  include the following footnote in December 31,
  2006, financial statements
• On November 20, 2004, the United States
  Bankruptcy Count for the Northern District of
  Illinios issued an Order that approved the claims
  of Boylston LLC against the Company. The First
  National Bank, as agent for the lenders under
  Boylstons 800 million Senior Secured Credit
  Agreement, filed four lawsuits against ExPro. On
  March 4, 2007, the company reached a settlement
  agreement with First National, pursuant to which
  all four of the cases, including ExPros
  counterclaim, were dismissed without prejudice.
  ExPro released to First National its claim to the
  370 million that was previously paid into an
  escrow account in April 2006.
• Which of the following is the most appropriate
  date for the auditors report?
• January 21, 2007 c. March 4, 2007
• January 21, 2007, except for Note 9, March 4,
  2007 d. December 31, 2006

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Case 3-4 Audit Report Deficiencies

• Timothy Ross completed field work on September
  23, 2008, and issued the following report to the
  directors of the Rancho Corporation
• To the Directors of the Rancho Corporation
• We have audited the balance sheet of the Rancho
  Corporation as of July 31, 2008 and the related
  statements of income and retained earnings. In
  accordance with your instructions, a complete
  audit was conducted.
• We conducted our audit in accordance with
  generally accepted auditing standards. An audit
  includes examining, on a test basis, evidence
  supporting the amounts and disclosures in the
  financial statements. We believe that our audit
  was appropriate in the circumstances.
• In many respects, this was an unusual year for
  the Rancho Corporation. The weakening of the
  economy in the early part of the year and the
  strike of plant employee in the summer of 2008
  led to a decline in sales and net income. After
  making several tests of sales records, nothing
  came to our attention that would indicate that
  sales have not been properly recorded.
• In our opinion, with the explanation given above
  and the exception of some minor errors that are
  considered immaterial, the aforementioned
  financial statements present fairly, in all
  material respects, the financial position of the
  Rancho Corporation at July 31, 2008, and the
  results of its operations for the year then
  ended, in conformity with pronouncements of the
  Financial Accounting Standards Board.
• Timothy Ross, CPA, September 23, 2008
• Required List and explain deficiencies and
  omissions in Rosss report. Do not discuss the
  type of opinion (unqualified, qualified, adverse,
  or disclaimer). Organize your answer by paragraph
  (introductory, scope, explanatory, and opinion)

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OTHER TYPES OF OPINIONS
Topic 2 Audit report opinions

• What types of opinions do our authoritative
  permissions allow?
• Departures from GAAP or scope limitation require
  other opinion
• Qualified sufficient evidence or assertions
  fairly presented except for certain matter(s)
• Adverse assertions are not fairly presented
• Disclaimer auditor does not express an opinion
  usually due to insufficient evidence (scope
  limitation)

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QUALIFIED OPINION

• Except for effects of a matter, financial
  statements present fairly in all other material
  respects
• Statements depart materially from GAAP
• Management unable to justify material change in
  accounting principle
• Scope of audit materially limited

In our opinion, except for the effects of the
accounting treatment for good will as discussed
in the preceding paragraph, the financial
statements referred to above present fairly ..

• 10. The opinion paragraph to a qualified opinion
  could include the expression
• With the exception
• When read in conjunction to note 10 to the
  financial statements
• With the foregoing explanation
• Subject to the departure from generally accepted
  accounting principles

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ADVERSE OPINION

• Managements financial statements do not present
  fairly
• Financial statements depart from GAAP
• Management unable to justify change in accounting
  principle
• Effects of departure so highly material that
  qualified opinion unwarranted

In our opinion, because of the effects of the
matter discussed in the preceding paragraph, the
financial statements referred to above do not
present fairly in conformity with generally
accepted accounting principles .
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DISCLAIMER OF OPINION

• Auditor does not express opinion
• Scope limitation so material auditor does not
  have reasonable basis to reach opinion
• Auditor is not independent of management

Because of the possible material effect of the
matters discussed in the preceding paragraph, we
are unable to express, and we do not express, an
opinion on the financial statements referred to
above.

• 4. Which of the following circumstances would
  most likely require a disclaimer of opinion?
• Management has denied the auditor access to
  evidence bearing on trade accounts receivable.
• Managements accounting for revenue recognition
  violates SEC Staff Accounting Bulletin No. 104,
  Revenue Recognition.
• The auditor detected an employee scheme that
  diverted funds to an off-shore company.
• The auditor disagrees with a change management
  implemented for long-term construction contract
  accounting.

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STANDARD REPORT MODIFICATIONSUnder what
circumstances and how? does an auditor depart
from the standard wording of an unqualified
opinion?
Topic 3 Modifications to audit reports
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MODIFICATIONSAnother Auditor

• Principle auditor shares responsibility with
  another auditor
• Modified wording in introductory opinion
  paragraphs
• (Introductory Paragraph)
• ... We did not audit the financial statements of
  the MacMillan/ McGraw-Hill School Publishing
  Company, a joint venture partnership, which
  statements reflect total assets of 1,332.4
  million as of December 31 and total revenues of
  286.4 million from the period of inception July
  1 through December 31. Those statements were
  audited by other auditors, and our opinion,
  insofar as it relates to the data included for
  the MacMillan/McGraw-Hill School Publishing
  Company is based solely on the report of the
  other auditors.
• (Opinion Paragraph)
• In our opinion, based on our audits and the
  report of other auditors, ...

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MODIFICATIONSAnother Auditor

• 18. An introductory paragraph reads in part as
  follows
• We have audited the accompanying balance sheet of
  Hastings Company and subsidiaries as of December
  31, 2007, and the related consolidated statements
  of operations, shareholders equity, and cash
  flows for the year then ended The accompanying
  2006 and 2005 consolidated financial statements
  were audited by other auditors who have ceased
  operations. Those auditors expressed an
  unqualified opinion on those financial statements
  
• For the year ended December 31, 2007, the
  auditors report likely expresses
• An unqualified opinion.
• An unqualified opinion that emphasizes the
  matter.
• A qualified opinion.
• No opinion on the 2006 financial statements.

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MODIFICATIONSEmphasis of a Matter

• Auditor wishes to emphasize a matter still
  issue an unqualified opinion
• Explanatory paragraph added after opinion
  paragraph
• Example (Explanatory Paragraph)
• As discussed in note 1 to the consolidated
  financial statements, effective October 6, INR
  Acquisition Corp acquired substantially all of
  the outstanding common stock of Insilco
  Corporation in a business combination accounted
  for as a purchase. As a result of the
  acquisition, the consolidated financial
  information for the periods after the acquisition
  is presented on a different cost basis than that
  for the periods before the acquisition and,
  therefore, is not comparable.

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MODIFICATIONSEmphasis of a Matter

• 16. An explanatory paragraph reads as follows
• On October 15, 2007, the Company emerged from
  bankruptcy. As discussed in the notes to the
  financial statements, the Company accounted for
  the reorganization using fresh start accounting
  and, as a result, the post-reorganization
  financial statements are not comparable to the
  pre-reorganization financial statements.
• The paragraph likely is intended to
• Qualify an opinion
• Emphasize a matter
• Report an inconsistency
• Indicate a departure from generally accepted
  accounting principles

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MODIFICATIONSDeparture from GAAP

• With auditors agreement
• Unqualified opinion
• Explanatory paragraph after opinion paragraph
• Without auditors agreement
• Material departure from GAAP in limited area
• Explanatory paragraph before opinion paragraph
  qualified opinion
• Example As discussed in Note 2, the Bank has
  charged goodwill to shareholders equity but GAAP
  requires an asset
• Pervasive departure from GAAP
• Explanatory paragraph before opinion paragraph
  adverse opinion
• Example The company carries property, plant,
  equipment at appraisal values but GAAP requires
  values not exceed cost.

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MODIFICATIONSInconsistency

• Justifiable Inconsistency
• Management changes accounting principle(s) and
  justifies change
• Explanatory paragraph after opinion paragraph
• Example As discussed in Note 3, the company
  changed its method of accounting for goodwill
  other intangibles
• Not Justified
• Management changes accounting principle(s) but
  fails to justify change
• Limited area - Explanatory paragraph before
  qualified opinion
• Pervasive - Explanatory paragraph before adverse
  opinion

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MODIFICATIONSInconsistency

• 15. An explanatory paragraph reads as follows
• The Company has adopted the first-in, first-out
  method of determining inventory costs, whereas it
  previously used the last-in, first-out method.
  Although use of the first-in, first-out method is
  in conformity with generally accepted accounting
  principles, in our opinion the Company has not
  provided reasonable justification for seeking a
  change as required by Opinion No. 20 of the
  Accounting Principles Board.
• The paragraph likely appears in
• An unqualified opinion.
• An unqualified opinion that emphasize the matter.
• A qualified opinion
• A disclaimer of opinion

• 17. A note to a public companys audited
  financial statements reads as follows
• As of January 1, the Company adopted Statement of
  Financial Accounting Standards No. 142, Goodwill
  and Other Intangible Assets. As a result of
  adopting SFAS No. 142, goodwill is no longer
  amortized, and intangible assets are to be tested
  at least annually for impairment. Goodwill
  amortization of 50 million is included in
  depreciation and amortization.
• The auditors report will likely include
• An unqualified opinion
• An unqualified opinion and an explanatory
  paragraph
• A qualified opinion
• An explanatory paragraph, depending on materiality

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MODIFICATIONSScope Limitation Limited Area

• Prevent auditor from performing 1 or more
  necessary auditing procedures
• Material Limitation
• Modify scope paragraph
• Except as discussed in the following paragraph,
  we conducted our audit
• Explanatory paragraph before qualified opinion
• We were unable to obtain evidential matter
  supporting the Companys representations
  regarding the contingent liability as discussed
  in Note 8.

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MODIFICATIONSPervasive Scope Limitation

• Prevent auditor from performing 1 or more
  necessary auditing procedures
• Pervasive limitation
• Modify introductory paragraph
• Omit scope paragraph
• Explanatory paragraph before disclaimer of
  opinion
• Example
• The Company did not give effect to all
  adjustments to the carrying value of assets
  classification of liabilities resulting from
  bankruptcy proceedings

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MODIFICATIONSGoing Concern

• When auditor retains substantial doubt as to
  ability of client to continue as a going concern
  (SAS 59)
• Explanatory paragraph after opinion paragraph
• Mack Trucks, Inc. (Explanatory
  Paragraph)
• The consolidated financial statements have been
  prepared assuming that the Company will continue
  as a going concern. As discussed in Note 1 to the
  financial statements, the liquidity of the
  Company has been adversely affected by recurring
  losses from operations, and the Company was in
  default under certain of its loan covenants at
  December 31, all of which raised substantial
  doubt about the Companys ability to continue as
  a going concern. The financial statements do not
  include any adjustments that might result from
  the outcome of the uncertainty.

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MODIFICATIONSLack of Independence

• Auditor is not independent of client
• SAS 26 requires a 1-paragraph explanation with
  disclaimer of opinion
• Example (Explanatory Paragraph)
• We are not independent with respect to the
  Trailways Company. . . .the balance sheet,
  statements of income, retained earnings, cash
  flows were not audited by us. We do not express
  an opinion on them.

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Case 3-8 Drafting an Opinion Paragraph

• Sturdy Corporation owns and operates a large
  office building in a desirable section of New
  York Citys financial district. For many years
  the management of Sturdy Corporation has (a)
  written-up building accounts to appraisal values
  and (b) accounted for depreciation expense on the
  basis of appraised values. Wyley, the successor
  auditor, was engaged to audit Sturdys financial
  statements for the year ended December 31, 2008.
  After completing the audit, Wyley concluded that,
  consistent with prior year, an adverse opinion
  would have to be issued because of the
  materiality of the apparent departure from
  historical cost.
• Required
• Describe in detail what Wyley should include in
  an explanatory paragraph
• Draft the opinion paragraph

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UPDATED REPORTS
Topic 4 Updated reports reports for foreign
countries

• When opinions differ
• Criteria for both opinions must be met with
  explanatory paragraphs
• When opinion updated
• Update opinion paragraph add explanatory
  paragraph acknowledging change

• 20. Resolution in 2007 of a material departure
  from GAAP that drove a qualified opinion in 2006
  would likely cause an independent auditor in 2007
  to
• Reissue the 2006 audit report with an unqualified
  opinion
• Include in the 2007 audit report an unqualified
  opinion on 2006 and an explanatory paragraph.
• Include in the 2007 audit report an unqualified
  opinion for 2006 but not an explanatory
  paragraph.
• Include in the 2007 audit report a qualified
  opinion for 2006.

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REPORTS FOREIGN COUNTRIES

• When financial statements are used outside the
  U.S. only
• statements audited,
• basis of statement presented,
• audit made in accordance with U.S. auditing
  standards, and
• opinion on whether the statements are presented
  fairly in conformity with the basis described
• When financial statements are used outside and in
  the U.S
• standard audit report, modified for departures
  from U.S. GAAP
• separate paragraph to express an opinion on
  whether the financial statements are presented in
  conformity with GAAP in the other country

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REPORTS ON ATTESTATION SERVICES
Topic 5 Reports on attest assurance services

• Letter communicating
• Managements attesters responsibilities
• Attester's opinion
• Managements assertions (if written)
• Types of opinions
• Unqualified opinion in attestation report means
  managements assertions are fairly presented in
  the attester's opinion
• Departures from attestation standards or
  measurement criteria require other opinion
• Qualified assertions fairly presented except for
  certain matter(s)
• Adverse assertions are not fairly presented
• Disclaimer attester does not express an opinion
  usually due to insufficient evidence
• What are the components of an attestation report?

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(Introductory Paragraph) We have examined the
Proof Positive Methodology of MCI
Telecommunications Corporation (MCI) for the
period September 28, 2000 through December 27,
2000. Our examination was made in accordance with
standards established by the AICPA and,
accordingly, included such procedures as we
considered necessary in the circumstances. The
Prove Positive Methodology and Statement are the
responsibility of MCIs management. Our
responsibility is to express an opinion on the
methodology and statement based on our
examination. (Scope Paragraph) The Proof
Positive Methodology for comparing MCI Preferred
billing charges between MCI and ATT is footnoted
in the You Save Money with MCI section of the
enclosed customized Proof Positive Statement. The
Proof Positive Methodology for comparing billing
charges between alternative MCI services is
footnoted in the You Always Get MCIs Best price
section of the enclosed statement. The
methodology was designed by MCI to compute the
lowest telephone service cost under the MCI and
most widely used ATT programs indicated in the
specified sections for each customers actual
usage billed by MCI during the specified
period. (Opinion Paragraph) In our opinion,
the Proof Positive Methodology referred to above
properly compares billing charges between MCI and
ATT and between alternative MCI services and
accurately reflects the price differences for the
period September 28, 2000 through December 27,
2000, as applied to actual usage billed by
MCI PricewaterhouseCoopers, LLP
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ATTESTATION REPORT

• 5. A report issued by a public accounting firm
  uses the language, In our opinion, the schedule
  presents, in all material respects The firms
  report is likely
• A standard audit report
• A qualified audit report
• An attestation report
• A qualified attestation report
• 7. Does an accountant make the following
  representations explicitly or implicitly in an
  unqualified attestation report?
• Assertion is Capable of Evaluation Assertions
  are
• Against Reasonable Criteria
  Managements Responsibility
• Explicitly Explicitly
• Implicitly Implicitly
• Implicitly Explicitly
• Explicitly Implicitly

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REPORTS FOR ASSURANCE SERVICES

• Not required
• Short history of offering assurance services
• Traditionally, reports not required
• Oscars
• Tony awards
• National book awards
• If issued, what are the components of an
  assurance service report?