AUDITORS REPORTS

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CHAPTER 18

• AUDITORS REPORTS

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ASSOCIATION WITH FINANCIAL STATEMENTS

• An accountant (auditor) is associated with the
  financial statements of an entity when he/she
  has
• consented to the use of his/her name in a report,
  document, or written communication containing the
  financial statements, or
• submitted to his/her client or to others
  financial statements that he/she has prepared or
  assisted in preparing.

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ASSOCIATION WITH FINANCIAL STATEMENTS

• If the accountant (auditor) is associated with
  the financial statements of a public entity, but
  has not audited or reviewed such statements, the
  accountant should issue the following form of
  report
• Addressee
• The accompanying balance sheet of X
  Company as of December 31, 2004, and the related
  statements of income, retained earnings, and cash
  flows for the year then ended were not audited by
  us and, accordingly, we do not express an opinion
  on them.
• SignatureDate

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TYPES OF AUDITORS' AND ACCOUNTANTS' REPORTS ON
FINANCIAL STATEMENTS

• Auditors' Reports - Reports on audits of
  financial statement(s) that purport to be in
  conformity with GAAP.
• Special Reports
• Reports on Application of Accounting Principles
• Letters for Underwriters
• Review of Interim Financial Information
• Compilation and Review of Financial Statements
  (AR 100-600)
• Prospective Financial Statements (AT 200)
• Pro Forma Financial Statements (AT 300)

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TYPES OF AUDITORS' AND ACCOUNTANTS' REPORTS ON
FINANCIAL STATEMENTS

• Reports on the audit of a governmental entitys
  financial statements performed in accordance with
  one or more of the following
• Generally Accepted Auditing Standards (GAAS)
• Governmental Auditing Standards (GAS)
• Single Audit Act of 1984

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Types of Auditor Reports Opinions (see Table 1)

• Unqualified Opinion
• Standard report
• Report with explanatory language added that does
  not affect the auditors unqualified opinion
• Qualified Opinion (sometimes called an Except for
  Qualified Opinion)
• Material departure from GAAP (including
  inadequate disclosure)
• Significant scope limitation.
• Adverse Opinion Material departure from GAAP
• Disclaimer of Opinion ? Significant scope
  limitation

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EXPLANATORY LANGUAGE ADDED TO THE AUDITOR'S
REPORT

• The auditor's opinion is based in part on the
  report of another auditor.
• To prevent the financial statements from being
  misleading due to unusual circumstances, the
  financial statements contain a departure from
  "promulgated" GAAP.
• The financial statements are affected by
  significant uncertainties concerning future
  events, the outcome of which is not susceptible
  to reasonable estimation. (Eliminated by SAS
  79).
• There is substantial doubt about the entity's
  ability to continue as a going concern.
• There has been a material change between periods
  in accounting principles or their method of
  application.
• The auditor wishes to add an explanatory
  paragraph to the audit report to emphasize a
  matter in the financial statements, but still
  express an unqualified opinion.

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EXPLANATORY LANGUAGE ADDED TO THE AUDITOR'S
REPORT

• Certain circumstances relating to reports on
  comparative financial statements exist.
• Selected quarterly financial data required by SEC
  Regulation S-K have been omitted or have not been
  reviewed.
• Supplementary information required by the FASB or
  the GASB
• Supplementary information has been omitted from
  the financial statements, or
• Presentation of such information departs
  materially from FASB or GASB guidelines, or
• Auditor is unable to complete prescribed
  procedures with respect to such information, or
• Auditor is unable to remove substantial doubts
  about whether the supplementary information
  conforms to FASB or GASB guidelines, or
• Other information in a document containing
  audited financial statements is materially
  inconsistent with information appearing in the
  financial statements.

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AUDITOR'S OPINION IS BASED IN PART ON THE REPORT
OF ANOTHER AUDITOR

• When a principal auditor decides to make
  reference to the report of another auditor,
  he/she should
• disclose this fact in the introductory paragraph
  of his or her report by indicating the dollar
  amounts, or the relative percentages, of assets
  and revenues examined by the other auditors,
• refer to the report of the other auditor in the
  scope paragraph by inserting after "We believe
  that our audit" the phrase "and the report of the
  other auditors,".
• refer to the report of the other auditor in the
  opinion paragraph by inserting after "In our
  opinion," the phrase "based on our audit(s) and
  the report of the other auditors,".

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Example of a Report Indicating Division of
Responsibility

• Report of Independent Registered Public
  Accounting Firm
• To the Board of Directorsof X Company

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Example of a Report Indicating Division of
Responsibility - Intro

• We have audited the accompanying balance sheets
  of X Company as of December 31, 2004 and 2003,
  and the related statements of income,
  shareholders equity, and cash flows for each of
  the two years in the period ended December 31,
  2004. 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 audits. We did
  not audit the financial statements of B Company,
  a wholly owned subsidiary, which statements
  reflect total assets of ______ and _______ as
  of December 31, 2004 and 2003, respectively, and
  total revenues of _______ and _______ for the
  years 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 B Company, is based
  solely on the reports of the other auditors.

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Example of a Report Indicating Division of
Responsibility - Scope

• 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 an 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 audits and the reports of the other auditor
  provide a reasonable basis for our opinion.

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Example of a Report Indicating Division of
Responsibility - Opinion

• In our opinion, based on our audits and the
  reports of the other auditors, the financial
  statements referred to above present fairly, in
  all material respects, the financial position of
  X Company as of December 31, 2004 and 2003, and
  the results of operations and its cash flows for
  each of the two years in the period ended
  December 31, 2004, in conformity with U.S.
  generally accepted accounting principles.
• SignatureCity and State or Country)Date

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TO PREVENT THE FINANCIAL STATEMENTS FROM BEING
MISLEADING DUE TO UNUSUAL CIRCUMSTANCES, THE
FINANCIAL STATEMENTS CONTAIN A DEPARTURE FROM
"PROMULGATED" GAAP

• Management and the auditor must be able to
  justify that, due to unusual circumstances,
  adherence to "promulgated" GAAP would be
  misleading.
• Though the auditor's report contains a departure
  from the standard report, the opinion expressed
  by the auditor is an unqualified opinion.

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TO PREVENT THE FINANCIAL STATEMENTS FROM BEING
MISLEADING DUE TO UNUSUAL CIRCUMSTANCES, THE
FINANCIAL STATEMENTS CONTAIN A DEPARTURE FROM
"PROMULGATED" GAAP

• The auditor's report should include, in a
  separate explanatory paragraph, in which the
  auditor describes the
• departure,
• approximate effects, if practicable, and
• reasons why compliance with promulgated GAAP
  would be misleading.
• The separate explanatory paragraph should precede
  the opinion paragraph.

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THERE IS SUBSTANTIAL DOUBT ABOUT AN ENTITY'S
ABILITY TO CONTINUE AS A GOING CONCERN

• The following are audit procedures that may
  identify a going concern problem
• Analytical procedures.
• Review of subsequent events.
• Review of compliance with the terms of debt and
  loan agreements.
• Reading minutes of meetings of stockholders,
  board of directors, and important committees of
  the board.
• Inquiry of a client's legal counsel about
  litigation, claims, and assessments.
• Confirmation with related and third parties of
  the details of arrangements to provide or
  maintain financial support.

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• Conditions or Events That Could Cast Substantial
  Doubt on a Client's Ability to Continue as a
  Going Concern for a Reasonable Period of Time
• Negative trends such as operating losses,
  working capital deficiencies, negative cash
  flows, adverse key financial ratios
• Other indications of possible financial
  difficulties such as default on bonds or loans,
  denial of normal trade credit from suppliers,
  restructuring of debt, noncompliance with
  statutory capital requirements
• Internal matters that have occurred such as work
  stoppages
• External matters that have occurred such as
  litigations loss of a key franchise, license or
  patent loss of a principal customer uninsured
  catastrophes such as drought, flood, or
  earthquake.

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• If the auditor concludes that there is
  substantial doubt about the client's ability to
  continue as a going concern for a reasonable
  period of time, the auditor should evaluate
  managements plans to mitigate the effects of the
  adverse conditions or events. The following are
  examples of mitigating factors
• Sale of assets
• Reduction or postponement of discretionary
  expenditures, such as expenditures for research
  and development
• Restructuring of existing debt
• Issuance of new debt
• Issuance of capital stock
• Reduce or eliminate dividends on common or
  preferred stock

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• If the auditor concludes that there is
  substantial doubt about the client's ability to
  continue as a going concern for a reasonable
  period of time and the mitigating factors are not
  sufficient to remedy the substantial doubt, the
  auditor should include an explanatory paragraph
  such as the following in the report.
• The accompanying financial statements have
  been prepared assuming that the X Company will
  continue as a going concern. As discussed in Note
  X to the financial statements, the X Company has
  suffered recurring losses from operations and has
  a net capital deficiency that raise substantial
  doubts about its ability to continue as a going
  concern. Management's plans in regard to these
  matters are also described in Note X. The
  financial statements do not include any
  adjustments that might result from the outcome of
  this uncertainty.
• The explanatory paragraph should follow the
  opinion paragraph

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There Has Been a Material Change Between Periods
in Accounting Principles or in Their Method of
Application

• The auditor's standard report implies that the
  auditor is satisfied that
• The comparability of financial statements between
  periods has not been materially affected by
  changes in accounting principles, and
• Such principles have been consistently applied
  between or among periods.

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• If (a) there has been a change in accounting
  principles or in the method of their application
  that has a material affect on the comparability
  of the client's financial statements and (b) if
  management has provided proper justification for
  the change, then the auditor would refer to the
  change in an explanatory paragraph in his or her
  report.
• The explanatory paragraph should follow the
  opinion paragraph.
• The explanatory paragraph should identify the
  nature of the change and refer the reader to the
  note in the financial statements that discusses
  the change in detail.
• The auditor's concurrence with the change is
  implicit unless he or she takes exception to the
  change in expressing his or her opinion as to
  fair presentation of the financial statements.
• The explanatory paragraph should be included in
  reports on the financial statements of subsequent
  years as long as the financial statements for the
  year of the change is presented on a comparative
  basis with the financial statements of subsequent
  years.
• The only exception to Part 4 above is when the
  change is accounted for by retroactive
  restatement of the financial statements affected.
  In this case, the explanatory paragraph is
  required only in the year of the change.

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• The following is an example of an appropriate
  explanatory paragraph due to a change in
  accounting principlesAs discussed in Note 14
  to the consolidated financial statements, in the
  first quarter of fiscal 2002, the Company changed
  its method of recognizing revenue for pharmacy
  automation equipment. In addition, as discussed
  in Note 1 to the consolidated financial
  statements, the Company changed its method of
  accounting for purchased goodwill and other
  intangible assets in accordance with Statement of
  Financial Standards ("Statement") No. 142 during
  the first quarter of fiscal 2002 .
• The explanatory paragraph should follow the
  opinion paragraph.

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• If management is not able to provide reasonable
  justification for the change, then the auditor
  would not follow the guidance above. Instead, the
  auditor would issue a short-form report that
  contains either a qualified opinion or an adverse
  opinion.

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Emphasis of a Matter

• In certain circumstances, an auditor may wish to
  add an explanatory paragraph to the audit report
  to emphasize a matter in the financial
  statements, but still express an unqualified
  opinion.
• For example, the auditor may wish to emphasize
  that
• The client is a component of a larger business
  enterprise.
• The client has had significant transactions with
  related parties.
• The financial statements disclose a highly
  material uncertainty.
• An unusually important subsequent event or an
  accounting matter affects the comparability of
  the financial statements with those of a
  preceding period.
• Phrases such as "with the foregoing explanation"
  should not be included in the opinion paragraph
  to refer to an explanatory paragraph that
  emphasizes a matter.

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Qualified, Adverse, and Disclaimer

• Qualified Opinion
• An auditor may express a qualified opinion on
  audited financial statements either because of a
  departure from GAAP (including inadequate
  disclosure) or because of a significant scope
  limitation.
• Key terminology is except for.
• Types of qualified opinions
• Material departure from GAAP or inadequate
  disclosure - States that, "except for the effects
  of the matter..." to which the qualification
  relates, the financial statements present fairly.
  
• Significant scope limitation - States that
  "except for the effects of such adjustments, if
  any, as might have been determined to be
  necessary had we been able to examine evidence
  regarding ..." to which the scope limitation
  relates, the financial statements present fairly.

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Qualified, Adverse, and Disclaimer

• Adverse Opinion
• States that the financial statements "do not
  present fairly, in conformity with accounting
  principles generally accepted in the United
  States of America, the financial position of X
  Company as of December 31, 19XX, or the results
  of its operations or its cash flows for the year
  then ended."
• Key terminology is do not present fairly.
• Results from the highly material affects of a
  departure from GAAP or inadequate disclosure.
  However, the omission of the statement of cash
  flows would result only in an "except for"
  qualified opinion.

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Qualified, Adverse, and Disclaimer

• Disclaimer of Opinion
• States that the auditor has not performed an
  audit that was "sufficient to enable us to
  express, and we do not express, an opinion on
  these financial statements."
• Key terminology is does not express an opinion.
• Results from a significant scope limitation or
  lack of independence relative to a publicly-held
  entity.

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