Auditors

1
Section 3

• Auditors Reports

2
Introduction

• Expressing and independent and expert opinion

• Third reporting standard
• The auditors report should contain either an
  expression of opinion on the financial statements
  or an assertion that an opinion cannot be
  expressed. In the latter case, the reasons
  therefor should be stated.

3
Financial Statements

• What is included in the financial statements?

• Notes to the Financial Statements
• Why needed?

4

• Type of information in the notes

1. Financial data
2. Accounting information
3. Other matters

5

• A list of common requirements

1. Significant accounting policies
2. Changes in accounting principles and practices
3. Subsequent events
4. Segmented information
5. Related party transactions

6
The Auditors Standard Report

• What does the standard report imply?

• Adopted in 1990 by the Auditing Standards Board
• Three paragraphs

7
AUDITORS REPORT To the Shareholders of XYZ
Industries Ltd. We have audited the balance sheet
of XYZ Industries LTD. as at December 31, 200X,
and the statements of income, retained earnings,
and cash flows for the year then ended. These
financial statements are the responsibility of
the companys management. Our responsibility is
to express an opinion on these financial
statements based on our audit. We conducted our
audit in accordance with generally accepted
auditing standards. Those standards require that
we plan and perform an audit to obtain reasonable
assurance 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. In our opinion, these financial
statements present fairly, in all material
respects, the financial position of the company
as at December 31, 200X, and the results of its
operations and cash flows for the year then ended
in accordance with generally accepted accounting
principles. Carney, Black and Heath,
LLP Chartered Accountants Toronto, Canada March
1, 200Y
8
Introductory Paragraph

• The first paragraph
• Indicates that

• 1.
• 2.
• 3.

9
Scope Paragraph

• The second paragraph
• Describes

• 1.
• 2.
• 3.

10
Opinion Paragraph

• The last paragraph
• Indicates what?

• What does present fairly mean?

11
Signing The Report

• In a partnership, not an individual

• A sole practitioner

12
Date of The Report

• What does this date represent?

• This date is significant

13
Unqualified Auditors Report Issuance

• When

• No material departure from GAAP
• Performed in accordance with GAAS

14
Expression of An Opinion

• A number of options

1. Unqualified opinion
2. Qualified opinion
3. Adverse opinion
4. Denial of opinion

15
Materiality

• CICA 5130

• A misstatement or the aggregate of all
  misstatements in financial statements is
  considered to be material if, in the light of
  surrounding circumstances, it is probable that
  the decision of a person who is relying on the
  financial statements, and who has a reasonable
  knowledge of business and economic activities,
  would be changed or influenced by such
  misstatement or the aggregate of all
  misstatements.

16
Why is materiality important?

• Material departure from GAAP

• Use material to describe

17
Fair Presentation, GAAP, and Professional Judgment

• The auditors professional judgment on the fair
  presentation of financial statements must be made
  within the framework of GAAP

• Thus the GAAP used

18
The Unqualified Report

• When does the auditor express an unqualified
  opinion?

• Additional wording can be added to the standard
  report

19
Statutory Requirements

• CICA 5701

• EG Consistency of application of GAAP

20
Emphasis of a Matter

• EG

• Separate paragraph after the opinion paragraph

21
Reservation

• Inability of the auditor to express an
  unqualified opinion?

• Reservation paragraph

22
Qualified Opinions

• Restricts the auditors responsibility for fair
  presentation in some area of the financial
  statements

• Reservation paragraph

23
Departure From GAAP

• Some specific circumstances

1. An inappropriate accounting treatment
2. An inappropriate valuation
3. A failure to disclose essential information or to
   present information in an appropriate manner

24
Scope Limitations

• Some specific circumstances

1. The timing of the auditors appointment and the
   audit work
2. The unavailability of accounting records
3. The inability to perform necessary audit
   procedures

25
A Departure From GAAP

• Qualified or an adverse opinion

• Depends on materiality

26
Why qualify?

• What usually happens?
• Introductory and scope paragraphs do not change

27
Misapplication of Accounting principles Note 9
to the financial statements describes the
depreciation policy with respect to the companys
manufacturing plants and equipment. The note also
indicates that the company is not depreciating
its head office building, which it acquired five
years ago, on the grounds that it is not a
producing asset and is maintaining its value as a
potential rental or resale property. In this
respect the financial statements are not in
accordance with generally accepted accounting
principles. The estimated useful life of similar
buildings is usually considered to be between 30
and 40 years. If depreciation had been provided
on the basis of an estimated life of, say, 35
years, depreciation for the current year would
have been increased by 200,000 (1999, 220,000),
net income after taxes would have decreased by
100,000 (1999, 110,000), accumulated
depreciation would have increased by 200,000
(1999, 220,000) and the closing balance of
retained earnings would have been reduced by
610,000 (1999, 510,000). In our opinion, except
for the effects of the failure to record
depreciation as described in the preceding
paragraph, these financial statements present
fairly, in all material respects, the financial
position of the company as at December 31, 2000,
and the results of its operations and cash flows
for the year then ended in accordance with
generally accepted accounting principles.
28
Inadequate Disclosures The accompanying
financial statements, in our opinion, do not draw
attention explicitly to doubts concerning the
companys ability to realize its assets and
discharge its liabilities in the normal course of
business. These doubts arise because it is
uncertain whether the company will be able to
refinance long-term debt in the amount of
10,000,000 due on March 26, 2001, in view of the
existence of recurring operating losses in the
past five years and the deficiency in working
capital of 2,000,000 at December 31, 2000. If
refinancing cannot be arranged, it is not known
whether the company can sell its hotel property
for an amount sufficient to realize its carrying
value of 9,000,000 and to generate adequate
funds to repay this debt. In our opinion, except
for the the omission of the disclosure described
in the preceding paragraph, these financial
statements present fairly, in all material
respects, the financial position of the company
as at December 31, 2000, and the results of its
operations and cash flows for the year then ended
in accordance with generally accepted accounting
principles.
29
Consistency of Accounting Principles

• A change in accounting principle

• Is a reservation for lack of consistency required?

30
Limitations on Scope of Examination

• Inability to perform necessary auditing procedures

• If the scope limitation is not so material

31
Scope Limitations Except as explained in the
following paragraph, we conducted our audit in
accordance with generally accepted auditing
standards. Those standards require that we plan
and perform an audit to obtain reasonable
assurance 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. Because we were appointed auditors
of the company during the current year, we were
not able to observe the counting of physical
inventories at the beginning of the year nor to
satisfy ourselves concerning those inventory
quantities by alternative means. Since opening
inventories enter into the determination of the
results of operations and cash flows, we were
unable to determine whether adjustments to cost
of sales, income taxes, net income for the year,
opening retained earnings, and cash provided from
operations might be necessary. In our opinion,
except for the effect of adjustments, if any,
which we might have determined to be necessary
had we been able to examine opening inventory
quantities, as described in the preceding
paragraph, the statement of income, retained
earnings and cash flow present fairly, in all
material respects, the results of operations, and
cash flows of the company for the year ended
December 31, 2000, in accordance with generally
accepted accounting principles. Further, in our
opinion, the balance sheet presents fairly, in
all material respects, the financial position of
the company as at December 31, 2000, in
accordance with generally accepted accounting
principles.
32
Reliance on Other Auditors

• Primary auditors, on occasion, must rely on the
  audit work of another accounting firm

• Common situation

33
To Justify Reliance

• Consider professional qualifications,
  competence,and integrity of the secondary auditor
• Communicate with the secondary auditor
• Read the report of the secondary auditor
• Obtain a written communication from the secondary
  auditor
• Review the work of the secondary auditor

34
Major Uncertainty Affecting a Clients Business

• Can be a wide range here

• CICA 5510

35
A Major Contingency

• Auditor must obtain sufficient appropriate audit
  evidence
• A reservation of opinion?

36
A Going Concern

• What conditions could precipitate this?
• Reservation of opinion?

37
Adverse Opinions

• The opposite of an unqualified opinion
• Disclosure required
• Standard introductory and scope paragraphs

38

• Adverse Opinion
• In the opinion paragraph

In our opinion, because of the effects of the
matters discussed in the preceding paragraph,
these these financial statements do not present
fairly the financial position of the company as
at December 31, 2000, and the results of its
operations and cash flows for the year then ended
in accordance with generally accepted accounting
principles.

• What would the preceding paragraph be?

39
Denial of Opinion

• No opinion
• When required
• Separate reservation paragraph

40
Denial of Opinion Except as explained in the
following paragraph, we conducted our audit in
accordance with generally accepted auditing
standards. Those standards require that we plan
and perform an audit to obtain reasonable
assurance 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 were not appointed auditor until
after December 31, 2000, and thus did not observe
the taking of physical inventories at the
beginning of the year or the end of the year and
were not able to satisfy ourselves concerning
inventory quantities by alternative means. Also,
our examination indicated serious deficiencies in
the accounting records and in internal control.
As a consequence, we were unable to satisfy
ourselves that all revenues and expenditures of
the company had been recorded, nor were we able
to satisfy ourselves that the recorded
transactions were proper. As a result, we were
unable to determine whether adjustments were
required in respect of recorded or unrecorded
assets, recorded or unrecorded liabilities, and
the components making up the statements of
income, retained earnings, and cash flow. In view
of the possible material effects on the financial
statements of the matters described in the
preceding paragraph, we are unable to express an
opinion whether these financial statements are
presented fairly in accordance with generally
accepted accounting principles.
41
Summary of Appropriate Auditors Reports
Type of Report
Materiality of the Issue
Not Material
Unqualified
Departure from GAAP
Scope limitation
Material
Qualified
Qualified
Very Material
Adverse
Denial
42
Comparative F/S in Audit Reports

• CICA has long supported presentation of
  comparative F/S
• When comparative statements are presented

43
Dating and Double Dating the Auditors Report

• Why is the date important?
• CICA 5405.06
• Substantial completion of examination

44

• Subsequent event and dating

• Two options
• Double dating
• Redating

45
Auditors Responsibility for Information in the
Annual Report

• Other information
• CICA 7500
• Accurately reproduced F/S and Audit Report
• Is any of this information inconsistent?

46

• Error in Reproduction

• Inconsistency resulting from an error

47
Reports to the SEC in the United States

• Two principal laws
• Securities Act of 1933
• Securities and Exchange Act of 1934
• Forms S-1 through S-18
• Form 8-K
• Form 10-Q
• Form 10-K

48

• Problem 1. Types of report. What types of report
  (unqualified, qualified, adverse, denial) should
  the auditors generally issue in each of the
  following situations?
• Client-imposed restrictions limit very
  significantly the scope of the auditors
  procedures.
• The auditors decide that it is necessary to make
  reference in their report of another public
  accounting firm (the secondary auditor).
• The auditors believe that the financial
  statements have been stated in conformity with
  generally accepted accounting principles in all
  respects other than a disclosure of a material
  uncertainty.

49

• Problem 2. Rowe Myers are the primary auditors
  of Dunbar Electronics. During the audit, Rowe
  Myers engaged Jones Abbot, an American public
  accounting firm, to audit Dunbars wholly owned
  U.S. subsidiary.
• Must Rowe Myers make reference to the other
  auditors in their audit report?
• Assume that Jones Abbot issued a qualified
  report on the U.S. subsidiary. Must Rowe Myers
  include the same qualification in their report on
  Dunbar electronics?

50

• Problem 3. While performing your audit of
  Williams Paper limited, you discover evidence
  that indicates that Williams may not have the
  ability to continue as a going concern.
• Discuss the types of information that may
  indicate a going-concern problem.
• Explain the auditors reporting obligation in
  such situations.

51
Problem 4 2-24. Roscoe, public accountant, has
completed the examination of the financial
statements of Excelsior Corporation as of and for
the year ended December 31, 1999. Roscoe also
examined and reported on the Excelsior financial
statements for the prior year. Roscoe drafted the
following report for 1999. We have audited the
balance sheet and statements of income and
retained earnings of Excelsior Corporation as of
December 31, 1999. We conducted our audit in
accordance with generally accepted accounting
standards. Those standards require that we plan
and perform the audit to obtain reasonable
assurance about whether the financial statements
are free of misstatement. We believe that our
audits provide a reasonable basis for our
opinion. In our opinion, the financial
statements referred to above present fairly the
financial position of Excelsior Corporation as of
December 31, 1999, and the results of its
operations for the year then ended in conformity
with generally accepted auditing standards,
applied on a basis consistent with those of the
preceding year. Other Information 1. Excelsior
is presenting comparative financial
statements. 2. Excelsior does not wish to
present a cash flow statement for either year.
52
3. During 1999, Excelsior changed its method of
accounting for long-term construction contracts,
properly reflected the effect of the change in
the current years financial statements, and
restated the prior years statements. Roscoe is
satisfied with Excelsiors justification for
making the change. The change is discussed in
footnote 12. 4. Roscoe was unable to perform
normal accounts receivable confirmation
procedures, but alternate procedures were used to
satisfy Roscoe as to the existence of the
receivables. 5. Excelsior Corporation is the
defendant in a lawsuit, the outcome of which is
highly uncertain. If the case is settled in
favour of the plaintiff, Excelsior will be
required to pay a substantial amount of cash
which might require the sale of certain capital
assets. The litigation and the possible effects
have been properly disclosed in footnote
11. 6. Excelsior issued debentures on January
31, 1997, in the amount of 10,000,000. The funds
obtained from the issuance were used to finance
the expansion of plant facilities. The debenture
agreement restricts the payment of future cash
dividends to earnings after December 31, 1998.
Excelsior declined to disclose this essential
data in the footnotes to the financial statements.
53

• Required
• Identify and explain any items included in Other
  Information that need not be part of the
  auditors report.
• Explain the deficiencies in Roscoes auditors
  report as drafted.

54

• Problem 5 2-25. For the following independent
  situations, assume you are the audit partner on
  the engagement.
• During your examination of Debold Brothers Ltd.,
  you conclude there is a possibility that
  inventory is materially overstated. The client
  refuses to allow you to expand the scope of your
  examination sufficiently to verify whether the
  balance is actually misstated.
• You are auditing Woodcolt Linen Services, Inc.,
  for the first time. Woodcolt has been in business
  for several years but has never had an audit
  before. After the audit is completed, you
  conclude that the current year balance sheet is
  stated correctly in accordance with GAAP. The
  client did not authorize you to do test work for
  any of the previous years.
• You were engaged to examine Cutter Steel Corp.s
  financial statements after the close of the
  corporations fiscal year. Because you were not
  engaged until after the balance sheet date, you
  were not able to physically observe inventory,
  which is very material. On the completion of your
  audit, you are satisfied that Cutters financial
  statements are presented fairly, including
  inventory about which you were able to satisfy
  yourself by the use of alternative audit
  procedures.

55

1. Four weeks after the year-end date, a major
   customer of Prince Construction Ltd. Declared
   bankruptcy. Because the customer had confirmed
   the balance due to Prince at the balance sheet
   date, management refuses to charge off the
   account or otherwise disclose the information.
   The receivable represents approximately 10
   percent of accounts receivable and 20 percent of
   net earnings before taxes.
2. You complete the audit of Johnson Department
   Store Ltd., and, in your opinion, the financial
   statements are fairly presented. On the last day
   of the examination, you discover that one of your
   supervisors assigned to the audit had a material
   investment in Johnson. If you decide no auditors
   report can be issued, explain your decision.
3. Auto Delivery Company Ltd. has a fleet of several
   trucks. In the past, Auto Delivery had followed
   the policy of purchasing all equipment. In the
   current year, they decided to lease the trucks.
   This change in policy is fully disclosed in the
   notes.

56
Problem 6 2-33. The following is an auditors
report, except for the opinion paragraph, of
Tri-Nation Corp. We have audited the
accompanying consolidated balance sheet of
Tri-Nation Corp. and subsidiaries as of July 31,
1999, and the related statements of income,
shareholders equity, and cash flow for the year
then ended. These financial statements are the
responsibility of management. Our responsibility
is to express an opinion on these financial
statements based on our audit. Except as
explained in the following paragraph, we
conducted our audit in accordance with generally
accepted auditing standards. Those standards
require that we plan and perform an audit to
obtain a 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. The company
had significant deficiencies in internal control,
including the lack of detailed records and
certain supporting data which were not available
for our examination. Therefore, we were not able
to obtain sufficient evidence in order to form an
opinion on the accompanying financial statements,
including whether the inventory at July 31, 1999,
(670,490) was stated at lower of cost or market,
or whether the deferred subscription revenue
(90,260) is an adequate estimate for the
applicable liability, as discussed in notes 5 and
12, respectively. Required Write the opinion
paragraph for this auditors report. State any
assumptions you have made.