Chapter 3.Full Version

3 - 1©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder

Audit ReportsAudit Reports

Chapter 3Chapter 3


Learning Objective 1Learning Objective 1

Describe the parts of the standardDescribe the parts of the standard

unqualified audit report.unqualified audit report.


Parts of the StandardParts of the StandardUnqualified Audit ReportUnqualified Audit Report

1. Report title1. Report title2. Audit report address2. Audit report address3. Introductory paragraph3. Introductory paragraph4. Scope paragraph4. Scope paragraph5. Opinion paragraph5. Opinion paragraph6. Name of CPA firm6. Name of CPA firm7. Audit report date7. Audit report date



Specify the conditions requiredSpecify the conditions required

to issue the standard unqualifiedto issue the standard unqualified

audit report.audit report.


Conditions for StandardConditions for StandardUnqualified Audit ReportUnqualified Audit Report

1. All financial statements are included.1. All financial statements are included.

2. The three general standards have been2. The three general standards have beenfollowed in all respects on the engagement.followed in all respects on the engagement.

3. Sufficient evidence has been accumulated3. Sufficient evidence has been accumulatedto conclude that the three standards ofto conclude that the three standards offield work have been met.field work have been met.


Conditions for StandardConditions for StandardUnqualified Audit ReportUnqualified Audit Report

4. The financial statements are presented in4. The financial statements are presented inaccordance with generally acceptedaccordance with generally acceptedaccounting principlesaccounting principles..

5. There are no circumstances requiring the5. There are no circumstances requiring theaddition of an explanatory paragraph oraddition of an explanatory paragraph ormodification of the wording of the report.modification of the wording of the report.


Four Categories of Audit ReportsFour Categories of Audit Reports

Standard unqualifiedStandard unqualified

QualifiedQualified

Unqualified withUnqualified withexplanatory paragraphexplanatory paragraph

or modified wordingor modified wording

Adverse or disclaimerAdverse or disclaimer



Understand combined reportingUnderstand combined reporting

on financial statements andon financial statements and

internal control over financialinternal control over financial

reporting under Section 404 ofreporting under Section 404 of

the Sarbanes-Oxley Act.the Sarbanes-Oxley Act.


Sarbanes-Oxley ActSarbanes-Oxley Act

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

PCAOB Auditing standard 2 requiresPCAOB Auditing standard 2 requiresthe audit of internal control to be integratedthe audit of internal control to be integratedwith the audit of the financial statements.with the audit of the financial statements.


Sarbanes-Oxley ActSarbanes-Oxley Act

Combined Report on Financial Statements andCombined Report on Financial Statements andInternal Control Over Financial ReportingInternal Control Over Financial Reporting

1. Introductory paragraph1. Introductory paragraph2. Scope paragraph 2. Scope paragraph 3. Definition paragraph3. Definition paragraph4. Inherent limitations paragraph4. Inherent limitations paragraph5. Opinion paragraph5. Opinion paragraph



Describe the five circumstancesDescribe the five circumstances

when an unqualified report withwhen an unqualified report with

an explanatory paragraph oran explanatory paragraph or

modified wording is appropriate.modified wording is appropriate.


Unqualified Report with Unqualified Report with Explanatory ParagraphExplanatory Paragraph

1. Lack of consistent application of generally1. Lack of consistent application of generallyaccepted accounting principlesaccepted accounting principles

2. Substantial doubt about going concern2. Substantial doubt about going concern3. Auditor agrees with a departure from3. Auditor agrees with a departure from

promulgated accounting principlespromulgated accounting principles4. Emphasis of a matter4. Emphasis of a matter5. Reports involving other auditors5. Reports involving other auditors


Consistency VersusConsistency VersusComparabilityComparability

Changes that affect consistency and requireChanges that affect consistency and requirean explanatory paragraph if they are material:an explanatory paragraph if they are material:

1. Changes in accounting principles1. Changes in accounting principles2. Changes in reporting entities2. Changes in reporting entities3. Corrections of errors involving principles3. Corrections of errors involving principles



Changes that affect comparability but notChanges that affect comparability but notconsistency:consistency:

1. Changes in an estimate1. Changes in an estimate2. Error corrections not involving principles2. Error corrections not involving principles3. Variations in format and presentation3. Variations in format and presentation

of financial informationof financial information4. Changes because of substantially4. Changes because of substantially

different transactions or eventsdifferent transactions or events



The Auditing Standards Board has issuedThe Auditing Standards Board has issueda proposal to the PCAOB to eliminatea proposal to the PCAOB to eliminatethe consistency explanatory paragraph.the consistency explanatory paragraph.


Substantial Doubt AboutSubstantial Doubt AboutGoing ConcernGoing Concern

1. Significant recurring operating losses1. Significant recurring operating lossesoror working capital deficienciesworking capital deficiencies

2. Inability of the company to pay its2. Inability of the company to pay itsobligations as they come dueobligations as they come due

3. Loss of major customers, the occurrence3. Loss of major customers, the occurrenceof uninsured catastrophesof uninsured catastrophes

4. Legal proceedings, legislation that might4. Legal proceedings, legislation that mightjeopardize the entity’s ability to operatejeopardize the entity’s ability to operate


Auditor Agrees with a DepartureAuditor Agrees with a Departurefrom a Promulgated Principlefrom a Promulgated Principle

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


Emphasis of a MatterEmphasis of a Matter

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


Reports Involving Other AuditorsReports Involving Other Auditors

1. Make no reference in the audit report.1. Make no reference in the audit report.

3. Qualify the opinion.3. Qualify the opinion.

2. Make reference in the report2. Make reference in the report (modified wording report).(modified wording report).



Identify the types of audit reportsIdentify the types of audit reports

that can be issued when anthat can be issued when an

unqualified opinion is not justified.unqualified opinion is not justified.


Departures from anDepartures from anUnqualified OpinionUnqualified Opinion

1. Scope limitation1. Scope limitation

2. GAAP departure2. GAAP departure

3. Auditor not independent3. Auditor not independent


Qualified OpinionQualified Opinion

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


Adverse OpinionAdverse Opinion

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


Disclaimer of OpinionDisclaimer of Opinion

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



Explain how materiality affectsExplain how materiality affects

audit reporting decisions.audit reporting decisions.


MaterialityMateriality

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


Levels of MaterialityLevels of Materiality

Amounts are immaterial.Amounts are immaterial.

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

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


Relationship of Materiality toRelationship of Materiality toType of OpinionType of Opinion

MaterialityMaterialityLevelLevel

Significance in Terms ofSignificance in Terms ofReasonable Users’ DecisionsReasonable Users’ Decisions

Type ofType ofOpinionOpinion

Users’ decisions are unlikelyUsers’ decisions are unlikelyto be affected.to be affected.ImmaterialImmaterial UnqualifiedUnqualified

Users’ decisions are likelyUsers’ decisions are likelyto be affected.to be affected.MaterialMaterial QualifiedQualified

Users’ decisions are likelyUsers’ decisions are likelyto be significantly affected.to be significantly affected.

HighlyHighlymaterialmaterial

DisclaimerDisclaimeror adverseor adverse


Materiality DecisionsMateriality Decisions

Failure toFailure tofollow GAAPfollow GAAP

Audit reportAudit report

UnqualifiedUnqualified QualifiedQualifiedopinion onlyopinion only AdverseAdverse



Dollar amount compared with a baseDollar amount compared with a base

MeasurabilityMeasurability

Nature of the itemNature of the item



ScopeScopelimitationlimitation

Audit reportAudit report

UnqualifiedUnqualified Qualified scopeQualified scopeand opinionand opinion DisclaimerDisclaimer



Draft appropriately modifiedDraft appropriately modified

audit reports under a varietyaudit reports under a variety

of circumstances.of circumstances.


Discussion of ConditionsDiscussion of ConditionsRequiring DepartureRequiring Departure

Auditor’s scope has been restricted.Auditor’s scope has been restricted.

Statements are not in conformity with GAAP.Statements are not in conformity with GAAP.

Auditor is not independent.Auditor is not independent.



Determine the appropriate auditDetermine the appropriate audit

report for a given audit situation.report for a given audit situation.


Auditor’s Decision ProcessAuditor’s Decision Process

Determine whether any condition existsDetermine whether any condition existsrequiring a departure from a standardrequiring a departure from a standardunqualified report.unqualified report.

Decide the materiality for each condition.Decide the materiality for each condition.

Decide the appropriate type of report.Decide the appropriate type of report.

Write the audit report.Write the audit report.


Scope Restricted by ClientScope Restricted by Clientor Other Conditionsor Other Conditions

ImmaterialImmaterial MaterialMaterial

Level of MaterialityLevel of Materiality

ExtremelyExtremelyMaterialMaterial

UnqualifiedUnqualifiedreportreport

Qualified scope, additionalQualified scope, additionalparagraph, and qualifiedparagraph, and qualified

opinion (except for)opinion (except for)

DisclaimerDisclaimerof opinionof opinion


Statements Not Prepared in Statements Not Prepared in Accordance With GAAPAccordance With GAAP




UnqualifiedUnqualifiedreportreport

Additional paragraphAdditional paragraphand qualified opinionand qualified opinion

(except for)(except for)

AdverseAdverseopinionopinion


The Auditor Is Not IndependentThe Auditor Is Not Independent




Disclaimer of opinionDisclaimer of opinion(regardless of materiality)(regardless of materiality)


Number of ParagraphsNumber of Paragraphsin the Reportin the Report

Standard unqualifiedStandard unqualified 33Unqualified with explanatory paragraphUnqualified with explanatory paragraph 44Unqualified shared report with other auditorsUnqualified shared report with other auditors 33Qualified – opinion onlyQualified – opinion only 44Qualified – scope and opinionQualified – scope and opinion 44Disclaimer – scope limitationDisclaimer – scope limitation 33AdverseAdverse 44

Type of ReportType of Report



Discuss the impact of e-commerceDiscuss the impact of e-commerce

on audit reporting.on audit reporting.


Impact of E-Commerce onImpact of E-Commerce onAudit ReportingAudit Reporting

Auditors are not required to read informationAuditors are not required to read informationcontained in electronic sites.contained in electronic sites.

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

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


End of Chapter 3End of Chapter 3

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