Audit Reports

Chapter 3

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3-1

Learning Objective 1
Describe the parts of the standard
unqualified audit report.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3-2

Parts of the Standard

Unqualified Audit Report
1. Report title
2. Audit report address
3. Introductory paragraph

4. Scope paragraph
5. Opinion paragraph
6. Name of CPA firm
7. Audit report date

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3-3

Parts of the Standard

Unqualified Audit Report

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3-4

Learning Objective 2
Specify the conditions required to issue the
standard unqualified audit report.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3-5

Conditions for Standard

Unqualified Audit Report
1. Includes all financial statements
2. Three general standards are met
3. Complies with the three standards of field work

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3-6

Conditions for Standard

Unqualified Audit Report
4. Financial statements comply with GAAP
5. No circumstances require an explanatory
paragraph or report modification

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3-7

Four Categories of Audit Reports

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3-8

Learning Objective 3
Understand reporting on financial
statements and internal control over
financial reporting under Section 404 of
the Sarbanes-Oxley Act.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3-9

Reporting on Internal Control

over Financial Reporting
Auditors of public companies subject to Section
404 of the Sarbanes-Oxley Act must
report on the effectiveness of internal
control over financial reporting.
PCAOB Auditing Standard 5 requires
the audit of internal control to be integrated
with the audit of the financial statements.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 10

Reporting on Internal Control

over Financial Reporting
SarbanesOxley
Sec.404

2010
Legislation

Accelerated Filer

Non-accelerated
Filer

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

ICFR
Effectiveness
Audits

Permanent
Exemption

3 - 11

Sarbanes-Oxley Act
Separate Report on Financial Statements and
Internal Control Over Financial Reporting
1. Introductory paragraph
2. Scope paragraph
3. Definition paragraph
4. Inherent limitations paragraph
5. Opinion paragraph
6. Cross-Reference Paragraph

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 12

Separate Report on ICFR

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 13

Learning Objective 4
Describe the five circumstances when an
unqualified report with an explanatory
paragraph or modified wording is
appropriate.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 14

Unqualified Report with

Explanatory Paragraph
1. Lack of consistent application of generally
accepted accounting principles
2. Substantial doubt about going concern
3. Auditor agrees with a departure from
promulgated accounting principles
4. Emphasis of a matter
5. Reports involving other auditors

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 15

Lack of Consistent Application of

GAAP
Auditors must note circumstances in which
accounting principles are not consistently
applied

Auditor should modify the report when a

material change occurs by adding an
explanatory paragraph in the report

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 16

Substantial Doubt About

Going Concern
Significant recurring operating
losses or working capital deficiencies.
Inability of the company to pay its
obligations as they come due.
Loss of major customers, the
occurrence of uninsured catastrophes.
Legal proceedings, legislation that
might jeopardize the entitys ability to operate.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 17

Auditor Agrees with a Departure

from a Promulgated Principle
Departure may not require a qualified or
adverse opinion

The auditor must separately explain in the

audit report that adhering to the principle
would have produced a misleading result.
Circumstances are most unusual
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 18

Emphasis of a Matter
Under certain circumstances, the CPA may
want to emphasize specific matters regarding
the financial statements, even though the
CPA intends to express an unqualified opinion.
Subsequent
Events

Related Party
Transactions

Financial
Statement
Comparability
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Material
Uncertainties
3 - 19

Reports Involving Other

Auditors
1. Make no reference in the audit report
2. Make reference in the report
(modified wording report)
3. Qualify the opinion

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 20

Reports Involving Other

Auditors

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 21

Learning Objective 5
Identify the types of audit reports that can
be issued when an unqualified opinion is
not justified.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 22

Departures from an
Unqualified Opinion
1. Scope limitation
2. GAAP departure

3. Auditor not independent

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 23

Qualified Opinion
A qualified opinion report can result from
a limitation on the scope of the audit or
failure to follow generally accepted
accounting principles.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 24

Qualified Opinion

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 25

Adverse Opinion
Auditor believes the financial statements are
not presented fairly in conformity with GAAP.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 26

Adverse Opinion

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 27

Disclaimer of Opinion
It is issued when the auditor is unable
to be satisfied that the overall financial
statements are fairly presented.

It can arise only from a lack of

knowledge by the auditor.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 28

Disclaimer of Opinion

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 29

Learning Objective 6
Explain how materiality affects audit
reporting decisions.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 30

Materiality
A misstatement in the financial statements
can be considered material if knowledge of
the misstatement would affect a decision
of a reasonable user of the statements.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 31

Levels of Materiality
Amounts are immaterial.
Amounts are material but do not overshadow
the financial statements as a whole.
Amounts are so material or so pervasive that
overall fairness of the statements is in question.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 32

Materiality Decisions
Failure to
follow GAAP
Audit report

Unqualified

Qualified
opinion only

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Adverse

3 - 33

Relationship of Materiality to
Type of Opinion
Materiality Significance in Terms of
Level
Reasonable Users Decisions

Type of
Opinion

Users decisions are unlikely

Immaterial to be affected.

Unqualified

Material

Users decisions are likely

to be affected.

Qualified

Highly
material

Users decisions are likely

to be significantly affected.

Disclaimer
or adverse

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 34

Materiality Decisions
Dollar amount compared with a base
Measurability
Nature of the item

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 35

Materiality Decisions
Scope
limitation
Audit report

Unqualified

Qualified scope
and opinion

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Disclaimer

3 - 36

Learning Objective 7
Draft appropriately modified audit reports
under a variety of circumstances.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 37

Discussion of Conditions
Requiring Departure
Auditors scope has been restricted
Statements are not in conformity with GAAP

Auditor is not independent

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 38

Learning Objective 8
Determine the appropriate audit report for a
given audit situation.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 39

Auditors Decision Process

Determine whether any condition exists
requiring a departure from a standard
unqualified report.

Decide
Materiality

Decide appropriate
type of report

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Write
Audit
Report

3 - 40

More Than One Condition Requiring

a Departure or Modification
The auditor is not independent.

There is a scope limitation.

Going concern uncertainty exists.

Statements are not prepared in

accordance with GAAP.
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 41

Number of Paragraphs
in the Report
Type of Report

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 42

Learning Objective 9
Understand proposed use of international
accounting and auditing standards by U.S.
companies.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 43

Proposed Use of International

Accounting and Auditing Standards
by U.S. companies
Globalization of worlds capital markets are
leading to calls for a single set of accounting
standards to be used around the world.

SEC
Developing
Workplan

If plan is approved?

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

2015
Implementation
of IFRS
into U.S.

3 - 44

End of Chapter 3

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

3 - 45