CHAPTER 18

AUDITORS REPORTS
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.
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.
Signature
Date
TYPES OF AUDITORS' AND
ACCOUNTANTS'
REPORTS ON FINANCIAL STATEMENTS
A. Auditors' Reports - Reports on audits of financial
statement(s) that purport to be in conformity with GAAP.
B. Special Reports
C. Reports on Application of Accounting Principles
D. Letters for Underwriters:
E. Review of Interim Financial Information
F. Compilation and Review of Financial Statements (AR 100-
600)
G. Prospective Financial Statements (AT 200)
H. Pro Forma Financial Statements (AT 300)
TYPES OF AUDITORS' AND
ACCOUNTANTS'
REPORTS ON FINANCIAL STATEMENTS
I. 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
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
EXPLANATORY LANGUAGE ADDED
TO THE AUDITOR'S REPORT
1. The auditor's opinion is based in part on the report of another
auditor.
2. To prevent the financial statements from being misleading due to
unusual circumstances, the financial statements contain a
departure from "promulgated" GAAP.
3. 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).
4. There is substantial doubt about the entity's ability to continue as
a going concern.
5. There has been a material change between periods in
accounting principles or their method of application.
6. 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.
EXPLANATORY LANGUAGE ADDED
TO THE AUDITOR'S REPORT
7. Certain circumstances relating to reports on comparative
financial statements exist.
8. Selected quarterly financial data required by SEC Regulation S-K
have been omitted or have not been reviewed.
9. 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.
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,".
Example of a Report Indicating
Division of Responsibility
Report of Independent Registered Public Accounting Firm

To the Board of Directors
of X Company
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.
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.
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.
Signature
City and State or Country)
Date
TO PREVENT THE FINANCIAL STATEMENTS
FROM BEING MISLEADING DUE TO UNUSUAL
CIRCUMSTANCES, THE FINANCIAL
STATEMENTS CONTAIN A DEPARTURE FROM
"PROMULGATED" GAAP
A. Management and the auditor must be able to
justify that, due to unusual circumstances,
adherence to "promulgated" GAAP would be
misleading.
B. Though the auditor's report contains a departure
from the standard report, the opinion expressed
by the auditor is an unqualified opinion.
TO PREVENT THE FINANCIAL STATEMENTS
FROM BEING MISLEADING DUE TO UNUSUAL
CIRCUMSTANCES, THE FINANCIAL
STATEMENTS CONTAIN A DEPARTURE FROM
"PROMULGATED" GAAP
C. The auditor's report should include, in a separate
explanatory paragraph, in which the auditor describes the
1. departure,
2. approximate effects, if practicable, and
3. reasons why compliance with promulgated GAAP would
be misleading.
D. The separate explanatory paragraph should precede the
opinion paragraph.
THERE IS SUBSTANTIAL DOUBT ABOUT
AN ENTITY'S ABILITY TO CONTINUE AS
A GOING CONCERN
A. The following are audit procedures that may identify a going
concern problem:
1. Analytical procedures.
2. Review of subsequent events.
3. Review of compliance with the terms of debt and loan
agreements.
4. Reading minutes of meetings of stockholders, board of
directors, and important committees of the board.
5. Inquiry of a client's legal counsel about litigation, claims,
and assessments.
6. Confirmation with related and third parties of the details
of arrangements to provide or maintain financial support.
B. 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
1. Negative trends such as operating losses,
working capital deficiencies, negative cash flows,
adverse key financial ratios
2. 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
3. Internal matters that have occurred such as work
stoppages
4. 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.
C. 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:
1. Sale of assets
2. Reduction or postponement of discretionary
expenditures, such as expenditures for research and
development
3. Restructuring of existing debt
4. Issuance of new debt
5. Issuance of capital stock
6. Reduce or eliminate dividends on common or
preferred stock
D. 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.
E. The explanatory paragraph should follow the opinion
paragraph
There Has Been a Material Change Between
Periods in Accounting Principles or in Their
Method of Application
A. The auditor's standard report implies that the
auditor is satisfied that:
1. The comparability of financial statements
between periods has not been materially
affected by changes in accounting principles,
and
2. Such principles have been consistently
applied between or among periods.
B. 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.
1. The explanatory paragraph should follow the opinion paragraph.
2. 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.
3. 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.
4. 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.
5. 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.
C. The following is an example of an appropriate
explanatory paragraph due to a change in accounting
principles:

As 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 .
D. The explanatory paragraph should follow the opinion
paragraph.
E. 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.
Emphasis of a Matter
A. 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.
B. For example, the auditor may wish to emphasize that:
1. The client is a component of a larger business enterprise.
2. The client has had significant transactions with related
parties.
3. The financial statements disclose a highly material
uncertainty.
4. An unusually important subsequent event or an accounting
matter affects the comparability of the financial statements
with those of a preceding period.
C. 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.
Qualified, Adverse, and Disclaimer
A. Qualified Opinion:
1. 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.
2. Key terminology is except for.
3. Types of qualified opinions:
a) 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.
b) 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.
Qualified, Adverse, and Disclaimer
B. Adverse Opinion:
1. 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."
2. Key terminology is do not present fairly.
3. 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.
Qualified, Adverse, and Disclaimer
C. Disclaimer of Opinion:
1. 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."
2. Key terminology is does not express an
opinion.
3. Results from a significant scope limitation or
lack of independence relative to a publicly-
held entity.