Chapter 17

Auditors’ Reports
Slides prepared
by
John Awakari

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
 Audit Report
 Providing an independent and expert
opinion on the fairness of financial
statements through an audit is the most
frequent attestation service
 An audit provides users of financial
statements reasonable assurance that the
statements are in conformity with GAAP

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 Fourth Standard of Reporting
 Fourth Standard of Reporting:
The auditor must either express an opinion regarding the financial statements,
taken as a whole, or state that an opinion cannot be expressed, in the auditor's
report. When the auditor cannot express an overall opinion, the auditor should
state the reasons therefore in the auditor's report. In all cases where an auditor's
name is associated with financial statements, the auditor should clearly indicate
the character of the auditor's work, if any, and the degree of responsibility the
auditor is taking, in the auditor's report.

 Thestandard report meets the fourth

standard by:
(1) stating that the audit was performed in conformity with generally
accepted auditing standards and
(2) expressing an opinion that the client’s financial statements are
presented fairly in conformity with generally accepted accounting
principles.

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 Types of Reports
Reports on the financial statements ordinarily
include:
 The financial statements themselves:
 Balance sheet
 Income statement
 Statement of cash flows
 Statement of retained earnings (equity)
 Financial Statement Disclosures
 The notes to the financial statements are considered an integral
part of the financial statements

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 Auditors’ Standard Report –
Nonpublic Clients
 Details
 Title includes word independent
 Addressed to person or audit committee who
retained the auditors
 Signed with name of CPA firm not individual
partner unless sole practitioner
 Dated last day of fieldwork or date on which
the auditors obtained sufficient appropriate
audit evidence to support their opinion

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The AICPA Standard Auditors’
Report--Introductory Paragraph

We have audited the accompanying balance

sheet of XYZ Company as of December 31,
20XX, and the related statements of income,
retained earnings, and cash flows for the year
then ended. 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 audit.

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 The AICPA Standard Auditors’
Report--Scope Paragraph

We conducted our audit in accordance with auditing

standards generally accepted in the United States of
America. Those standards require that we plan and perform
the 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 audit provides
a reasonable basis for our opinion.

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 The AICPA Standard Auditors’
Report--Opinion Paragraph

In our opinion, the financial statements

referred to above present fairly, in all material
respects, the financial position of XYZ
Company as of December 31, 20XX, and the
results of its operations and its cash flows for
the year then ended in conformity with
accounting principles generally accepted in
the United States of America.

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 Conditions Required for Issuance of
an Unqualified Report

 The financial statements are presented in

conformity with GAAP, including adequate
disclosure.

 The audit was performed in accordance with

GAAS, and there were no significant scope
limitations.

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 Auditors’ Standard Report –
Public Clients
 Differences from nonpublic
 Includes the words “Registered” and “Independent” in the title.
 References standards of the PCAOB (Public Company
Oversight Board) rather than generally accepted auditing
standards (GAAP)
 Includes the city and state—or city and country in the case of
non–U.S. auditors—where the auditors’ report has been issued.
(Historically, auditors have included this information, although it
was not required.)
 Includes an additional paragraph indicating that the auditors
have also issued a report on the client’s internal control over
financial reporting.
• The report on internal control may either be presented separately or
combined with the report on the financial statements into one overall
report
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 Types of Opinions
1. An unqualified opinion—standard report. This report expresses a “clean
opinion” and may be issued only when the two conditions listed in the
preceding section have been met, and when no conditions requiring
explanatory language exist.
2. An unqualified opinion—with explanatory language. In certain circumstances
explanatory language is added to the auditors’ report with no effect on the
auditors’ opinion.
3. A qualified opinion. A qualified opinion states that the financial statements
are presented fairly in conformity with generally accepted accounting
principles “except for” the effects of some matter.
4. An adverse opinion. An adverse opinion states that the financial statements
are not presented fairly in conformity with generally accepted accounting
principles.
5. A disclaimer of opinion. A disclaimer of opinion means that due to a
significant scope limitation, the auditors were unable to form an opinion or
did not form an opinion on the financial statements.

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Modifications of the Auditors’ Report-
-Unqualified Opinions
Type of Report Introductory or Explanatory Opinion
Scope paragraph Paragraph Paragraph

Shared Describe work of None "…based on our

responsibility other auditors audit and the
report of other
auditors"
Going concern None Describe None
uncertainty uncertainty
GAAP not None Describe change None
consistent in principle
Emphasis of a None Describe matter None
matter
Justified None Describe None
departure from departure
GAAP

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 Modifications of Auditors’ Report—
Qualified Opinions
Type of Introductory or Explanatory Opinion
Report Scope Paragraph Paragraph
Paragraph
Describe “except for the
Qualified— None departure and effects of the
GAAP effects departure the
Departure financial
statements…”

“Except as Describe “except for the

Qualified— explained in the scope effects of such
Scope following limitation adjustments, if any,
Limitation paragraph…” as might have been
determined to be
necessary had we
been able to…”

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 Modifications of Auditors’ Report—
Adverse Opinions and Disclaimers
Type of Report Introductory or Explanatory Opinion
Scope Paragraph Paragraph
Paragraph

Adverse None Describe reason for "The financial

opinion statements do not
present fairly"

Disclaimer of "We were engaged"; Describe scope "we do not express

Opinion--Scope Omit responsibility. restriction and any an opinion on the
Limitation Omit scope reservations financial
paragraph statements."

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Shared Responsibility Report
[Standard introductory paragraph language] We did not audit the
financial statements as and for the year ended December 31, 2001
of Glendo, Inc., which statements reflect total sales constituting
27 percent of total consolidated sales for 2001. Those statements
were audited by other auditors whose reports have been furnished
to us, and our opinion, insofar as it relates to data included for
Glendo, Inc. for 2001, is based solely on the report of the other
auditors.

[Standard scope paragraph language] We believe that our audits and

the reports of other auditors provide a reasonable basis for our
opinion.

In our opinion, based on our audits and the reports of other

auditors, …
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 Going concern
 SAS 59
 Auditor not required to perform procedures

specifically designed to test going-concern

assumption but must evaluate the assumption
 Conditions

• Negative cash flows from operations

• Defaults on loan agreements
• Adverse financial ratios
• Work stoppages
• Legal proceedings

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 Explanatory Paragraph--Going
Concern Problem
The accompanying financial statements have been prepared assuming that
[America West Airlines, Inc..] will continue as a going concern. As discussed
in note 1 to the financial statements, the Company filed a voluntary petition
seeking to reorganize under chapter 11 of the federal bankruptcy laws. This
event and circumstances relating to this event, including the Company’s
significant losses, accumulated deficit, and highly leveraged capital structure,
raise substantial doubt about its ability to continue as a going concern.
Although the Company is currently operating as debtor-in-possession under
the jurisdiction of the Bankruptcy Court, the continuation of the business as a
going concern is contingent upon, among other things, the ability to (1)
formulate a Plan of Reorganization which will gain approval of the creditors
and stockholders and confirmation of the Bankruptcy Court, (2) maintain
compliance with all debt covenants under the debtor-in-possession financing
agreements, (3) achieve satisfactory levels of future operating results and
cash flows, and (4) obtain additional debt and equity. The accompanying
financial statements do not include and adjustments that might result from the
outcome of these uncertainties.

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 Explanatory Paragraphs--
Consistency
As discussed in the Notes to the consolidated financial statements,
effective January 1, 20X1, the Company changed its method for
accounting for derivative financial instruments to conform with SFAS
No. 133, Accounting for Derivative Instruments
and Hedging Activities.
____________________________________

As discussed in Note 15, effective January 1, 20X2, the Company

changed its method of accounting for goodwill and intangible assets
upon adoption of Statement of Financial Accounting Standards (SFAS)
No. 142, “Goodwill and Other Intangible Assets.”

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 Qualified Opinion
 Departure from GAAP
 Immaterial – unqualified

 Material – qualified or adverse (if overall financial

statements considered misleading)

 Consider effects of departure(s):
 Dollar magnitude of effects

 Significance of item to particular client

 Number of financial statement accounts and

disclosures affected
 Effect on financial statements taken as a whole

 Consider inadequate disclosures

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 Example of a Qualified Report--
Departure from GAAP

(Introductory and Scope Paragraphs are Standard)

The Company has excluded from property and debt in the accompanying
balance sheet certain lease obligations that, in our opinion, should be
capitalized in order to conform with generally accepted accounting
principles. If these lease obligations were capitalized, property would be
increased by $__________, long-term debt by $___________, and
retained earnings by $__________ as of December 31, 20X1, and net
income and earnings per share would be increased (decreased) by
$___________ and $_____, respectively, for the year then ended.

In our opinion, except for the effects of not capitalizing lease

obligations, as discussed in the preceding paragraph, the financial
statements referred to above present fairly, in all material respects, the
financial position of XYZ Company as of December 31, 20X1, and the
results of its operations and cash flows for the year then ended in
conformity with accounting principles generally accepted in the United
States of America.

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 Qualified Opinion
 Scope limitations
 Auditor unable to perform an essential audit
procedure
 Imposed by circumstances
• Engaged too late in year to observe client’s
beginning inventory
 Imposed by client
• Client refused to allow auditors to send
confirmations to customers

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 Example of a Qualified Report--
Scope Limitation

Standard Introductory Paragraph

Except as discussed in the following paragraph, we conducted our

audit...

We were unable to obtain audited financial statements supporting the

Company’s investment in a foreign affiliate stated at $_______, or its
equity in earnings of that affiliate of $_______, which is included in net
income, as described in Note 8 to the financial statements; nor were we
able to satisfy ourselves as to the carrying value of the investment in the
foreign affiliate or the equity in earnings by other auditing procedures.

In our opinion, 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 the foreign affiliate investment and
earnings, the financial statements referred to above present fairly,...

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 Adverse
 Financial statements do not present fairly
the financial position, results of operations,
and cash flows of client in conformity with
GAAP
 Very material departures from GAAP
 Auditor believes departure causes
financial statements taken as a whole to
be misleading

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 Adverse Opinion

In our opinion, because of the effects of the

matters discussed in the preceding
paragraph, the financial statements referred
to above do not present fairly, in conformity
with accounting principles generally accepted in
the United States of America, the financial
position of XYZ Company as of December 31,
20X5, or the results of its operations or its cash
flows for the year then ended.

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 Disclaimer of Opinion
 Auditor has no opinion
 Issued whenever unable to form an
opinion as to fairness of financial
statements
 Circumstances resulting in a disclaimer:
 Substantial circumstance-imposed scope
restrictions
 Scope restrictions imposed by the client
 Uncertainties
 Not an alternative to adverse opinion
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Disclaimer of Opinion
We were engaged...

The Company did not make a count of its physical

inventory, stated in the accompanying financial
statements at $_____ as of December 31, 20X2.
Further, evidence supporting the cost of property and
equipment acquired prior to December 31, 20X1, is no
longer available. The Company’s records do not permit
the application of other auditing procedures to
inventories or property and equipment.

Since the Company did not take physical inventories

and we were not able to apply other auditing
procedures to satisfy ourselves as to inventory
quantities and the cost of property and equipment, the
scope of our work was not sufficient to enable us to
express, and we do not express, an opinion on these
financial statements.

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Placement of Explanatory Paragraphs

 Before opinion paragraph

 Qualified opinions
 Disclaimers
 Adverse opinions
 Following opinion paragraph
 Consistency
 Substantial doubt about continued existence
 Other types of paragraphs may precede or
follow the opinion paragraph

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17-28
 Two or More Report Modifications

 Qualified by two or more

 Examples: Qualified because of both a scope
limitation and separate departure from GAAP
 Wording of report would include appropriate
qualifying language and explanatory paragraphs
for both types of qualifications
 Auditor should consider cumulative effects –
disclaimer of opinion may be appropriate

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Different Opinions on Different Statements

 Fourth standard: Auditor shall express an

opinion on the financial statements “taken as a
whole”
 Can apply to individual financial statements
 It is acceptable to express an unqualified opinion on
one statement while expressing a qualified or adverse
on the others
 Example: Auditors retained after client has taken its
beginning inventory. A disclaimer may be issue don
the income statement (the auditor doesn't know if
income is reasonably stated, but an unqualified
opinion on the year-end balance sheet.

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 Reporting on Comparative
Financial Statements
 Report should cover current year as well as prior period
audited by their firm.
 Can express different opinions on different years
 Auditor should update report for all prior periods
presented for comparison
 If prior period audited by another (predecessor) CPA firm
 Current year opinion only covers years the CPA firm audited
 For financial statements audited by predecessor auditors either:
• Predecessor auditor reissues report with original date or
• Current auditors refer to report of other auditors

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