AUDITING: A RISK

ANALYSIS APPROACH

5th edition

Larry F. Konrath

Electronic Presentation
by Harold
O. Wilson
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Chapter 14

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 KEY CONCEPTS OVERVIEW

 The Audit Report contents

 Auditor responsibility
 Nature of the examination
 Auditor’s Findings
 The Standard Audit Report (and related
conditions)
 Departures from the standard report
 Explanatory paragraphs; other topics
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 Learning Objectives

 Describe the standard audit report,

conditions of its issuance
 Describe non-standard reporting, e.g.,
disclaimer of an opinion
 Understand using explanatory paragraphs
 Define material scope limitations
 Identify departures from GAAP
 Define continuing auditor, “updating”
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Levels of Attestation in Pubic
Accounting

 INDEPENDENT AUDITS.
 REVIEW ENGAGEMENTS.
 COMPILATIONS of financial
statements.

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 NATURE OF THE
AUDIT REPORT
• Basic objective: Auditor’s expression of
an overall opinion on the financial
statements taken as a whole.
• Client’s written assertions identified—
after adjustments and footnotes suggested
or accepted by the auditor.
• The standard audit report has a title, an
addressee, three informative paragraphs,
and a signature & date.
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 Components of the
Audit Report

 Title—includes the word “independent,”

unless independence is lacking.
 Addressee—the party paying for the audit
and/or whoever appointed the auditing firm.
 Signature & Date—original is manually
signed and is dated the last day of field
work.

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 Components of the
Audit Report
Introductory paragraph—contrasts
management’s role vs. the auditor’s
role, must identify the financial
statements (client assertions)
subjected to audit, and auditor
states assurance that due
professional care was exercised.
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 Components of the
Audit Report
Scope paragraph—describes the nature
of the examination (audit work)
and states specifically that GAAS
was followed to provide a basis for
reasonable assurance that the
financial statements are free of
material misstatement; scope
limitations stated.
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 Components of the
Audit Report

Opinion paragraph—contains the

auditor’s findings relative to an an
expression of an opinion, if any,
concerning the fairness of the
financial statements, taken as a whole,
and their conformity with GAAP on a
consistent basis.
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 FAQ?
What is so significant to the auditor
about the “last date of field work?”
It represent the time limit on
responsibility for location the
potential impacts of subsequent
events upon the auditor’s report,
and in some cases, “dual-dated”
audit reports.
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 FAQ?

What is the impact of significant financial

events occurring AFTER the last day of field
work, but BEFORE the report is released?
 Footnote disclosure, properly referenced in
the report as a “subsequent event” AND/OR
 “Dual dating” with the later date applying
only to the subsequent (newly audited) item.
RARE!
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KINDS OF AUDIT REPORTS

 Unqualified Opinion
 Qualified Opinion
 Adverse Opinion
 Disclaimer of Opinion
There are special situations where an auditor
may be involved in a “divided responsibility” report
with another auditing firm.
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 UNQUALIFIED OPINION
(broadly defined)
In an attestation report, an
“unqualified” opinion means
the attestor’s opinion is that the client’s
written assertions are presented fairly in all
material respects in conformity with some
established criteria, without any qualifiers.

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 UNQUALIFIED OPINION
(independent auditing)
In an auditor’s report, an
“unqualified” opinion means
the auditor’s opinion is that the client’s
financial statements, taken as a
whole, are presented fairly in all
material respects in conformity with
GAAP consistently applied, without
any qualifiers.
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 FAQ?
Does “unqualified” mean some lack of
qualifications, OR does it mean “no
reservations or exceptions”?
 The latter! There are no exceptions
to the opinion being expressed!
 Comments may refer to other experts
involved, an emphasis, subsequent
events, or the date of the report, but these are
NOT NECESSARILY “qualifications.”
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 SOURCES OF GAAP

 Pronouncements by authoritative bodies

(FASB, APB, GASB, AICPA)
 Other authoritative literature (including
publications of the above bodies, various
international accounting standards, and
promulgations of professional associations
and/or regulator agencies, as applicable)
 Respected textbooks, handbooks & articles.

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 Auditor must believe there is…

 General acceptance of the principle(*)

 Applicability in the circumstances
 Proper disclosure
 Valid economic substance
 Acceptable levels of audit risks
 No misleading aspects of the audit
(*) is not identical to general usage.
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 Knowledge of departures from
GAAP means auditors…
 May render a “qualified” opinion if there is
a material distortion of facts, OR
 May not qualify the opinion IF the usual
compliance with GAAP would create a
misleading financial statement.

The burden of proof is upon the

auditor in the latter case!
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 EXPLANATORY PARAGRAPHS
& FOOTNOTES
 Departures from GAAP, material
restrictions on scope, or material
uncertainties are explained between
the scope and the opinion paragraphs.
 Overcoming scope restrictions by “other
means” allows an unqualified opinion;
otherwise, the auditor may render a
qualified or an adverse opinion, depending
on materiality and circumstances..
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 Scope Restrictions &
Disclaimer of Opinion
 Client-imposed scope restrictions
 Auditor prohibited from gathering sufficient,
competent evidential matter
 Example: Disallowed confirmation procedures.
 Non-client-imposed scope restrictions
 Circumstantial situations
 Examples: Auditor engaged after FYE
inventory; pending material lawsuits.

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 Qualified Opinions;
Adverse Opinions
 “Except for…,” or “Subject to…,” are
phrases used for specific items or
uncertainties—QUALIFIERS!
 “…do not present fairly…” is the
ADVERSE OPINION phrase, if financial
statements are misleading, inadequate or
contain material misstatements.

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 Disclaimer of Opinion
(when no opinion is formed)
 Major uncertainties precludes an opinion.
 Non-audit engagements, i.e., compilations.
 Lack of independence—must be expressed.
 Impractical or impossible to comply with
audit programs; but, consider practicality of
a compilation or review engagement.

The latter requires independence.

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 FAQ?

Are there degrees of “lack of independence?”

Could an accountant be so involved with a
company or its personnel, that even performing
a compilation would render the work suspect
and/or ineffective?
The AICPA Audit Alerts say “Yes!”
Comments?
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 A MAJOR DANGER ZONE IN
Explanatory Paragraphs

Uncertainties of the “Twilight Zone:”

In rare cases, the “going concern”
assumption comes under question. If the
auditor develops serious doubt about an
entity’s survival skills, the audit report
must include such reservations. This
quasi-qualification by CPAs can
become a self-fulfilling prophecy.
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Adherence to GAAP does
not assure successes. Here,
the key consideration is the
ability to meet obligations
as they come due—over the
next year or so(?)

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 More concerns…just CPA,
not wizards…
 The “going concern” evaluation by the auditor
may be “softened” by statements about
management’s specific plans to survive.
 Clues are negative trends, defaults on loans,
cash flow problems, legal problems, pending
debt restructurings, major asset disposals,
inconsistencies, etc.
• Inconsistencies usually follow changes in GAAP
or in applications of GAAP. Explain the
reasons and the specific impacts!
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 A PROBLEM ZONE IN
Explanatory Paragraphs

In rare cases, a Principal

Auditor may use another
firm, a Correspondent CPA
firm, to audit a portion (e.g., subsidiary or the
inventory) of a distant client location, etc.;
the former decides whether to take full or
“divided” responsibility.
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 Other salient points…

 Using a Correspondent CPA does not call for a

Qualified Opinion report.
 An explanatory paragraph may be included for
emphasis, or clarity (e.g, change in accounting
principles. Danger: unintended overemphasis.
 A Disclaimer may not be substituted in lieu of an
Adverse Opinion is such is formed.

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 FAQ?

What is the impact of a nonstandard

audit report, e.g., affect on the market?
There is the potential for SEC reactions
(e.g., suspending trading of the stock),
investor lawsuits, credit sources being
limited, and adverse effects on the CPA
firm.
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 OTHER COMPREHENSIVE
BASIS OF ACCOUNTING
 OCBOA (non-GAAP and/or non-accrual
accounting) must be explained by
auditor, as The Criteria.
 Regulatory bodies (e.g., FCC), tax basis
accounting (e.g., IRS), Cash basis, and
many special reports.
 Common terms not used: Balance Sheet,
Income Statement, Statement of
Retained Earnings, but “fairly” is!
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 OTHER AUDIT REPORT
TOPICS
 A “continuing auditor” (several prior
consecutive periods) might “update” a
prior audit report (e.g., to correct a
departure from GAAP, to report a
resolution of a prior uncertainty or
qualification).
 Prior auditors’ work may or may not be
included currently (special rules).
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 OTHER AUDIT REPORT
TOPICS
 Discovery of relevant, material, new facts or
omitted procedures, AFTER releasing
the audit report. What to do?
 Inform the client, who informs regulatory
bodies promptly.
 Consider responsibility to third parties, and
recalling & reissuing the reports.
 Call the CPA firm’s attorney!
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 OTHER AUDIT REPORT
TOPICS
 Management’s discussion and analysis
(MD&A)—A supplemental letter to
stockholders.
 Explains and/or elaborates on the financial
situation and the audit report.
 The MD&A is not part of the audit, but
should be read for inconsistencies, etc.
 Other supplemental information may be
audited, then included in the report.
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 CRITICAL KEY TERMS

 Going concern  Explanatory paragraph

 Scope restrictions  MD&A
 OCBOA  Opinion paragraph
 Continuing auditor  Presents fairly
 Departure from GAAP  Predecessor auditor
 Disclaimers  Qualified opinion
 Dual-dated reports  Standard audit report
 Divided responsibility  Supplemental data

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End of Chapter 14

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