Section 3

1. Section 3 Auditors’ Reports

2. Introduction • Third reporting standard: • The auditors’ report should contain either an expression of opinion on the financial statements or an assertion that an opinion cannot be expressed. In the latter case, the reasons therefor should be stated. • Expressing and independent and expert opinion

3. Financial Statements • Notes to the Financial Statements • Why needed? • What is included in the financial statements?

4. Type of information in the notes • Financial data • Accounting information • Other matters

5. A list of common requirements • Significant accounting policies • Changes in accounting principles and practices • Subsequent events • Segmented information • Related party transactions

6. The Auditors’ Standard Report • Adopted in 1990 by the Auditing Standards Board • Three paragraphs • What does the standard report imply?

7. AUDITORS’ REPORT To the Shareholders of XYZ Industries Ltd. We have audited the balance sheet of XYZ Industries LTD. as at December 31, 200X, and the 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. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance 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. In our opinion, these financial statements present fairly, in all material respects, the financial position of the company as at December 31, 200X, and the results of its operations and cash flows for the year then ended in accordance with generally accepted accounting principles. Carney, Black and Heath, LLP Chartered Accountants Toronto, Canada March 1, 200Y

8. Introductory Paragraph 1. 2. 3. • The first paragraph • Indicates that:

9. Scope Paragraph 1. 2. 3. • The second paragraph • Describes:

10. Opinion Paragraph • What does present fairly mean? • The last paragraph • Indicates what?

11. Signing The Report • A sole practitioner • In a partnership, not an individual

12. Date of The Report • This date is significant • What does this date represent?

13. Unqualified Auditors Report Issuance • No material departure from GAAP • Performed in accordance with GAAS • When:

14. Expression of An Opinion • Unqualified opinion: • Qualified opinion • Adverse opinion • Denial of opinion • A number of options:

15. Materiality • A misstatement or the aggregate of all misstatements in financial statements is considered to be material if, in the light of surrounding circumstances, it is probable that the decision of a person who is relying on the financial statements, and who has a reasonable knowledge of business and economic activities, would be changed or influenced by such misstatement or the aggregate of all misstatements. • CICA 5130:

16. Why is materiality important? • Use material to describe • Material departure from GAAP

17. Fair Presentation, GAAP, and Professional Judgment • Thus the GAAP used • The auditors’ professional judgment on the fair presentation of financial statements must be made within the framework of GAAP

18. The Unqualified Report • Additional wording can be added to the standard report • When does the auditor express an unqualified opinion?

19. Statutory Requirements • EG: Consistency of application of GAAP • CICA 5701

20. Emphasis of a Matter • Separate paragraph after the opinion paragraph • EG:

21. Reservation • Reservation paragraph • Inability of the auditor to express an unqualified opinion?

22. Qualified Opinions • Reservation paragraph • Restricts the auditors’ responsibility for fair presentation in some area of the financial statements

23. Departure From GAAP • Some specific circumstances • An inappropriate accounting treatment • An inappropriate valuation • A failure to disclose essential information or to present information in an appropriate manner

24. Scope Limitations • Some specific circumstances • The timing of the auditors’ appointment and the audit work • The unavailability of accounting records • The inability to perform necessary audit procedures

25. A Departure From GAAP • Depends on materiality • Qualified or an adverse opinion

26. Why qualify? • What usually happens? • Introductory and scope paragraphs do not change

27. Misapplication of Accounting principles: Note 9 to the financial statements describes the depreciation policy with respect to the company’s manufacturing plants and equipment. The note also indicates that the company is not depreciating its head office building, which it acquired five years ago, on the grounds that it is not a producing asset and is maintaining its value as a potential rental or resale property. In this respect the financial statements are not in accordance with generally accepted accounting principles. The estimated useful life of similar buildings is usually considered to be between 30 and 40 years. If depreciation had been provided on the basis of an estimated life of, say, 35 years, depreciation for the current year would have been increased by $200,000 (1999, $220,000), net income after taxes would have decreased by $100,000 (1999, $110,000), accumulated depreciation would have increased by $200,000 (1999, $220,000) and the closing balance of retained earnings would have been reduced by $610,000 (1999, $510,000). In our opinion, except for the effects of the failure to record depreciation as described in the preceding paragraph, these financial statements present fairly, in all material respects, the financial position of the company as at December 31, 2000, and the results of its operations and cash flows for the year then ended in accordance with generally accepted accounting principles.

28. Inadequate Disclosures: The accompanying financial statements, in our opinion, do not draw attention explicitly to doubts concerning the company’s ability to realize its assets and discharge its liabilities in the normal course of business. These doubts arise because it is uncertain whether the company will be able to refinance long-term debt in the amount of $10,000,000 due on March 26, 2001, in view of the existence of recurring operating losses in the past five years and the deficiency in working capital of $2,000,000 at December 31, 2000. If refinancing cannot be arranged, it is not known whether the company can sell its hotel property for an amount sufficient to realize its carrying value of $9,000,000 and to generate adequate funds to repay this debt. In our opinion, except for the the omission of the disclosure described in the preceding paragraph, these financial statements present fairly, in all material respects, the financial position of the company as at December 31, 2000, and the results of its operations and cash flows for the year then ended in accordance with generally accepted accounting principles.

29. Consistency of Accounting Principles • Is a reservation for lack of consistency required? • A change in accounting principle

30. Limitations on Scope of Examination • If the scope limitation is not so material • Inability to perform necessary auditing procedures

31. Scope Limitations: Except as explained in the following paragraph, we conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance 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. Because we were appointed auditors of the company during the current year, we were not able to observe the counting of physical inventories at the beginning of the year nor to satisfy ourselves concerning those inventory quantities by alternative means. Since opening inventories enter into the determination of the results of operations and cash flows, we were unable to determine whether adjustments to cost of sales, income taxes, net income for the year, opening retained earnings, and cash provided from operations might be necessary. In our opinion, except for the effect of adjustments, if any, which we might have determined to be necessary had we been able to examine opening inventory quantities, as described in the preceding paragraph, the statement of income, retained earnings and cash flow present fairly, in all material respects, the results of operations, and cash flows of the company for the year ended December 31, 2000, in accordance with generally accepted accounting principles. Further, in our opinion, the balance sheet presents fairly, in all material respects, the financial position of the company as at December 31, 2000, in accordance with generally accepted accounting principles.

32. Reliance on Other Auditors • Common situation • Primary auditors, on occasion, must rely on the audit work of another accounting firm

33. To Justify Reliance • Consider professional qualifications, competence,and integrity of the secondary auditor • Communicate with the secondary auditor • Read the report of the secondary auditor • Obtain a written communication from the secondary auditor • Review the work of the secondary auditor

34. Major Uncertainty Affecting a Client’s Business • CICA 5510: • Can be a wide range here

35. A Major Contingency • Auditor must obtain sufficient appropriate audit evidence • A reservation of opinion?

36. A Going Concern • What conditions could precipitate this? • Reservation of opinion?

37. Adverse Opinions • The opposite of an unqualified opinion • Disclosure required • Standard introductory and scope paragraphs

38. Adverse Opinion: • In the opinion paragraph: In our opinion, because of the effects of the matters discussed in the preceding paragraph, these these financial statements do not present fairly the financial position of the company as at December 31, 2000, and the results of its operations and cash flows for the year then ended in accordance with generally accepted accounting principles. • What would the “preceding paragraph” be?

39. Denial of Opinion • No opinion • When required • Separate reservation paragraph

40. Denial of Opinion: Except as explained in the following paragraph, we conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance 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 were not appointed auditor until after December 31, 2000, and thus did not observe the taking of physical inventories at the beginning of the year or the end of the year and were not able to satisfy ourselves concerning inventory quantities by alternative means. Also, our examination indicated serious deficiencies in the accounting records and in internal control. As a consequence, we were unable to satisfy ourselves that all revenues and expenditures of the company had been recorded, nor were we able to satisfy ourselves that the recorded transactions were proper. As a result, we were unable to determine whether adjustments were required in respect of recorded or unrecorded assets, recorded or unrecorded liabilities, and the components making up the statements of income, retained earnings, and cash flow. In view of the possible material effects on the financial statements of the matters described in the preceding paragraph, we are unable to express an opinion whether these financial statements are presented fairly in accordance with generally accepted accounting principles.

41. Summary of Appropriate Auditors’ Reports Materiality of the Issue Type of Report Not Material Departure from GAAP Unqualified Scope limitation Material Qualified Qualified Very Material Adverse Denial

42. Comparative F/S in Audit Reports • CICA has long supported presentation of comparative F/S • When comparative statements are presented

43. Dating and Double Dating the Auditors’ Report • Why is the date important? • CICA 5405.06 • Substantial completion of examination

44. Subsequent event and dating • Two options • Double dating • Redating

45. Auditors’ Responsibility for Information in the Annual Report • Other information • CICA 7500 • Accurately reproduced F/S and Audit Report • Is any of this information inconsistent?

46. Error in Reproduction • Inconsistency resulting from an error

47. Reports to the SEC in the United States • Two principal laws • Securities Act of 1933 • Securities and Exchange Act of 1934 • Forms S-1 through S-18 • Form 8-K • Form 10-Q • Form 10-K

48. Problem 1.Types of report. What types of report (unqualified, qualified, adverse, denial) should the auditors generally issue in each of the following situations? • Client-imposed restrictions limit very significantly the scope of the auditor’s procedures. • The auditors decide that it is necessary to make reference in their report of another public accounting firm (the secondary auditor). • The auditors believe that the financial statements have been stated in conformity with generally accepted accounting principles in all respects other than a disclosure of a material uncertainty.

49. Problem 2. Rowe & Myers are the primary auditors of Dunbar Electronics. During the audit, Rowe & Myers engaged Jones & Abbot, an American public accounting firm, to audit Dunbar’s wholly owned U.S. subsidiary. • Must Rowe & Myers make reference to the other auditors in their audit report? • Assume that Jones & Abbot issued a qualified report on the U.S. subsidiary. Must Rowe & Myers include the same qualification in their report on Dunbar electronics?

50. Problem 3. While performing your audit of Williams Paper limited, you discover evidence that indicates that Williams may not have the ability to continue as a going concern. • Discuss the types of information that may indicate a going-concern problem. • Explain the auditors’ reporting obligation in such situations.