Reporting Addendum & Problems

1. Reporting Addendum & Problems

2. Non-Audit Engagements • Review services and compilation engagements • What types of companies?

3. Review standards • Adequate planning and proper execution • Possess or acquire sufficient knowledge of the business • Plausibility

4. REVIEW ENGAGEMENT REPORT To [person engaging the public accountant]: We have reviewed the balance sheet of XYZ Limited as at ……………200X, and the statements of income retained earnings, and cash flows for the year then ended. Our review was made in accordance with generally accepted standards for review engagements and accordingly consisted of enquiry, analytical procedures and discussion related to information supplied to us by the company. A review does not constitute an audit, and consequently, we do not express an audit opinion on these financial statements. Nothing has come to our attention as a result of our review that causes us to believe that these financial statements are not, in all material respects, in accordance with generally accepted accounting principles. Carney, Black and Heath, LLP Chartered Accountants Toronto, Canada Date

5. Compilation services. • A compilation involves • The purpose • Not intended to provide any assurance

6. NOTICE TO READER To [person engaging the public accountant] We have compiled the balance sheet of Client Limited as at December 31, 200X, and the statements of income, retained earnings, and cash flows for the [period] then ended from information provided by management (the proprietor). We have not audited, reviewed or otherwise attempted to verify the accuracy or completeness of such information. Readers are cautioned that these statements may not be appropriate for their purposes. Carney, Black and Heath, LLP Chartered Accountants Toronto, Canada Date • Lack of Independence • I am not independent of X Limited because my spouse owns 25 percent of the shares of the company.

7. 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.

8. 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?

9. 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.

10. Problem 2-22. Roscoe, public accountant, has completed the examination of the financial statements of Excelsior Corporation as of and for the year ended December 31, 2001. Roscoe also examined and reported on the Excelsior financial statements for the prior year. Roscoe drafted the following report for 2001. • We have audited the balance sheet and statements of income and retained earnings of Excelsior Corporation as of December 31, 2001. We conducted our audit in accordance with generally accepted accounting standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of misstatement. • We believe that our audits provide a reasonable basis for our opinion. • In our opinion, the financial statements referred to above present fairly the financial position of Excelsior Corporation as of December 31, 2001, and the results of its operations for the year then ended in conformity with generally accepted auditing standards, applied on a basis consistent with those of the preceding year. • (Signed) • Roscoe, Public Accountant • Other Information: • Excelsior is presenting comparative financial statements. • Excelsior does not wish to present a cash flow statement for either year.

11. During 2001, Excelsior changed its method of accounting for long-term construction contracts, properly reflected the effect of the change in the current year’s financial statements, and restated the prior year’s statements. Roscoe is satisfied with Excelsior’s justification for making the change. The change is discussed in footnote 12. • Roscoe was unable to perform normal accounts receivable confirmation procedures, but alternate procedures were used to satisfy Roscoe as to the existence of the receivables. • Excelsior Corporation is the defendant in a lawsuit, the outcome of which is highly uncertain. If the case is settled in favour of the plaintiff, Excelsior will be required to pay a substantial amount of cash which might require the sale of certain capital assets. The litigation and the possible effects have been properly disclosed in footnote 11. • Excelsior issued debentures on January 31, 1999, in the amount of $10,000,000. The funds obtained from the issuance were used to finance the expansion of plant facilities. The debenture agreement restricts the payment of future cash dividends to earnings after December 31, 2000. Excelsior declined to disclose this essential data in the footnotes to the financial statements. Required: • Identify and explain any items included in “Other Information” that need not be part of the auditor’s report. • Explain the deficiencies in Roscoe’s auditor’s report as drafted.

12. Problem 2-23. For the following independent situations, assume you are the audit partner on the engagement. • During your examination of Debold Brothers Ltd., you conclude there is a possibility that inventory is materially overstated. The client refuses to allow you to expand the scope of your examination sufficiently to verify whether the balance is actually misstated. • You are auditing Woodcolt Linen Services, Inc., for the first time. Woodcolt has been in business for several years but has never had an audit before. After the audit is completed, you conclude that the current year balance sheet is stated correctly in accordance with GAAP. The client did not authorize you to do test work for any of the previous years. • You were engaged to examine Cutter Steel Corp.’s financial statements after the close of the corporation’s fiscal year. Because you were not engaged until after the balance sheet date, you were not able to physically observe inventory, which is very material. On the completion of your audit, you are satisfied that Cutter’s financial statements are presented fairly, including inventory about which you were able to satisfy yourself by the use of alternative audit procedures.

13. Four weeks after the year-end date, a major customer of Prince Construction Ltd. Declared bankruptcy. Because the customer had confirmed the balance due to Prince at the balance sheet date, management refuses to charge off the account or otherwise disclose the information. The receivable represents approximately 10 percent of accounts receivable and 20 percent of net earnings before taxes. • You complete the audit of Johnson Department Store Ltd., and, in your opinion, the financial statements are fairly presented. On the last day of the examination, you discover that one of your supervisors assigned to the audit had a material investment in Johnson. If you decide no auditor’s report can be issued, explain your decision. • Auto Delivery Company Ltd. has a fleet of several trucks. In the past, Auto Delivery had followed the policy of purchasing all equipment. In the current year, they decided to lease the trucks. This change in policy is fully disclosed in the notes. • Required: • For each situation, state the type of auditor’s report that should be issued. If your decision depends on additional information, state the alternative reports you are considering and the additional information you need to make the decision.

14. Problem 2-24. For the following independent situations, assume you are the audit partner on the engagement. • Kieko Corporation has prepared financial statements but has decided to exclude the cash flow statement. Management explains to you that the users of their financial statements find that particular statement confusing and prefer not to have it included. • Jet Stream Airlines, Inc. has been audited by your firm for ten years. In the past three years their financial condition has steadily declined. In the current year, for the first time, the current ratio is below 2:1, which is the minimal requirement specified in Jet Stream's major loan agreement. You now have reservations about the ability of Jet Stream to continue in operation for the next year. • Approximately 20 percent of the audit for Furtney Farms, Inc. was performed by a different public accounting firm, selected by you. You have reviewed its working papers and believe it did an excellent job on its portion of the audit. Nevertheless, you are unwilling to take complete responsibility for its work. • The controller of Fair City Hotels Company Ltd. Will not allow you to confirm the receivable balance for two of its major customers. The amount of the receivable is material in relation to Fair City’s financial statements. You are unable to satisfy yourself as to the receivable balance by alternative procedures.

15. 5. In the last three months of the current year, Oil Refining Corp. decide to change direction and go significantly into the oil-drilling business. Management recognizes that this business is exceptionally risky and could jeopardize the success of its existing refining business, but there are significant potential rewards. During the short period of operation in drilling, the company has had three dry wells and no successes. The facts are adequately disclosed in the footnotes. Required: a. For each situation, identify which of the conditions requiring modification of or a deviation from an unqualified standard report is applicable. b. State the level of materiality as immaterial, material, or material and pervasive. If you cannot decide the level of materiality, state the additional information needed to make the decision. • Given your answers in parts (a) and (b), identify the appropriate auditor’s report from the following: (1) Unqualified (2) Qualified opinion only – except for (3) Scope and opinion qualified (4) Denial (5) Adverse

16. Problem 2-25. The following are independent situations for which you will recommend an appropriate auditor’s report: • Subsequent to the date of the financial statements as part of the [post-balance sheet date audit procedures, a public accountant learned of heavy damages to one of a clients two plants due to a recent fire; the loss will not be reimbursed by insurance. The newspapers described the event in detail. The financial statements and appended notes prepared by the client did not disclose the loss caused by the fire. • A public accountant is engaged in the examination of the financial statements of a large manufacturing company with branch offices in may widely separate cities. The public accountant was not able to count the substantial undeposited cash receipts at the close of business on the last day of the fiscal year at all the branch offices. As an alternative to this auditing procedure used to verify the accurate cutoff of cash receipts, the public accountant observed that deposits in transit as shown on the year-end bank reconciliation appeared as credits on the bank statement on the first business day of the new year. The public accountant was satisfied as to the cutoff of cash receipts by the use of the alternative procedure. • On January 2, 2002, the Retail Auto Parts Company Limited received a notice from its primary supplier that, effective immediately, all wholesale prices would be increased by 10 percent. On the basis of the notice, Retail Auto Parts revalued its December 31, 2001, inventory to reflect the higher costs. The inventory constituted a material proportion of total assets; however, the effect of the revaluation was material to current assets but not to total assets or net income. The increase in valuation is adequately disclosed in the footnotes. 4. During 2001, the research staff of Scientific Research Corporation devoted its entire efforts toward developing a new pollution-control device. All costs that could be attributed directly to the project were accounted for as deferred charges and classified on the balance sheet at December 31, 2001, as a noncurrent asset. In the course of her audit of the corporation's 2001 financial statements, Marika Vlasic, public accountant, found persuasive evidence that the research conducted to date would probably result in a marketable product. The deferred research charges are significantly material in relation to both income an total assets.

17. For the past five years, a public accountant has audited the financial statements of a manufacturing company. During this period, the examination scope was limited by the client as to the observation of the annual physical inventory. Since the public accountant considered the inventories to be of a material amount and he was not able to satisfy himself by other auditing procedures, he was not able to express an unqualified opinion on the financial statements in each of the five years. The public accountant was allowed to observe physical inventories for the current year ended December 31, 2001, because the client’s banker would no longer accept the qualified auditor’s reports. In the interest of economy, the client requested that the public accountant not extend his audit procedures to the inventory as of January 1, 2001. • During the course of the examination of the financial statements of a corporation for the purpose of expressing an opinion on the statements, a public accountant is refused permission to inspect the minute books. The corporation secretary instead offers to give the public accountant a certified copy of all resolutions and actions relating to accounting matters. Required: • For each situation, identify which of the conditions requiring a deviation from or modification of an unqualified standard report is applicable. • State the level of materiality as immaterial, material, or material and pervasive. If you cannot decide the level of materiality, state the additional information need to make a decision. • Given your answers in parts (a) and (b), identify the appropriate auditor’s report from the following alternatives: (1) Unqualified – standard wording (2) Qualified opinion only – except for (3) Qualified scope and opinion (4) Denial (5) Adverse

18. Problem 2-28. The following are two unrelated situations: • You are the auditor of Xact Ltd., a company which at December 31, 2001, had working capital of $200,000, total assets of $2,500,000, and total liabilities of $2,200,000. During the three years ended December 31, 2001, the company has sustained operating losses totaling $700,000. Management has been informed that Butler Inc. will not renew a debenture they hold issued by Xact in the amount of $500,000 and maturing September 30,2002. The debenture is presently classed as a long-term liability. Although preliminary discussions have already been held with various commercial lenders, it presently appears uncertain as to whether Xact will be able to refinance this debt. In addition, it appears doubtful that Xact will be able to obtain short-term borrowing to finance the debt. • Your client, Bat Ltd., owns 15 percent of the shares of Bird Ltd. The 2001 pre-tax net income of Bat is $1,000,000 and its shareholder's equity is $3,000,000. The investment in Bird is carried on Bat’s balance sheet (as of December 31, 2001) at $250,000, which represents original cost. Bird has incurred significant loses in the past few years. A current appraisal by a qualified business valuator indicates that the current market value of 100 percent of the issued and outstanding shares of Bird is $1,000,000. You are also aware that an investor who held 20 percent of the shares of Bird recently sold those shares for $180,000. Your client, Bat Ltd., insists that the shares be shown at their original cost of $250,000 but is willing to expand note disclosure. Required: • Outline possible deviations (if any) from a standard auditor’s report that may be necessary, and give reasons. State your assumptions. b. Outline the minimum note disclosure you would consider in the circumstances. What additional disclosure would be desirable?

19. Problem 2-32. The following is an auditor’s report, except for the opinion paragraph, of Tri-Nation Corp. We have audited the accompanying consolidated balance sheet of Tri-Nation Corp. and subsidiaries as of July 31, 1999, and the related statements of income, shareholders’ equity, and cash flow for the year then ended. These financial statements are the responsibility of management. Our responsibility is to express an opinion on these financial statements based on our audit. 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 a reasonable assurance as to 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. The company had significant deficiencies in internal control, including the lack of detailed records and certain supporting data which were not available for our examination. Therefore, we were not able to obtain sufficient evidence in order to form an opinion on the accompanying financial statements, including whether the inventory at July 31, 1999, ($670,490) was stated at lower of cost or market, or whether the deferred subscription revenue ($90,260) is an adequate estimate for the applicable liability, as discussed in notes 5 and 12, respectively. Required: Write the opinion paragraph for this auditor’s report. State any assumptions you have made.