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Audit Reports

Audit Reports. Dr. Donald McConnell Jr,. There Are Four Fundamental Types of Audit Reports. Unqualified (the standard report) Qualified, due to material: Improper GAAP (the numbers or notes) Scope restriction: Imposed by circumstances Client imposed

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Audit Reports

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  1. Audit Reports Dr. Donald McConnell Jr,

  2. There Are Four Fundamental Types of Audit Reports • Unqualified (the standard report) • Qualified, due to material: • Improper GAAP (the numbers or notes) • Scope restriction: • Imposed by circumstances • Client imposed • Adverse: extremely material GAAP impropriety • Disclaimer: technically not an opinion

  3. The Unqualified Report (AU 508.08) • The standard report (clean opinion) • Issued when: • Full and fair disclosure of all material facts • No material scope restrictions • Auditor is independent • Has three paragraphs: • Introductory paragraph • Scope paragraph • Opinion paragraph • Analysis of the report: AU 508.08

  4. Very Common Types of CPA Exam Questions: • identify the deficiencies in a presented audit report • Less commonly, write an audit report based on a given set of circumstances • Multiple-choice questions on reports tend to be extremely “picky” • What does this suggest?

  5. Departures from Unqualified Opinions: Qualified, Adverse, and Disclaimer • Know how they differ from one another and the standard report • Know the conditions for issuing each type of report

  6. Qualified Opinions (AU 508.20) • Expressed when there is a material • GAAP departure • Scope restrictions imposed by client or circumstances • These are the “except for” opinions • Must include a separate explanatory paragraph (s) preceding opinion paragraph: • Explaining all substantive reasons for qualification • Financial statement effects, if practicably determinable

  7. GAAP Departure Qualifications (AU 508.39) • Note explanatory paragraph indicating reasons for qualification and effects • Explanatory paragraph must precede the opinion paragraph • “except for…” stated only once: in opinion paragraph

  8. Scope Restriction Qualifications (AU 508.26) • “except for…” stated twice: once in scope paragraph and once in opinion paragraph • “except for” wording in opinion paragraph should base qualification on possible effects to the F.S.’s, and not on the scope limitation itself • Example: “in our opinion, except for the above mentioned limitation on scope…” is unacceptable

  9. What Is the Difference between Material and Extremely Material? Some Examples: • Assume client has $10 million total assets • Client has capitalized $1 million of R & D expenditures. What opinion would auditor render? • Material: qualified for GAAP departure • $5 million? • Extremely material: adverse opinion • What if R & D expenditures are $10,000? • Immaterial: unqualified opinion

  10. Adverse Opinions (AU 508.60) • Only used for extremely material GAAP departures: F.S.’s rendered meaningless • Extremely rare • State that the financial statements donot present fairly • Characterized by knowledge of F.S. effect • Substantive reasons and effects (if determinable) must be in a paragraph(s) preceding opinion paragraph

  11. Disclaimer of Opinion (AU 508.63) • Required for: • Extremely material scope limitation, whether imposed by client or circumstances • Auditor lacking independence • Optional for extremely material uncertainty (AU 341.13, fn 4) • Scope issues: • Have not obtained sufficient competent evidential matter • Substantive reasons for disclaimer must be in a paragraph preceding opinion paragraph

  12. Disclaimer of Opinion (AU 508.63) (con.) • Report must disclose any other reservations concerning fair presentation in accordance with GAAP • AU 508.63: note many significant differences from standard report • A common “real world” cause for disclaimers: new audit client with material inventories (AU 508.67)

  13. Various Audit Report Issues • What happens if there is an immaterial GAAP problem and/or immaterial scope problem? • Unqualified report is issued • In “real world,”nonstandard opinions are unusual. Why? • Client imposed scope: what if F.S. effects potentially borderline between material and extremely material? • Disclaimer. • What’s a piecemeal opinion? (AU 508.64)

  14. Modified Unqualified Opinions (AU 508.11) • A subset of unqualified opinions • “Clean opinions” with modifying language or, more typically, modifying paragraph(s) • Modifying paragraph(s) can precede or follow opinion paragraph except in case of: • Substantial doubt about going concern status • Material change in accounting principles (fn 8) • Discussion of examples in AU 508.11

  15. Comparative Financial Statements (Au508.65) • Usual convention is to report comparatively • Fourth standard of reporting requires an opinion on all presented financial statements, unless clearly labeled unaudited • Prior Period Financial statements may have been: • Audited by our CPA firm • Audited by another CPA firm

  16. Comparative F.S.’s Audited by Our CPA Firm (AU 508.67) • The auditor may express a different opinion for one or more periods • AU 508.67 shows an example of an unqualified opinion last year with a qualified opinion on the current year’s financial statements

  17. Comparative F.S.’s Audited by Our CPA Firm (Con.) (AU 508.68) • The auditor might also change a previously issued opinion on a prior period. • In such cases, auditor must: • Indicate that the F.S.’s have been restated from last year • Include an explanatory paragraph preceding the opinion paragraph indicating (508.69): • Substantive reasons for opinion change and prior report date • Type of opinion previously expressed • Indicate updated opinion is different from the previous opinion

  18. Previous Year Financial Statements Audited by Another CPA Firm • Predecessor auditor’s prior audit report usually not presented • Less commonly, predecessor auditor reissues the previous report [SEC audits require this.]

  19. Predecessor Auditor Consents to Reissue Prior Report (Au 508.71) • Usually only done for audits of public companies • Predecessor auditor must: • Determine that the prior opinion is still appropriate • Read current period comparative F.S. presentation; compare with last year F.S.’s that prior CPA had reported upon • Obtain rep letter from successor: no current matters effect last year’s F.S.’s • Reissued report date would ordinarily be same as last year (Au 508.73) • There will be two audit reports in the registration (IPO) filed with SEC

  20. Predecessor Auditor’s Report Not Presented (AU 508.74) • This is more common: we simply make reference to the prior audit • Note only current year F.S.’s opined upon in opinion paragraph • Introductory paragraph of audit report is modified to: • Indicate the prior F.S.’s were audited by another auditor • The date and type of report which was issued • Substantive reasons, if prior report was not standard

  21. Predecessor Auditor’s Report Not Presented (Con.) (AU 508.74) • Introductory paragraph would be modified as follows: • … our responsibility is to express an opinion on these financial statements based on our audit. [Note: not audits-only opining on current year F.S.’s] The financial statements of ABC as of December 31, 19x1 were audited by other auditors whose report dated March 1, 19x2 [was unqualified or] included an explanatory paragraph that described the change in the Company’s method of computing depreciation discussed in Note xx to the financial statements.

  22. Consistency of Application of GAAP ( AU 420) • Second standard of reporting implies that comparability has not been affected by a change in accounting principles • Accounting changes can: • Affect consistency, or • Affect comparability, but not consistency

  23. Accounting Changes Affecting Consistency (AU 420.06) • Require an additional explanatory paragraph which must follow the opinion paragraph • Examples requiring paragraph (.06-.14): • Material change in accounting principle • Change in reporting entity (presenting consolidated vs. individual F.S.’s, change in component subsidiaries) • Change from an incorrect principle to a correct accounting principle • Principle change inseparable from a change in estimate • Change in definition of cash equivalents

  24. Accounting Changes Not Affecting Consistency (AU 420.06) • Do not require an additional paragraph • Will require footnote disclosure if material • Examples include (.15-.21): • Change in accounting estimate • Error correction not involving principle (math mistake, misuse of facts) • Changes in F.S.classifications • First-time adoption of a new principle • A change in principle not having a current material effect, but which is expected to become material

  25. Consistency of Application of GAAP: Other Considerations • Inadequate client disclosure of accounting changes requires a qualified or adverse opinion (420.21) • If auditor reports only on current period, must obtain sufficient, competent evidence about consistency of current GAAP with prior periods, even though prior period F.S.’s not presented (.22) • Same is true concerning first-year audits. Must verify consistency of principles with prior year (420.24) • If cannot (inadequate records or client limitations), would be unable to express opinion on current year’s financial statements: disclaimer (420.25)

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