Rick Stephan Hayes, Philip Wallage, and Hans Gortemaker

Audit Reports and CommunicationPrinciples of Auditing: An Introduction to International Standards on Auditing - - Ch. 12 Rick Stephan Hayes, Philip Wallage, and Hans Gortemaker

Management Responsibility for Audit Report - SOx Sox Requires that the principal executive officer or officers and the principal financial officer or officers, certify in each report filed with the SEC the following: • the signing officer has reviewed the report; • the report does not contain any untrue statement of a material fact or omit to state a material fact; • the financial statements, and other financial information, fairly present in all material respects the financial condition of the company; • the signing officers • are responsible for establishing and maintaining internal controls; • have evaluated the effectiveness of the company’s internal controls; and • have presented in the report their conclusions about the effectiveness of their internal controls based on their evaluation;

Corporate Responsibility for Audit Report under SOx (cont.) Requires that the principal executive officer or officers and the principal financial officer or officers, certify in each report filed with the SEC the following: • the signing officers have disclosed to the company’s auditors and the audit committee of the board of directors — • all significant deficiencies in the design or operation of internal controls which could adversely affect the company’s ability to record, process, summarize, and report financial data and have identified for the company’s auditors any material weaknesses in internal controls; and • any fraud, whether or not material, that involves management or other employees who have a significant role in the company’s internal controls;

Old Style Audit Report (3 paragraph)

Contents of the PCAOB Combined Financial Statement and Internal Control Auditor's Report • title, • Addressee (not required PCAOB AS 5) • opening or introductory paragraph • scope paragraph (describing the nature of an audit) • Definition paragraph • Limitations paragraph • opinion paragraph containing an expression of opinion on the financial statements, • the date of the report, the auditor's address, and auditor’s signature US Classes

Example PCAOB sample combined financial statement and internal control audit report from Audit Standard No. 5 NEXT SLIDES U.S. Classes

Report of Independent Registered Public Accounting Firm [Introductory paragraph] We have audited the accompanying balance sheets of W Company as of December 31, 20X8 and 20X7, and the related statements of income, stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 20X8. We also have audited management's assessment, included in the accompanying [title of management‘s report], that W Company maintained effective internal control over financial reporting as of December 31, 20X8, based on [Identify control criteria, for example, "criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)." ]. W Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the company's internal control over financial reporting based on our audits.

[Scope paragraph] We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. US Classes

[Definition paragraph] A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. US Classes

[Inherent limitations paragraph] Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. [Opinion paragraph] In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of W Company as of December 31, 20X8 and 20X7, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 20X8 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, W Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 20X8, based on [Identify control criteria, for example, "criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)." ]. [Signature] [City and State or Country] [Date] US Classes

ISA 700 Auditors Opinion on F/S • Title: “Independent Auditor’s Report” • [Appropriate Addressee] • Introductory Paragraph (Report on Financial Statements) • Management’s Responsibility for the Financial Statements • Auditor’s Responsibility • Opinion • Report on Other Legal and Regulatory Requirements [Form and content of this section of the auditor’s report will vary depending on the nature of the auditor’s other reporting responsibilities.] • [Auditor’s signature] • [Date of the auditor’s report] • [Auditor’s address]

ISA 700 Sample Financial Statement Audit Report Independent Auditor’s Report [Appropriate Addressee] Report on the Financial Statements We have audited the accompanying financial statements of ABC Company, which comprise the statement of financial position as at December 31, 20X1, and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and a summary of significant accounting policies and other explanatory information.

Included in the Audit Report • A title, e.g. “Independent Auditor’s Report” • An addressee, as required by the circumstances of the engagement, e.g.”Shareholders of ABC company” • An introductory paragraph that identifies the financial statements audited

Management’s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s Responsibility Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with International Standards on auditing. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.

The Audit Report Management Responsibility and Auditor Responsibility • A description of the responsibility of management for the preparation of the financial statements. • A description of the auditor’s responsibility to express an opinion on the financial statements and the scope of the audit, that includes: • A reference to International Standards on Auditing and the law or regulation; and • A description of an audit in accordance with those standards.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion In our opinion, the financial statements present fairly, in all material respects, (or give a true and fair view of) the financial position of ABC Company as at December 31, 20X1, and (of) its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards. Report on Other Legal and Regulatory Requirements [Form and content of this section of the auditor’s report will vary depending on the nature of the auditor’s other reporting responsibilities.] [Auditor’s signature] [Date of the auditor’s report] [Auditor’s address]

Included in the Audit Report Opinionand Signatures • An opinion paragraph containing an expression of opinion on the financial statements and a reference to the applicable financial reporting framework used to prepare the financial statements (including identifying the jurisdiction of origin of the financial reporting framework that is not International Financial Reporting Standards or International Public Sector Accounting Standards, • The auditor’s signature; • The date of the auditor’s report; and • The auditor’s address.

The objectives of the auditor are: • To form an opinion on the financial statements based on an evaluation of the conclusions drawn from the audit evidence obtained and • To express clearly that opinion through a written report that also describes the basis for that opinion.

The report must be dated. The auditor shall date the report no earlier than the date on which the auditor has obtained sufficient appropriate audit evidence on which to base the auditor’s opinion on the financial statements including evidence that: (a) all the statements that comprise the financial statements, including the related notes, have been prepared; and (b) those with recognized authority have asserted that they have taken responsibility for those financial statements.

The opinion expressed in the auditor's report may be one of four types: Unmodified (unqualified), Three Modified Opinions: qualified, adverse, or disclaimer of opinion Q U A D

Unqualified Audit Opinion – Also called Unmodified Opinion • Unmodified (unqualified) opinion—The opinion expressed by the auditor when the auditor concludes that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. • Most common type of audit report • Called “clean opinion” • Used for more than 90 per cent of all audit reports • Other audit reports are referred to as ‘modified opinion. (adverse opinion, disclaimer of opinion, and qualified opinion).

An Unmodified (Unqualified)Audit Opinion should be expressed when the auditor concludes that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework.

Evaluation of the compliance to the reporting framework include consideration of these qualitative aspects • whether the financial statements adequately disclose the significant accounting policies selected and they are consistent and appropriate; • accounting estimates made by management are reasonable; • information presented in the financial statements is relevant, reliable, comparable, and understandable; • disclosures to enable the intended users to understand the effect of material transactions and events on the information conveyed in the financial statements; and • terminology used in the financial statements, including the title of each financial statement, is appropriate. • whether the financial statements achieve fair presentation. If they are prepared in accordance with a fair presentation framework,

at least two circumstances where the auditor may not be able to express an unmodified opinion: • A limitation in scope; • The auditor’s judgment about the pervasiveness of the effects or possible effects of the matter on the financial statements. The circumstances described in 1 – scope limitation – could lead to a modified opinion or a disclaimer of opinion. The circumstances described in 2 – disagreement with management – could lead to a modified opinion or an adverse opinion.

The objective of the auditor is to express clearly an appropriately modified opinion on the financial statements that is necessary when • The auditor concludes, based on the audit evidence obtained, that the financial statements as a whole are not free from material misstatement; or • The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement.

Auditor’s Qualified Opinion Express a qualified opinion when: The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are material, but not pervasive, to the financial statements; or The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive.

Auditors Responsibility …We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified audit opinion. Basis for Qualified Opinion ABC Company’s investment in XYZ Company, a foreign associate acquired during the year and accounted for by the equity method, is carried at xxx on the statement of financial position as at December 31, 20X1, and ABC’s share of XYZ’s net income of xxx is included in ABC’s income for the year then ended. We were unable to obtain sufficient appropriate audit evidence about the carrying amount of ABC’s investment in XYZ as at December 31, 20X1 and ABC’s share of XYZ’s net income for the year because we were denied access to the financial information, management, and the auditors of XYZ. Consequently, we were unable to determine whether any adjustments to these amounts were necessary. Qualified Opinion In our opinion, except for the possible effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements present fairly, in all material respects, (or give a true and fair view of) the financial position of ABC Company as at December 31, 20X1, and (of) its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards.

Auditor’s Adverse Opinion ( ISA 705) The auditor shall express an adverse opinion when the auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are both material and pervasive to the financial statements.

Auditor’s Disclaimer of Opinion (ISA 705) The auditor shall disclaim an opinion when the auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, and the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive. or interaction of multipleuncertainties on F/S

ISA 705 Appendix Types of Modified Opinions

Basis for Modification Paragraph When the auditor modifies the opinion on the financial statements, the auditor shall, in addition to the specific elements required by ISA 700, include a paragraph in the auditor’s report that provides a description of the matter giving rise to the modification. The auditor shall place this paragraph immediately before the opinion paragraph in the auditor’s report and use the heading “Basis for Qualified Opinion,” “Basis for Adverse Opinion,” or “Basis for Disclaimer of Opinion,” as appropriate.

An Emphasis of a Matter Paragraph with an Unmodified (Unqualified) Opinion An auditor’s unqualified report is sometimes expanded upon to explain matters that do not affect the auditor’s opinion, but should be emphasized to the financial statement user.

ISA 706 “Emphasis of Matter Paragraphs and Other Matters Paragraphs in the Independent Auditor’s Report” The auditor’s report should emphasize a matter when it is necessary to: (a) EofM: Draw users’ attention to matters presented or disclosed in the financial statements that are of such importance that they are fundamental to users’ understanding of the financial statements; or (b) Other Matter: Draw users’ attention to any matters other than those presented or disclosed in the financial statements that are relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report.

Report of Independent Registered Public Accounting Firm [Standard Introductory Paragraph] [Management Responsibility Paragraph] [Auditor Responsibility Paragraphs] [Opinion Paragraph] Required Emphasis Paragraph[s] [Emphasize those matters that are important in understanding the financial statement presentation, including significant management judgments and estimates and areas with significant measurement uncertainty. Discuss the audit procedures performed on these significant matters. This discussion should not include matters that the company has not disclosed in the financial statements and should make reference to the notes in the financial statements that disclose each matter.] “Without qualifying our opinion we draw attention to Note X to the financial statements. The Company is the defendant in a lawsuit alleging infringement of certain patent rights and claiming royalties and punitive damages. The Company has filed a counter action, and preliminary hearings and discovery proceedings on both actions are in progress. The ultimate outcome of the matter cannot presently be determined, and no provision for any liability that may result has been made in the financial statements.” [Signature] [City and State or Country] [Date]

When the auditor includes an Emphasis of Matter paragraph in the auditor’s report, the auditor shall: (a) Include it immediately after the Opinion paragraph in the auditor’s report; (b) Use the heading “Emphasis of Matter,” (c) Include in the paragraph a clear reference to the matter being emphasized and to where relevant disclosures that fully describe the matter can be found in the financial statements; and (d) Indicate that the auditor’s opinion is not modified in respect of the matter emphasized

An auditor might write an Emphasis of a Matter paragraph: • If there is a significant uncertainty which may affect the financial statements, the resolution of which is dependent upon future events • Examples of uncertainties that might be emphasized include • the existence of related party transactions, • important accounting matters occurring subsequent to the balance sheet date • matters affecting the comparability of financial statements with those of previous years (e.g. change in accounting methods) • Litigation, long-term contracts, recoverability of asset values, losses on discontinued operations • To highlight a material matter regarding a going concern problem.

Going Concern

In a going concern judgment, the objectives of the auditor are: • To obtain sufficient appropriate audit evidence about the appropriateness of management’s use of the going concern assumption in the preparation and presentation of the financial statements; • To conclude, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern; and (c) To determine the implications for the auditor’s report.

The Going Concern disclosure should: • describe the principal conditions that raise doubt; • state that there are doubts about going concern, therefore the entity may be unable to realize its assets and discharge its liabilities in the normal course of business; • state that the financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or to amounts and classification of liabilities that may be necessary should the entity be unable to continue as a going concern.

Lack of Consistency Lack of consistency in the application of accounting principles in the current period in relation to the preceding period may require a modification to an unmodified opinion based on standards in many countries.

Reports involving other auditors and experts ISA 620 suggests that when expressing an unmodified (unqualified) opinion the auditor should not refer to the work of an expert in her report as such a reference might be misunderstood to be a qualification of the auditor's opinion or a division of responsibility. If the auditor references the work of an expert in the auditor’s report because it is relevant to a modification to the auditor’s opinion, the auditor shall indicate this does not reduce the auditor’s responsibility for that opinion.

Communications With Those Charged With Governance • The objective of the auditor is to provide those charged with governance with timely observations arising from the audit that are significant and relevant to their responsibility to oversee the financial reporting process including: • Qualitative aspects of the entity’s accounting practices • Significant difficulties encountered during the audit • Significant matters arising from the audit that were discussed with management • Other matters arising from the audit that are significant to the oversight of the financial reporting process

Governance Structures • The structures of governance vary from country to country reflecting cultural and legal backgrounds. • In some countries, the supervision function, and the management function are legally separated into different bodies, such as a supervisory (wholly or mainly non-executive) board and a management (executive) board. • In other countries, like the U.S., both functions are the legal responsibility of a single, unitary board.

Auditor Communications to Governance Entity Audit matters of governance interest to be communicated by the auditor to the board or audit committee ordinarily include: • Material deficiencies in internal control; • Non-compliance with laws and regulations. • Fraud involving management • Questions regarding management integrity; • The general approach and overall scope of the audit; • The selection of, or changes in, significant accounting policies and practices that have a material effect on the financial statements;

Auditor Communications to Governance Entity (cont) Audit matters of governance interest to be communicated by the auditor to the board or audit committee ordinarily include: • The potential effect on the financial statements of any significant risks and exposures, such as pending litigation, that requires disclosure in the financial statements; • Significant audit adjustments to the accounting records; • Material uncertainties related to the entity’s ability to continue as a going concern; • Disagreements with management about matters that could be significant to the entity’s financial statement. • Expected modifications to the auditor’s report

Reporting Fraud and Error • If the auditor has identified a fraud or has obtained information that indicates that a fraud may exist, the auditor shall communicate these matters on a timely basis to the appropriate level of management • The auditor shall determine whether there is a responsibility to report the occurrence or suspicion to a party outside the entity. The auditor’s legal responsibilities may override the duty of confidentiality in some circumstances.

Reporting of Non-compliance with Laws • If non compliance is suspected, the auditor should communicate to those charged with governance. • If the auditor concludes that the noncompliance has a material effect on the financial statements, and has not been properly reflected in the financial statements, the auditor should express a qualified or an adverse opinion. • The auditor shall determine whether the auditor has responsibility to report the identified or suspected non-compliance to parties outside the entity.

Long-Form Audit Report • In many countries it is customary for the auditor to prepare a ‘long-form’ report to the Audit Committee of an entity’s board of directors in addition to the publicly published ‘short-form’ report discussed in this chapter. • A long- form report ordinarily includes: • Overview of the Audit Engagement • Analysis of Financial Statements • Risk Management and Internal Control • Optional Topics • Auditor independence and quality control • Fees

Management Letter • The management letter identifies issues not required to be disclosed in the Annual Financial Report but represent the auditors concerns and suggestions noted during the audit. An evaluation is made of the present system, pointing out problem areas. Recommendations for improvement are cited. Also included is a discussion of any problem which may require immediate action to correct.

Rick Stephan Hayes, Philip Wallage, and Hans Gortemaker