Professional Documents
Culture Documents
CHAPTER 12
Reports on Audited Financial Statements
LEARNING OBJECTIVES
Review
Checkpoints
Multiple
Choice
Exercises and
Problems
1.
1, 2, 3, 4, 5, 6,
7, 8
60
2.
31, 36, 38
3.
32, 34, 37
4.
35, 43, 44
12-1
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The reports that accompany a public entitys financial statements are mandatory reports on (1) internal
control over financial reporting (prepared by management), (2) internal control over financial reporting
(prepared by auditors), and (3) financial statements and related disclosures (prepared by auditors).
A report on the fairness of financial statements and related disclosures may accompany a nonpublic entitys
financial statements. These reports are not mandatory and are based on user demand.
12.2
There are no mandated audit requirements for the financial statements of nonpublic entities. Audits for
these entities may result from (1) requirements of regulatory bodies other than the SEC or (2) demand from
third-party users of financial statements (lenders and investors).
Public entities are required to file audited financial statements with the SEC within 60 days of their fiscal
year-end. Thus, public entities are required to have an audit examination on an annual basis.
12.3
The auditors report is addressed to the person(s) who retain the auditor and pay the fee. For public entities,
this party would be the board of directors and shareholders. For nonpublic entities, potential addressees
include the board of directors and shareholders or the party who requested the audit (prospective or current
lenders, prospective or current creditors, and prospective or current investors).
12.4
The four major sections of the standard (unmodified) auditors report are:
1.
Introductory paragraph: Identifies the financial statements and years examined by the audit team.
2.
Managements Responsibility for the Financial Statements: Indicates that the entitys management
is responsible for the fairness of the financial statements and the design, implementation, and
maintenance of internal control over financial reporting.
Auditors Responsibility: Identifies the audit teams responsibility to conduct an audit under GAAS,
provides a brief description of an audit, and indicates that the audit evidence provides a basis for the
audit teams opinion.
3.
4.
Opinion: Expresses the audit teams opinion on whether the financial statements present the financial
condition, results of operations, and cash flows in accordance with GAAP.
12.5
The auditors report is dated using the date when auditors have obtained sufficient appropriate evidence to
support the opinion (this is known as the date of the auditors report).
12.6
Major differences in the auditors report for nonpublic and public entities include:
12.7
In describing the standards under which the audit is conducted, the report for public entities references
"standards of the Public Company Accounting Oversight Board (United States)" rather than "auditing
standards generally accepted In the United States of America."
The report for public entities has a paragraph that references the audit team's report and opinion on the
entity's internal control over financial reporting.
The report for public entities uses a number of different subject headings to identify different sections of
the report.
When reporting on the financial statements and internal control over financial reporting in the audit of
public entities, auditors may either prepare two separate reports or a single, combined report (known as an
integrated report). If separate reports are prepared, each report must contain a reference to the other report.
12-2
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Unmodified (or unqualified) opinions indicate that the financial statements present the financial condition,
results of operations, and cash flows in accordance with GAAP.
Qualified opinions indicate that, with the exception of one or more issues, the financial statements present
the financial condition, results of operations, and cash flows in accordance with GAAP.
Adverse opinions indicate that the financial statements do not present the financial condition, results of
operations, and cash flows in accordance with GAAP.
Disclaimers of opinion do not express an opinion on the fairness of the entitys financial statements.
12.9
If a departure from GAAP exists and the effect is immaterial, then an unmodified opinion may be issued. If
the effect of the departure is material (but not pervasive) and isolated to a single event, then a qualified
opinion would be issued. If the effect is both material and pervasive, the auditors should issue an adverse
opinion.
12.10
Qualified opinions indicate that, except for the effects of an isolated departure from GAAP, the financial
statements are presented in accordance with GAAP. Adverse opinions indicate that the financial statements
are not presented in accordance with GAAP. Clearly, the wording used in the adverse opinions represents
more material and pervasive departures from GAAP and more serious concerns on the part of the audit
team.
12.11
12.12
1.
The opinion paragraph would be modified to express either a qualified opinion (except for, the
financial statements present the financial condition, results of operations, and cash flows in
accordance with GAAP) or adverse opinion (the financial statements do not present the financial
condition, results of operations, and cash flows in accordance with GAAP.) In addition, the
opinion paragraph would be labeled either Qualified Opinion or Adverse Opinion.
2.
An additional paragraph (labeled either Basis for Qualified Opinion or Basis for Adverse
Opinion) would be added prior to the opinion paragraph that described the nature of the departure
from GAAP.
A client-imposed scope limitation results from managements refusal to provide access to evidence or
otherwise limit the auditors application of auditing procedures while a circumstance-imposed scope
limitation occurs when circumstances beyond the auditors or clients control result in the inability of
auditors to perform certain procedures.
Because of the deliberate and intentional nature of client-imposed scope limitations, these scope limitations
are of more concern to auditors than circumstance-imposed scope limitations.
12.13
If auditors are able to perform alternative procedures, the standard (unmodified) report would not be
modified.
12.14
Assuming that alternative procedures cannot be performed, the auditors reporting options are as follows:
1.
2.
3.
If the scope limitation is not material, an unmodified opinion (standard report) is issued.
If the scope limitation is material, but not pervasive, a qualified opinion is issued.
If the scope limitation is highly material and pervasive, a disclaimer of opinion is issued.
12-3
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12.15
1.
2.
12.16
A report qualified for a scope limitation would modify the standard (unmodified) report as
follows:
a.
An additional paragraph would be included describing the scope limitation, the accounts
or disclosures affected by the scope limitation, and the dollar amounts involved, if
determinable.
b.
An except for phrase would be included in the opinion paragraph that recognizes the
scope limitation may have affected auditors ability to identify misstatements.
A report in which the opinion is disclaimed because of a scope limitation would modify the
standard (unmodified) report as follows:
a.
The introductory paragraph would indicate [w]were engaged to audit instead of [w]e
have audited.
b.
The Auditors Responsibility section would be modified to (1) indicate that the auditor
was not able to obtain sufficient appropriate evidence and (2) delete paragraphs
describing an audit and indicating that the audit provides a basis for the opinion.
c.
d.
Group auditors perform the audit of a material portion of the consolidated entitys financial statements;
component auditors are engaged to audit divisions, subsidiaries, or segments that are included in the group
financial statements.
The issue introduced when component auditors are involved in the audit of group financial statements is
that the group auditors opinion on the group financial statements is based, in part, on the work of the
component auditors.
12.17
When component auditors are involved in the audit of group financial statements, group auditors can
assume responsibility for the component auditors work; if so, no reference is made to the component
auditors work in the group auditors report (the standard (unmodified) report can be issued).
If group auditors decide to refer to the work and reports of component auditors, they would modify the
Auditors Responsibility section and opinion paragraph of their report to indicate the involvement of
component auditors.
12.18
The group auditors reference in their report to component auditors is not a scope limitation. The reference
only shows the involvement of component auditors in the audit of group financial statements.
12.19
Emphasis-of-matter paragraphs and other matter paragraphs are paragraphs added to an otherwise
unmodified opinion that provide additional information to users.
12-4
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Other-matter paragraphs provide information relevant to users understanding of the audit, the
auditors responsibility, or auditors report.
12.20
The following matters cause auditors to modify their reports to identify inconsistent applications of GAAP:
12.21
The following circumstances may indicate substantial doubt about an entitys ability to continue as a going
concern:
Labor problems.
Significant litigation.
12.22
When going-concern uncertainties exist, auditors may either add an emphasis-of-matter paragraph to an
unmodified opinion or disclaim an opinion on the entitys financial statements. Disclaimers would typically
be issued when the going-concern uncertainties are more serious and pervasive.
12.23
Auditors only reference other information accompanying the financial statements in their reports when this
information is inconsistent with the audited financial statements or contains material misstatements.
Assuming that the financial statements are fairly stated (and, therefore, the issue is related to the other
information), auditors will add an other-matter paragraph to their report which identifies the misstatement or
inconsistencies in the other information.
Auditors are required to report on required supplementary information when such information is provided
with the financial statements and footnotes accompanying the financial statements. An other-matter
paragraph is added to their report on the financial statements that identifies the supplementary information,
describes any procedures performed with respect to this information, and identifies any issues related to this
information.
12.24
Comparative financial statements are financial statements for more than one period presented in side-byside format. The issue introduced when financial statements are presented in comparative form is that users
may assume auditors have examined all comparative years presented.
12.25
An updated report is a report on prior-years financial statements that is based on both the prior-years
audits and on information that has come to light in the most recent audit. An updated report may be
modified for events occurring subsequent to the date of the initial report.
A reissued report is a copy of a previously issued report that auditors provide or grant entities permission
to use in another document after its delivery date. This report is not modified to consider events occurring
subsequent to the date of the initial report.
12.26
If auditors wish to express a different opinion on prior-years financial statements in the current report than
in a previously issued report, the current report would contain an other-matter paragraph that states:
The type of opinion expressed in the previously issued report (and date of the report)
The present opinion is different from that expressed in the previous report
12.27
If predecessor auditors examined prior-years financial statements presented in comparative form, the
current auditors can:
12-5
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12.28
Add an other-matter paragraph to their report, indicating the date of the predecessor auditors
report and opinion expressed by the predecessor auditor (in this case, the predecessor auditors are
not identified by name)
When engaged to report on summary financial statements, auditors should issue a separate report that
indicates whether the information in the summary financial statements is fairly stated in all material
respects in relation to the complete financial statements.
When engaged to report on supplementary information, auditors can either issue a separate report on the
supplementary information or add an other-matter paragraph to their report on the financial statements. In
either case, auditors will indicate whether the supplementary information is fairly stated, in all material
respects, to the financial statements as a whole.
12.29
When auditors are not independent with respect to the entity, they should issue a disclaimer of opinion that
indicates they are not independent. However, the report should not mention any reasons for the lack of
independence.
12.31
12.32
12.33
a.
Correct
b.
c.
Incorrect
Incorrect
d.
Incorrect
a.
Incorrect
b.
c.
d.
Incorrect
Incorrect
Correct
a.
Correct
b.
Incorrect
c.
Incorrect
d.
Incorrect
NOTE TO INSTRUCTOR: Since this question asks students to identify which statement does not represent
a difference in the audit examinations and reports for public and nonpublic entities, the item labeled
correct is not an appropriate difference and those labeled incorrect are appropriate differences.
a.
Incorrect
b.
Incorrect
c.
Correct
Audit examinations for nonpublic entities are based on user demand, but are
required by the SEC for public entities.
The report for both types of entities will express an opinion on the entitys
financial statements.
The reporting requirement for internal control over financial reporting is related
to the audit of public entities, not nonpublic entities.
12-6
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Incorrect
Management is responsible for the fairness of the financial statements for both
types of entities.
12-7
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McGraw-Hill Education.
12.34
a.
Incorrect
b.
Incorrect
c.
Incorrect
d.
Correct
12.35
a.
b.
c.
d.
Incorrect
Correct
Incorrect
Incorrect
The prior audit must be described regardless of the type of opinion issued.
The predecessor auditors should be named only if their report is included.
The type of opinion must be stated.
The predecessor auditors should not be named unless their report is included.
12.36
a.
Correct
b.
Incorrect
c.
Incorrect
d.
Incorrect
a.
Incorrect
b.
Incorrect
c.
Correct
d.
Incorrect
12.37
12.38
12.39
NOTE TO INSTRUCTOR: Since this question asks students to identify when disclaimers of opinion
cannot be issued, the item labeled correct represents a situation when disclaimers cannot be issued and
those labeled incorrect represents situations when disclaimers can be issued.
a.
Incorrect
b.
Incorrect
c.
d.
Incorrect
Correct
a.
Correct
b.
Incorrect
c.
Incorrect
d.
Incorrect
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12.40
12.41
12.42
12.43
12.44
a.
Incorrect
b.
Incorrect
c.
Correct
d.
Incorrect
The client is the entity or individual that engages the auditor (in this case,
Company A). Megabank is the user of the financial statements.
The client is the entity or individual that engages the auditor (in this case,
Company A). Samson & Delilah is the auditor.
The client is the entity or individual that engages the auditor (in this case,
Company A).
The client is the entity or individual that engages the auditor (in this case,
Company A). Company B is the client.
NOTE TO INSTRUCTOR: Since this question asks students to identify which statement is not included in
the auditors standard (unmodified) report, the item labeled correct would not be included and those
labeled incorrect would be included.
a.
b.
c.
Incorrect
Incorrect
Incorrect
d.
Correct
a.
Correct
b.
Incorrect
c.
Incorrect
d.
Incorrect
a.
Incorrect
b.
Incorrect
c.
Incorrect
d.
Correct
a.
Incorrect
b.
Incorrect
c.
Correct
d.
Incorrect
12-9
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Basic Reports
If the amounts involved are immaterial, auditors can issue the standard report (unmodified opinion);
otherwise, materiality and pervasiveness affects the choice of auditors reports as follows:
12.46
a.
Scope limitation on
examination of accounts
receivable.
Disclaimer of opinion.
b.
Adverse opinion.
c.
Adverse opinion.
d.
Auditors would issue the standard (unmodified) report, with no modification or reference to the
departure from GAAP.
b.
Auditors would express a qualified opinion, which would modify the standard (unmodified) report
as follows:
Add a paragraph (Basis for Qualified Opinion) prior to the opinion that describes the
departure from GAAP, accounts affected by the departure, and amounts.
Label the opinion paragraph Qualified Opinion and modify the opinion paragraph to
indicate that except for the effects of the matter described in the Basis for Qualified
Opinion paragraph, the financial statements present the entitys financial condition,
results of operations, and cash flows in accordance with GAAP.
12-10
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c.
12.47
Auditors would express an adverse opinion, which would modify the standard (unmodified) report
as follows:
Add a paragraph (Basis for Adverse Opinion) prior to the opinion that describes the
departure from GAAP, accounts affected by the departure, and amounts.
Label the Opinion Paragraph Adverse Opinion and modify the opinion paragraph to
indicate that because of the significance of the matter discussed in the Basis for Adverse
Opinion paragraph, the financial statements do not present the entitys financial
condition, results of operations, and cash flows in accordance with GAAP.
Scope Limitations
a.
b.
Scope limitations impact the auditors ability to express an opinion on the entitys financial
statements because of the potential inability of auditors to identify misstatements that might have
been revealed had the procedures related to the scope limitation been performed.
c.
1.
If the account balances affected by the scope limitation are not material, auditors would
issue an unmodified opinion on the clients financial statements.
2.
If alternative procedures are performed and support the accounts affected by the scope
limitation, auditors would issue an unmodified opinion on the clients financial
statements.
3.
Because the scope limitation is material and auditors are unable to perform alternative
procedures, either a qualified opinion or disclaimer of opinion would be issued on the
clients financial statements. The type of opinion issued by the auditors would depend
upon the materiality and pervasiveness of the scope limitation, with disclaimers being
issued for more significant scope limitations (those involving material and pervasive
accounts).
12-11
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d.
1.
The auditors report would not be affected; a standard (unmodified) report would be
issued.
2.
The auditors report would not be affected; a standard (unmodified) report would be
issued (the report would not need to mention that alternative procedures were performed
by auditors).
3.
The auditors report modifications are shown below. The modifications to the auditors
standard (unmodified) report differ, depending upon whether a qualified opinion or
disclaimer of opinion is issued.
Qualified
Disclaimer
Introductory
paragraph
No modification
Auditors
Responsibility
No modification
Opinion
paragraph
Additional
paragraph
12-12
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12.48
Scope Limitations
Scenario A: Bruce can issue an unmodified opinion (standard report), since alternative procedures were
performed and allowed Bruce to be satisfied as to the ending balances in inventory.
Scenario B: In this situation, Bruce is unable to evaluate the ending balances in inventory. As a result, he
would issue either a qualified opinion or disclaimer of opinion on the financial position, results of
operations, and cash flows for the year ended December 31, 2014. Bruces choice of opinions would
depend upon the materiality and pervasiveness of the inventory account to the financial statements.
Because this is a circumstance-imposed limitation resulting from Bruces late appointment, the
ramifications are not as serious in terms of other areas of the audit examination.
Scenario C: This scenario introduces some unique circumstances. While it appears that Bruce has gathered
sufficient appropriate evidence with respect to Weavers ending inventory balances and would be able to
issue an unmodified opinion (standard report), some concerns would exist with respect to Weavers request
that Bruce not observe physical inventories. Clearly, Bruce should consider the reasons for this request and
the potential impact of this request on his ability to rely on Weavers representations related to other matters
in the audit examination.
Scenario D: In this scenario, the inability of Bruce to observe inventories or perform alternative procedures
represents a scope limitation that precludes the issuance of an unmodified opinion. While either a qualified
opinion or disclaimer of opinion could be issued in this situation, the fact that this is a client-imposed scope
limitation suggests that a disclaimer of opinion would be more appropriate. Clearly, Bruce should consider
the reasons for this request and the potential impact of this request on his ability to rely on Weavers
representations related to other matters in the audit examination.
12-13
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12.49
Scope Limitations
a.
In this situation, the fact that Brady is only able to obtain evidence related to one of Patriots
warehouses (which represents 20 percent of the inventories) and that Brady does not feel this level
of testing provides sufficient appropriate evidence would likely be considered a scope limitation.
This is a circumstance-imposed scope limitation, assuming that Patriot did not restrict or otherwise
limit Brady from observing inventory counts in its remaining warehouses.
b.
Assuming Patriot did not restrict or limit Brady from observing inventory counts in its remaining
warehouses and the effects of the scope limitation were not pervasive, Brady would issue a
qualified opinion on Patriots financial statements. The standard (unmodified) report would be
modified as follows:
An additional paragraph would be added to the report to discuss the nature and magnitude
of the scope limitation.
Alternatively, if Brady felt that the scope limitation was of such a level of materiality and
pervasiveness that a disclaimer of opinion was appropriate, his report would be modified as
follows:
c.
The introductory paragraph would be modified to indicate that Brady was engaged to
audit (instead of audited) Patriots financial statements.
The first paragraph in the Auditors Responsibility section would be modified to note that
the auditors were not able to obtain sufficient appropriate evidence.
The last two paragraphs in the Auditors Responsibility section would be deleted.
An additional paragraph would be added to the report to discuss the nature and magnitude
of the scope limitation.
12-14
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d.
The type of opinion issued would depend upon the alternative procedures performed. With one
exception, assuming the alternative procedures provided Brady with sufficient appropriate
evidence as to the fairness of Patriots inventories, an unmodified opinion (standard report) would
be issued. This report would not reference the fact that Brady did not observe inventory counts at
the remaining warehouses nor the alternative procedures performed.
The use of component auditors would require a modification of Bradys report. If Brady decided
to utilize component auditors and refer to their work, the report would be modified to indicate that
component auditors performed part of the examination and to provide an indication as to the
magnitude of the inventories related to their procedures. Bradys opinion on Patriots financial
statements would still be unmodified in this instance.
12.50
Michaels should:
1.
2.
Obtain a representation from Thomas that Thomas is independent under the requirements
of the AICPA or the requirements of the SEC, as appropriate
3.
Adopt appropriate measures to ensure the coordination of activities with Thomas in order
to achieve a proper review of matters affecting the consolidating or combining of
accounts in the financial statements. In order to accomplish this, Michaels must ascertain
that:
Thomas is aware that the financial statements of the component Thomas has
examined are to be included in the financial statements on which Michaels will
report and that Thomass report thereon will be relied upon (and, where
applicable, referred to) by Michaels.
b.
If Michaels decides to make reference to the examination of Thomas, Michaelss report should
indicate the involvement of Thomas as a component auditor. The report should disclose the
magnitude of the portion of the financial statements examined by Thomas by stating the dollar
amounts or percentages of one or more of the following: total assets, total revenues, or other
appropriate criteria, whichever most clearly represents the portion of the financial statements
examined by Thomas. Thomas may be named, but only with Thomass express permission and
provided Thomass report is presented together Michaels report.
c.
If Michaels does not wish to assume responsibility for Thomas work nor refer to Thomas work
and report, Michaels (the group auditor) faces a scope limitation (a portion of the financial
statements is essentially unaudited insofar as Michaels is concerned, assuming that Michaels is not
able to audit the portion). As a result, Michaels will express either a qualified opinion or
disclaimer of opinion.
12-15
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12-16
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12.51
a.
Either a qualified opinion or a disclaimer of opinion, depending upon the reason for the
scope limitation (client-imposed versus circumstance-imposed) and the degree of
materiality and pervasiveness.
b.
2.
3.
4.
a.
Either a qualified opinion or adverse opinion, depending upon degree of materiality and
pervasiveness of the GAAP departure.
b.
Explain the departure from GAAP in an additional paragraph before the opinion
paragraph and modify the opinion paragraph to express the appropriate opinion.
NOTE: Because the auditors believe a loss should be recorded based on the probable settlement,
this represents a departure from GAAP.
a.
Either a qualified opinion or adverse opinion, depending upon degree of materiality and
pervasiveness of the GAAP departure.
b.
Explain the departure from GAAP in an additional paragraph before the opinion
paragraph and modify the opinion paragraph to express the appropriate opinion.
a.
b.
5.
a.
Unmodified opinion.
b.
Without modifying the paragraphs of the standard (unmodified) report, describe the
omitted information in an other-matter paragraph following the opinion paragraph.
12-17
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6.
7.
8.
a.
Unmodified opinion.
b.
Describe the component auditors work in the Auditors Responsibility section and
modify the opinion paragraph to indicate In our opinion, based upon our audit and the
report of other auditors, the financial statements... (NOTE: The phrase component
auditors could be substituted for other auditors in the above).
a.
Unmodified opinion.
b.
Without modifying the paragraphs of the standard (unmodified) report, identify the
change in accounting principle and refer to the financial statement note discussing this
change in principle in an emphasis-of-matter paragraph following the opinion paragraph.
a.
Unmodified opinion.
b.
Without modifying the paragraphs of the standard (unmodified) report, identify the
going-concern uncertainty and refer to the financial statement note discussing the goingconcern uncertainty in an emphasis-of-matter paragraph following the opinion paragraph.
NOTE: If the going-concern uncertainty was highly significant, a disclaimer of opinion would be
a reporting option in this situation.
12.52
The introductory and opinion paragraphs would only refer to Lucks 2014 financial statements.
Stanford would add an other-matter paragraph to the report that indicated the 2013 financial
statements were audited by other auditors and that an unmodified opinion was issued on those
statements.
2.
Stanford would add an emphasis-of-matter paragraph to its report to reference the significant
decline in the value of RealCos investment properties. Because this decline has been
appropriately recognized by RealCo, it is not a departure from GAAP and an unmodified opinion
would still be appropriate in this situation.
3.
If Stanford believed that substantial doubt exists about TechTimes ability to continue as a going
concern, it would add an emphasis-of-matter paragraph to the report to disclose this matter. (If
these going-concern uncertainties were extremely material and pervasive, a disclaimer of opinion
would be a reporting option for Stanford).
4.
Because Stanford has not audited Cardinal, Inc.s financial statements, it should issue a disclaimer
of opinion. The communication from Cardinal makes it possible that users may misunderstand
Stanfords level of involvement unless a disclaimer of opinion is issued.
5.
Stanford would issue a separate report to indicate that the summary financial information is fairly
stated in relation to the complete financial statements. It is important to note that it would not be
appropriate for Stanford to indicate that the summary financial information is fairly presented
according to GAAP.
6.
Stanford should add an other-matter paragraph indicating that the verbiage in Plunketts
Management Discussion & Analysis section is not consistent with Plunketts financial statements.
It is important to note that it would still be appropriate for Stanford to issue an unmodified opinion
on Plunketts financial statements, since they are presented in accordance with GAAP.
12-18
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7.
12.53
Stanford should expand its report on Oil Patchs financial statements to add an other-matter
paragraph that identifies the supplementary information and describes the procedures performed
with respect to this information. In addition, Stanford should specifically disclaim an opinion or
any form of assurance on the supplementary information. Because the supplementary information
was presented in conformity with FASB guidelines and did not appear to depart from GAAP, no
additional references should be made to this information.
Because the departure is not material, the auditors could issue an unmodified opinion without
modifying the standard (unmodified) report or referencing the departure.
2.
Because the auditors were able to perform alternative procedures, a standard report (unmodified
opinion) could be issued without any reference to the scope limitation or alternative procedures
performed by the auditors. The fact that the scope limitation is circumstance-imposed rather than
client-imposed is not relevant with respect to this reporting decision; however, the fact that it is
circumstance-imposed does not raise other potentially negative issues associated with clientimposed scope limitations.
3.
Because the auditors do not agree with the rationale for the change in accounting principle, this
would be treated as a departure from GAAP and a qualified or adverse opinion would be
appropriate. The opinion paragraph of the standard (unmodified) report would be modified to
reflect the auditors opinion and an additional paragraph would be added discussing the departure
from GAAP, its effects on the financial statements, and the auditors disagreement with the
rationale for the change.
4.
The auditors would issue a one-paragraph disclaimer of opinion indicating that they are not
independent with respect to the client.
5.
The auditors would issue an unmodified opinion and add an emphasis-of-matter paragraph
referencing the entitys disclosure of going-concern uncertainties. (If these going-concern
uncertainties were extremely serious, a disclaimer of opinion would be a reporting option).
6.
The auditors would issue an unmodified opinion and add an emphasis-of-matter paragraph to the
standard (unmodified) report describing the acquisitions.
7.
The auditors would issue an unmodified opinion and modify the Auditors Responsibility section
and opinion paragraphs of the standard (unmodified) report on the group financial statements to
indicate the involvement of component auditors.
8.
The auditors could issue either a qualified or adverse opinion, depending upon the materiality of
the misstatement and the pervasiveness of its impact on the financial statements. The opinion
paragraph of the standard (unmodified) report would be modified to reflect the auditors opinion
and an additional paragraph would be added discussing the departure from GAAP and its effects
on the financial statements.
12-19
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9.
The auditors could issue either a qualified opinion or a disclaimer of opinion, depending upon the
materiality and pervasiveness of the accounts impacted by the scope limitation. The report
modifications would depend upon the type of opinion selected, as noted below:
Qualified
Disclaimer
Introductory
paragraph
No modification
Auditors Responsibility
section
No modification
Opinion
paragraph
Additional
paragraph
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12.54
2.
The auditors should address the report to the body that has engaged them (the Continental
Corporation Board of Directors). While the report may be read and used by others who are indirect
beneficiaries of the audit, it is not appropriate to address the report to the unknown class of users.
3.
The statement of cash flows is not referenced in the introductory paragraph, yet an opinion is
provided in the opinion paragraph on cash flows.
4.
The sentence that identifies the auditors responsibility for issuing an opinion on the financial
statements is missing from the Auditors Responsibility section.
5.
The report uses inappropriate language in the Auditors Responsibility section; instead of
referencing auditing standards generally accepted in the United States of America, it indicates
that the audit was performed in accordance with instructions by Continentals management and
that a complete audit was conducted, both of which are inappropriate.
6.
The sentence in the Auditors Responsibility section related to obtaining reasonable assurance
about whether the financial statements are free from material misstatement is not included.
7.
The opinion paragraph should not be modified with the phrase with the explanation given
below.
8.
The opinion paragraph should not mention minor errors we consider immaterial, but it should
contain the phrase present fairly in all material respects.
9.
The opinion paragraph should not include reference to cash flows because the introductory
paragraph did not state that the cash flow statement was audited. This may be a deficiency in the
identification of the financial statements that were actually audited. (See earlier deficiency related
to the introductory paragraph).
10.
The opinion paragraph refers improperly to FASB pronouncements. It should refer to accounting
principles generally accepted in the United States of America.
11.
The date of Rosss report should be September 23 (the audit completion date) and not Continental
Corporations fiscal year end date (July 31).
12.
The inclusion of the emphasis-of-matter paragraph describing the economy and the strike is
questionable. Assuming that its inclusion is appropriate, the reference to negative assurance
(concerning the recording of sales) is not appropriate.
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12.55
The report is improperly addressed to the president instead of to the board of directors or others
that engaged the auditors.
2.
The introductory paragraph does not identify the specific financial statements audited: balance
sheet, statements of income, changes in shareholders equity, and cash flows.
3.
The introductory paragraph incorrectly includes information about the auditors responsibility to
conduct an audit in accordance with GAAS (this information should be presented in the Auditors
Responsibility section).
4.
The Managements Responsibility for the Financial Statements section has been omitted.
5.
The Basis for Adverse Opinion paragraph does not make reference to the requirements of
GAAP; specifically, that property and equipment should be stated at an amount not exceeding
historical cost, and deferred income taxes should be provided. Therefore, all the substantive
reasons for the adverse opinion have not been stated in the report.
6.
The Basis for Adverse Opinion paragraph should either provide the monetary effects of the
departures from GAAP (appraisal values and installment method) or indicate that the monetary
effects are not reasonably determinable.
7.
8.
The opinion paragraph should contain a direct reference to the additional paragraph that provides
the basis for the adverse opinion.
9.
The conclusion in the opinion paragraph that the financial statements referred to above, present
fairly, in all material respects is not appropriate for an adverse opinion.
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12.56
The financial statements are not individually identified in the introductory paragraph.
2.
While the financial statements have not been individually identified (see [1] above), the
description of the time period is also inappropriate. For the results of operations, changes in
shareholders equity, and cash flows, instead of indicating as of, the report should indicate for
the two years ended.
3.
The opinion paragraph refers only to the current-year financial statements, but should refer to both
the current-year (2014) and the prior-years (2013) financial statements presented in comparative
form.
4.
The phrase based upon the following in the opinion paragraph is not appropriate and may be
misinterpreted as some sort of qualification.
5.
The consistency phrase (consistently applied) in the opinion paragraph is inappropriate; the
change in method of computing inventory cost should be mentioned in a separate emphasis-ofmatter paragraph.
6.
The consistency matter should not be phrased using except for terms because this language is
reserved for use to qualify an opinion for a GAAP departure or a scope limitation.
7.
The type of opinion (adverse) previously issued on the prior-years financial statements and date
of the auditors report on the prior-years financial statements is not identified in the other-matter
paragraph.
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12.57
Audit Report Deficiencies: Audits of Group Financial Statements and Other Operating Matters
Auditors Responsibility Section
1.
The magnitude of the assets and revenues audited by the component auditors is not disclosed.
2.
The component auditors name is disclosed, which is only appropriate if the component auditors
report is included with the group auditors report. This report provides no indication that the
component auditors report is presented along with the group auditors report.
3.
The phrase with the exception of this matter is not appropriate, since the involvement of
component auditors does not result in a violation of GAAS.
Opinion Paragraph
4.
The opinion should not appear to be qualified by use of the phrase except for the matter of the
report of the component auditors. The proper wording is In our opinion, based on our audit and
the report of component auditors, the financial statements... (NOTE: The phrase other auditors
could be substituted for component auditors in the report.)
5.
The opinion omits the required reference to accounting principles generally accepted in the United
States of America.
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12.58
Reason
Correction
1.
2.
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12.59
The phrase in accordance with accounting principles generally accepted in the United States of
America is omitted.
Auditors Responsibility:
The auditors obtain reasonable assurance about whether the financial statements are free of
material misstatement, not fairly presented.
An audit provides a basis for our audit opinion, not a basis for determining whether any
material modifications should be made to the financial statements.
This paragraph should follow the opinion paragraph, not precede it.
Opinion Paragraph:
The phrase except for the accounting change, with which we concur should not be used in
conjunction with the consistency issue. Related to this, the auditors concurrence with the change
in accounting principles is implicit and should not be mentioned.
The fact that the outcome of the lawsuit cannot presently be estimated is omitted.
It is inappropriate to state that provision for any liability is subject to adjudication because the report
is ambiguous as to whether a liability has been recorded.
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12.60
Opinion
Internal Control
Report
Combined
Auditor
Unmodified
Additional Paragraph(s)
or Matter(s)
None
ExxonMobil
(XOM)
Wal-Mart Stores
(WMT)
Chevron (CVX)
Unmodified
None
Separate
EY
Unmodified
Reference to financial
statement schedule
Reference to condensed
financial information
and financial statement
schedule
Two paragraphs related
to consistency
Combined
PwC
ConocoPhillips
(COP)
Unmodified
Separate
EY
General Motors
(GM)
Unmodified
Separate
Deloitte
PwC
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12-28
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b.
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McGraw-Hill Education.
12.62
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12.63
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12.65
The financial review section contains statements inconsistent with the audited financial statements.
This case does not address the materiality of the inconsistency.
Calculations:
Operating income
Current
Year
Prior
Year
$ 400,000
$ 360,000
Incremental
Basis
$ 40,000
Extraordinary gain
realization of tax
benefits
100,000
Interest expense
( 81,250)
( 60,000)
( 21,250)
Income taxes
(127,500)
(120,000)
( 7,500)
Net income
$ 291,250
100,000
$ 180,000
$ 111,250
$360,000 /
$60,000
$40,000 /
$21,250
Ratio
4.92:1
6:1
1.88:1
Ratio including
Extraordinary gain in
Numerator
6.15:1
6:1
6.59:1
Notice that the officers have managed to find the combination of numbers that produces the
highest (most favorable) ratio in the current year. They compared the ratio of operating income to
interest expense for the previous year to that same ratio on an incremental basis. While the
calculations are correct, a more appropriate comparison would be to compare the current-years
ratio (excluding the extraordinary gain) to that for the prior year.
b.
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b.
12.67
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b.
Reporting on an accounting change the auditors think is not reported or disclosed in accordance
with ASC 250.
Independent Auditor's Report
12.68
This issue is a difficult one because the firm is dealing with another accounting firm conducting a
significant part of the audit. However, when large balances make up a significant portion of an
entitys balance sheet (in this case, 38 percent of Parmalats assets were in the subsidiarys bank
account), auditors should take additional care to obtain additional corroboration. They certainly
should have visited the component auditors offices to examine their documentation.
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12.69
Examining the financial information in Exhibit GM 1, it appears that GMs financial distress
began in 2005. It was during this year that GM suffered its first negative operating loss and first
net loss. Similarly, Exhibit GM 2 reveals that GMs stock price significantly declined during 2005.
2.
3.
Internal matters (work stoppages or other labor difficulties, substantial dependence on the
success of a particular project, uneconomic long-term commitments, or the need to
significantly revise operations).
External matters (legal proceedings; legislation; loss of a key franchise, license, or patent;
loss of a principal customer or supplier; or, uninsured or underinsured catastrophe).
This is a question that requires judgment on the part of the student. Clearly, while the losses in
2005 are of concern given GMs consistent profitability to that point, 2005 may have been viewed
as an abnormal year and the loss judged to be a one-time occurrence. While GM also experienced
a net loss in 2006, the amount of this loss was lower than that in 2005 (likely because of the spinoff of GMAC). In both years, GM showed negative cash flow from operations, raising further
questions as to GMs ability to continue as a going-concern.
In 2007, GMs net loss reached almost $39 billion; however, cash flow from operations was a
positive $7.7 billion in that year. Based on AU 570, the third consecutive year of recurring
operating losses (see [2] above) might be interpreted as some to have been indicative of goingconcern uncertainties. However, it is also reasonable to conclude that the positive cash flow from
operations in 2007 might mitigate Deloitte & Touches concerns to some extent.
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