Applause

Chapter 17 - Auditors' Reports
CHAPTER 17
Auditors' Reports
Review Questions
171 The sections of the standard audit report for a nonpublic company are: (1) introductory section (hich
does not ha!e a section title)" (#) mana$ement%s responsibility for the financial statements" (&) auditor%s
responsibility" and (') opinion(
17# The function of notes to financial statements is to pro!ide ade)uate disclosure hen information in the
financial statements is insufficient to attain this ob*ecti!e(
17& The primary differences are that the +CA,- report (& re)uired):
.ncludes the ords /Re$istered/ in the title(
References standards of the +CA,- rather than $enerally accepted auditin$ standards(
.ncludes less detailed discussions of mana$ement and auditor responsibilities(
.ncludes an additional para$raph indicatin$ that the auditors ha!e also issued a report
on the client's internal control o!er financial reportin$(
0oes not include section titles(

17' 0isa$ree( 1hile 2AA+ is a fre)uently used financial reportin$ frameor3" 2AA4 is a set of auditin$
standards" not a financial reportin$ frameor3(
175 The types of unmodified and modified opinions include:
(1) 6nmodified opinion 7standard(
(#) 6nmodified opinion ith an emphasis-of-matter para$raph(
(&) 6nmodified opinion ith an other-matter para$raph(
(') 6nmodified opinion ith di!ided responsibility on $roup financial statements(
(5) 8ualified opinion(
(9) Ad!erse opinion(
(7) 0isclaimer of opinion(
179 The report should be dated as of the date 2reen obtained sufficient appropriate audit e!idence to
support the opinion" :ebruary #;( (The financial statements and the re!ie of the audit both must be
completed()
177 <o( Reference to a component auditor in a $roup audit report" in itself" does not represent a
)ualification( Rather" this form of opinion merely di!ides the auditors' o!erall responsibility for the
en$a$ement beteen to or more C+A firms( <ote" hoe!er" that factors other than the di!ision of
responsibility may lead to a )ualified report (i(e(" departures from 2AA+ and scope limitations)(
17-1
= #;1' by >c2ra-?ill @ducation( This is proprietary material solely for authoriAed instructor use( <ot authoriAed for sale or distribution in any manner(
This document may not be copied" scanned" duplicated" forarded" distributed" or posted on a ebsite" in hole or part(
17B The ordin$ of a report ith an unmodified opinion mi$ht depart from the ordin$ of the standard
report hen (only three re)uired)
4ubstantial doubt about an entity%s ability to continue as a $oin$ concern eCists(
+rinciples of accountin$ ha!e not been consistently applied in relation to the prior year(
The auditors ish to emphasiAe some matter in the financial statements (e($(" si$nificant
related party transactions" si$nificant e!ents" uncertainties)(
A $roup auditor ma3es reference to a component auditor(
17D The audit report should include an emphasis-of-matter section that describes the chan$e and ma3es
reference to the financial statement note eCplainin$ the nature of and *ustification for the chan$e in the
method of !aluin$ the in!entories and the effect of such chan$e upon the financial statements(
171; The to circumstances resultin$ in modified opinions are (a) materially misstated financial statements
(a Edeparture from 2AA+F) and (b) inability to obtain sufficient appropriate audit e!idence (a Escope
limitationF)(
1711 The statement is incorrect( .f the misstatement is immaterial" an unmodified opinion may be issued( .f
it is material" the auditors issue either a )ualified opinion or an ad!erse opinion dependin$ upon
hether they belie!e the misstatement is per!asi!e(
171# @ffects of misstatements become per!asi!e hen" in the auditor%s *ud$ment" they meet one or more of
the folloin$ three criteria:
They are not confined to specific elements" accounts" or items of the financial statementsG
.f confined" they represent or could represent a substantial proportion of the financial
statementsG or
.n relation to disclosures" they are fundamental to users% understandin$ of the financial
statements(
171& A client can a!oid an opinion )ualified because of inade)uate disclosure merely by ma3in$ the
appropriate disclosure in the financial statements(
171' .n such a circumstance a -asis for 8ualified ,pinion section is added to the report and the opinion
para$raph is modified(
1715 4ince the auditors ha!e not been able to form an opinion on the financial statements ta3en as a hole"
they must disclaim an opinion( ?oe!er" they should set forth their reser!ations about the accountin$
treatment of the deferred income taCes in an eCplanatory para$raph to their disclaimer(
1719 ,rdinarily" ad!erse opinions do the client no $ood( +resumably" creditors and stoc3holders ould not
pro!ide debt or e)uity capital and" if the client is under 4@C *urisdiction" the 4@C mi$ht launch an
in!esti$ation of mana$ement for !iolations of the federal securities acts( Thus" the client usually ill
ma3e hate!er chan$es in the financial statements that the auditors re)uire in order to a!oid recei!in$
an ad!erse opinion( .n fact" in the fe cases in hich the client and its auditors cannot a$ree" the client
ould probably dischar$e the auditors instead of ha!in$ them complete an audit that culminates in an
ad!erse opinion(
1717 The statement is not correct( A basis for modification para$raph is of three possible types: (1) basis
for )ualified opinion para$raph" (#) basis for ad!erse opinion para$raph" and (&) basis for disclaimer
of opinion para$raph( 1hile 2AA4 (and international standards) refer to a basis for modification
para$raph" that term is not used in an audit report7one of the three more descripti!e terms is used
hen an audit opinion is modified(
171B Hes( @ach year%s financial statements /stand alone(/ Thus" the C+As may issue different types of
opinions on the financial statements of successi!e years hen reportin$ on comparati!e statements(
17-#
171D Hes( 1hen reportin$ on comparati!e statements" C+As should update their report on the prior year's
statements to determine hether it is still the proper type of report to accompany those statements( :or
eCample" a departure from 2AA+ that eCisted last year" resultin$ in a report )ualification" mi$ht ha!e
been corrected( .n this case" it is appropriate for the auditors to re!ise their report on the prior year's
statements to a standard un)ualified report(
17#; The reports containin$ audited financial statements filed by a company sub*ect to the reportin$
re)uirements of the 4@C may include:
Forms S-l throu$h S-11( These are the /re$istration statements/ for clients plannin$ to issue securities
to the publicG they are accompanied by comparati!e audited financial statements(
Forms SB-1 and SB-2. These forms are more simplified re$istration forms for small businesses(
Form 8-K( A report filed upon the occurrence of a specified si$nificant e!ent( .f the e!ent is a
si$nificant ac)uisition or disposal of assets" Form 8-K ill be accompanied ith pro forma financial
information( An B-I report is used to report a chan$e in auditors(
Form 10-Q. This form includes )uarterly financial statements re!ieed by the company%s auditors(
Form 10-K( This report is filed annually by publicly oned companies and includes audited financial
statements" reports on internal control o!er financial reportin$" and other detailed financial information(
Questions Requiring Analysis
17#1 a. (1) The first sentence of the statement is partially true( .t is important to
read the notes to financial statements because they pro!ide important supplementary
information(
(#) <otes often pertain to compleC matters and are presented in technical lan$ua$e(
Certainly it must be ac3noled$ed that sometimes they could be presented in a clearer
form(
(&) To the eCtent the notes supplement disclosures in the body of the financial statements"
they could reduce the auditors' eCposure to third-party liability( The disclosure must be
supplementary" not contradictory(
b. (1) The second statement is ron$ in assertin$ that the notes can be used to
correct or contradict financial statement presentation( <otes are an inte$ral part of the
financial statements( .f there is contradiction or if the presentation is
incomprehensible" this constitutes inade)uate reportin$ and re)uires )ualification of
the audit report(
(#) The statement fails to reco$niAe that hile there is a need for accuracy and
completeness" those notes should also be comprehensible(
(&) The statement incorrectly assi$ns mana$ement's primary responsibility for the
financial statements and notes to the auditors( The auditors' relationship to the notes is
the same as their relationship to the balance sheet and other financial statementsG their
actions are $o!erned by the same reportin$ responsibilities and liabilities to interested
parties(
(') -ecause notes are prepared by mana$ement" the auditors cannot control their content(
,ther ad!isers" e($(" le$al counsel" ill influence the ordin$ of notes( The auditors
properly should recommend impro!ements in presentation" but they ill modify their
report%s opinion only if disclosure is inade)uate or so unclear as to be misleadin$(
17## a. The $roup auditors are not re)uired to ma3e reference to the component auditors(
>a3in$ reference merely di!ides the auditors' collecti!e responsibility for the en$a$ement
17-&
beteen the to C+A firms( .f the $roup auditors are illin$ to assume full responsibility for
the en$a$ement (hich they often ill do if they retained the component auditors)" they need
ma3e no reference to the other auditors in their report( <ote" hoe!er" as is discussed in the
chapter" hen no reference is made the $roup auditors must perform additional audit
procedures" the scope of hich is based upon the si$nificance of the subsidiary audited by the
component auditors(
b. Althou$h Jones K Abbot issued a )ualified report on the Canadian subsidiary" Roe K >yers
do not necessarily ha!e to )ualify their report( Roe K >yers ill e!aluate issues in li$ht of
hat is material to the consolidated entity" hereas Jones K Abbot e!aluated them in relation
to hat as material for the Canadian subsidiary( As the consolidated entity is lar$er than the
subsidiary" the problem at the subsidiary may be immaterial to 0unbar @lectronics(
17#& a. 1hen a component auditor eCists" the $roup en$a$ement partner should
determine hether sufficient appropriate audit e!idence can reasonably be eCpected to
be obtained re$ardin$ the consolidation process and the financial information on the
components( .n addition" the $roup auditor should obtain an understandin$ of
1hether the component auditor is competent and understands and ill comply
ith all ethical re)uirements" particularly independence(
The eCtent to hich the $roup en$a$ement team ill be in!ol!ed ith the
component auditor(
1hether the $roup en$a$ement team ill be able to obtain necessary
information on the consolidation process from the component auditor(
1hether the component auditor operates in a re$ulatory en!ironment that
acti!ely o!ersees auditors(
b. .f >ichaels decides to ma3e reference to the audit of Thomas" >ichaels' report should indicate
clearly" in the auditor%s responsibility section of the audit report the di!ision of responsibility
beteen that portion of the financial statements co!ered by >ichaels' audit and that co!ered by
the audit of Thomas( .n the opinion para$raph" after E.n our opinion"F the folloin$ should be
added Ebased on our audit and the report of the other auditors(F
17#' a. .nformation contrary to an assumption that a client ill remain a $oin$ concern
usually relates to the company's ability to meet its financial obli$ations( Conditions that
indicate such a problem include recurrin$ operatin$ losses" or3in$ capital deficiencies"
ad!erse financial ratios" defaults on loans" and arreara$es in di!idends( ,ther conditions such
as or3 stoppa$es" le$al matters" le$islation" and loss of principal customers may also indicate
a )uestion as to a client's ability to remain a $oin$ concern(
b. After disco!erin$ conditions and e!ents that mi$ht indicate substantial doubt as to hether a
firm can continue as a $oin$ concern" the auditors must obtain and e!aluate mana$ement's
plans for dealin$ ith the conditions and e!ents( After re!iein$ the feasibility of
mana$ement's plans" if the auditors still belie!e that there is substantial doubt as to ability to
continue as a $oin$ concern" they should determine that the matters are properly disclosed in
the financial statements and also should modify the audit report to reflect that conclusion(
Obe!tive Questions
17#5 >ultiple Choice 8uestions
17-'
a. (&) 1hen the auditors ta3e eCception to the application of accountin$
principles in the client's financial statements" they ill issue either a )ualified or
ad!erse opinion" dependin$ on hether the misstatement is considered per!asi!e(
b. (#) The audit report should be dated no earlier than hen the auditors ha!e accumulated
sufficient appropriate e!idence( This date is often the last day of fieldor3(
c. (1) Reference to the or3 of a component auditor is not" in itself" a )ualification
of the $roup audit report( This reference does not lessen the auditors' collecti!e
responsibility( Rather" it merely di!ides this responsibility amon$ to or more C+A
firms(
d. (') This phrase !iolates the fourth standard of reportin$" because it does not $i!e
the reader of the report a clear-cut indication of the auditors' opinion( The phrase
appears to modify the standard opinion para$raph" but is not forceful enou$h to
constitute )ualifyin$ lan$ua$e(
e. (1) The auditor communicates throu$h the auditors' report" and therefore only
anser (1) is correct( <ote that the client ill include a discussion of the related party
transactions in a note to the financial statements(
f. (&) 1hen a misstatement is per!asi!e" an ad!erse opinion is appropriate(
g. (1) A consistency modification results in an emphasis-of-matter para$raph(
8ualified and ad!erse opinions include a basis for modification para$raph( 1hen a
report refers to component auditors no additional para$raph is added(
h. (#) An audit report of a public client indicates that the audit as performed in
accordance ith standards of the +ublic Company Accountin$ ,!ersi$ht -oard
(6nited 4tates)(
i. (&) An audit report for a public client indicates that the financial statements are
presented in conformity ith $enerally accepted accountin$ principles (6nited 4tates)(
The +CA,- does not issue accountin$ standards(
j. (&) 4ubstantial doubt about a client%s ability to continue as a $oin$ concern results
in either an un)ualified report ith eCplanatory lan$ua$e or a disclaimer of opinion(
Accordin$ly anser (&) is correct since a )ualified report is not appropriate(
k. (#) 1hen an un*ustified chan$e in accountin$ principles occurs" either a )ualified
or ad!erse opinion is appropriate as this represents a departure from $enerally
accepted accountin$ principles( Accordin$ly" anser (#) is correct since an ad!erse
opinion" but not a disclaimer of opinion is appropriate(
l. (&) An emphasis-of-matter para$raph is appropriate hen an auditor ishes to
emphasiAe a matter concernin$ the financial statements" but not a matter concernin$
the scope of the audit en$a$ement( Accordin$ly" anser (&) is not a situation in hich
an emphasis-of-matter para$raph is appropriate since confirmin$ accounts recei!able
relates to the scope of the audit(
17#9 Tas3--ased 4imulation
a. 1( An unmodified (standard report) should be issued(
b. 9( @ither a )ualified or an ad!erse opinion is re)uired( Laluation of properties at appraised
!alues is not in accordance ith $enerally accepted accountin$ principles( 4ince the difference
17-5
beteen appraised !alue and cost is si$nificant" an un)ualified opinion ould not be
appropriate(
c. 7( A scope restriction results in either a )ualified opinion or a disclaimer of opinion( -ecause
e ha!e no information on hether a possible misstatement could per!asi!ely misstate the
financial statements" either type of opinion is possibly appropriate(
d. &( -ecause the misstatements could be material" but could not per!asi!ely misstate the
financial statements" a )ualified opinion is appropriate(
e. 9( A )ualified or an ad!erse opinion is necessary( The C+A firm has ac)uired sufficient
appropriate e!idence to the effect that the in!estments in stoc3 of subsidiary companies are
o!erstated( <ote disclosure does not compensate for improper balance sheet presentation(
17#7 Tas3--ased 4imulation
a. 5( -ecause the possible effects on the financial statements of undetected
misstatements" if any" could be both material and per!asi!e" a disclaimer is appropriate(
b. 1( 1hen no reference is made to the component auditors" a standard unmodified report is
issued(
c. &( A lac3 of disclosure leads to either a )ualified opinion or an ad!erse opinion( 4ince the
effect is material" but not per!asi!e" a )ualified opinion is appropriate(
d. #( 4ince the auditor concurs that the chan$e is desirable" an unmodified opinion ith an
emphasis-of-matter para$raph is appropriate(
e. '( -ecause the auditor does not concur ith the chan$e" it is a departure from 2AA+(
-ecause the amount is material and per!asi!e" an ad!erse opinion is appropriate(
17#B
.tem
<o( Type of Chan$e
@mphasis-of->atter
+ara$raph on
Consistency AddedM
(1) An accountin$ chan$e in!ol!in$ a chan$e
from one $enerally accepted accountin$
principle to another $enerally accepted
accountin$ principle(
Hes
(#) An accountin$ chan$e in!ol!in$ a chan$e
in an accountin$ estimate(
<o
(&) An error correction not in!ol!in$ an
accountin$ principle(
Hes
(') An accountin$ chan$e in!ol!in$ a
correction of an error in principle that is
accounted for as a correction of an error(
Hes
(5) A chan$e in accountin$ estimate effected
by a chan$e in accountin$ principle(
Hes
(9) <ot an accountin$ chan$e but rather a
chan$e in classification(
<o
(7) An accountin$ chan$e from one $enerally
accepted accountin$ principle to another
$enerally accepted accountin$ principle(
Hes
17-9
17#D Tas3--ased 4imulation
1( (:"J) A situation in hich an auditor is unable to obtain audited financial statements
for an in!estee represents a scope restriction( 4cope restrictions lead to either a
)ualified opinion or a disclaimer of opinion( A decision as to hether the auditors
should )ualify or disclaim the opinion is dependent upon hether per!asi!e
misstatements are possible(
#( (A".) 4ubstantial doubt about an entity's ability to continue as a $oin$ concern leads
to either an un)ualified opinion ith an emphasis-of-matter para$raph" or a disclaimer(
-ecause the problem indicates a disclaimer ill not be issued" only an un)ualified
opinion ith an emphasis-of-matter para$raph is appropriate(
&( (A">) A standard unmodified opinion is appropriate in circumstances in hich a
$roup auditor ta3es responsibility for the or3 of a component auditor(
'( (A".) 1hen an auditor a$rees ith a chan$e in accountin$ principles" a lac3 of
consistency results in an unmodified opinion ith an emphasis-of-matter para$raph
folloin$ the opinion para$raph(
17-7
5( (-"J) 0epartures from $enerally accepted accountin$ principles result in either a
)ualified opinion or an ad!erse opinion" based on the per!asi!eness of misstatements(
2i!en that the situation su$$ests that the misstatement cannot be per!asi!e" a )ualified
opinion is appropriate(
17&; Tas3--ased 4imulation
"ituation
Re#
port
Co$$ent
1( A company has not folloed $enerally accepted accountin$ principles
in the recordin$ of its leases(
7 This is a departure from 2AA+(
#( A company has not folloed $enerally accepted accountin$ principles
in the recordin$ of its leases( The amounts in!ol!ed are immaterial(
1 -ecause the amounts in!ol!ed are immaterial"
no audit report modification is necessary(
&( A company !alued its in!entory at current replacement cost( 1hile
the auditor belie!es that the in!entory costs do approCimate
replacement costs" these costs do not approCimate any 2AA+ in!entory
!aluation method(
7 Althou$h the auditor belie!es that the costs
approCimate replacement costs" they depart from
2AA+(
'( A client chan$ed its depreciation method for production
e)uipment from the strai$ht-line method to the units-of-production
method based on hours of utiliAation( The auditor concurs ith the
chan$e(
# This situation in!ol!es a lac3 of consistency(
5( A client chan$ed its depreciation method for production
e)uipment from the strai$ht-line to a units-of-production method
based on hours of utiliAation( The auditor does not concur ith the
chan$e(
7 -ecause the auditor does not concur ith the
chan$e" it is treated as a departure from 2AA+(
9( A client chan$ed the depreciable life of certain assets from 1;
years to 1# years( The auditor concurs ith the chan$e(
1 A proper chan$e in estimate does not re)uire an
emphasis-of-matter para$raph(
7( A client chan$ed the depreciable life of certain assets from 1;
years to 1# years( The auditor does not concur ith the chan$e(
Confined to fiCed assets and accumulated depreciation" the
misstatements in!ol!ed are not considered per!asi!e(
& -ecause the auditor does not concur ith the
chan$e in estimate" it is treated as a departure
from 2AA+( A )ualified report is appropriate
because the misstatements are not considered
per!asi!e(
B( A client chan$ed from the method it uses to calculate
postemployment benefits from one acceptable method to another one(
The effect of the chan$e is immaterial this year" but is eCpected to be
material in the future(
1 A chan$e in accountin$ principles ith an
immaterial effect (e!en if eCpected to become
material in the future) does not result in addition
of an emphasis-of-matter para$raph on
consistency(
D( A client chan$ed the sal!a$e !alue of certain assets from 5 percent
to 1; percent of ori$inal cost( The auditor concurs ith the chan$e(
1 This is a chan$e in estimate that does not result
in addition of an emphasis-of-matter para$raph
on consistency(
1;( A client uses the specific identification method of accountin$ for
!aluable items in in!entory" and N.:, for less !aluable items( The
auditor concurs that this is a reasonable practice(
1 Consistency is a beteen periods conceptG usin$
different in!entory !aluation methods such as
here is acceptable and does not result in an
emphasis-of-matter para$raph on consistency(
11( 0ue to recurrin$ operatin$ losses and or3in$ capital
deficiencies" an auditor has substantial doubt about an entity's ability
to continue as a $oin$ concern for a reasonable period of time( The
notes to the financial statements ade)uately disclose the situation(
9 This is a situation in hich there is substantial
doubt about a client%s $oin$ concern(
1#( 0ue to recurrin$ operatin$ losses and or3in$ capital
deficiencies" an auditor has substantial doubt about an entity's ability
to continue as a $oin$ concern for a reasonable period of time( The
notes to the financial statements do not ade)uately disclose the
substantial doubt situation" and the auditor belie!es the omission
fundamentally affects the users% understandin$ of the financial
statements(
' The lac3 of disclosure creates a departure from
2AA+( -ecause effects are per!asi!e
(fundamental to users% understandin$ of the
financial statements is a characteristic of
per!asi!eness)" an ad!erse opinion is
appropriate(
1&( An auditor reportin$ on $roup financial statements decides to ta3e 1 -ecause the auditor ta3es responsibility for the
17-B
responsibility for the or3 of a component auditor ho audited a 7;
percent oned subsidiary and issued an unmodified opinion( The total
assets and re!enues of the subsidiary are 5 percent and B percent"
respecti!ely" of the total assets and re!enues of the entity bein$ audited(
or3 of the component auditor" there is no
mention of the component auditor(
1'( An auditor reportin$ on $roup financial statements decides not to
ta3e responsibility for the or3 of a component auditor ho audited a
7; percent oned subsidiary and issued an un)ualified opinion( The
total assets and re!enues of the subsidiary are 5 percent and B percent"
respecti!ely" of the total assets and re!enues of the entity bein$ audited(
1; .n this situation the auditor%s responsibility
section and the opinion sections ha!e additional
ordin$ added" but there is no emphasis-of-
matter para$raph in hat remains a report ith
an unmodified opinion(
15( An auditor as hired after year-end and as unable to obser!e the
countin$ of the year-end in!entory( 4he is unable to apply other
procedures to determine hether endin$ in!entory and related
information are properly stated(
B This is a scope limitation(
19( An auditor as hired after year-end and as unable to obser!e the
countin$ of the year-end in!entory( ?oe!er" she as able to apply
other procedures and determined that endin$ in!entory and related
information are properly stated(
1 -ecause the auditor has satisfied herself throu$h
performin$ other procedures" a standard report
is appropriate(
17( An auditor disco!ered that a client made ille$al political payoffs to
a candidate for president of the 6nited 4tates( The auditor as unable
to determine that amounts associated ith the payoffs because of the
client's inade)uate record-retention policies( The client has added a
note to the financial statements to describe the ille$al payments and has
stated that the amounts of the payments are not determinable(
B This is a scope limitation because of the
inade)uate record retention policies and the
auditor%s inability to perform other procedures(
1B( An auditor disco!ered that a client made ille$al political payoffs to
a candidate for president of the 6nited 4tates( The auditor as unable
to determine that amounts associated ith the payoffs because of the
client's inade)uate record-retention policies" althou$h there is no
li3elihood that the financial statements are per!asi!ely misstated" they
may be materially misstated( The client refuses to disclose the payoffs
in a note to the financial statements(
& The lac3 of disclosure results in a departure
from 2AA+( -ecause the effect is less than
per!asi!e" a )ualified opinion is appropriate(
1D( .n auditin$ the lon$-term in!estments account of a ne client" an
auditor finds that a lar$e contin$ent liability eCists that is material to the
consolidated company( .t is probable that this contin$ent liability ill
be resol!ed ith a material loss in the future" but the amount is not
estimable( Althou$h no ad*ustin$ entry has been made" the client has
pro!ided a note to the financial statements that describes the matter in
detail(
1 -ecause the amount is not estimable" no
ad*ustin$ entry can be recorded( The auditor
mi$ht choose to emphasiAe this matter" but the
problem%s bac3$round rules out this treatment(
#;( .n auditin$ the lon$-term in!estments account of a ne client" an
auditor finds that a lar$e contin$ent liability eCists that is material to the
consolidated company( .t is probable that this contin$ent liability ill
be resol!ed ith a material loss in the future" and this amount is
reasonably estimable as O#";;;";;;( Althou$h no ad*ustin$ entry has
been made" the client has pro!ided a note to the financial statements
that describes the matter in detail and includes the O#";;;";;; estimate
in that note(
7 -ecause the amount is estimable" an ad*ustin$
entry should be recordedG since it as not" a
departure from 2AA+ eCists(
#1( A client is issuin$ to years of comparati!e financial statements(
The first year as audited by another auditor ho is not bein$ as3ed to
reissue her audit report( (Reply as to the successor auditor%s report()
1; The successor auditor reports on year #( -ut an
other-matter para$raph is added indicatin$ (1)
the prior-period statements ere audited by
other auditors" (#) the date and type of report
issued and" (&) if the report as other than
standard" the reasons therefore(
##( A client is issuin$ to years of comparati!e financial statements(
The first year as audited by another auditor ho is bein$ as3ed to
reissue her audit report( (Reply as to the successor auditor%s report()
1 A standard report is issued on the second year(
The other auditor%s report on the first year is
reissued and included(
#&( A client's financial statements follo 2AA+" but the auditor ishes
to emphasiAe in his audit report a si$nificant related party transaction
that is ade)uately described in the notes to the financial statements(
# This is an emphasis-of-matter situation(
#'( A client's financial statements follo 2AA+ eCcept that they do not
include a note on a si$nificant related party transaction(
7 This is a departure from 2AA+( <o information
is pro!ided on hether the omission is
considered per!asi!e(
17-D
17&1 Tas3--ased 4imulation
1( Correct( The title should include the ord Eindependent(F
#( Correct( The report should include an addressee(
&( Correct( There should be a section on mana$ement%s responsibility for the financial
statements(
'( .ncorrect( The report has the proper ordin$(
5( .ncorrect( -ecause Johnson K -ar3ley ish to assume responsibility for the or3 of Nar3in K
Na3e" no mention of Nar3in K Na3e should be made in the report(
9( .ncorrect( The para$raph is re)uired(
7( Correct( The emphasis-of-matter para$raph should follo the opinion para$raph(
B( .ncorrect( The opinion section should not mention consistency(
D( Correct( The date should be the date on hich sufficient appropriate audit e!idence has been
$athered(
1;( .ncorrect( The titles of the financial statements are not repeated in the opinion para$raph(
Proble$s
17&# 4,N6T.,<: 1illiams K Co(" C+As (@stimated time: #; minutes)
The auditors' report contains the folloin$ deficiencies:
.ntroductory section
1( The financial statements audited should indi!idually be named(
Auditor%s Responsibility section
#( 1hat should be the second sentence is missin$ (E1e conducted our audit in accordance ith
auditin$ standards $enerally accepted in the 6nited 4tates of America(F)
&( An auditor obtains reasonable assurance about hether the financial statements are /free of
material misstatement"/ not /in conformity ith $enerally accepted accountin$ principles/
(final sentence in first para$raph)(
'( The one sentence final para$raph (/1e belie!e that the audit pro!ides a reasonable basis for
our opinion(/) is omitted(
@mphasis-of->atter section
5( The section should follo the opinion para$raph(
9( The auditors should not $i!e an opinion concernin$ the entity's sur!i!al /beyond a reasonable
period of time(/
17-1;
,pinion section
7( A )ualified opinion is inappropriate (it should be unmodified)(
B( The date of the financial statements audited is omitted(
D( There should be no reference to consistency(
17&& 4,N6T,<: Nenses Co( (@stimated time: #; minutes)
The auditors' report contains the folloin$ deficiencies:
1( The title should include the ord E.ndependentF
#( The address ordinarily should not be mana$ement (it should be the board of directors" the audit
committee" or the shareholders" etc()
.ntroductory para$raph
&( .t should be$in ith E1e ha!e auditedP(F rather than E1e ha!e eCaminedP(F(
'( The final sentence concernin$ +CA,- re)uirements should not be included(
4cope para$raph
5( The audit should be conducted in accordance ith +ublic Company Accountin$ ,!ersi$ht
-oard standards rather than $enerally accepted auditin$ standards(
9( The auditor obtains reasonable assurance" not positi!e assurance(
7( The assurance relates to the financial statements bein$ free of EmaterialF misstatements not
EallF misstatements(
,pinion para$raph
B( The term EpresentF should be Epresent fairly(F
D( EApplied on a consistent basisF at the end of the para$raph is inappropriate and should be
deleted(
.nternal control para$raph
1;( E1e also ha!e re!ieedF at the be$innin$ of the para$raph should be E1e ha!e audited(F
17&' 4,N6T.,<: 4turdy Corporation (@stimated time: #; minutes)
a. A separate basis for modification section (titled E-asis for Ad!erse ,pinionF) should set forth
reasons for the eCpression of an ad!erse opinion and the principal effects of the sub*ect matter
of the ad!erse opinion( The section should state the folloin$" pro!idin$ dollar amounts here
practicable:
The company carries its buildin$ accounts at appraisal !alues and pro!ides for
depreciation on the basis of such !alues(
-uildin$s" accumulated depreciation" and e)uity (attributed to appraisals) are o!erstated(
<et income is understated(
0epreciation eCpense is o!erstated(
b. The opinion para$raph should contain a reference to the separate para$raph and state the
financial statements do not present fairly the financial position" results of operations" and cash
flos( .t should be orded as follos:
Ad!erse ,pinion
.n our opinion" because of the si$nificance of the matter discussed in the -asis
for Ad!erse ,pinion para$raph" the consolidated financial statements referred to
17-11
abo!e do not eCpress fairly the financial position of 4turdy Corporation as of
0ecember &1" 1DQ&" and the results of its operations and its cash flos for the
year then ended(
17&5 4,N6T.,<: @Ccelsior Corporation (@stimated time: #5 minutes)
%ndependent Auditor&s Report
To the -oard of 0irectors and 4toc3holders of @Ccelsior Corporation
1e ha!e audited the accompanyin$ consolidated financial statements of @Ccelsior Corporation and its subsidiaries" hich
comprise the consolidated balance sheet as of 0ecember &1" #;Q1" and the related consolidated statements of income"
chan$es in stoc3holders% e)uity and cash flos for the year then ended" and the related notes to the financial statements(
Managements !es"onsibilit# for the Financial Statement
>ana$ement is responsible for the preparation and fair presentation of these consolidated financial statements in accordance
ith accountin$ principles $enerally accepted in the 6nited 4tates of AmericaG this includes the desi$n" implementation and
maintenance of internal control rele!ant to the preparation and fair presentation of consolidated financial statements that are
free from material misstatement" hether due to fraud or error(
$%ditors !es"onsibilit#
,ur responsibility is to eCpress an opinion on these consolidated financial statements based on our audit( 1e conducted our
audit in accordance ith auditin$ standards $enerally accepted in the 6nited 4tates of America( Those standards re)uire that
e plan and perform the audit to obtain reasonable assurance about hether the consolidated financial statements are free of
material misstatement(
An audit in!ol!es performin$ procedures to obtain audit e!idence about the amounts and disclosures in the consolidated
financial statement( The procedures selected depend on the auditor%s *ud$ment" includin$ the assessment of the ris3s of
material misstatement of the consolidated financial statements" hether due to fraud or error( .n ma3in$ those ris3
assessments" the auditor considers internal control rele!ant to the entity%s preparation and fair presentation of the consolidated
financial statements in order to desi$n audit procedures that are appropriate in the circumstances" but not for the purpose of
eCpressin$ an opinion on the effecti!eness of the entity%s internal control( Accordin$ly" e eCpress no such opinion( An audit
also includes e!aluatin$ the appropriateness of accountin$ policies used and the reasonableness of si$nificant accountin$
estimates made by mana$ement" as ell as e!aluatin$ the o!erall presentation of the consolidated financial statements(
1e belie!e that the audit e!idence e ha!e obtained is sufficient and appropriate to pro!ide a basis for our audit opinion(
Basis for Q%alified &"inion
The corporation declined to disclose that the a$reement eCecuted in con*unction ith the issuance of the debentures of
January &1" #;Q1" for the purpose of financin$ eCpansion of plant facilities" restricts the payment of future cash di!idends to
earnin$s after 0ecember &1" #;Q1(
Q%alified &"inion
.n our opinion" eCcept for the effects of omittin$ the information on the debentures discussed in the -asis for 8ualified
,pinion +ara$raph" the financial statements referred to abo!e present fairly" in all material respects" the financial position of
@Ccelsior Corporation and its subsidiaries as of 0ecember &1" #;Q1" and the results of their operations and their cash flos
for the year then ended in accordance ith accountin$ principles $enerally accepted in the 6nited 4tates of America(
'm"hasis-of-Matters
As discussed in note 11 to the financial statements" the corporation is the defendant in a lasuit relatin$ to (state type of
liti$ation)( The ultimate outcome of the lasuit cannot presently be determined" and no pro!ision for any liability that may
result has been made in the financial statements( ,ur opinion is not modified ith respect to this matter(
As discussed in note 1# to the financial statements" the corporation chan$ed its method of accountin$ for lon$-term
construction contracts( ,ur opinion is not modified ith respect to this matter(
4il!er" -ell" AriAona Roscoe & Jones, Ltd
:ebruary 1;" #;Q#
The only item of other information that is not part of the abo!e report is Roscoe's failure to confirm
accounts recei!able( 1hen alternate procedures are performed and pro!ide sufficient appropriate audit
e!idence" the auditors need not refer to the omission of the normal procedures in the report(
This and the neCt problem are similar" althou$h this problem is for a nonpublic company and includes a
departure from 2AA+(
17-1#
17&9 4,N6T.,<: @Cchec3er Corporation (@stimated time: &5 minutes)
Report o' %ndependent Registered Publi! A!!ounting (ir$
T)e *oard o' +ire!tors and "to!,)olders
E-!)e!,er Corporation
1e ha!e audited the accompanyin$ consolidated balance sheets of @Cchec3er Corporation as of
0ecember &1" #;Q1 and #;Q;" and the related consolidated statement of income" stoc3holders% e)uity" and cash
flos for each of the three years in the period ended 0ecember &1" #;Q1( These financial statements are the
responsibility of the Company%s mana$ement( ,ur responsibility is to eCpress an opinion on these financial
statements based on our audits(
1e conducted our audits in accordance ith the standards of the +ublic Company Accountin$ ,!ersi$ht
-oard (6nited 4tates)( Those standards re)uire that e plan and perform the audit to obtain reasonable assurance
about hether the financial statements are free of material misstatement( An audit includes eCaminin$" on a test
basis" e!idence supportin$ the amounts and disclosures in the financial statements( An audit also includes
assessin$ the accountin$ principles used and si$nificant estimates made by mana$ement" as ell as e!aluatin$ the
o!erall financial statement presentation( 1e belie!e that our audits pro!ide a reasonable basis for our opinion(
.n our opinion" the financial statements referred to abo!e present fairly" in all material respects" the
consolidated financial position of @Cchec3er Corporation at 0ecember &1" #;Q1 and #;Q;" and the consolidated
results of its operations and its cash flos for each of the three years in the period ended 0ecember &1" #;Q1" in
conformity ith 6(4( $enerally accepted accountin$ principles(
1e also ha!e audited" in accordance ith the standards of the +ublic Company Accountin$ ,!ersi$ht
-oard (6nited 4tates)" @Cchec3er Corporation%s internal control o!er financial reportin$ as of 0ecember &1"
#;Q1" based on criteria established in .nternal Control-.nte$rated :rameor3 issued by the Committee of
4ponsorin$ ,r$aniAations of the Treaday Commission and our report dated :ebruary 1;" #;Q# eCpressed an
un)ualified opinion thereon(
As discussed in note 11 to the financial statements" the corporation is the defendant in a lasuit relatin$
to (state type of liti$ation)( The ultimate outcome of the lasuit cannot presently be determined" and no pro!ision
for any liability that may result has been made in the financial statements(
As discussed in note 1# to the financial statements" the corporation chan$ed its method of accountin$ for
lon$-term construction contracts(
Rotter & Co, Ltd
4il!er -ell" AriAona
:ebruary 1;" #;Q#
The only item of other information that is not part of the abo!e report is Roscoe's failure to confirm
accounts recei!able( 1hen alternate procedures are performed and pro!ide sufficient appropriate audit
e!idence" the auditors need not refer to the omission of the normal procedures in the report(
This and the precedin$ problem are similar" althou$h this is for a public company( Also" e omitted the
departure from 2AA+ since the 4@C ill ordinarily not allo )ualified reports(
%n#Class Tea$ Case
17&7 Reportin$ 4cenarios (@stimated time: 5; minutes)
Cir!u$stan!e Type o' Opinion Report Alteration
1 2AA+ 8 -:>
A -:>
# @>+? 6 @,>
17-1&
& 4C,+@ 8 -:>
0 -:>
' 2C 6 @,>
0 -:>
5 2R,6+ 6 ,T?@R
9 2R,6+ 6 <,
7 C,< or <,<@ 6 <,
B C,< 6 <,
D @>+? 6 @,>
1; C,>+ 6 ,>
<ote on placement of para$raphs:
@,>7After opinion section(
,>7After opinion section (also after any @,>)(
-:>7+rior to opinion para$raph(
17-1'
17&B
"ituation Opinion Opinion
1( A company in its first year of eCistence !alues its in!entory at
current replacement cost( Althou$h you belie!e that the
in!entory costs do approCimate replacement costs" these costs
do not approCimate any 2AA+ in!entory !aluation method(
The difference in!ol!ed is material" but not per!asi!ely
material to the financial statements(
8
#( 0ue to recurrin$ operatin$ losses and or3in$ capital
deficiencies" you ha!e substantial doubt about an entity%s ability
to continue as a $oin$ concern for a reasonable period of time(
The notes to the financial statements ade)uately disclose the
substantial doubt situation(
6 0
&( Hou ha!e disco!ered that a client made ille$al payoffs to a
candidate for president of the 6nited 4tates( Hou are unable to
determine the amounts associated ith the payoffs because of
the client%s inade)uate record retention policies( The client has
added a note to the financial statements to describe this all" and
has stated that the amounts of the payments are not
determinable(
8 0
'( .n auditin$ the lon$-term in!estments account of a ne client"
you find that a O#";;;";;; contin$ent liability eCists that is
material to the consolidated company( .t is probable this
contin$ent liability ill be resol!ed ith a material loss in the
future( Althou$h no ad*ustin$ entry has been made" the client
has pro!ided a note to the financial statements that describes
the matter in detail and includes the O# million estimate(
8 A
5( A client is issuin$ # years of comparati!e financial statements(
The first year as audited by another auditor ho is not bein$
as3ed to reissue her audit report(
6
9( An entity chan$es its depreciation method for production
e)uipment from the strai$ht-line to the units-of-production
method based on hours of utiliAation( Hou concur ith the
chan$e(
6
7( A client has chan$ed the method it uses to calculate
postemployment benefits from one acceptable method to
another one( The effect of the chan$e is immaterial this year"
but eCpected to be material in the future(
4
B( A component auditor has audited a subsidiary of your client as
a part of a $roup audit( Hou ha!e decided to rely upon the
component auditor%s or3(
4
D( A client omits a note disclosure related to si$nificant
accountin$ policies that the auditor belie!es to be fundamental
to users% understandin$ of the financial statements(
A
1;( A client does not count its year-end in!entory( The auditors are
unable to obtain sufficient appropriate audit e!idence related to
in!entory and they consider in!entory as representin$ an
eCtremely substantial proportion of the financial statements(
0
17-15
Resear!) and +is!ussion Case
17&D >etropolitan +oer 4upply (@stimated time: 55 minutes)
a. Ar$uments for auditors insistin$ that some portion of construction costs be eCpensed:
The concept that an asset should not be carried at a !alue $reater than its /ser!ice
potential/ is F$SB $S( )*0-10. This statement re)uires that the carryin$ amount of an
asset be reduced hene!er the sum of the eCpected future cash flos is less than the
carryin$ amount(
.t appears that @a$le >ountain ultimately ill cost far more than >+4 can eCpect to
reco!er throu$h operations( Therefore" some of the total cost should be re$arded as a loss"
not as a producti!e asset( The asset should be ritten don to its fair !alue( The fair
!alue is probably best measured as the present !alue of the eCpected future cash flos
from the plant( 2ranted" the computation of the loss is somehat sub*ecti!e" but it must
be done to fairly present the asset(
Ar$ument a$ainst insistin$ that some construction costs be eCpensed:
As >+4%s auditors" e do not 3no hat the future cash flos from operations ill be(
+resumably" the Ereco!erable costsF are hate!er the state utilities commission ultimately
allos >+4 to pass on to its ratepayers( 6ntil this determination is made" or until >+4
abandons the pro*ect" any $uesses as to the reco!erable cost ould be sheer speculation(
,ur opinion on part a: 1e belie!e that the carryin$ !alue of the plant should be reduced to its
estimated fair !alue measured as the discounted eCpected future cash flos from the plant in
accordance ith F$SB $S( )*0-10-)+. >ana$ement of >+4 should be able to reasonably
estimate the amount of the cost that the utility commission ill allo the company to reco!er
based on their eCperience in the industry(
b. .t appears that there is considerable ris3 that continuin$ ith the @a$le >ountain pro*ect may
ultimately cause >+4 to become insol!ent( The )uestion" therefore" is hether this ris3 is
sufficient for the auditors to modify their report as to >+4's ability to remain a $oin$ concern(
Althou$h the case does not ma3e it alto$ether clear hen the company ould be li3ely to
become insol!ent" there is no indication that it ill ithin a one-year period as indicated in
A.C+A A6 57; (+CA,- &'1) relatin$ to $oin$ concern )uestions( Thus" the facts do not
su$$est that auditors should issue a $oin$ concern modification merely because they anticipate
problems years don the road(
.n the opinion of the authors" the client should recei!e the benefit of the doubt( An opinion
should not be modified ith respect to a $oin$-concern )uestion unless there is substantial
doubt that the client ill become insol!ent ithin one year from the date of the balance sheet(
To speculate o!er lon$er periods of time simply in!ol!es too much con*ecture to be consistent
ith the attest function(
Althou$h e ould not modify our opinion as to >+4's ability to remain a $oin$ concern" e
ould consider includin$ an emphasis-of-matter para$raph describin$ the uncertainty
surroundin$ the ultimate realiAation of the capitaliAed construction costs( Therefore" e ould
consider includin$ an emphasis-of-matter para$raph discussin$ the company's ability to
finance the completion of the @a$le >ountain facility and to reco!er the capitaliAed
construction costs(
17-19

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Chapter 17 - Auditors' Reports

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