Professional Documents
Culture Documents
CHAPTER 12
Reports on Audited Financial Statements
LEARNING OBJECTIVES
Review
Checkpoints
Exercises, Problems,
and Simulations
1.
1, 2
2.
3.
4, 5, 6, 7
38, 49, 50
4.
8, 9
40, 44 (partial), 46
(partial), 48 (partial),
56, 57 (partial), 59
(partial), 60 (partial),
5.
10, 11
44 (partial), 46
(partial), 48 (partial),
53, 60 (partial)
6.
7.
12-1
Management prepares a report on the effectiveness of internal control over financial reporting.
The auditors prepare reports on (1) the entitys financial statement and other disclosures and (2) the
effectiveness of the entitys internal control over financial reporting. These can be presented as two separate
reports or a combined report.
12.2
Managements report on internal control over financial reporting consists of the following major components:
A statement indicating that management is responsible for establishing and maintaining adequate internal
control over financial reporting.
A statement identifying the framework used by management to assess the effectiveness of the entitys
internal control.
Managements opinion on the effectiveness of the entitys internal control, including an explicit
statement as to whether the internal control over financial reporting is effective.
A statement that the registered accounting firm auditing the financial statements (auditor) has issued an
attestation report on the entitys internal control over financial reporting.
12.3
The auditors report serves to communicate to users three specific statements with respect to the financial
statements, the conduct of the audit, and the entity in general. First, the report indicates whether the
financial statements are presented in conformity with GAAP. Second, auditors use their report to indicate
any unusual aspects of the audit examination. Third, even if the financial statements are fairly presented and
no problems were noted in the conduct of the audit, the auditors can use the report to communicate
information useful to decision makers that may not appear on the face of the financial statements.
12.4
Title. The title should contain the word independent, as in Independent Registered Public
Accounting Firm or Independent Auditors.
2.
Address. The report shall be addressed to the client, which occasionally may be different from
the auditee.
3.
Notice of Audit. A sentence should identify the financial statements and indicate that they were
audited. This appears in the introductory paragraph.
4.
Responsibilities. The report should state managements responsibility for the financial statements
and the auditors responsibility for the report. These statements are also in the introductory
paragraph.
5.
Description of the Audit. The second paragraph (scope paragraph) should declare that the audit
was conducted in accordance with the standards of the Public Company Accounting Oversight
Board (PCAOB) and describe the principal characteristics of an audit, including a statement of
belief that the audit provided a reasonable basis for the opinion.
6.
Opinion. The report shall express an opinion (opinion paragraph) regarding conformity of the
financial statements with accounting principles generally accepted in the United States of
America.
12-2
12.4
12.5
(Continued)
7.
Internal Control. The report should reference the auditors examination, report, and opinion on
the clients internal control over financial reporting.
8.
Signature. The auditors (partner of the audit team) shall sign the report, manually or otherwise.
9.
Date. The report shall be dated using the date when the auditors have obtained sufficient
appropriate evidence to support their opinion (the audit completion date).
a.
The objects of the audit are the financial statements (balance sheet, income statement, statement of
comprehensive income, statement of shareholders equity, and statement of cash flows) and the
related footnote disclosures.
b.
This statement means that the auditors complied with the general standards and standards of field
work, which require that auditors:
1.
2.
3.
4.
5.
6.
12.6
12.7
The major differences in the report issued under AS 5 (for public entities) and SAS 58 (for nonpublic
entities) include:
1.
The AS 5 report is titled Report of Independent Registered Public Accounting Firm while the
SAS 58 report is titled Report of Independent Auditors.
2.
The AS 5 report references standards established by the PCAOB (United States) while the SAS
58 report references auditing standards generally accepted in the United States.
3.
The SAS 58 report does not contain a reference to the auditors examination and report on the
effectiveness of the clients internal control over financial reporting (such examinations are not
required for nonpublic entities).
Major reasons for departures from the wording in the standard report include:
1.
2.
Matters (scope limitations) affect the ability of auditors to conduct an audit in accordance with
GAAS.
3.
The auditors wish to reference other matters affecting the audit or the client.
12-3
Qualified opinions indicate that, except for the effects of an isolated departure from GAAP, the financial
statements are presented in conformity with GAAP. Adverse opinions indicate that the financial statements
are not presented in conformity with GAAP. Clearly, the wording used in the adverse opinions represents
more serious and significant departures from GAAP.
12.10
A client-imposed scope limitation results from managements refusal to let auditors perform 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 greater concern to auditors than circumstance-imposed scope limitations.
12.11
1.
2.
12.12
In comparison to the standard report, a report qualified for a scope limitation has:
a.
An except for phrase in the scope paragraph identifying the scope limitation.
b.
c.
An except for phrase in the opinion paragraph that recognizes the scope limitation may
have affected auditors ability to identify misstatements.
In comparison to the standard report, a report in which the opinion is disclaimed because of a
scope limitation has:
a.
b.
The introductory paragraph omits the sentence in which the auditors indicate their
responsibility for an opinion on the financial statements.
c.
d.
e.
The opinion paragraph refers to the explanatory paragraph and disclaims an opinion on
the financial statements.
When auditors are not independent with respect to an entity, a disclaimer of opinion should be issued
because auditors are required to be independent to conduct an examination (and express an opinion). While
this disclaimer will indicate that the auditors were not independent, it should not refer to the reason(s) for
the lack of independence.
12-4
12.13
The following situations cause auditors to modify their reports to identify inconsistent applications of
GAAP:
1.
2.
3.
4.
5.
12.14
The following circumstances may indicate substantial doubt about an entitys ability to continue as a going
concern:
12.15
When going-concern uncertainties exist, auditors may either add an explanatory paragraph to an unqualified
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.
12.16
Rule 203 allows auditors to issue an unqualified opinion on an entitys financial statements when those
statements contain a departure from a FASB or GASB (or their predecessors) standard. This rule relates to
situations in which auditors believe that this departure prevents the financial statements from being
misleading.
12.17
When a division of responsibility exists, principal auditors can assume responsibility for the other auditors
work; if so, no reference is made to the other auditors work in the principal auditors report (the standard
report can be issued). If principal auditors decide to refer to the work and reports of other auditors, they
would modify the introductory, scope, and opinion paragraphs of their report to indicate the division of
responsibility.
12.18
The principal auditors reference in their report to other auditors is not a scope limitation. The reference
only shows the division of responsibility for the audit work.
12.19
Circumstances, events, or transactions that auditors may wish to emphasize to financial statement users
include:
12-5
12.20
Auditors are associated with financial statements when they consent to the use of their name in some form
of communication containing the financial statements or submit to their clients or others financial
statements they have prepared or assisted in preparing. When associated with an entitys unaudited
financial statements, auditors are required to disclaim an opinion on financial statements.
With respect to unaudited financial statements, in addition to issuing a disclaimer of opinion, the following
guidelines should be observed:
12.21
1.
The report should not mention any auditing procedures applied because readers might erroneously
conclude that these procedures were sufficient to enable an opinion to be expressed on the
financial statements.
2.
If the auditors should learn that the financial statements are not in conformity with generally
accepted accounting principles (including adequate disclosures), the departures should be
explained in the disclaimer.
3.
If prior-years unaudited financial statements are presented, the disclaimer should cover them as
well as the current-year statements.
4.
An updated report is a report on prior-year financial statements that is based on both the prior-year audit
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 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.
12.22
Material inconsistency of other information with disclosures and information included in the
audited financial statements.
b.
12.23 Auditors are prohibited from issuing a standard report on condensed financial statements because the
condensed financial statements are not a fair presentation of financial position, results of operations, and
cash flows in conformity with GAAP. (These financial statements present only a subset of the necessary
disclosures required for conformity with GAAP).
12-6
12.24
When these problems are encountered, auditors should expand their report on the financial statements or
disclaim an opinion on the supplemental information.
12.26
12.27
12.28
a.
Correct
b.
c.
Incorrect
Incorrect
d.
Incorrect
a.
Incorrect
b.
c.
Incorrect
Incorrect
d.
Correct
a.
Correct
b.
Incorrect
c.
Incorrect
d.
Incorrect
a.
Incorrect
b.
Incorrect
c.
Correct
d.
Incorrect
12-7
12.29.
a.
b.
Incorrect
Incorrect
c.
Incorrect
d.
Correct
12.30
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.
12.31
Correct
b.
Correct
c.
Incorrect
d.
Incorrect
a.
Correct
b.
c.
d.
Incorrect
Incorrect
Incorrect
12.33
a.
b.
c.
d.
Incorrect
Incorrect
Incorrect
Correct
12.34
a.
Correct
b.
c.
Incorrect
Incorrect
d.
Incorrect
a.
b.
c.
d.
Incorrect
Incorrect
Correct
Incorrect
12.32
12.35
12-8
12.36
12.37
NOTE TO INSTRUCTOR: Since this question asks students to identify which statement is not included in
the auditors standard report, the item labeled correct would not be included and those labeled
incorrect would be included.
a.
b.
c.
d.
Incorrect
Incorrect
Incorrect
Correct
a.
Correct
b.
Incorrect
c.
Incorrect
d.
Incorrect
Audit Simulation: Reports on Financial Statements (Deficiencies and Omissions in the Auditors
Report)
1.
Title. The report needs a title referring to Ross as the Independent Registered Public Accounting
Firm.
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, current custom is not to address the report to the unknown class of users.
3.
Financial Statements: 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.
Responsibilities. The introductory paragraph does not address the auditors responsibility for
issuing an opinion on the financial statements.
5.
Scope. The report uses inappropriate language; instead of referencing the standards of the
PCAOB, it indicates that the audit was performed in accordance with your [the clients]
instructions and that a complete audit was conducted, both of which are inappropriate.
6.
Scope: The scope paragraph of the report should explicitly mention that the audit was conducted
in accordance with the standards of the Public Company Accounting Oversight Board (United
States).
7.
Opinion. The opinion paragraph should not be modified with the phrase with the explanation
given above.
12-9
12.39
8.
Opinion. The opinion paragraph should not mention minor errors we consider immaterial, but it
should contain the phrase presents fairly in all material respects.
9.
10.
Opinion. The opinion paragraph refers improperly to FASB pronouncements. It should refer to
accounting principles generally accepted in the United States of America.
11.
Date. The date accompanying Ross signature should be September 23 (the audit completion date)
and not Continental Corporations fiscal year end date (July 31).
12.
Internal Control Paragraph: The date of the Ross report on internal control should be September
23 (the audit completion date) and not Continental Corporations fiscal year end date.
13.
Other. The commentary on the economy and the strike are not generally appropriate for the report.
Even if the auditors wanted to draw attention to these matters, their relevance for understanding
the financial statements and their manner of expression are both questionable.
14.
Other. The negative assurance (concerning the recording of sales) is not permitted in auditors
reports.
Item
Should Auditors
Report Be
Modified?
Type of Change
1.
Yes
2.
No
3.
No
4.
Yes
5.
Yes
12-10
12.40
6.
Yes
7.
No
8.
Yes
The report is improperly addressed to the president instead of to the board of directors that
engaged the auditors.
2.
3.
The combined introductory and scope paragraph does not identify the specific financial statements
audited: balance sheet, statements of income, comprehensive income, shareholders equity, and
cash flows.
4.
The combined introductory and scope paragraph does not contain the required sentence about
managements responsibility for the financial statements.
5.
The combined introductory and scope paragraph also does not contain the required sentence about
the auditors responsibility to express an opinion based on the audit.
6.
7.
The explanatory 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.
8.
The explanatory 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.
9.
The opinion paragraph does not contain a direct reference to the explanatory paragraph that
provides the basis for the adverse opinion.
10.
The report is not properly dual dated for the audit completion date of March 7 and the March 14
subsequent event. The date should be March 7, except for Note K, for which the date is March
14.
12-11
11.
12.41
12.42
The internal control paragraph following the opinion paragraph inappropriately disclaims an
opinion on Cooks internal control over financial reporting. Since the case facts indicate that an
engagement was performed and the internal control was found to be effective, an unqualified
opinion on internal control over financial reporting should be expressed.
Reports on Financial Statements (Errors in a Comparative Report with Change from Prior Year)
1.
The financial statements are not individually identified in the introductory paragraph.
2.
The description of the time period for results of operations and cash flows is inappropriate; instead
of indicating as of, the report should indicate for the two years ended.
3.
The type of opinion (adverse) previously issued on the prior-years financial statements is not
identified.
4.
The date of the previous auditors report is incorrect. It should be March 5 instead of the prior
balance sheet date (December 31).
5.
The substantive reason for changing the prior-years opinion during the current year is not given
(change from an unacceptable accounting principle, NIFO, to an acceptable one, FIFO).
6.
The phrase based upon the preceding in the opinion paragraph is not appropriate and may be
misinterpreted as some sort of qualification.
7.
The opinion paragraph refers only to the current-year financial statements, but should refer to both
the current-year and the prior-years financial statements presented in comparative form.
8.
9.
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 (GAAS
departure).
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:
12-12
12.43
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 division of responsibility. 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 can neither assume responsibility for Thomas work nor indicate division of
responsibility by referring to Thomas work and report, Michaels (the principal 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 scope
paragraph will be qualified to explain the unaudited portion (provided it is material), and the
opinion paragraph will express a qualified opinion or disclaimer of opinion.
The statement of cash flows is not identified, but the opinion paragraph references cash flows
when expressing an opinion.
2.
The sentence identifying managements responsibility for the financial statements is omitted.
3.
The magnitude of the assets and revenues audited by the other auditors is not disclosed.
4.
The other auditors name is disclosed, but it can be used only if the other auditors report is also
included. Here we see no indication that the other auditors report is printed along with the
principal auditors report.
SCOPE PARAGRAPH
5.
The scope paragraph should not be is qualified because of reliance on the work of other auditors.
This phrase should be removed.
6.
The scope paragraph should not contain any mention of assessing control risk.
7.
The concluding sentence should refer both to our audit and to the report of other auditors.
The latter reference is omitted.
12-13
OPINION PARAGRAPH
12.44
8.
The opinion should not appear to be qualified by use of the phrase except for the report of the
other auditors. The proper wording is In our opinion, based on our audit and the report of other
auditors, the financial statements...
9.
The opinion paragraph expresses an opinion on the presentation of cash flows, but this financial
statement was not identified in the introductory paragraph as being audited (see earlier reference
to this deficiency in the introductory paragraph section).
10.
The opinion omits the required reference to accounting principles generally accepted in the United
States of America.
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 explanatory paragraph before the opinion
paragraph and modify the opinion paragraph to express the appropriate opinion.
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 explanatory paragraph before the opinion
paragraph and modify the opinion paragraph to express the appropriate opinion.
a.
b.
5.
a.
Unqualified opinion.
12-14
6.
b.
Without modifying the paragraphs of the standard report, describe the omitted
information in a separate paragraph following the opinion paragraph.
a.
Unqualified opinion.
b.
12.44
Describe the other auditors work in the introductory paragraph; modify the concluding
sentence of the scope paragraph to indicate [w]e believe that our audit and the reports of
other auditors provide a reasonable basis for our opinion; modify the opinion paragraph
to indicate In our opinion, based upon our audit and the reports of other auditors, the
financial statements... Do not add a separate explanatory paragraph.
Reports on Financial Statements: Various Reporting Situations (Continued)
7.
8.
12.45
a.
Unqualified opinion.
b.
Without modifying the paragraphs of the standard report, identify the change in
accounting principle and refer to the financial statement note discussing this change in
principle in a paragraph following the opinion paragraph.
a.
Unqualified opinion.
b.
Without modifying the paragraphs of the standard report, identify the going-concern
uncertainty and refer to the financial statement note discussing the going-concern
uncertainty in a separate paragraph following the opinion paragraph.
Reason
Correction
1.
2.
12-15
b.
c.
12.47
Standard report
Rule 203 report justifying departures from official pronouncements.
Updated reports on prior-years comparative financial statements.
Reports modified for a division of responsibility.
Adverse opinion for departures from generally accepted accounting principles.
Qualified opinion for departures from generally accepted accounting principles.
Reports modified by including an explanatory paragraph for consistency.
Reports modified by including an explanatory paragraph to emphasize a matter.
Reports modified by including an explanatory paragraph for going-concern uncertainties.
Reports modified by including an explanatory paragraph to identify inconsistencies,
misstatements, or omissions of other information and quarterly and supplemental
information
Qualified opinion resulting from material (but not pervasive) scope limitations.
The auditors obtain reasonable assurance about whether the financial statements are free of
material misstatement, not fairly presented.
An audit provides a reasonable basis for an opinion, not a basis for determining whether any
material modifications should be made.
An explanatory paragraph added to the report to describe a change in accounting principle (lack of
consistency) should follow the opinion paragraph, not precede it.
12-16
Audit Simulation: Reports on Financial Statements (Unqualified Opinion, Accounting Change, and
Uncertainty) (Continued)
Fourth (opinion) paragraph:
The phrase except for should not be used in conjunction with the consistency issue.
The auditors concurrence with the change in accounting principles is implicit and should not be
mentioned.
12.48
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.
12.49
Material
Pervasive
a.
Scope limitation on
examination of
accounts receivable.
Disclaimer of opinion.
b.
Adverse opinion.
c.
Adverse opinion.
d.
Uncertainty related to
the amount of damage
that might eventually
be confirmed by an
appeals court ruling.
12-17
12.50
12-18
12.52
12-19
12.53
12.54
Division of Responsibility
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Ferguson Company
12-20
We have audited the accompanying balance sheets of Ferguson Company and subsidiaries as of December
31, 2008 and 2007 and the related statements of income, comprehensive income, shareholders equity, and
cash flows for each of the years in the two-year period ended December 31, 2008. These financial
statements are the responsibility of Ferguson Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits. We did not examine the financial statements of
certain consolidated subsidiaries, which statements reflect total assets and revenues constituting 29 percent
and 36 percent in 2008 and 31 percent and 41 percent in 2007, respectively, of the related consolidated
totals. These statements were examined by other auditors whose reports have been furnished to us, and our
opinion expressed herein, insofar as it relates to the amounts included for these subsidiaries, is based solely
on the reports of the other auditors.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. We believe that our audits and the reports
of other auditors provide a reasonable basis for our opinion.
In our opinion, based upon our audits and the reports of other auditors, the financial statements referred to
above present fairly, in all material respects, the consolidated financial position of Kingston Company and
subsidiaries at December 31, 2008 and 2007, and the consolidated results of their operations and their cash
flows for each of the years in the two-year period ended December 31, 2008 in conformity with accounting
principles generally accepted in the United States of America.
[Standard internal control paragraph]
Anderson, Olds & Watershed
February 10, 2009
12.55
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
12-21
$ 111,250
$400,000 /
$81,250
$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.
12.56
12-22
12.56
There are two possibilities. On one hand, if one takes the view that fixed assets (including land)
should not reflect appraisal values, the case could be made that the reporting options in (a) or (b)
are appropriate, depending upon materiality. On the other hand, a report conforming to Rule 203
could be prepared, assuming that the auditors felt that presentation in conformity with GAAP
would create misleading financial statements. Ordinarily, because of the strict prohibitions of
reflecting appraisal values for fixed assets under GAAP, most students would argue that a report
conforming to Rule 203 would not be appropriate in this situation.
12-23
When discussing this with students, it is interesting to ask students to identify the pros and cons of
the different types of presentations. After all, an individual reading the reports shown in (a), (b),
and (c) (shown below) would have access to exactly the same information with respect to the
valuation of the land; only the auditors opinion (and accompanying language) differs.
If prepared, a report conforming to Rule 203 that could be prepared is shown below.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Graham Company
[Standard introductory paragraph]
[Standard scope paragraph]
As explained in Note 1 to the financial statements, Graham Company reports its investment in
land on which its buildings stand at appraisal value, and reports the amount in excess of cost in a
stockholder equity account entitled Current value increment. The asset total of $5,394,000 and
the shareholders equity of $3,594,000, each reflect the $600,000 appraisal increment reduced by
implicit disposal taxes at the rate of 33 percent; as a result, total assets and total shareholders
equity are $400,000 than if Graham accounted for the land at its historical cost. While Accounting
Principles Board Opinion No. 6 provides that property shall not be written up to reflect appraisal
values in excess of cost, we believe nonrecognition of the significant increase in land value would
omit relevant information from the financial statements and cause the report of total asset and
shareholders equity values to be materially misleading.
In our opinion, the financial statements referred to above present fairly, in all material respects, the
financial position of Graham Company as of December 31, 2008, and the results of its operations
and its cash flows for the year then ended, in conformity with accounting principles generally
accepted in the United States of America.
[Standard internal control paragraph]
Anderson, Olds & Watershed
February 10, 2009
12.57
a.
12-24
As described in Note 2 to the financial statements, Williams Company changed its accounting
principles from the last-in first-out method to the first-in first-out method for the year ended
December 31, 2008.
[Standard internal control paragraph]
12.57
Reporting on an accounting change the auditors think is not justified in accordance with SFAS 154.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Williams Company
[Standard introductory paragraph]
[Standard scope paragraph]
As disclosed in Note 2 to the financial statements, Williams Company has adopted the FIFO
method of accounting for the cost of inventory and goods sold, whereas it previously used the
LIFO method. Although the FIFO method is in conformity with generally accepted accounting
principles, in our opinion Williams Company has not provided reasonable justification, in this
period of rising prices, for making a change as required by Statement of Financial Accounting
Standards No. 154. Inventories that would have been reported at $1.5 million (LIFO) are reported
at $1.9 million (FIFO); operating income before tax that would have been $130,000 is reported at
$530,000. As a result of this change, current assets, total assets, and shareholders equity are
increased by 17, 9, and 14 percent, respectively.
In our opinion, except for the change in accounting principle as stated above, the aforementioned
financial statements present fairly, in all material respects, the financial position of Williams
Company as of December 31, 2008, and the results of its operations and its cash flows for the year
then ended, in conformity with accounting principles generally accepted in the United States of
America.
[Standard internal control paragraph]
Anderson, Olds & Watershed
February 10, 2009
12.58
This issue is a tricky 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 consolidated 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 other auditors offices to examine their documentation.
12-25
12.59
Kaplan CPA Exam Simulation: Reports on Financial Statements (General Auditors Reports)
A
Specifies that the financial statements are the responsibility of the companys
management.
(This is included in the first, or introductory, paragraph.)
Specifies that the financial statements present accurately in all material respects the
financial position, results of operations, and cash flows.
(Replace the word accurately with fairly and the statement is correctly included in
the third, or opinion, paragraph. This is a subtle but important point to remember.
Accurately suggests absolute precision, which is generally not ascertainable in an
audit for many reasonsfor instance, cost-benefit.)
Specifies that evidence supporting amounts and disclosures has been examined, but
only on a test basis.
(This is included in the second, or scope, paragraph.)
12-26
Kaplan CPA Exam Simulation: Reports on Financial Statements (Opinions and Report
Modifications)
A
A consolidated subsidiary of the Ferreira Company was audited by another CPA firm.
Riley & Associates has carried out the necessary procedures and has decided not to
indicate the division of responsibility in its auditors report.
(If the CPA firm chooses not to indicate the division of responsibility with the other
auditors, a standard report can be issued.)
Riley & Associates was not able to observe the physical inventory count because of the
date on which the firm was hired. The inventory is a material amount, but the firm is
not able to gain sufficient, satisfactory evidence by other means.
(The CPA firm was not able to follow generally accepted auditing standards so that the
assurance level must be reduced or eliminated. A scope qualification or a disclaimer
should be issued. Those reports necessitate changes in the scope paragraph and
opinion paragraph along with an added explanatory paragraph prior to the opinion
paragraph.)
Riley & Associates believes that there is substantial doubt that Ferreira Company can
remain a going concern for a period of 12 months from the companys balance sheet
date. Ferreira Company has made appropriate disclosure of this uncertainty in its
financial statements.
(The CPA firm needs to draw attention to this problem although it has no impact on
the auditors opinion. An explanatory paragraph is added at the end of the report
without any change in the wording of the other paragraphs. In extreme cases, the
CPA does have the right to issue a disclaimer of opinion.)
12-27
Kaplan CPA Exam Simulation: Reports on Financial Statements (Opinions and Report
Modifications) (Continued)
C
Riley & Associates discovers that Ferreira Company has not provided adequate
disclosure of required information of a material nature about its employee pension
plan and refuses to do so because of employee confidentiality.
(The financial statements contain a material misstatement so that either a qualified
opinion or an adverse opinion should be rendered. In both cases, an explanatory
paragraph is added and the opinion paragraph is modified.)
A consolidated subsidiary of the Ferreira Company was audited by another CPA firm.
Riley & Associates has carried out the necessary procedures and has decided to
indicate the division of responsibility in its auditors report.
(When the CPA chooses to indicate the division of responsibility for the opinion with
another CPA, all three paragraphs must be modified. However, no explanatory
paragraph need be added.)
A letter from the president of Ferreira Company that is attached to the financial
statements contains information that Riley & Associates believes to be misleading.
(This information is outside of the financial statements, but it is still misleading to the
user of the financial statements. Thus the CPA needs to draw attention to the problem
by adding an extra paragraph at the end of the auditors report although an
unqualified opinion is still expressed.)
12-28
12.61
Required
if Previous
Opinion is
Included
(X)
Required
if Previous
Opinion is
Omitted
(X)
(X)
(X)
(X)
(X)
Not
Required
(X)
Required in
Both
Situations
(X)
(X)
12-29
(X)
True
12-30