You are on page 1of 38

F1024

Financial Audit II
Week 8
AUDIT REPORTS ON FINANCIAL
STATEMENTS
PRINCIPLES UNDERLYING AUDIT REPORTING
Principles Underlying Audit
Reporting

• The American Institute of Certified Public Accountant’s


(AICPA) first and seventh principles governing an audit
conducted in accordance with generally accepted auditing
standards (GAAS) describe the principles underlying audit
reporting
• These principles require auditors to either:
– Express an unqualified opinion on the entire set of
financial statements and related footnotes, or
– State the reasons that such an opinion cannot be
expressed
Principles Underlying Audit
Reporting

• If the auditor concludes that the statements are not fairly


presented, and the auditor cannot resolve the issue with
management, the auditor needs to determine whether the
opinion should be modified.
– If the auditor determines that the financial statements as
a whole are misstated, the auditor would issue either a
qualified or an adverse opinion.
– If the auditor was not able to obtain sufficient
appropriate evidence, the auditor would issue either a
qualified opinion or disclaimer.
STANDARD UNQUALIFIED AUDIT REPORTS
ON FINANCIAL STATEMENTS
Standard Unqualified
Audit Reports
• Designed to promote clear communication between auditor
and financial statement user by delineating:
– Introductory paragraph
– Scope paragraph
– Opinion paragraph
Standard Unqualified
Audit Reports
• If a combined report on the financial statements and
internal controls, two additional paragraphs are included
– Definition paragraph - Defines what is meant by internal
control over financial reporting
– Inherent limitations paragraph - Discusses why internal
control may not prevent or detect misstatements
Other important
components of an audit
report
Title
• Includes the word ‘independent’

Addressee
• Board of directors or shareholders of the organization for public companies
• Varies depending on the circumstances of the engagement

Audit report date


• No earlier than the date on which the auditor has obtained sufficient appropriate
evidence to support the opinion

Signature of audit firm

City/state from which the auditor’s report has been issued


SEC Reporting
Requirements
Requirements for a Standard Unqualified
Audit Report on the Financial Statements
for U.S. Public Companies

• There should be no material violations of GAAP


• Disclosures should be adequate
• Auditor should be able to perform all of the necessary
procedures
• There should be no change in accounting principles that had
a material effect on the financial statements
• The auditor should not have significant doubt about the
client remaining a going concern
• The auditor should be independent
• Watch for new standard where “critical audit matters” will
be discussed
Modification of the standard
unqualified report

• When the conditions are not present, auditor should modify


the standard unqualified report
• Options include:
– Issue an unqualified opinion with explanatory language
– Qualify the audit opinion
– Issue an adverse opinion
– Issue a disclaimer
Standard Unqualified Audit
Reports - Nonpublic Companies
• Introductory paragraph - What was audited
• Management’s responsibility paragraph - Responsibilities of
client management
• Scope paragraph - Responsibilities of the auditor and the
nature of the audit process
• Opinion paragraph – Auditor’s opinion on the fairness of the
financial statements
• For some engagements, financial statements might be
audited in accordance with multiple auditing standards
UNQUALIFIED AUDIT REPORTS WITH
EXPLANATORY LANGUAGE
Unqualified Audit Reports with
Explanatory Language
• Used to explain:
– Justified departure from Accounting Standard
– Inconsistent application of Accounting Standard
– Substantial doubt about client being a going concern
– Emphasis of some matter, such as unusually important
subsequent events, risks, or uncertainties associated
with contingencies or significant estimates
– Reference to other auditors (group audits and
component auditors)
Explanatory Language - Justified
Departure from Accounting
Standard
• Rule 203 of the AICPA Code of Professional Conduct permits
auditor to issue an unqualified opinion when there has been
a material departure from Accounting Standard
– Only if the client can demonstrate, and auditor agrees,
that due to unusual circumstances, the financial
statements would have been misleading had Accounting
Standard been followed
Explanatory Language - Justified
Departure from Accounting
Standard
• Auditor should add:
– An informational paragraph either before or after the
opinion paragraph to describe the departure from
standard
– Its approximate effects
– Reasons for which compliance with accounting standard
would result in misleading statements
Explanatory Language -
Inconsistent Application of
accounting standard
• Change in accounting principles
– From one standard to another - FIFO to Average
– From non-IFRS/GAAP to IFRS/GAAP - Cash basis to
accrual basis
• Both changes would require auditor to add an explanatory
paragraph to the audit report
Explanatory Language -
Inconsistent Application of
Accounting Standard
• Changes in accounting estimates and accounting for new
transactions are not considered changes in accounting
principles
• Change in estimate affected by an accounting principle
requires an explanatory language in the audit report
• AS 6 requires an additional paragraph for the correction of
an error not involving an accounting principle for public
companies
Explanatory Language -
Inconsistent Application of
Accounting Standard

– The explanatory paragraph serves as a flag directing the


user’s attention to the relevant footnote disclosure if client
has:
– Changed an accounting principle
– Reasonable justification for the change
– Followed Accounting Standard in accounting for and
disclosing this change
Explanatory Language - Substantial
Doubt About the Client Being a
Going Concern

• Explanatory paragraph should be clearly worded to


indicate:
– Auditor’s substantial doubt about client’s continuing as
a going concern
– Reference to management’s footnote(s) explaining the
problems and plans to overcome the problem
• Auditor may not feel comfortable expressing any opinion
for some going-concern situations in which client is
experiencing severe financial distress
– Would issue a disclaimer
Explanatory Language -
Emphasis of a Matter
• Examples include:
– Significant transactions with related entities
– Important subsequent events, such as a board-of-
director decision to divest a major segment of the
business
– Important risks or uncertainties associated with
contingencies or significant estimates
Explanatory Language -
Reference to Other Auditors
• The principal auditor (group engagement partner) needs to
decide whether to mention the other auditor in the overall
audit report
• Care must be taken when relying on other auditors’ reports
– Principal auditor should have participated in the audit at
a sufficient level
– Regardless of reference being made in auditor’s report to
the report of another auditor, principal auditor is
responsible for the overall opinion
Explanatory Language -
Reference to Other Auditors

• If the principal audit firm chooses to mention the other firm


in the audit report
– Wording of the standard report is modified
– No additional paragraph is needed
• Change appears in:
– Introductory paragraph to indicate the shared
responsibility for the overall opinion
– Scope and opinion paragraphs modified to reference the
other auditor
QUALIFIED REPORTS, ADVERSE REPORTS,
AND DISCLAIMERS
Audit Reports with a Disclaimer
of Opinion

• An auditor issues a disclaimer of opinion report when:


– Scope limitation exists
– Substantial doubt exists about the client being a going
concern
– There is lack of independence
Disclaimer - Scope Limitation

• Scope limitations caused by circumstances are such that it is


not possible to form an opinion
– Introductory paragraph’s wording modified for a scope
limitation
– Scope paragraph is omitted
– Additional paragraph is inserted to describe the scope
limitation(s)
– Last paragraph states that no opinion can be expressed
Disclaimer - Scope Limitation
for Non-U.S. Companies

ISA 705 U.S. Standards

Auditors required to withdraw from Auditors required to consider


audit withdrawal from the engagement

If auditor concludes that possible


Auditor should consider whether to
effects of undetected
withdraw or disclaim an opinion on
misstatements could be both
the financial statements
material and pervasive
Disclaimer - Substantial Doubt About
the Client Being a Going Concern

• Auditor may issue a disclaimer of opinion if there is a


substantial doubt about the client continuing as a going
concern
• In such cases, auditor would believe that an additional
paragraph to an unqualified opinion is not appropriate
Disclaimer - Auditor Lacking
Independence

• When auditors lack independence with respect to a client:


– They cannot perform an audit in accordance with
professional auditing standards
– They are precluded from expressing an opinion on the
financial statements
• In such cases, a one-paragraph disclaimer should be issued
stating the lack of independence
– Auditor omits the reasons for lack of independence
Disclaimer - Auditor Lacking
Independence

• Report would have no title or salutation


• Such a situation should rarely occur
– It could happen when it is discovered late in the audit
that one of the auditors on the engagement had a
financial interest in the client
COMPARISONS OF MODIFICATIONS TO THE
STANDARD UNQUALIFIED AUDIT REPORT
Comparisons of Modifications
to the Standard Unqualified
Audit Report
• Deciding on the type of opinion is important
• This is particularly true of the decisions based on:
– Materiality level and pervasiveness of Accounting
Standard violations
– Significance of scope limitations
– Likelihood of the entity being a going concern
• Issuing an inappropriate opinion can lead to legal problems
• Report decision often involves consultation
AUDIT REPORTS ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
Audit Reports on Internal Control
Over Financial Reporting (ICFR)

• Auditor evaluates identified control deficiencies individually,


and in aggregate, to assess material weakness in ICFR
• Auditor issues an:
– Unqualified opinion when it is determined that there are
no material weaknesses in ICFR
– Adverse opinion when it is determined that there is one
or more material weaknesses in ICFR
Audit Reports on Internal Control
Over Financial Reporting (ICFR)

• PCAOB AS 5 identifies situations in which the auditor


modifies audit report on ICFR effectiveness
– Elements of management’s annual report on internal
control are incomplete or improperly presented
– There is a restriction on the scope of the engagement
– Auditor decides to refer to the report of other auditors
as the basis, in part, for the auditor’s own report
Audit Reports on Internal Control
Over Financial Reporting (ICFR)

– There is other information contained in management’s


annual report on ICFR
– Management’s annual certification pursuant to Section
302 of the Sarbanes-Oxley Act is misstated
Reference

• Karla M. Johnstone. (2016). Auditing : a risk-based


approach to conducting a quality audit. 10th ed. Cengage
Learning. Boston. ISBN: 9781305080577.
Thank You

You might also like