12-1
Chapter 12
Reports on Audited
Financial Statements
The very existence of the accounting profession depends on public
confidence in the determination of certified public accountants to
safeguard the public interest.
--J.L Carey (Professional Ethics of Public Accounting)
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Independent Auditor's Report (PCAOB 1)
Report Title
Report Address
Introductory Paragraph:
•Notice of audit,
•F/S Examined
•Auditor, Management responsibilities
Scope Paragraph:
Description of an audit
Opinion Paragraph
Internal Control
Paragraph
Signature
Report Date
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Apollo Shoes, Inc.
We have audited the balance sheets of Apollo Shoes, Inc. as of December 31,2006 and 2005, and the related
statements of income, comprehensive income, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 2006. These financial statements are the responsibility of Apollo Shoes, Inc.'s
management. Our responsibility is to express an opinion on these financial statements based on our audits.
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 provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial
position of Apollo Shoes, Inc. as of December 31, 2006 and 2005, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2006, in conformity with U.S. generally
accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States), the effectiveness of Apollo Shoes’s internal control over financial reporting as of December 31,
2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission and our report dated February 22, 2007 expressed an
unqualified opinion thereon.
Smith & Smith, CPAs
February 22, 2007
©2007 by the McGraw-Hill Companies, Inc. All rights reserved.
12-3
Presentation Outline
I.
Unqualified Opinion with Additional
Explanation
II. GAAP Departure Reports
III. Reporting on Unusual Aspects of the
Audit
IV. Other Issues Affecting the Auditor’s
Report
V. Reporting on Internal Control Over
Financial Reporting
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I. Unqualified Opinion with Additional
Explanation
A. Lack of Consistency
B. Going Concern Uncertainties
C. Emphasis of a Matter
D. Reference to Report on Internal Control
Over Financial Reporting
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A. Lack of Consistency
(Example in Exhibit 12.3 on p. 436)
• When evaluating a change in accounting principle,
auditors must be satisfied that management
demonstrates that the change is to an allowable
accounting principle that is preferable. Otherwise the
change is a GAAP departure.
• No Paragraph -- Not Consistency Standard
–
–
–
–
–
Change in Accounting Estimate
Correction of Error Not Involving Principle
Changes in Classification
Variation in Statement of Cash Flows
Changes not Material to Current but may affect Future F/S
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B. Going Concern Uncertainties
•
•
•
•
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The auditor must evaluate whether there is substantial doubt about the
entity remaining a going concern for a reasonable time after year-end,
not to exceed one year beyond F/S date.
Apply procedures and evaluate:
– negative trends
– defaults on debt obligations, restructuring of debt, arrearages of
dividends
– internal matters - work stoppages, dependence on one project
– external matters - legal proceedings, changes in governmental
regulations, natural disasters, etc.
If going concern problem, auditor may disclaim (e.g., if liquidation
values unknown), else add explanatory paragraph after opinion. No
standard language, but must include the words substantial doubt and
going concern.
See Auditing Insights on pages 438 and 439.
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C. Emphasis of a Matter
• Add explanatory paragraph after opinion
paragraph discussing the matter (e.g., a
subsequent event not affecting year-end
F/S’s)
• Usually items that are difficult to disclose in
the financial statements
– Often non-quantitative matters
– Often subsequent events
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D. Reference to Report on Internal Control over
Financial Reporting
(Example in Exhibit 12.3 on p. 436)
• Only for companies under guidelines of AS
2 (publicly-traded)
• Paragraph following opinion paragraph
– Indicates that auditor has examined the
effectiveness of the company’s internal control
over financial reporting
– Reference to report, including nature of
opinions express on management’s assessment
and effectiveness of internal control
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II. GAAP Departure Reports
A. Unjustified GAAP Departures
1. Qualified opinions
2. Adverse opinions
B. Justified GAAP Departures – Rule 203
Report
C. GAAP Departures Summary
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A1. Qualified (“Except for ...”) Opinion
(Example in Exhibit 12.6 on p. 443)
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• GAAP departures can cause adverse opinions or
qualified opinions -- depends upon severity and
materiality.
– Key question: Is the GAAP departure relatively
contained (“compartmentalized”) or does it permeate
the financial statements?
• Report Modifications:
– Intro and scope paragraphs remain the same
– Add middle paragraph explaining problem and
detailing $ amounts involved
– Change opinion paragraph (“In our opinion, except for
the matter discussed in the preceding paragraph,….”)
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A2. Adverse Opinion
(Example in Exhibit 12.7 on p. 443)
• Issued when statements are “so lacking in
fairness” that a qualified opinion would be
misleading (i.e., a serious departure from GAAP
that permeates the financial statements).
• Report Modifications:
– Intro and scope paragraphs remain the same
– Add middle paragraph explaining problem and
detailing $ amounts involved
– Change opinion paragraph (add “do not” and “because
of ...”, omit “in all material respects”)
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12-12
B. Justified GAAP Departures - Rule 203 Report
(Example in Exhibit 12.5 on p. 442)
• Rule 203 allows for non-GAAP solutions to fairly
present the company's financial situation.
– Rule 203 of the AICPA Code of Professional Conduct
recognizes that adherence to certain accounting
principles may create situations in which a company's
financial condition may not be fairly presented.
– Solution: Insert an additional middle paragraph
(between scope and opinion paragraphs) stating the
deviation from GAAP, but still issue an unqualified
report.
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C. GAAP Departures Summary
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III. Reporting on Unusual Aspects of the Audit
A. Scope limitation
1. Qualified opinion
2. Disclaimer of opinion
B. Lack of independence
C. GAAS Departures Summary
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A1. Qualified (“Except for ...”) Opinions
(Example in Exhibit 12.9 on p. 446)
• Scope limitations can cause disclaimers or qualified
opinions depending upon severity and materiality.
– Key question: Is the scope limitation limited, or does it permeate
the financial statements?
– If alternative procedures are available, the auditor may still be able
to issue an unqualified opinion.
• Report Modifications:
– Intro paragraph remain the same
– Scope paragraph: “Except for the problem noted, the audit was
conducted in accordance with auditing standards generally
accepted in the United States”.
– Add middle paragraph explaining problem
– Change opinion paragraph (“In our opinion, except for the matter
discussed in the preceding paragraph,….”)
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A2. Disclaimer of Opinion
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(Example in Exhibit 12.9 on p. 446)
• Significant scope limitation, usually company-imposed
(e.g., no physical inventory taken, confirming A/R not
allowed by company (and auditor cannot get satisfaction
otherwise), significant subsidiary not examined, etc.)
– The problem is that the auditor cannot gather sufficient competent
evidence to form an opinion, even an adverse one.
• Report Modifications:
– Intro paragraph: (“We were engaged to audit ….”; omit auditor
responsibility)
– Omit scope paragraph
– Add middle paragraph explaining problem
– Change opinion paragraph (“…we do not express an opinion….”)
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12-17
B. Lack of Independence
• Should state that CPA is not independent but need not state
the reason why
I am (We are) not independent with respect to the XYZ
Company and the accompanying balance sheet as of
December 31, 20XX, and the related statements of income
retained earnings, and cash flows for the year then ended
were not audited by me (us) and, accordingly, I (we) do not
express and opinion on them.
• No heading on report
• Do not describe procedures performed
• BUT must describe material departures from GAAP
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C. GAAS Departures Summary
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12-19
IV. Other Issues Affecting the
Auditor’s Report
A. Reference to Other Auditors
B. Circumstances Concerning Comparative
Financial Statements
C. Reporting on Other Information
Accompanying the Financial Statements
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A. Reference to Other Auditors
• Another auditor has performed a significant portion of the audit (e.g., a
partially-owned subsidiary or a branch located elsewhere).
– Choice 1 - make no reference to other auditors and just issue Standard
Report -- principal auditor assumes responsibility for other auditor's work.
– Choice 2 - Make reference to Other Auditors in all three paragraphs.
• Requirements - In either case, principal auditor must be satisfied that the
quality of the other auditor's work is good enough to be relied upon.
– Inquiries of Professional Reputation
– Obtain representation that other auditor is independent
– Communicate with other auditor about GAAP/GAAS matters, awareness
that statements will be consolidated (i.e., inter-company transfers, etc.),
maybe visit and review other auditor's work if taking full responsibility.
– If unable to rely on other auditor's work, consider scope limitation.
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B. Circumstances Concerning
Comparative Financial Statements
• Different opinions on the financial statements
– Most often occurs in first year audit with disclaimer on
income statement and unqualified on balance sheet
• Updating an opinion
– An updated prior year report for comparative financial
statements may be the same as previously issued or
changed to reflect information learned during the current
year audit.
– When the opinion differs from the prior report, the auditor
must explain the change by adding a paragraph just before
opinion paragraph explaining the change.
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C. Reporting on Other Information Accompanying The
Financial Statements
• Examples include the president’s letter and
management discussion and analysis of operations.
• Sections are separate and not considered part of the
audited financial statements.
• Standard report is silent about other information
unless an inconsistency or material misstatement of
fact exists.
• A company’s financial statements and other
information placed on a Web site are not currently
subject to auditor review for inconsistencies or
material misstatements.
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V. Reporting on Internal Control Over
Financial Reporting
A. Types of Opinions
B. Reporting Options for Internal Control
Report
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A. Types of Opinions
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Note that an auditor gives two opinions:
An opinion regarding whether management has properly
assessed internal control over financial reporting.
Auditor’s assessment of internal control over financial
reporting.
See Exhibit 12.19 on p. 462 for possible scenarios.
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12-25
B. Reporting Options for Internal
Control Report
• Present separate reports on company’s
financial statements and company’s internal
control over financial reporting
– Each of the reports would reference other report
• Present combined report on company’s
financial statements and company's internal
control over financial reporting. Note
components on p. 463 of text.
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Choosing the Right Report
Immaterial
Somewhat
Material
Very Material
Departure from GAAP -Unjustified
STANDARD
QUALIFIED
ADVERSE
Departure from GAAP -Justified
STANDARD
MODIFIED
MODIFIED
Scope Limitation
STANDARD
QUALIFIED
DISCLAIMER
Going Concern
NOT
APPLICABLE
NOT
APPLICABLE
STANDARD
PLUS
Consistency
STANDARD
STANDARD
PLUS
STANDARD
PLUS
Emphasize a matter
STANDARD
STANDARD
PLUS
STANDARD
PLUS
Situation
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