Section 3
Auditors’ Reports
Introduction
• Expressing and independent and expert
opinion
• Third reporting standard:
– The auditors’ report should contain either an expression
of opinion on the financial statements or an assertion
that an opinion cannot be expressed. In the latter case,
the reasons therefor should be stated.
Financial Statements
• What is included in the financial
statements?
• Notes to the Financial Statements
– Why needed?
• Type of information in the notes
1. Financial data
2. Accounting information
3. Other matters
• A list of common requirements
1.
Significant accounting policies
2.
Changes in accounting principles and practices
3.
Subsequent events
4.
Segmented information
5.
Related party transactions
The Auditors’ Standard Report
• What does the standard report imply?
• Adopted in 1990 by the Auditing Standards
Board
• Three paragraphs
AUDITORS’ REPORT
To the Shareholders of XYZ Industries Ltd.
We have audited the balance sheet of XYZ Industries LTD. as at December 31, 200X, and the
statements of income, retained earnings, and cash flows for the year then ended. These financial
statements are the responsibility of the company’s management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those
standards require that we plan and perform an audit to obtain reasonable assurance 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.
In our opinion, these financial statements present fairly, in all material respects, the financial
position of the company as at December 31, 200X, and the results of its operations and cash
flows for the year then ended in accordance with generally accepted accounting principles.
Carney, Black and Heath, LLP
Chartered Accountants
Toronto, Canada
March 1, 200Y
Introductory Paragraph
• The first paragraph
• Indicates that:
1.
2.
3.
Scope Paragraph
• The second paragraph
• Describes:
1.
2.
3.
Opinion Paragraph
• The last paragraph
• Indicates what?
• What does present fairly mean?
Signing The Report
• In a partnership, not an individual
• A sole practitioner
Date of The Report
• What does this date represent?
• This date is significant
Unqualified Auditors Report Issuance
• When:
• No material departure from GAAP
• Performed in accordance with GAAS
Expression of An Opinion
• A number of options:
1.
Unqualified opinion:
2.
Qualified opinion
3.
Adverse opinion
4.
Denial of opinion
Materiality
• CICA 5130:
• A misstatement or the aggregate of all misstatements in
financial statements is considered to be material if, in the
light of surrounding circumstances, it is probable that the
decision of a person who is relying on the financial
statements, and who has a reasonable knowledge of
business and economic activities, would be changed or
influenced by such misstatement or the aggregate of all
misstatements.
• Why is materiality important?
• Material departure from GAAP
• Use material to describe
Fair Presentation, GAAP, and
Professional Judgment
• The auditors’ professional judgment on the
fair presentation of financial statements
must be made within the framework of
GAAP
• Thus the GAAP used
The Unqualified Report
• When does the auditor express an
unqualified opinion?
• Additional wording can be added to the standard
report
• Statutory Requirements
• CICA 5701
• EG: Consistency of application of GAAP
• Emphasis of a Matter
• EG:
• Separate paragraph after the opinion paragraph
Reservation
• Inability of the auditor to express an
unqualified opinion?
• Reservation paragraph
Qualified Opinions
• Restricts the auditors’ responsibility for fair
presentation in some area of the financial
statements
• Reservation paragraph
• Departure From GAAP
• Some specific circumstances
1.
An inappropriate accounting treatment
2.
An inappropriate valuation
3.
A failure to disclose essential information or to present
information in an appropriate manner
• Scope Limitations
• Some specific circumstances
1.
The timing of the auditors’ appointment and the audit
work
2.
The unavailability of accounting records
3.
The inability to perform necessary audit procedures
A Departure From GAAP
• Qualified or an adverse opinion
• Depends on materiality
• Why qualify?
• What usually happens?
• Introductory and scope paragraphs do not
change
Misapplication of Accounting principles:
Note 9 to the financial statements describes the depreciation policy with respect to the
company’s manufacturing plants and equipment. The note also indicates that the
company is not depreciating its head office building, which it acquired five years ago,
on the grounds that it is not a producing asset and is maintaining its value as a
potential rental or resale property. In this respect the financial statements are not in
accordance with generally accepted accounting principles. The estimated useful life
of similar buildings is usually considered to be between 30 and 40 years. If
depreciation had been provided on the basis of an estimated life of, say, 35 years,
depreciation for the current year would have been increased by $200,000 (1999,
$220,000), net income after taxes would have decreased by $100,000 (1999,
$110,000), accumulated depreciation would have increased by $200,000 (1999,
$220,000) and the closing balance of retained earnings would have been reduced by
$610,000 (1999, $510,000).
In our opinion, except for the effects of the failure to record depreciation as
described in the preceding paragraph, these financial statements present fairly, in all
material respects, the financial position of the company as at December 31, 2000, and
the results of its operations and cash flows for the year then ended in accordance with
generally accepted accounting principles.
Inadequate Disclosures:
The accompanying financial statements, in our opinion, do not draw attention
explicitly to doubts concerning the company’s ability to realize its assets and
discharge its liabilities in the normal course of business. These doubts arise because it
is uncertain whether the company will be able to refinance long-term debt in the
amount of $10,000,000 due on March 26, 2001, in view of the existence of recurring
operating losses in the past five years and the deficiency in working capital of
$2,000,000 at December 31, 2000. If refinancing cannot be arranged, it is not known
whether the company can sell its hotel property for an amount sufficient to realize its
carrying value of $9,000,000 and to generate adequate funds to repay this debt.
In our opinion, except for the the omission of the disclosure described in the
preceding paragraph, these financial statements present fairly, in all material
respects, the financial position of the company as at December 31, 2000, and the
results of its operations and cash flows for the year then ended in accordance with
generally accepted accounting principles.
Consistency of Accounting Principles
• A change in accounting principle
• Is a reservation for lack of consistency
required?
Limitations on Scope of Examination
• Inability to perform necessary auditing
procedures
• If the scope limitation is not so material
Scope Limitations:
Except as explained in the following paragraph, we conducted our audit in accordance with
generally accepted auditing standards. Those standards require that we plan and perform an
audit to obtain reasonable assurance 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.
Because we were appointed auditors of the company during the current year, we were not able to
observe the counting of physical inventories at the beginning of the year nor to satisfy ourselves
concerning those inventory quantities by alternative means. Since opening inventories enter into
the determination of the results of operations and cash flows, we were unable to determine
whether adjustments to cost of sales, income taxes, net income for the year, opening retained
earnings, and cash provided from operations might be necessary.
In our opinion, except for the effect of adjustments, if any, which we might have determined to
be necessary had we been able to examine opening inventory quantities, as described in the
preceding paragraph, the statement of income, retained earnings and cash flow present fairly, in
all material respects, the results of operations, and cash flows of the company for the year ended
December 31, 2000, in accordance with generally accepted accounting principles. Further, in our
opinion, the balance sheet presents fairly, in all material respects, the financial position of the
company as at December 31, 2000, in accordance with generally accepted accounting principles.
Reliance on Other Auditors
• Primary auditors, on occasion, must rely on
the audit work of another accounting firm
• Common situation
To Justify Reliance
1. Consider professional qualifications, competence,and
integrity of the secondary auditor
2. Communicate with the secondary auditor
3. Read the report of the secondary auditor
4. Obtain a written communication from the secondary
auditor
5. Review the work of the secondary auditor
Major Uncertainty Affecting a Client’s
Business
• Can be a wide range here
• CICA 5510:
A Major Contingency
• Auditor must obtain sufficient appropriate audit
evidence
• A reservation of opinion?
A Going Concern
• What conditions could precipitate this?
• Reservation of opinion?
Adverse Opinions
• The opposite of an unqualified opinion
• Disclosure required
• Standard introductory and scope paragraphs
Adverse Opinion:
• In the opinion paragraph:
In our opinion, because of the effects of the matters discussed in the preceding
paragraph, these these financial statements do not present fairly the financial
position of the company as at December 31, 2000, and the results of its operations and
cash flows for the year then ended in accordance with generally accepted accounting
principles.
• What would the “preceding paragraph” be?
Denial of Opinion
• No opinion
• When required
• Separate reservation paragraph
Denial of Opinion:
Except as explained in the following paragraph, we conducted our audit in accordance with
generally accepted auditing standards. Those standards require that we plan and perform an
audit to obtain reasonable assurance 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 were not appointed auditor until after December 31, 2000, and thus did not observe the
taking of physical inventories at the beginning of the year or the end of the year and were not
able to satisfy ourselves concerning inventory quantities by alternative means. Also, our
examination indicated serious deficiencies in the accounting records and in internal control. As a
consequence, we were unable to satisfy ourselves that all revenues and expenditures of the
company had been recorded, nor were we able to satisfy ourselves that the recorded transactions
were proper. As a result, we were unable to determine whether adjustments were required in
respect of recorded or unrecorded assets, recorded or unrecorded liabilities, and the components
making up the statements of income, retained earnings, and cash flow.
In view of the possible material effects on the financial statements of the matters described in
the preceding paragraph, we are unable to express an opinion whether these financial
statements are presented fairly in accordance with generally accepted accounting principles.
Summary of Appropriate Auditors’ Reports
Materiality of
the Issue
Type of Report
Not Material
Departure
from GAAP
Material
Qualified
Qualified
Very Material
Adverse
Denial
Unqualified
Scope
limitation
Comparative F/S in Audit Reports
• CICA has long supported presentation of
comparative F/S
• When comparative statements are presented
Dating and Double Dating the Auditors’
Report
• Why is the date important?
• CICA 5405.06
• Substantial completion of examination
• Subsequent event and dating
• Two options
• Double dating
• Redating
Auditors’ Responsibility for Information
in the Annual Report
• Other information
• CICA 7500
1. Accurately reproduced F/S and Audit Report
2. Is any of this information inconsistent?
• Error in Reproduction
• Inconsistency resulting from an error
Reports to the SEC in the United States
• Two principal laws
• Securities Act of 1933
• Securities and Exchange Act of 1934
1.
2.
3.
4.
Forms S-1 through S-18
Form 8-K
Form 10-Q
Form 10-K
Problem 1. Types of report. What types of report (unqualified, qualified, adverse,
denial) should the auditors generally issue in each of the following situations?
a.
Client-imposed restrictions limit very significantly the scope of the auditor’s
procedures.
b.
The auditors decide that it is necessary to make reference in their report of another
public accounting firm (the secondary auditor).
c.
The auditors believe that the financial statements have been stated in conformity
with generally accepted accounting principles in all respects other than a disclosure
of a material uncertainty.
Problem 2. Rowe & Myers are the primary auditors of Dunbar Electronics. During the
audit, Rowe & Myers engaged Jones & Abbot, an American public accounting firm,
to audit Dunbar’s wholly owned U.S. subsidiary.
a.
Must Rowe & Myers make reference to the other auditors in their audit report?
b.
Assume that Jones & Abbot issued a qualified report on the U.S. subsidiary. Must
Rowe & Myers include the same qualification in their report on Dunbar electronics?
Problem 3. While performing your audit of Williams Paper limited, you discover
evidence that indicates that Williams may not have the ability to continue as a going
concern.
a.
Discuss the types of information that may indicate a going-concern problem.
b.
Explain the auditors’ reporting obligation in such situations.
Problem 4: 2-24.
Roscoe, public accountant, has completed the examination of the
financial statements of Excelsior Corporation as of and for the year ended December
31, 1999. Roscoe also examined and reported on the Excelsior financial statements for
the prior year. Roscoe drafted the following report for 1999.
We have audited the balance sheet and statements of income and retained earnings of
Excelsior Corporation as of December 31, 1999. We conducted our audit in
accordance with generally accepted accounting standards. Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of misstatement.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly the financial
position of Excelsior Corporation as of December 31, 1999, and the results of its
operations for the year then ended in conformity with generally accepted auditing
standards, applied on a basis consistent with those of the preceding year.
Other Information:
1. Excelsior is presenting comparative financial statements.
2. Excelsior does not wish to present a cash flow statement for either year.
3. During 1999, Excelsior changed its method of accounting for long-term
construction contracts, properly reflected the effect of the change in the current year’s
financial statements, and restated the prior year’s statements. Roscoe is satisfied with
Excelsior’s justification for making the change. The change is discussed in footnote
12.
4. Roscoe was unable to perform normal accounts receivable confirmation
procedures, but alternate procedures were used to satisfy Roscoe as to the existence of
the receivables.
5. Excelsior Corporation is the defendant in a lawsuit, the outcome of which is highly
uncertain. If the case is settled in favour of the plaintiff, Excelsior will be required to
pay a substantial amount of cash which might require the sale of certain capital assets.
The litigation and the possible effects have been properly disclosed in footnote 11.
6. Excelsior issued debentures on January 31, 1997, in the amount of $10,000,000.
The funds obtained from the issuance were used to finance the expansion of plant
facilities. The debenture agreement restricts the payment of future cash dividends to
earnings after December 31, 1998. Excelsior declined to disclose this essential data in
the footnotes to the financial statements.
Required:
a.
Identify and explain any items included in “Other Information” that need not be part
of the auditor’s report.
b.
Explain the deficiencies in Roscoe’s auditor’s report as drafted.
Problem 5: 2-25.
For the following independent situations, assume you are the audit
partner on the engagement.
1.
During your examination of Debold Brothers Ltd., you conclude there is a
possibility that inventory is materially overstated. The client refuses to allow you to
expand the scope of your examination sufficiently to verify whether the balance is
actually misstated.
2.
You are auditing Woodcolt Linen Services, Inc., for the first time. Woodcolt has
been in business for several years but has never had an audit before. After the audit
is completed, you conclude that the current year balance sheet is stated correctly in
accordance with GAAP. The client did not authorize you to do test work for any of
the previous years.
3.
You were engaged to examine Cutter Steel Corp.’s financial statements after the
close of the corporation’s fiscal year. Because you were not engaged until after the
balance sheet date, you were not able to physically observe inventory, which is very
material. On the completion of your audit, you are satisfied that Cutter’s financial
statements are presented fairly, including inventory about which you were able to
satisfy yourself by the use of alternative audit procedures.
4.
Four weeks after the year-end date, a major customer of Prince Construction Ltd.
Declared bankruptcy. Because the customer had confirmed the balance due to
Prince at the balance sheet date, management refuses to charge off the account or
otherwise disclose the information. The receivable represents approximately 10
percent of accounts receivable and 20 percent of net earnings before taxes.
5.
You complete the audit of Johnson Department Store Ltd., and, in your opinion, the
financial statements are fairly presented. On the last day of the examination, you
discover that one of your supervisors assigned to the audit had a material investment
in Johnson. If you decide no auditor’s report can be issued, explain your decision.
6.
Auto Delivery Company Ltd. has a fleet of several trucks. In the past, Auto Delivery
had followed the policy of purchasing all equipment. In the current year, they
decided to lease the trucks. This change in policy is fully disclosed in the notes.
Problem 6: 2-33.
The following is an auditor’s report, except for the opinion
paragraph, of Tri-Nation Corp.
We have audited the accompanying consolidated balance sheet of Tri-Nation Corp. and
subsidiaries as of July 31, 1999, and the related statements of income, shareholders’ equity, and
cash flow for the year then ended. These financial statements are the responsibility of
management. Our responsibility is to express an opinion on these financial statements based on
our audit.
Except as explained in the following paragraph, we conducted our audit in accordance with
generally accepted auditing standards. Those standards require that we plan and perform an audit
to obtain a reasonable assurance as to 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.
The company had significant deficiencies in internal control, including the lack of detailed
records and certain supporting data which were not available for our examination. Therefore, we
were not able to obtain sufficient evidence in order to form an opinion on the accompanying
financial statements, including whether the inventory at July 31, 1999, ($670,490) was stated at
lower of cost or market, or whether the deferred subscription revenue ($90,260) is an adequate
estimate for the applicable liability, as discussed in notes 5 and 12, respectively.
Required:
Write the opinion paragraph for this auditor’s report. State any assumptions you have
made.