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Auditing 1
T h e 1 0 G A A S S ta n d a r d s a n d t h e " O l d " A u d i to r ' s R e p o r t i n g
Model
The AICPA has stated that it will test both the Clarified SASs and the "old" SASs on the Auditing exam starting
on July 1, 2013. The AICPA has not given a definitive time period for this dual-testing, but has stated that
it will continue until the Clarified SASs fully replace the old SASs (most likely at the end of 2014). The good
news is that Becker is well-positioned to prepare you for the Auditing exam during this period of transition
from the old SASs to the Clarified SASs. This Audit B textbook (Clarified SASs), is essentially the Audit A
textbook (old SASs) with enhancements to cover the new/clarified provisions of the Clarified SASs. This new
section has been added to your Audit 1 lecture to cover two old SAS topics, the ten GAAS standards and the
old auditor's reporting model, that are not part of the Clarified SASs, but may still be tested on your Audit
Exam. If you would like to print out this new topic, please go to 2013 Edition course updates for the Audit B
textbook available at http://beckerkb.custhelp.com.
I.
Generally Accepted Auditing Standards
The ten Generally Accepted Auditing Standards comprise the foundation of auditing. These
standards are qualitative in nature and set minimum requirements for the profession. Auditing
standards differ from auditing procedures in that "procedures" relate to acts to be performed,
whereas "standards" deal with measures of audit quality and the objectives to be achieved in an
audit. Auditing standards (as distinct from auditing procedures) concern themselves not only with
the auditor's professional qualities, but also with the judgment exercised in the performance of the
examination and in the auditor's report.
A.
General Standards
1.
Training
General
Standards
"The auditor must have adequate technical training and proficiency to perform the
audit."
Comment: The auditor must have the education in accounting, the practical experience
in auditing, and knowledge of the particular industry being audited.
2.
Independence
"The auditor must maintain independence in mental attitude in all matters relating to the
audit."
Comment: This standard is often called the cornerstone of the profession since it is
necessary to add credibility to what we do. It is defined as independence in fact and
appearance. The auditor is judicially impartial. Various independence standards are
discussed in depth in the Ethics and Professional Responsibilities section of this
lecture.
a.
Independence in Fact and in Appearance
The auditor must be independent in fact and in appearance. Auditors must leave
no doubt as to their independence in the mind of the general public. Activities or
relationships that even suggest or imply a possible lack of independence must be
avoided by the auditor.
For example, assume the auditor owns an insignificant amount of the client's
common stock, and the auditor can in no way influence corporate policy. Thus,
the auditor is independent in fact. However, the appearance of independence is
nonetheless impaired. Any direct ownership of a company, no matter how small,
will impair independence. (An indirect financial interest that is immaterial does
not impair independence.)
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3.
Professional Care
"The auditor must exercise due professional care in the planning and performance of
the audit and the preparation of the report."
Due professional care imposes a responsibility upon each person within an
independent auditor's organization to observe the standards of fieldwork and reporting.
The auditor will be held to exercise the same components of professional care as a
reasonable auditor would exercise, which include good faith, integrity, and diligence,
but due professional care does not imply infallibility. Due professional care is
concerned with what the auditor does and how well it is done. The exercise of due
professional care implies that the auditor will obtain sufficient appropriate audit
evidence to limit audit risk to a low level. The high level of assurance expected to be
obtained is referred to as "reasonable assurance"; absolute assurance is not possible.
Due professional care also requires the auditor to exercise professional skepticism.
Professional skepticism can be defined as the maintenance of an objective attitude
throughout the audit, including a questioning mind and a critical assessment of audit
evidence. The auditor neither presumes management dishonesty nor presumes
unquestioned management honesty. The auditor needs to exercise professional
skepticism throughout the audit process, from engagement planning through
conducting fieldwork.
Comment: Often called the "average auditor" concept. The auditor should do what the
average auditor would do and never less, including review of work performed by
assistants and maintaining an attitude of professional skepticism. Evidence of "due
professional care" is indicated by critical management reviews of work performed at
every level of supervision.
B.
Standards of Fieldwork
1.
Planning and Supervision
"The auditor must adequately plan the work and must properly supervise any
assistants."
Standards of
Fieldwork
Comment: Audit programs are designed to enumerate appropriate action, and all work
of staff auditors should be reviewed by a qualified auditor.
2.
Internal Control, Entity, and Environment
"The auditor must obtain a sufficient understanding of the entity and its environment,
including its internal control, to assess the risk of material misstatement of the financial
statements whether due to error or fraud, and to design the nature, extent, and timing
of further audit procedures."
Comment: Appropriate internal controls provide the auditor with confidence that
material misstatements will be prevented, or detected and corrected, on a timely basis.
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a.
Strong controls imply the auditor will require less evidence from substantive
procedures.
b.
Weak controls imply the auditor will require more evidence from substantive
procedures.
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3.
Evidence
"The auditor must obtain sufficient appropriate audit evidence by performing audit
procedures to afford a reasonable basis for an opinion regarding the financial
statements under audit."
Comment: All specific audit work is performed in order to gather evidence.
C.
Standards of Reporting
1.
Standards
of Reporting
Accounting = GAAP
"The auditor must state in the auditor's report whether the financial statements are
presented in accordance with generally accepted accounting principles (GAAP)."
Comment: Explicit statement in auditor's report.
2.
Consistency
"The auditor must identify in the auditor's report those circumstances in which such
principles have not been consistently observed in the current period in relation to the
preceding period."
Comment: Implicit in auditor's report.
3.
Disclosure
"When the auditor determines that informative disclosures are not reasonably
adequate, the auditor must so state in the auditor's report."
Comment: Implicit in auditor's report.
4.Express Opinion
"The auditor must either express an opinion regarding the financial statements, taken
as a whole, or state that an opinion cannot be expressed, in the auditor's report. When
the auditor cannot express an overall opinion, the auditor should state the reasons in
the auditor's report. In all cases where an auditor's name is associated with financial
statements, the auditor should clearly indicate the character of the auditor's work, if
any, and the degree of responsibility the auditor is taking, in the auditor's report."
Comment: Explicit statement in auditor's report.
Pass K e y
The examiners test on which reporting standards are explicit (Accounting is GAAP & Express Opinion) and
which standards are implicit (Consistency & Disclosure).
a.
The objective of the fourth standard of reporting is to prevent misinterpretation of
the degree of responsibility the auditor is assuming when his/her name is
associated with financial statements.
(1) The auditor, when associated with the financial statements, has two major
choices:
(a) To render an opinion on the financial statements taken as a whole;
or
(b) To disclaim an opinion (e.g., because not enough audit work was
done, or because the auditor was not independent).
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(2) Taken as a whole applies equally to a complete set of financial statements
including footnotes, and to an individual financial statement, such as a
balance sheet.
(a) The auditor may express an unqualified opinion on one of the
financial statements (e.g., a balance sheet), while rendering a
qualified opinion or disclaimer of opinion on another financial
statement, such as the income statement (covered later).
(b) The auditor may report on one basic financial statement and not the
others, as long as access is not limited to information underlying the
basic financial statement. This is considered a "limited" reporting
engagement.
II.
Auditor's standard report (unqualified opinion)
The auditor's unqualified report states that the financial statements are presented fairly in all
material respects. The three-paragraph standard report includes all of the following:
A.Title
"Independent" (auditor's report) must be included in the report title.
B.Addressee
The report is generally addressed to the company, its stockholders and/or its board of
directors. It generally is not addressed to management.
C.
Introductory Paragraph
The introductory paragraph contains the following:
D.
1.
A statement that the financial statements as identified in the report were audited; and
2.
A statement that the financial statements are the responsibility of management and that
the auditor's responsibility is to express an opinion.
Scope Paragraph
The scope paragraph contains the following:
1.
A statement that the audit was conducted in accordance with United States GAAS;
a.
E.
For audits of issuers, reference is made to PCAOB standards instead of United
States GAAS.
2.
A statement that the audit was planned and performed to obtain reasonable assurance
that the financial statements are free from material misstatement;
3.
Statements that the audit included examining evidence on a test basis; assessing the
accounting principles used and significant estimates made by management; and
evaluating the overall presentation; and
4.
A statement that the audit provides a reasonable basis for an opinion.
Opinion Paragraph
The opinion paragraph of the report contains the following:
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1.
A statement referring to the financial statements specifically identified in the
introductory paragraph;
2.
An opinion as to the fair presentation of the financial statements; and
3.
A statement regarding conformity with United States generally accepted accounting
principles.
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F.
Auditing 1
Firm Name
The firm's name, either printed or signed, must appear in the report.
G.
Report Date
The date of the audit report must be included in the report.
1.
III.
The report should be dated on or after the date on which appropriate audit evidence,
sufficient to support the opinion, has been obtained. Sufficient appropriate audit
evidence includes evidence that:
a.
Audit documentation has been reviewed,
b.
Financial statements have been prepared, and
c.
Management has taken responsibility for the financial statements.
2.
The report date shows the final date of the auditor's responsibility.
3.
For comparative statements, the date appropriate for the most recent audit should be
used.
Unqualified opinion
A.
Sample Report—Unqualified Opinion (reporting on a single year)
(Name)
Opinion
In our opinion, the financial statements referred to above present fairly, in all material respects,
the financial position of ABC Company as of (at) December 31, 20XX, 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.
Scope
We conducted our audit in accordance with auditing standards generally accepted in the
United States of America. 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 audit provides a reasonable basis
for our opinion.
Intro
We have audited the accompanying balance sheet of ABC Company as of December 31, 20XX,
and the related 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.
Heading
INDEPENDEN T A UDI T O R ' S REP O R T
Auditor's Standard
Report
(Date)
Sign
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Auditing 1
B.
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Sample Report—Unqualified Opinion (reporting on a single financial statement)
( U N Q U A L I F I E D ) O P I N I O N O N B A L A N C E S H E E T O N LY
INDEPENDEN T AUDITOR' S REPORT
We have audited the accompanying balance sheet of X Company as of December 31, 20XX. This financial
statement is the responsibility of the Company's management. Our responsibility is to express an opinion on
this financial statement based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of
America. Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether the balance sheet is 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 audit provides a reasonable basis for our
opinion.
In our opinion, the balance sheet referred to above presents fairly, in all material respects, the financial
position of X Company as of (at) December 31, 20XX, in conformity with accounting principles generally
accepted in the United States of America.
C.PCAOB Standards
1.Audits of Issuers
PCAOB Auditing Standard No. 1 requires the auditor's report to include a reference to
the standards of the Public Company Accounting Oversight Board (United States).
a.
An auditor reporting on the audit of financial statements of an issuer should state
in the scope paragraph:
"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…"
b.
An auditor's report on the financial statements of an issuer should also include
identification of the city and state (or country) from which the report was issued.
Generally, this information is included with the signature and date.
2.Audits of Nonissuers
An auditor may (but is not required to) conduct the audit of a nonissuer in accordance
with both GAAS and the auditing standards of the PCAOB. Additional language may
be added to the scope paragraph to describe this situation:
"We conducted our audit in accordance with generally accepted auditing standards as established
by the Auditing Standards Board (United States) and in accordance with the auditing standards of
the Public Company Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit…"
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Pass K e y
When the examiners require CPA candidates to respond to questions concerning the standard audit report, you must
remember:
GAAS
Scope Paragraph
Opinion Paragraph
GAAP
E x am p l e
Which paragraphs of an auditor's standard report on financial statements should refer to Generally Accepted Auditing
Standards (GAAS) and Generally Accepted Accounting Principles (GAAP)?
GAAS
GAAP
a.Opening Scope
b.Scope
Scope
c.Scope
Opinion
d.Opening Opinion
Solution: Choice "c" is correct. The auditor states that the audit was conducted in accordance with U.S. GAAS in the scope
paragraph. The auditor expresses an opinion on the financial statements' conformity with U.S. GAAP in the opinion
paragraph.
D.
International Standards on Auditing
There are three major differences between the audit report under U.S. auditing standards and
the International Standards on Auditing:
1.
The ISA audit report includes expanded descriptions of management's and the
auditor's responsibilities (shown in the sample report below).
2.
The ISA audit report should be addressed as required by the circumstances of the
engagement and should name the location in the country or jurisdiction where the
auditor practices.
3.
When an audit is conducted in accordance with both the auditing standards of a
specific jurisdiction and International Standards on Auditing, the auditor's report may
refer to both the national auditing standards of that jurisdiction and the International
Auditing Standards only if there is no conflict between the two sets of standards that
would impact the report and the audit report includes all elements required by the ISAs.
[Appropriate Addressee]
INDEPENDEN T A UDI T O R ' S REP O R T
We have audited the accompanying financial statements of X Company, which comprise the balance sheet as of
December 31, 20XX, and the statement of comprehensive income, statement of changes in equity and cash flow
statement for the year then ended, and a summary of significant accounting policies and other explanatory
information.
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Management's Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance
with International Financial Reporting Standards, and for such internal control as management determines is
necessary to enable the preparation of financial statements that are free from material misstatement, whether due
to fraud or error.
Auditor's Responsibility
Our responsibility is to express an opinion on this financial statement based on our audit. We conducted our audit
in accordance with International Standards on Auditing. Those standards required that we comply with ethical
requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial
statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of
material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments,
the auditor considers internal control relevant to the entity's preparation and fair presentation of the financial
statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the
appropriateness of accounting policies used and the reasonableness of accounting estimates made by management,
as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence that we have obtained is sufficient and appropriate to provide a basis for our
audit opinion.
Opinion
In our opinion, the financial statements present fairly, in all material respects, (or give a true and fair view of) the
financial position of X Company as at December 31, 20XX, and (of) its financial performance and its cash flows for the
year then ended in accordance with International Financial Reporting Standards.
[Auditor's signature]
[Date of the auditor's report]
[Auditor's address]
IV.TYPES OF OPINIONS
A.
Unqualified (Clean) Opinion
An unqualified opinion states that the financial statements present fairly, in all material
respects, the financial position, results of operations, and cash flows of the entity in
conformity with United States GAAP. This is the opinion expressed in the standard report.
1.Explanatory Language (modified unqualified opinion)
Explanatory language may be added to the auditor's standard (unqualified) report.
Certain circumstances, even those not affecting the auditor's unqualified opinion on the
financial statements, may require that the auditor add an explanatory paragraph (or
other explanatory language) to the report.
B.
Qualified Opinion (except for)
A qualified opinion states that, "except for" the effects of the matter(s) to which the
qualification relates, the financial statements present fairly, in all material respects, the
financial position, results of operations, and cash flows of the entity in conformity with United
States GAAP.
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C.
Adverse Opinion
An adverse opinion states that the financial statements do not present fairly the financial
position, results of operations, or cash flows of the entity in conformity with United States
GAAP.
D.
Disclaimer of Opinion
A disclaimer of opinion states that the auditor does not express an opinion on the financial
statements because he or she was not able to perform an audit sufficient in scope to render
an opinion.
V.
BRIEF SUMMARY OF WHEN TO USE DIFFERENT OPINIONS (covered in greater detail later)
Materiality of Problem
Conformity with GAAP
Adherence to GAAS
None or immaterial
=
Unqualified
Unqualified
Material
=
Qualified Opinion (modify
opinion paragraph)
Qualified Opinion (modify
scope and opinion paragraphs)
Highly Material
=
Adverse Opinion
Disclaimer of Opinion
Pass K e y
A candidate must be able to identify the types of opinions available for GAAP issues (Qualified—"Except for" &
Adverse) and for GAAS issues (Qualified—"Except for" & Disclaimer).
VI.UNQUALIFIED OPINION
Unqualified Opinion
Qualified
"Except for"
GAAP
Qualified
"Except for"
GAAS
1. Non-GAAP Change
2. Inadequate Disclosure
3. Unjustified Departure from GAAP
4. Unreasonable Acctg. Estimate
1. Uncertainty
2. Scope Limitation
Adverse
GAAP
Disclaimer
GAAS
1. Non-GAAP Change
2. Inadequate Disclosure
3. Unjustified Departure from GAAP
4. Unreasonable Acctg. Estimate
1. Uncertainty
2. Scope Limitation
3. Lack of Independence
4. Unaudited
Withdraw
False, Fraudulent, Deceptive, or Misleading
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A.
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Uncertainty
1.General
Unqualified
Uncertainty
Uncertainties
An uncertainty involves a matter for which conclusive audit evidence
concerning its outcome is not currently available and will not be available until such
time in the future when the matter is resolved. (Note the use of the word "conclusive";
existing conditions and events to date may provide some audit evidence; see below.)
Uncertainties include (but are not limited to) contingencies.
2.
Management's Responsibility
Management must analyze the existing conditions, and in accordance with
GAAP, either:
3.
a.
Estimate the effect of future events on the financial statements and record and
present this estimate, or
b.
Determine that a reasonable estimate cannot be made and make the required
disclosures to that effect.
Auditor's Responsibility
The auditor's responsibility involves an assessment of whether the audit evidence that
is or should be available is sufficient to support management's analysis and
conclusions regarding presentation or disclosure of the uncertainty in the financial
statements (that is, management's assertion regarding the uncertainty).
a.
If management's analysis is supported and properly reported or disclosed, the
auditor issues an unqualified opinion with no reference to the uncertainty in the
audit report.
b.
If the auditor is unable to obtain sufficient audit evidence involving an uncertainty
and its presentation or disclosure in the financial statements, the auditor should
consider the need to express a qualified (GAAS) opinion or to disclaim an
opinion due to a limitation in scope.
c.
If the auditor concludes that the financial statements are materially misstated
due to a departure from GAAP related to an uncertainty, the auditor should
express a qualified (GAAP) or adverse opinion. GAAP departures related to
uncertainties include inadequate disclosure, use of inappropriate accounting
principles, and use of unreasonable accounting estimates.
Pass K e y
A commonly tested area is the concept of uncertainty. The chart below will assist in your mastering
this area.
U N C E R TA I N T Y
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GAAP & Evidence
Auditor
agrees with
management
No Evidence
Auditor unable
to obtain
evidence
Non-GAAP
Auditor
disagrees with
management
Unqualified
Qualified
(GAAS) or
Disclaimer
Qualified
(GAAP) or
Adverse
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B.
Modified Unqualified Opinion
There are several situations in which an auditor must modify the standard unqualified report
to explain or emphasize a matter. This modification, however, does not constitute a qualified
opinion. Variations of the auditor's standard report will occur in several situations.
1.
Modified Wording
Division of responsibility: The auditor's opinion is based in part on the report of another
auditor.
2.
Explanatory Paragraph
a.
Necessary and justified departure from GAAP: Due to unusual circumstances, a
GAAP departure prevents the financial statements from being misleading.
b.
Going concern: There is substantial doubt about the entity's ability to continue as
a going concern.
c.
To emphasize a matter regarding the financial statements, the auditor may add
an explanatory paragraph.
d.
A justified lack of consistency is caused by a material change in GAAP between
periods or a change in the method of the application of accounting principles.
e.
Required SEC regulation S-K quarterly financial data has been omitted or has
not been reviewed.
f.
When a designated accounting standard setter requires information to accompany
an entity's basic financial statements.
g.
Other information in a document containing audited financial statements is
materially inconsistent with information appearing in the financial statements.
Pass K e y
You will probably have questions involving the "modified" unqualified opinion. We will cover each of
these examples later. It is important to note, however, that this still represents an unqualified
opinion. The additional language is used to highlight the above circumstances.
C.
General Rule on Position of Explanatory Paragraph
1.Unqualified Opinion
The explanatory paragraph generally would follow the opinion paragraph.
2.Qualified, Adverse, and Disclaimer of Opinion
The explanatory paragraph generally would precede the opinion paragraph.
3.Exceptions
The following are exceptions to the general rules above. The explanatory paragraph
may be placed either before or after the opinion paragraph.
a.
Justified GAAP departure
b.
Emphasis of a matter
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