Auditing &
Assurance
Services,
6e
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Chapter 12
Reports on Audited
Financial Statements
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Enron Corp.
and subsidiaries as of December 31, 2000 and 1999, and the
results of their operations, cash flows, and changes in
shareholders’ equity for each of the three years in the period
ended December 31, 2000, in conformity with accounting
principles generally accepted in the United States.
Opinion paragraph from Arthur Andersen’s final audit of Enron
Corp. (dated February 23, 2001)
12-2
Chapter 12 Objectives
1.
Understand the types of reports that accompany an entity’s financial
statements and the content of the auditors’ standard (unmodified) report.
2.
Identify situations in which the language in the standard (unmodified)
report is modified and the type of opinion issued in those circumstances.
3.
Identify situations in which auditors add explanatory language to an
unmodified opinion.
4.
Identify other circumstances affecting auditors’ reporting responsibilities
and explain how they affect auditors’ reports on an entity’s financial
statements.
12-3
Major Topics
I. Overview of Reporting
II. The Standard (Unmodified) Report
III. Reasons for Departing from Standard (Unmodified)
Report
–
Departures from GAAP
–
Scope limitations
–
Audit of group financial statements
IV. Other Matters Encountered During the Audit
V. Other Issues and Reporting
12-4
Reports Accompanying Financial
Statements
Nonpublic entities
Auditor
Public entities
Fairness of financial
Fairness of financial
statements and related statements and related
disclosures
disclosures
Effectiveness of
internal control over
financial reporting
Management
Effectiveness of
internal control over
financial reporting
12-5
Major Topics
I. Overview of Reporting
II. The Standard (Unmodified) Report
III. Reasons for Departing from Standard (Unmodified)
Report
–
Departures from GAAP
–
Scope limitations
–
Audit of group financial statements
IV. Other Matters Encountered During the Audit
V. Other Issues and Reporting
12-6
Components of the Standard
(Unmodified) Report
• Introductory paragraph
– F/S and years examined
• Management’s Responsibility section
– Management responsible for financial statements
– Management responsible for internal control
• Auditor’s Responsibility section
– Auditor responsible for issuing opinion on financial statements
– Audit conducted in accordance with GAAS
– Audit provides reasonable assurance
• Opinion
– Are F/S presented in accordance with applicable financial reporting framework
(GAAP)?
12-7
The Standard (Unmodified) Report
(Other Elements)
1. Title includes the word “independent”
2. Addressed to the client (normally,
shareholders and board)
3. Dated when auditors have obtained
sufficient appropriate evidence (date of
the auditors’ report)
4. Signed by the accounting firm
12-8
Types of Opinions
1.
2.
Unmodified opinion
•
F/S are in accordance with GAAP
•
Standard report may be modified to disclose additional matters
Qualified opinion
•
3.
Adverse opinion
•
4.
“Except for” some matter, F/S are in accordance with GAAP
F/S are not in accordance with GAAP
Disclaimer of opinion
•
No opinion is issued by auditors
12-9
Major Topics
I. Overview of Reporting
II. The Standard (Unmodified) Report
III. Reasons for Departing from Standard
(Unmodified) Report
–
Departures from GAAP
–
Scope limitations
–
Audit of group financial statements
IV. Other Matters Encountered During the Audit
V. Other Issues and Reporting
12-10
Departures from GAAP
Is the
Departure
Material?
NO
Standard Report
(Unmodified
Opinion)
YES
NO
Is the
Departure
Pervasive?
Qualified
Opinion
YES
Adverse
Opinion
12-11
Qualified Opinion
• Issued when departure is material, yet not
pervasive
• Report Modifications:
– Add paragraph preceding the opinion paragraph
explaining departure and detailing $ amounts involved
– Modify opinion paragraph (“In our opinion, except for
the matter discussed in the preceding paragraph,….”)
Report Example
12-12
Adverse Opinion
• Issued when F/S do not present fairly according
to GAAP (i.e., a serious, pervasive departure from
GAAP).
• Report Modifications:
– Add paragraph preceding the opinion paragraph
explaining the departure and detailing $ amounts
involved
– Change opinion paragraph (“financial statements do
not present fairly”)
Report Example
12-13
Major Topics
I. Overview of Reporting
II. The Standard (Unmodified) Report
III. Reasons for Departing from Standard (Unmodified)
Report
–
Departures from GAAP
–
Scope limitations
–
Audit of group financial statements
IV. Other Matters Encountered During the Audit
V. Other Issues and Reporting
12-14
Scope Limitations
Is the
Limitation
Material?
NO
Standard Report
(Unmodified
Opinion)
Alternative
Procedures
Available?
YES
Standard Report
(Unmodified
Opinion)
NO
Qualified
Opinion
YES
NO
Is the
Limitation
Pervasive?
YES
Disclaimer of
Opinion
12-15
Type of Scope Limitations
• Circumstance-Imposed
– Situation in which matters beyond auditors’ and client’s control
limit procedures performed by auditors
– Example: inability to observe year-end inventory because of late
appointment
• Client-Imposed
– Situation in which client specifically limits auditors’ procedures
– Should be viewed as a significant restriction and a disclaimer is
ordinarily issued
12-16
Scope Limitation: Qualified Opinion
• Issued when scope limitations are material, but
not pervasive
• Report Modifications:
– Add paragraph preceding the opinion
paragraph describing the scope limitation
– Modify opinion paragraph (“In our opinion,
except for”)
Report Example
12-17
Scope Limitation: Disclaimer of
Opinion
• Pervasive scope limitation, usually client-imposed
– Significance of the limitation is such that auditors cannot gather
sufficient appropriate evidence to form an opinion
• Report Modifications:
– Introductory paragraph: (“We were engaged to audit ….”)
– Modify Auditor’s Responsibility section:
• Note that auditors were not able to obtain sufficient appropriate evidence
• Delete paragraphs describing an audit and indicating that the audit provides a
basis for the opinion
– Add paragraph preceding the opinion paragraph describing the
scope limitation
– Modify opinion paragraph (“…we do not express an opinion….”)
Report Example
12-18
Major Topics
I. Overview of Reporting
II. The Standard (Unmodified) Report
III. Reasons for Departing from Standard (Unmodified)
Report
–
Departures from GAAP
–
Scope limitations
–
Audit of group financial statements
IV. Other Matters Encountered During the Audit
V. Other Issues and Reporting
12-19
Audit of Group Financial
Statements
• Group financial statements: Financial
statements comprised of more than one
division/subsidiary/segment/component
• Group auditors: Conduct audit of material
portion of the entity
• Component auditors: May be engaged by
group auditors to audit divisions, subsidiaries,
or components
12-20
Audit of Group F/S
Take
Responsibility
for
Component
Auditors’
Work?
YES
Standard Report
(Unmodified
Opinion)
YES
Obtain permission
and present
component
auditors’ report
NO
Refer to
Component
Auditors by
Name?
NO
Indicate Division
of Responsibility
in Unmodified
Opinion
12-21
Effect on Report
• Group auditors should
– Verify component auditors’ reputation and independence
– Communicate and coordinate with component auditors
• Options
– Take responsibility for work: Standard (unmodified) report
– Name component auditors
• Present report of component auditors, only with their permission
– Refer to component auditors
• Modify Auditor’s Responsibility section
• Modify opinion paragraph
• Still express unmodified opinion, if appropriate
Report Example
12-22
Summary
Standard
Report
Unmodified
Opinion
Qualified
Opinion
Adverse
Opinion
Material
and
Pervasive
Departures from
GAAP
Not Material
Material, but
Not Pervasive
Scope Limitations
Not Material
Material but
Not Pervasive
Audit of Group
Financial
Statements
Assume
Responsibility
for Work of
Component
Auditors
Disclaimer of
Opinion
Material and
Pervasive
Do Not
Assume
Responsibility
for Work of
Component
Auditors
12-23
Major Topics
I. Overview of Reporting
II. The Standard (Unmodified) Report
III. Reasons for Departing from Standard (Unmodified)
Report
–
Departures from GAAP
–
Scope limitations
–
Audit of group financial statements
IV. Other Matters Encountered During the Audit
V. Other Issues and Reporting
12-24
General Approach for Other
Matters
• Issue unmodified opinion but
add paragraph to report to
discuss the matter
– Emphasis-of-matter paragraphs
provide information related to
users’ understanding of F/S
– Other-matter paragraphs
provide information related to
users’ understanding of audit,
auditors’ responsibility, or
auditors’ report
• Situations
– Consistency
– Going-concern
– Other Information
– Required
Supplementary
Information
– Emphasis of a matter
12-25
Consistency
• Relates to:
– Change in accounting principles
– Adjustments to correct misstatements in previously issued F/S
• Type of changes in accounting principles:
– Accounting principles (GAAP to GAAP)
– Form of reporting entity
– Accounting principles (non-GAAP to GAAP)
– Accounting principle inseparable from changes in estimates
12-26
Consistency: Effect on Report
• Add emphasis-of-matter paragraph following
the opinion paragraph
• May issue a qualified opinion (GAAP
departure) if:
– Change is not justified
– Change is not accounted for in accordance
with GAAP
12-27
Going-Concern Uncertainties
• Auditors are responsible to evaluate whether
substantial doubt exists about ability of entity to
continue in existence for one year beyond date of F/S
• Options
– Add emphasis-of-matter paragraph following opinion
paragraph (still unmodified opinion)
– If serious uncertainty, may issue disclaimer of opinion
– Modified language must include the words substantial
doubt and going concern
12-28
Non-F/S Information
• Other Information Accompanying F/S
– Auditors required to ensure information consistent with F/S
– If not consistent, either revise opinion on F/S or add
emphasis-of-matter paragraph
• Required Supplementary Information
– Auditors required to perform limited procedures and
expand report on F/S to address
– Add other-matter paragraph to identify information,
describe procedures performed, and identify any issues
12-29
Emphasis of a matter
• Call user attention to important matters
• Add emphasis-of-matter paragraph after
opinion paragraph discussing the matter
12-30
Major Topics
I. Overview of Reporting
II. The Standard (Unmodified) Report
III. Reasons for Departing from Standard (Unmodified)
Report
–
Departures from GAAP
–
Scope limitations
–
Audit of group financial statements
IV. Other Matters Encountered During the Audit
V. Other Issues and Reporting
12-31
Comparative F/S
• Continuing auditors
– Report should address all years presented in comparative form
– Update opinion by considering if previously issued opinions still appropriate
– If previously issued opinions not appropriate, revise opinion in current report
(other-matter paragraph)
• Predecessor auditors
– With permission, auditors may present reissued report from predecessor on prioryears’ F/S along with successor’s report on current F/S
– If predecessors’ report not presented, successor auditors’ report must reference
predecessors’ report and opinion on prior-years’ F/S (other-matter paragraph)
12-32
Summary Financial Statements
• Derived from the full set of financial statements
• Auditor can only examine and report if audited full
financial statements
• Report
– Refers to auditors’ report on full financial statements
– Indicates whether information in summary financial
statements is consistent in relation to the full financial
statements
12-33
Association with Unaudited F/S
• Auditors permit use of name in communication
including F/S
• Issue disclaimer of opinion (one paragraph)
– Do not mention auditing procedures performed
– Must identify any known departures from GAAP in the
report
– Should cover all unaudited prior-years’ financial
statements
12-34
Lack of Independence
• Scenario: Auditors begin engagement but
independence subsequently compromised
• Report
– Single paragraph
– Indicates auditors are not independent
– Does not indicate why independence lacking
12-35
Reporting Summary
Opinion
Material
Pervasive
Departure from GAAP
Qualified
Adverse
Scope Limitation
Qualified
Disclaimer
Audit of Group F/S
Unmodified
Unmodified
Other matters (Consistency,
Going-concern, Required
Supplementary, Emphasis of
Matter, etc.)
Unmodified
Unmodified
Components modified/added
Intro
X
(Disclaimer)
Auditor’s
Respons
Opinion
Add’l
X
X
X
(Disclaimer)
X
X
X
X
X
May issue disclaimer if:
• Lack of independence
• Associated with financial statements
• Material and pervasive going-concern uncertainty
12-36
Report Examples
12-37
We have audited the accompanying financial statements of Dunder-Mifflin,
Inc., which comprise the balance sheet as of December 31, 2014, and the
related statements of income, changes in shareholders’ equity, and cash
flows for the year then ended, and the related notes to the financial
statements.
Management’s Responsibility for the Financial Statements
Auditor’s Responsibility
Opinion Paragraph
Return to Overview
12-38
Management’s Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of
these financial statements in accordance with accounting principles
generally accepted in the United States of America; this includes the design,
implementation, and maintenance of internal control relevant to the
preparation and fair presentation of financial statements that are free from
material misstatement, whether due to fraud or error.
Auditor’s Responsibility
Opinion Paragraph
Return to Overview
12-39
Management’s Responsibility for the Financial Statements
Auditor’s Responsibility
Our responsibility is to express an opinion on these financial statements 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
financial statements are free from 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. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of
accounting policies used and the reasonableness of significant accounting estimates made by management, as
well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our
audit opinion
Opinion Paragraph
Return to Overview
12-40
Management’s Responsibility for the Financial Statements
Auditor’s Responsibility
Opinion Paragraph
In our opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Dunder-Mifflin, Inc. as of
December 31, 2014, and the results of its operations and its cash flows for
the year then ended in accordance with accounting principles generally
accepted in the United States of America.
Return to Overview
12-41
Management’s Responsibility for the Financial Statements
Auditor’s Responsibility
Basis for Qualified Opinion
As discussed in Note 16, an additional provision In the amount of $30,000,000 for possible
uncollectible receivables at December 31, 2013, was charged to operations during the year
ended December 31, 2014, which, in our opinion, should have been reflected In the financial
statements for 2013. Had this provision been properly recorded in the 2013 financial statements,
Dunder-Mifflin, Inc. would have reported net earnings of $700,000 for the year ended December
31, 2014, rather than the net loss of $29,300,000 as reflected in the statements of income,
changes in shareholders’ equity, and cash flows for that period.
Qualified Opinion
In our opinion, except for the effects of the matter described in the Basis for Qualified Opinion
paragraph, the financial statements referred to above present fairly, in all material respects, the
financial position of Dunder-Mifflin, Inc. as of December 31, 2014, and the results of its
operations and its cash flows for the year then ended in accordance with accounting principles
generally accepted in the United States of America.
Return to Overview
12-42
Management’s Responsibility for the Financial Statements
Auditor’s Responsibility
Basis for Adverse Opinion
As discussed in Note 16, an additional provision In the amount of $30,000,000 for possible uncollectible
receivables at December 31, 2013, was charged to operations during the year ended December 31, 2014,
which, in our opinion, should have been reflected In the financial statements for 2013. Had this provision been
properly recorded in the 2013 financial statements, Dunder-Mifflin, Inc. would have reported net earnings of
$700,000 for the year ended December 31, 2014, rather than the net loss of $29,300,000 as reflected in the
statements of income, changes in shareholders’ equity, and cash flows for that period.
Adverse Opinion
In our opinion, because of the significance of the matter discussed In the Basis for Adverse Opinion paragraph,
the financial statements referred to above do not present fairly the financial position of Dunder-Mifflin, Inc. as
of December 31, 2014, or the results of its operations or its cash flows for the year then ended in accordance
with accounting principles generally accepted in the United States of America.
Return to Overview
12-43
Introductory Paragraph
Management’s Responsibility for the Financial Statements
Auditor’s Responsibility
Basis for Qualified Opinion
Dunder-Mifflin, Inc. did not make a count of their physical inventory in 2014, stated in the
accompanying financial statements at $10,000,000 at December 31, 2014, and we were unable
to observe the physical quantities on hand. Dunder-Mifflin, Inc.'s records do not permit the
application of other auditing procedures to the audit of inventories.
Qualified Opinion
In our opinion, except for the possible effects of the matter described in the Basis for Qualified
Opinion paragraph, the financial statements referred to above present fairly, in all material
respects, the financial position of Dunder-Mifflin, Inc. as of December 31, 2014, and the results of
its operations and its cash flows for the year then ended in accordance with accounting principles
generally accepted in the United States of America.
Return to Overview
12-44
We were engaged to audit the accompanying financial statements of Dunder-Mifflin, Inc., which comprise the
balance sheet as of December 31, 2014, and the related statements of income, stockholders' equity, and cash
flows for the year then ended, and the related notes to the financial statements.
Management's Responsibility for the Financial Statements
Auditor's Responsibility
Our responsibility is to express an opinion on these financial statements based on conducting the audit in
accordance with auditing standards generally accepted In the United States of America. Because of the matter
described in the Basis for Disclaimer of Opinion paragraph, however, we were not able to obtain sufficient
appropriate audit evidence to provide a basis for an audit opinion.
[Remainder of section deleted]
Basis for Disclaimer of Opinion
Dunder-Mifflin, Inc. did not make a count of their physical inventory in 2014 , stated in the accompanying
financial statements at $10,000,000 at December 31, 2014, and we were unable to observe the physical
quantities on hand. Dunder-Mifflin, Inc.'s records do not permit the application of other auditing procedures to
the audit of inventories.
Disclaimer of Opinion
Because of the significance of the matter described in the Basis for Disclaimer of Opinion paragraph, we have
not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion.
Accordingly, we do not express an opinion on these financial statements.
Return to Overview
12-45
Management's Responsibility for the Financial Statements
Auditor's Responsibility
Our responsibility is to express an opinion on these financial statements based on our audit. We did not
audit the financial statements of B Company, a wholly-owned subsidiary, which statements reflect
total assets constituting 20 percent of total assets at December 31, 2014 and total revenues
constituting 18 percent of total revenues for the year then ended. Those statements were audited by
other auditors, whose report has been furnished to us, and our opinion, insofar as it relates to the
amounts included for B Company, is based solely on the report of the other auditors. 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 from material misstatement.
(No revisions to remainder of the section)
Opinion
In our opinion, based on our audit and the report of other auditors, the financial statements referred
to above present fairly, in all material respects, the financial position of Dunder-Mifflin, Inc. as of
December 31, 2014 and the results of its operations and its cash flows for the year then ended in
accordance with accounting principles generally accepted in the United States of America.
Return to Overview
12-46