CHAPTER 20 20-1 WRITING THE AUDIT REPORT The purposes of the scope paragraph in the auditor’s report are to inform the financial statement users that the audit was conducted in accordance with generally accepted auditing standards, in general terms what those standards mean, and whether the audit provides a reasonable basis for an opinion The information in the scope paragraph includes: 20-2 20-3 The auditor followed generally accepted auditing standards The audit is designed to obtain reasonable assurance about whether the statements are free of material misstatement Discussion of the audit evidence accumulated Statement that the auditor believes the evidence accumulated was appropriate for the circumstances to express the opinion presented The purpose of the opinion paragraph is to state the auditor’s conclusions based upon the results of the audit evidence The most important information in the opinion paragraph includes: The words “in our opinion” which indicate that the conclusions are based on professional judgment A restatement of the financial statements that have been examined and the dates thereof or a reference to the introductory paragraph A statement about whether the financial statements were presented fairly and in accordance with generally accepted accounting principles The common definition of materiality as it applies to accounting and, therefore, to audit reporting is: A misstatement in the financial statements can be considered material if knowledge of the misstatement would affect a decision of a reasonable user of the statements Auditors must have knowledge of the likely uses of their client’s statements and the decisions that are being made Materiality involves both quantitative and qualitative considerations In assessing the quantitative importance of a misstatement, it is necessary to relate the peso amount of the error to the financial statements under examination Qualitative considerations, on the other hand, relate to the causes of the 20-2 Solutions Manual to Accompany Applied Auditing, 2006 Edition misstatement An error that may not be material quantitatively, may be material qualitatively This may occur, for instance, when the misstatement is attributed to an irregularity or an illegal act by the client 20-4 Materiality for lack of independence in audit reporting is easiest to define If the auditor lacks independence as defined by the Code of Professional Ethics, it is always considered highly material and therefore a disclaimer of opinion is always necessary For failure to follow GAAP, there are three levels of materiality: immaterial, material, and highly material 20-5 The auditor’s opinion may be qualified by scope limitations caused by client restrictions or by limitations resulting from conditions beyond the client’s control The former occurs when the client will not, for example, permit the auditor to confirm material receivables or physically observe inventories The latter may occur when the engagement is not agreed upon until after the client’s year end when it may not be possible to physically observe inventories or confirm receivables A disclaimer of opinion is issued if the scope limitation is so material that the auditor cannot determine if the overall financial statements are fairly presented If the scope limitation is caused by the client’s restriction the auditor should be aware that the reason for the restriction may be to deceive the auditor For that reason a disclaimer is more likely for client restrictions than for conditions beyond anyone’s control When there is a scope restriction that results in the failure to verify material, but not pervasive accounts, a qualified opinion may be issued This is more likely when the scope limitation is for conditions beyond the client’s control than for restrictions by the client 20-6 When another CPA has performed part of the audit, the primary auditor issues one of the following types of reports based on the circumstances No reference is made to the other auditor This will occur if the other auditor examined an immaterial portion of the statement, the other auditor is known or closely supervised, or if the principal auditor has thoroughly reviewed the other auditor’s work Issue a shared opinion in which reference is made to the other auditor This type of report is issued when it is impractical to review the work of the other auditor or when a portion of the financial statements audited by the other CPA is material in relation to the total The report may be qualified if the principal auditor is not willing to assume any responsibility for the work of the other auditor A disclaimer may be issued if the segment audited by the other CPA is highly material Writing the Audit Report 20-7 20-3 1) Disclaimer of opinion Because the client refuses to allow the auditor to expand the scope of his examination, a disclaimer of opinion is appropriate rather than a qualified as to scope and opinion 2) Disclaimer of opinion The auditor cannot issue an unqualified opinion on the income statement or the statement of cash flows because a disclaimer of opinion is necessary for the beginning balance sheet The auditor may issue an unqualified opinion on the ending balance sheet and a disclaimer of opinion on the income statement, statement of cash flows, and the beginning balance sheet 3) Unqualified opinion The auditor is able to satisfy him or herself that with the use of alternative procedures, a qualified opinion is not necessary 4) Qualified opinion or adverse opinion for failure to follow generally accepted accounting principles The materiality of twenty per cent of net earnings before taxes would be sufficient for many auditors to require an adverse opinion That materiality question is a matter of auditor judgment 5) Disclaimer of opinion Lack of independence by audit personnel on the engagement mandates a disclaimer for lack of independence 6) Unqualified opinion The company has made a decision to follow a different financing method which is adequately disclosed There is no change of accounting principle 20-8 a CONDITION b TYPE OF REPORT COMMENT Failure to follow GAAP (4) Qualified opinion only – except for or (7) Adverse Disclosure of this information is required in a footnote Failure to so is a violation of GAAP and is likely to be a qualified opinion, or it could be so important as to require an adverse Scope of the auditor’s examination has been restricted (1) Unqualified – standard Because the auditor was able to obtain alternative evidence, no scope qualification is necessary If there were such a qualification, it would be a qualified scope and opinion or a disclaimer, depending on materiality 20-4 Solutions Manual to Accompany Applied Auditing, 2006 Edition Failure to follow GAAP (4) Qualified opinion only – except for Retail Auto Parts has used a replacement cost inventory rather than lower of cost or market It is not sufficiently material to require an adverse opinion Failure to follow GAAP (7) Adverse FASB No requires the expending in the current period of all research and development costs regardless of the benefit in future years Given the materiality of the amount, an adverse opinion would be required Scope of the auditor’s examination has been restricted (5) Qualified scope and opinion Because the auditor was unable to satisfy himself about beginning inventories, it would be necessary to issue either a qualified or disclaimer of opinion on the income statement and statement of cash flows as well as the beginning balance sheet The use of a qualified or disclaimer would depend upon the opinion given in the prior year An unqualified opinion could be issued for the current period balance sheet Scope of the auditor’s examination has been restricted (6) Disclaimer Failure of the client to allow the auditor to inspect the minutes book would be a material client-imposed restriction Due to the importance of the minutes book, a disclaimer would be necessary The certified copy of all resolutions and actions would not be a satisfactory alternative Writing the Audit Report 20-5 procedure Accounting principles used in the financial statements have not been consistently applied 20-9 (1) Unqualified – standard wording The change of estimated life is a change of condition and not a change in accounting principles Therefore, an unqualified opinion is appropriate since there is adequate disclosure Young Manufacturing Corporation The auditor’s report on his examination of the financial statements of the Young Manufacturing Corporation includes the following deficiencies: The audit report has no title It should include a phrase such as “independent auditor’s report.” The audit report is addressed to the president It is usually more appropriate to address it to the stockholders or board of directors The date of the auditor’s report should be the date of the completion of the auditor’s field work, not the balance sheet date The report includes only two paragraphs It should be three paragraphs if it is standard wording, or more if there is a violation of GAAP, which there is There must be reference to both the 2007 and 2006 financial statements in the scope and opinion paragraphs, including a statement about the degree of responsibility the auditor is taking for each year’s statements The auditor’s report is deficient because the dates of the balance sheet and the period covered by the income statement are not given These dates should be given so that the reader will clearly understand that the opinion is limited to specific financial statements Clarification as to the statements covered by the opinion is imperative because comparative financial statements are presented The title “Balance Sheet” is used in the report, but “statements of condition” is employed as the title of the financial statement Different titles should not be used because a criterion of professional work is that uniform and accurate terminology be used Although the auditor’s report states that he or she examined the Statement of Income and Retained Earnings, the attached financial statements not include the Retained Earnings statement All financial statements referred to in the auditor’s report should be appended to the report 20-6 Solutions Manual to Accompany Applied Auditing, 2006 Edition The difference of P66,481 between the opening and closing balances of the Retained Earnings account is not reconcilable to the reported net income for the year of P52,924 Because an amount of P13,557 in the Retained Earnings account is not accounted for, the auditor’s report should contain at least a qualification on the grounds of inadequate disclosure If the auditor’s examination disclosed that the P13,557 is a net amount of charges and credits to the Retained Earnings account, some of which bear directly upon the current year’s income statement, the auditor may be compelled to render an adverse opinion There is no reference in the introductory paragraph to the responsibilities of the auditor and management 10 The mandatory standard scope paragraph is excluded 11 Two items in the Statements of Condition, “Accounts receivable” and “Inventories,” are listed as “pledged,” but no footnotes or comments disclose the nature or extent of the commitments The item “other liabilities” probably represents the liability for which the assets serve as security; its nature should be appropriately disclosed in the statements Also, the terms of the long-term mortgage should be disclosed Therefore, the auditor should disclose this information in a separate paragraph in the report and his or her opinion should be appropriately qualified 12 The auditor’s report is written in the first person apparently because the auditor is an individual practitioner Although some CPAs contend that it is inappropriate for an individual to practice under a style that denotes a partnership, individual practitioners generally use “we” rather than “I” in writing their reports The “we” used in the report is the so-called “editorial we” and it is used because it is more formal, impersonal, and carries more dignity As used in auditor’s reports “we” is not to be taken in its literal (plural) sense 13 The opinion paragraph should contain the phrase “in our opinion” to clearly disclose that the statement as to fair presentation is a professional opinion, not a statement of fact 14 A statement of cash flows is not included in the financial statements of the audit report’s introductory paragraphs A qualified opinion is required when no statement of cash flows is included 15 There is not inclusion of the phrase “in all material respects” in the opinion 16 There should be no reference to consistency in the opinion paragraph 17 The opinion paragraph should include no reference to what is done on the audit That should be in the scope paragraph 18 As stated above, the opinion paragraph should not be unqualified, because of the missing statements or retained earnings and cash flow and the omitted footnotes  ...20-2 Solutions Manual to Accompany Applied Auditing, 2006 Edition misstatement An error that may not be material quantitatively,... qualified scope and opinion or a disclaimer, depending on materiality 20-4 Solutions Manual to Accompany Applied Auditing, 2006 Edition Failure to follow GAAP (4) Qualified opinion only – except... statements referred to in the auditor’s report should be appended to the report 20-6 Solutions Manual to Accompany Applied Auditing, 2006 Edition The difference of P66,481 between the opening and closing