Solution manual aswers auditing theory by cabrera chapter 28 ans

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CHAPTER 28 THE AUDITOR’S REPORT ON FINANCIAL STATEMENTS I Review Questions Scope paragraph (a) The objects of the audit are the financial statements – balance sheet(s), income statement(s), and cash flow statement(s), and related footnote disclosure, not the “books and records.” (b) The description of the audit means: (1) (2) (3) (4) (5) (6) (7) * the auditors were trained and proficient the auditors were independent due professional care was exercised the work was planned and supervised internal controls was properly studied and evaluated sufficient competent evidential matter was obtained the GAAS reporting standards were followed Professional judgment was exercised in performing the tests and choosing the procedures to perform in the circumstances Report and the evidence dimension Unqualified opinion Adverse opinion Opinion qualified for a departure from SFAS Paragraph for inconsistent GAAP application Paragraph for an uncertainty Disclaimer of opinion Fully sufficient competent evidence X X Isolated evidence deficiency Pervasive lack of evidence X X X X 28-2 Solutions Manual - Assurance Principles, Professional Ethics… Major reasons for departure from the standard unqualified report Disagreement with management regarding the acceptability of the accounting policies selected, the method of their application or the adequacy of financial statement disclosure Limitation on scope of the audit (resulting in a lack of evidence) Using extra paragraph(s) to emphasize significant matters Different opinion on prior year comparative statements Relying on the work and reports of other independent auditors Required supplementary data omitted or departs from guidelines “Other information” inconsistent with financial statements or contains material misstatement of fact Auditor is not independent Students may identify more than one description of the “most important” distinction between an opinion and a disclaimer All the following are valid, although (a) is intended to be the “Most Important:” a b c d An opinion (unqualified, qualified or adverse) is an explicit statement of the auditor’s conclusion(s), while a disclaimer is an (empty) assertion of “no conclusion.” An (unqualified) opinion is the highest level of assurance, while a disclaimer is the lowest level (no assurance) An opinion requires evidence as a basis, while a disclaimer results from lack of evidence Auditors must be independent to give an opinion, while a disclaimer can result from a CPA’s lack of independence A material scope restriction occurs when the auditor is unable to gather sufficient competent evidence to support an unqualified opinion on the financial statements Scope restrictions may be client-imposed or they may result from other circumstances, e.g., appointment of the auditor after the client’s physical inventory has been taken A material scope restriction need not result in a modification of the auditor’s opinion provided the auditor can obtain satisfaction by alternate means A principal auditor is one who has examined the major portion of the combined entity When financial statements of the prior year are presented together with those of the current year, a continuing auditor must report on both years In “updating” the prior year’s report, the auditor must decide whether to restate the report in its same form or modify it to reflect current information not available at the date of issuance of the prior report The Auditor’s Report on Financial Statements 28-3 A continuing auditor can update a previously-issued report by obtaining and evaluating information during the current engagement Thus, an updated report is a previously-issued report that has been reevaluated in light of current information and evidence (The updated report itself may be a compilation report, a review report, or an audit report) The reevaluation may cause the updated version to be different from the report previously issued (for example, a new reason to write a qualification may be found) An updated report carries a current date, not the date of the previous report A predecessor auditor usually does not have the current information necessary to update a report Either a continuing auditor or a predecessor auditor can reissue previouslyreissued report The process does not contemplate consideration of information and evidence obtained during a current engagement Thus, a reissued report is a current release of a previously-issued report without benefit of any additional examination or review of the subject financial statements The report date should be the date of the end of field work for the original issue of the report A principal auditor is the one who (a) audits a material portion of a reporting entity’s assets, liabilities, revenues and expenses (usually over 50 percent) and (b) knows enough about the whole entity to sign the audit report 10 The principal auditor’s reference in his report to another auditor is not a qualification in scope The reference only shows the divided responsibility for the audit work 11 When an auditor is not independent with respect to a client, a disclaimer of opinion must be rendered The disclaimer must be issued because the statements cannot be audited in accordance with generally accepted auditing standards (An accountant, not an auditor, is the person associated with compiled and reviewed financial statements An accountant can give a compilation – disclaimer – report on compiled unaudited financial statements) 12 When the “going concern assumption” is in doubt, auditors have serious reservations about the recoverability and amounts of reported assets and the amount and classification of reported liabilities These opinions may be used, depending on the circumstances: a b Standard unqualified report with an uncertainty notice paragraph calling attention to the going concern problem Disclaimer of opinion to express unwillingness to give an opinion on the presentation 28-4 Solutions Manual - Assurance Principles, Professional Ethics… c Opinion qualified or adverse for departure from GAAP if all appropriate disclosures are not made 13 According to PSA 700, “In certain circumstances, an auditor’s report may be modified by adding an emphasis of matter paragraph to highlight a matter affecting the financial statements which is included in a note to the financial statements that more extensively discusses the matter The addition of such an emphasis of matter paragraph does not affect the auditor’s opinion The paragraph would preferably be included after the opinion paragraph and would ordinarily refer to the fact that the auditor’s opinion is not qualified in this respect The auditor should modify the auditor’s report by adding a paragraph to highlight a material matter regarding a going concern problem The auditor should consider modifying the auditor’s report by adding a paragraph if there is a significant uncertainty (other than a going concern problem), the resolution of which is dependent upon future events and which may affect the financial statements An uncertainty is a matter whose outcome depends on future actions or events not under the direct control of the entity but that may affect the financial statements.” 14 Whether to divide responsibility or accept full responsibility is a function of: a b Relationship of the principal auditor to the other auditors; and Materiality of the component(s) examined by other auditors 15 The auditor may decide to disclaim an opinion when confronted by a material scope limitation that precludes gathering sufficient evidence to support an opinion as to overall fairness of financial presentation The auditor may also disclaim an opinion if his/her name is associated with financial statements for which an audit was not intended (e.g., compilations and reviews), or if the auditor is not independent 16 Two conditions are necessary for an unqualified opinion: a b No material scope restrictions have prevented the auditor from collecting sufficient, competent evidence; and The financial statements, including footnote disclosures, contain no material departures from GAAP 17 An auditor may agree with a departure from a designated principle only when, in his/her judgment, application of the designated principle would make the financial statements materially misleading The Auditor’s Report on Financial Statements 28-5 18 The audit opinion does not extend to the other information, and therefore, the opinion is not affected by omission or inconsistency or incorrect supplemental information 19 The auditor must evaluate, on every audit, the ability of the entity to meet its obligations on a continuing basis during a reasonable period (usually 12 months) following the balance sheet date Although the auditor is not required to apply additional procedures in making the initial evaluation, if he/she has substantial doubt as to ability of the client to continue, added procedures may have to be applied to resolve the issues 20 The auditor should add an explanatory paragraph regarding a material uncertainty, provided the outcome of the events surrounding the uncertainty cannot be reasonably estimated by management If the probability of an unfavorable outcome is remote, the explanatory paragraph is not needed If a material loss is probable, but is not susceptible to reasonable measurement, and is properly footnoted, the auditor should add an explanatory paragraph directing the reader’s attention to the footnote The greater the materiality, and the higher the probability of loss, the more inclined will be the auditor to add the explanatory paragraph 21 Upon learning of a change in accounting principle, the auditor should first determine the materiality and appropriateness of the change If material and the auditor agree with the client’s justification for the change, an explanatory paragraph should be added following the opinion paragraph The paragraph will refer to the footnote describing the change If the change is not properly accounted for or is inadequately disclosed, the auditor should consider issuing a qualified or adverse opinion II Multiple Choice Questions 10 c d a c c c c a d c 11 12 13 14 15 16 17 18 19 20 c b d a b d d a b c 21 22 23 24 25 26 27 28 29 30 c c a d c a a c c b 31 32 33 34 35 36 37 38 39 40 b c b c d b d a d b 28-6 Solutions Manual - Assurance Principles, Professional Ethics… III Comprehensive Cases Case You must determine whether an unqualified opinion satisfies the GAAS reporting standard, in particular: a Determine whether the financial statements are presented in conformity with GAAP Read the footnote description of accounting policies Use a GAAP checklist Review the working papers for any indication of accounting policies not described in the footnote or ones apparently not in conformity with GAAP Determine if: (i) The accounting principles are generally acceptable, having authoritative support (ii) The accounting principles are appropriate in the circumstances (iii) The financial statements are informative (iv) The information is reasonably summarized (v) Material adjustments have not been waived without good reasons b Determine whether any accounting changes have been made and whether accounting principles have been applied consistently c Determine whether the footnote disclosures are adequate to inform users of any material information evident in the working papers Case The auditor is reporting to the body that has engaged the auditing services While the report may be read and used by others who are indirect beneficiaries of the audit, current custom is not to address the report to the unknown class of users The scope paragraph should specifically identify the audited statements by name so that there can be no mistake about the subject of the report The alternative language is not as precise The standard language effectively bases the audit on an extensive body of written auditing standards that are known to others and can be cited in case of controversy The alternative language, on the other hand, seems to break loose from profession-wide quality norms and make the audit quality depend more on “the circumstances,” which introduces an element of mystery and lack of definition into the report The Auditor’s Report on Financial Statements 28-7 The alternative wording is similar to the typical British audit report, and they seem to be able to live with it, but American auditors believe that “opinion” connotes belief or judgment stronger than impression but less strong than positive knowledge American auditors not wish to appear to have full, positive knowledge about the statements on the grounds that it’s not feasible to know all there is to know about the financial statements Also, the standard language leans heavily on GAAP as the criteria for fair presentation whereas the alternative language contains no reference to authoritative accounting criteria Case Title The report needs a title referring to Rose as the independent auditor or independent accountant Notice of audit The report does not give the proper declaration of an audit of the financial statements, especially the part about “in accordance with your instructions,” which suggest that Rose surrendered some audit independence The reference to a “complete audit” is ill advised because it suggests a 100% investigation, which is contradicted by the sentence about “tests of the sales records.” Responsibilities The report says nothing about the auditor’s responsibility for the audit report Opinion The opinion sentence should not be modified with the phrase “with the explanation given above.” Opinion The opinion sentence should not mention “minor errors we consider immaterial,” but it should contain the phrase “presents fairly in all material respects.” Opinion/Identification of Financial Statements The opinion should not include reference to cash flows because the introductory paragraph did not state that the cash flow statement was audited This may be a deficiency in the identification of the financial statements that were actually audited Opinion The opinion paragraph refers improperly to ASC pronouncements It should refer to “generally accepted accounting principles.” Date The date accompanying Rose’s signature should be September 23 – the day the field work was completed – not the company’s fiscal year-end date Other The commentary on the economy and the strike are not generally appropriate for an audit report Even if the auditor wanted to draw attention to these matters, their relevance for understanding the financial statements and their manner of expression are both questionable 10 Other The negative assurance (concerning the recording of sales) is not permitted in audit reports 28-8 Solutions Manual - Assurance Principles, Professional Ethics… Case Independent Auditor’s Report To the shareholders and board of directors of Various Fabrics, Inc.: We have audited the accompanying balance sheets of Various Fabrics, Inc as of January 31, 2004 and 2003 and the related statements of income, retained earnings, and cash flows for the years 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 audits We conducted our audits in accordance with generally accepted auditing standards 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 Various Fabrics, Inc as of January 31, 2004 and 2003 and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles Aya de Jesus, CPA March 2, 2004 Case F, L B, I B, Q A, J Case A B C D E F G 1, 2, H I J K L 3, 2, 3, 1, B, I B, I E, J 7c 7a (Note: The change in principle should be described in the descriptive paragraph following the scope paragraph.) 7c 7b 7d (given the materiality of property, plant, and equipment) 7e The Auditor’s Report on Financial Statements M 1, 7b and 7e 28-9 ...28-2 Solutions Manual - Assurance Principles, Professional Ethics… Major reasons for departure from the standard... Disclaimer of opinion to express unwillingness to give an opinion on the presentation 28-4 Solutions Manual - Assurance Principles, Professional Ethics… c Opinion qualified or adverse for departure... modify the auditor’s report by adding a paragraph to highlight a material matter regarding a going concern problem The auditor should consider modifying the auditor’s report by adding a paragraph if
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