15.6

Question 1

A major purpose of the auditor’s report on financial statements is to

Answer 1

Clarify for the public the nature of the auditor’s responsibility and performance.

One of the highest priorities of the AICPA has been to reduce the gap between the nature of the auditor’s responsibility and performance and the public’s perception of the audit function. The auditor’s report issued in accordance with auditing standards clarifies the role of the auditor with the intention of diminishing the gap.

Question 2

An auditor may not express a qualified opinion when

Answer 2

The auditor lacks independence with respect to the audited entity.

An auditor must be independent of the entity when performing an audit in accordance with GAAS unless (1) GAAS provide otherwise or (2) a law or regulation requires the auditor to report on the statements (AU-C 200).

Question 3

A CPA is considered not associated with unaudited financial statements of a public entity when (s)he

Answer 3

Completed an audit and reported on the financial statements that, without the CPA’s consent, were part of a prospectus including unaudited financial statements.

PCAOB auditing standards apply to engagements involving issuers. Under these standards, a CPA is associated with unaudited financial statements of a public entity when (s)he prepares or assists in preparing them or consents to the use of his or her name with them. If neither condition is met, the CPA is not associated with the unaudited statements in the prospectus (PCAOB AS 3320).

Question 4

The accuracy of information included in notes that accompany the audited financial statements of a company whose shares are traded on a stock exchange is the primary responsibility of the

Answer 4

Company’s management.

The notes are considered part of the basic financial statements. Because management has the primary responsibility for the financial statements, it also has the primary responsibility for the accuracy of information included in notes.

Question 5

On September 30, Year 2, Miller was asked to reissue an auditor’s report dated March 31, Year 2, on a client’s financial statements for the year ended December 31, Year 1. Miller will submit the reissued report to the client in a document that contains information in addition to the client’s basic financial statements. However, Miller discovered that the client suffered substantial losses on receivables resulting from conditions that occurred since March 31, Year 2. Miller should

Answer 5

Request the client to disclose the event in a separate, appropriately labeled note to the financial statements and reissue the original report with its original date.

To prevent the financial statements from being misleading, management may disclose an event that arose after the date of the auditor’s report. If the event is included in a separate note labeled as unaudited [e.g., a note captioned as “Event (Unaudited) Subsequent to the Date of the Independent Auditor’s Report”], the auditor need not perform any procedures on the note. Moreover, the auditor’s report should have the same date as the original report (AU-C 560).

Question 6

On August 13, a CPA dated the audit report on financial statements for the year ended June 30. On August 27, an event came to the CPA’s attention that should be disclosed in the notes to the financial statements. The event was properly disclosed by the entity, but the CPA decided not to dual-date the auditor’s report and dated the report August 27. Under these circumstances, the CPA was taking responsibility for

Answer 6

All subsequent events that occurred through August 27.

Subsequent events are material events or transactions that occur after the balance sheet date but prior to the issuance of the financial statements. They require adjustment or disclosure in the financial statements. If the auditor dates the report August 27, the auditor is assuming responsibility for all subsequent events that occurred through August 27.

Question 7

How are management’s responsibility and the auditor’s responsibility represented in the auditor’s report?

Management’s responsibility:
auditor’s responsibility:

Answer 7

explicitly
explicitly

The auditor’s report explicitly states, “Management is responsible for the preparation and fair presentation of these financial statements . . .” It also states, “Our responsibility is to express an opinion on these financial statements based on our audit” (AU-C 700).

Question 8

An auditor expresses a qualified opinion because of a material misstatement related to specific amounts in the financial statements. Which of the following phrases should be included in the report?

“read in conjunction with note X”:
“with the foregoing explanation”:

Answer 8

no
no

The auditor should use the phrase “except for” to qualify an opinion, and include a reference to a paragraph that describes the deficiency. Given a qualification because of a material misstatement related to specific amounts in the financial statements, the reference should describe the matter resulting in the qualification. It also should include (1) a description and quantification of the financial effects, if practicable; (2) an explanation of how narrative disclosures are misstated; or (3) omitted information, if practicable, and a description of its nature. However, if financial-effects disclosures are made in a note to the statements, the report may refer to it. Furthermore, the notes are part of the financial statements, and a phrase such as “when read in conjunction with Note X” in the report is likely to be misunderstood. Also, wording such as “with the foregoing explanation” is neither clear nor forceful enough.

Question 9

In which of the following circumstances would an auditor usually choose between expressing a qualified opinion or disclaiming an opinion?

Answer 9

Inability to obtain sufficient appropriate audit evidence.

Scope limitations may require a qualification of the opinion or a disclaimer. The choice depends on whether the possible effects of undetected misstatements are material and pervasive.

Question 10

Green, CPA, was engaged to audit the financial statements of Essex Co. after its fiscal year had ended. The timing of Green’s appointment as auditor and the start of field work made confirmation of accounts receivable by direct communication with the debtors ineffective. However, Green applied other procedures and was satisfied as to the reasonableness of the account balances. Green’s auditor’s report most likely contained a(n)

Answer 10

Unmodified opinion.

Because the CPA is satisfied as to the amounts of receivables, no scope limitation exists. Accordingly, the report need not refer to the omission of the procedures or the use of alternative procedures, and the CPA may express an unmodified opinion.

Question 11

If an issuer releases financial statements that purport to present its financial position and results of operations but omits the statement of cash flows, the auditor ordinarily will express a(n)

Answer 11

Qualified opinion.

An entity that reports financial position and results of operations should provide a statement of cash flows. Thus, the omission of the cash flow statement is normally a basis for modifying the opinion. If the statements fail to disclose required information, the auditor should provide the information in the report, if practicable. However, the auditor is not required to prepare a basic financial statement. Accordingly, (s)he should qualify the opinion and explain the reason in a basis for qualified opinion paragraph.

Question 12

Restrictions imposed by management of a retail entity that is a new client prevent an auditor from observing any physical inventories. These inventories account for 40% of the entity’s assets, and the possible effects of the omission are material and pervasive. Alternative auditing procedures cannot be applied due to the nature of the entity’s records. Under these circumstances, the auditor should express a(n)

Answer 12

Disclaimer of opinion.

The auditor may become aware of a management-imposed scope limitation after accepting the engagement that is likely to result in a qualified opinion or a disclaimer of opinion. The auditor should request removal of the limitation. If it is not removed, the auditor should communicate with those charged with governance and determine whether alternative procedures can be performed. If the auditor cannot obtain sufficient appropriate evidence because of the limitation, (s)he should determine whether the possible effects of undetected misstatements could be material and pervasive. If they are, the auditor should disclaim an opinion or withdraw from the engagement (AU-C 705).

Question 13

A client using U.S. GAAP has capitalizable leases but refuses to capitalize them in the financial statements. Which of the following reporting options does an auditor have if the effects on the financial statements are material and pervasive?

Answer 13

Adverse opinion.

An adverse opinion is expressed when the financial statements are not presented fairly in accordance with the applicable reporting framework. An adverse is appropriate when a material misstatement exists that has pervasive effects on the financial statements.

Question 14

Eagle Company’s financial statements contain a departure from generally accepted accounting principles because, due to unusual circumstances, the statements would otherwise be misleading. The auditor should express an opinion that is

Answer 14

Unmodified and describe the departure in an other-matter paragraph.

A material departure from GAAP prohibits expression of an opinion that financial statements are in conformity with GAAP. However, an exception is permitted when the auditor can demonstrate that because of unusual circumstances the statements would otherwise have been misleading. Given these circumstances, and if no other basis for modifying the opinion exists, the auditor may express an unmodified opinion, provided that (s)he describes in an other-matter paragraph of the report the departure, its effects, and the reasons compliance with GAAP would have been misleading.

Question 15

Due to a scope limitation, an auditor disclaimed an opinion on the financial statements as a whole, but the auditor’s report included a statement that the current asset portion of the entity’s balance sheet was fairly stated. The inclusion of this statement is

Answer 15

Not appropriate because it may tend to overshadow the auditor’s disclaimer of opinion.

A piecemeal opinion is an expression of an opinion on a specific element of a financial statement when the auditor has disclaimed an opinion or expressed an adverse opinion on the financial statements as a whole. This type of assurance is inappropriate because it would contradict a disclaimer of opinion or an adverse opinion (AU-C 705).

Question 16

Which of the following statements is a basic element of the auditor’s report for a nonissuer?

Answer 16

The procedures used depend on the auditor’s judgment.

The auditor’s responsibility section states, “The procedures selected depend on the auditor’s judgment . . .”

Question 17

Which of the following parts of the auditor’s report on the financial statements of a nonissuer are changed when an adverse opinion is expressed?

introductory paragraph:
auditor’s responsibility paragraph:
opinion paragraph:

Answer 17

no
yes
yes

The opinion should state that, because of the significance of the matter(s) described in the basis for adverse opinion paragraph, the financial statements are not presented fairly in accordance with the framework. The following are other effects on the auditor’s report when an adverse opinion is expressed: (1) The introductory paragraph is unchanged; (2) the management’s responsibility paragraph is unchanged; and (3) the auditor’s responsibility section is changed to state, “We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our adverse audit opinion.”

Question 18

Park, CPA, was engaged to audit the financial statements of Tech Co., a new client, for the year ended December 31, Year 1. Park obtained sufficient appropriate audit evidence for all of Tech’s financial statement items except Tech’s opening inventory. Due to inadequate financial records, Park could not verify Tech’s January 1, Year 1, inventory balances. Park’s opinion on Tech’s Year 1 financial statements most likely will be

Balance sheet:
Income statement:

Answer 18

Unmodified
Disclamer

The auditor may report on one basic financial statement and not on the others. Because the balance sheet presents information at a specific moment in time, the auditor should be able to become satisfied regarding the balances presented at year end. However, beginning inventory is included in the determination of the results of operations and cash flows. Thus, the auditor will probably not be able to form an opinion as to the fairness of these statements and should disclaim an opinion on them.

Question 19

Fact Pattern:
An audit was performed by Leo Gonzales, CPA, of the financial statements of Lectronic Leasing Company for the year ended December 31. A cash advance to Computer Credit Corporation is material to the presentation of Lectronic’s financial position. Computer Credit’s unaudited financial statements show negative working capital, negative equity, and losses in each of the 5 preceding years. Mr. Gonzales has suggested an allowance for the uncollectibility of the advance to Computer Credit. All of the stock of both Lectronic and Computer Credit is owned by Paul McRae and his family. Mr. McRae adamantly refuses to consider an allowance for uncollectibility. He insists that Computer Credit eventually will be profitable and be able to repay the advance. Mr. McRae proposes the following note to Lectronic’s statements:
Note to Financial Statements
At December 31, the Company had advanced $500,000 to Computer Credit Corporation. We obtained written confirmation of this debt from Computer Credit Corporation and reviewed unaudited financial statements of Computer Credit Corporation. Computer Credit Corporation is not in a position to repay this advance at this time, but the Company has informed us that it is optimistic as to the future of Computer Credit Corporation. Computer Credit Corporation’s stock is wholly owned by Lectronic Leasing Company’s common shareholders.
Assume that subsequent to the date of the auditor’s report (but prior to issuance of the related financial statements) Mr. McRae and his family sell all of their stock in Computer Credit and the new owners repay the advance from Lectronic. Mr. Gonzales’ opinion as to Lectronic’s financial statements will be

Answer 19

Unmodified because the issue of collectibility is now settled.

The subsequent event provides additional evidence with respect to conditions existing at the balance sheet date. Such an event may require adjustment of the financial statements and may affect the audit report (AU-C 560). Consequently, the auditor can express an unmodified opinion, assuming no other basis exists for modifying the opinion. The subsequent event has eliminated the issue of collectibility of the receivable.

Question 20

An auditor’s opinion reads as follows: “In our opinion, except for the above-mentioned limitation on the scope of our audit…” This is an example of an

Answer 20

Unacceptable reporting practice.

When an opinion is qualified because of a scope limitation, the opinion paragraph should indicate that the qualification pertains to the possible effects on the statements of undetected misstatements (AU-C 705 and AS 3105). The language given in the question bases the qualification on the restriction itself and is unacceptable.