A1: Audit Reports-Audited Financial Statements: The Basics

Question 1

Responsibilities of Management

Answer 1

1. the preparation and fair presentation of the f/s in accordance with the applicable financial reporting framework
2. the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of f/s that are free of material misstatement due to error or fraud
3. providing auditor with access to information and persons within the entity needed to complete the audit.

Question 2

Auditor Responsibilities

Answer 2

responsible for expressing an opinion on the f/s based on the audit. The auditor is also responsible for having appropriate competence and capabilities to perform the audit, complying with relevant ethical requirements, maintaining professional skepticism, and exercising professional judgement, throughout the planning and performance of the audit.

Question 3

Inherent Limitations of an Audit

Answer 3

1. The nature of financial reporting-level of variability due to judgement by management; (accounting estimates) such as intangibles, impairment, asset life/salvage, bad debts, warranties, lawsuits
2. The nature of audit procedures-fraud (intentional), or errors (unintentional)
3. Timeliness of financial reporting and the balance between cost and benefit-impossible to address all information as it is the expectation of users of f/s that the auditor will form an opionion on the f/s within a reasonable period of time.

Question 4

Professional Standards

Auditing Standards

Answer 4

Generally Accepted Auditing Standards (GAAS)-issued by AICPA’s Auditing Standards Board (ASB) in the form of Statements on Auditing Standards (SAS)

Generally Accepted Government Auditing Standards (GAGAS)

Public Company Accounting Oversight Board (PCAOB)

International Standards on Auditing (ISA)-established by The International Auditing and Assurance Standards Board (IAASB), which is a standard setting board of the International Federation of Accountants (IFAC)

Question 5

Auditing Standards

PCAOB

Answer 5

established pursuant to Sarbanes-Oxley Act of 2002. Establishes auditing and related professional practice standards to be used in the preparation and issuance of audit reports of issuers.

1. five full time members
2. public accounting firms must register with PCAOB in order to audit public companies.

Question 6

Standards for Engagements other than Audits

Answer 6

Statements on Standards for Attestation Engagements (SSAE)-issued by AICPA

Statements on Standards for Accounting and Review Services (SSARS)-The Accounting and Review Services Comittee was established by the AICPA to establish standards for privately-held (nonissuer) companies not seeking audited statements. SSARS are issued by this Committee and they are applicable to unaudited financial statements or unaudited financial information of a nonpublic entity.

Question 7

Auditing Guidance: The GAAS Hierarchy

Three levels of auditing guidance

Answer 7

1. AICPA Statements on Auditing Standards and PCAOB Auditing Standards-in the United States, auditors are required to comply with SASs published by the Auditing Standards Board for audits of nonissuers and PCAOB Auditing Standards for audits of issuers.
2. Interpretive Publications-recommendations regarding how SASs should be applied in specific situations. They are not to be considered auditing standards
3. Other Auditing Publications-

Question 8

Auditing Guidance: The GAAS Hierarchy

Specific Language within SASs and PCAOB Auditing Stds to clarify the auditors responsibility

Answer 8

1. the terms “must” or “is required” indicate an unconditional requirement, which must be followed in all cases where the requirement is relevant.
2. The term “should” indicates a presumptively mandatory requirement, which must be followed in all cases where the requirement is relevant, except in rare circumstances in which departure from the requirement is permitted if there is appropriate justification, performance of sufficient alternative procedures, and thorough documentation.
3. the terms “may,” “might,” and “could indicate explanatory material that does not impose a professional requirement for performance.

Question 9

Overall objectives of auditor

Answer 9

1. to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to error or fraud, which enables the auditor to express an opinion on whether the financial statements are presented fairly, in all material respects, in accordance with an applicable financial reporting framework and;
2. to report on the financial statements and communicate as required by GAAS

Question 10

Conduct of Audit

Answer 10

1. Professional Skepticism
2. Ethical Requirements-independence in both face and appearance. Auditor must be independent of an entity when performing an engagement in accordance with GAAS unless: a)GAAS provides otherwise, or b)the auditor is required by law or regulation to accept the engagement and report on the f/s.
3. Professional Judgement-auditor should exercise professional judgement in planning and performing an audit. Necessary when making decisions about: materiality, audit risk, the nature, extent and timing of audit procedures, evaluating whether sufficient , appropriate evidence has been obtained, evaluating mgmnts judgments, drawing conclusions based on the audit evidence obtained.
4. Sufficient Appropriate Audit Evidence and Audit Risk-to obtain reasonable assurance, the auditor shoudl obtain sufficient appropriate audit evidence to reduce audit risk to an acceptably low level and thereby enable the auditor to draw reasonable conclusions on which to base the auditors opinion–>weak internal control not equal to adverse opinion.
5. Compliance with GAAS-don’t represent cmpliance unless complied with all GAAS. Also, the auditor maybe required to comply with other auditing requirements in addition to GAAS. GAAS do not override laws or regulations that govern an audit of f/s. The auditor may conduce the audit in accordance with both GAAS and:
   
   • auditing stds issued by the PCAOB
   • International Standards on Auditing
   • government auditing standards (GAGAS) or
   • auditing standards of a specific jurisdiction or country

Question 11

Unmodified Audit Opinion

Answer 11

Clean opinion

auditor concludes that the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reproting framework.

Question 12

Independent Auditor’s Report

Answer 12

1. Title-“Independent” (auditor’s report) should be included in the report title.
2. Addressee-required by the circumstances of the engagement
3. Introductory Paragraph
   
   • identify entity being audited
   • state the f/s have been audited
   • identify each title of each f/s
   • specify dates covered by each f/s
4. Management’s Responsibility(MR) for the F/S-auditors report should include section with heading “Management’s Responsibility for the F/S”
   
   • explanation that mgmnt responsible for preparation and fair presentation of the f/s in accordance with applic. financ. reporting. framework
   • a stmnt that this resp. includes the design, implementation, and maintenance (DIM) of internal control relevant to the preparation and fair presentation of f/s that are free from material misstatement, whether due to fraud or error.
5. Auditor’s Responsiblity-auditor’s report should include a section with the heading “Auditor’s Responsibility”
   
   • a statement that the responsibility of the auditor is to express an opinion on the f/s based on the audit.
   • a statment on GAAS
   • a stmnt that those standards require the auditor plan and perform the audit to obtain reasonable assurance about whether the f/s are free from material misstatement.
   • a description of the audit that states that:
     
     • an audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the f/s
     • the procedures selected depend on the auditors judgement, including the assessment of the risks of material misstatement of the f/s
     • in making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the finanancial 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, and accordingly, no such opinion is expressed.
     • an audit includes evaluating the appropriateness of the accounting policies used and the reasonableness of the significant accounting estimates made by management as well as evaluating the overall presentation of the f/s.
6. Auditor’s Opinion
7. Other Reporting Responsibilities
8. Signature of Auditor
9. Auditors Address
10. Date of Auditor’s report

Question 13

Auditor’s Opinion

Answer 13

The auditor’s report should include a section with the title “Opinion” that includes

1. statement that the f/s present fairly, in all material respects, the financial position of the entity (assuming unmodified opinion) as of the b/s date and the results of operations and its cash flows for the period then ended, in accordance with the applicable financial reporting framework.
2. identification of the applicable financial reporting framework and its origin.

Question 14

Reference to Auditing Standards in Auditors Report

Answer 14

GAAS–>referenced in the Auditor’s Responsiblity Paragraph

GAAP(U.S. or other applicable financial reporting framework)–> Management’s Responsiblity Paragraph and Opinion Paragraph

Question 15

Differences between Auditor’s report under U.S. GAAS and the ISAs

REquirements in the ISAs and not in US GAAS

Answer 15

ISAs indicate that the description in the auditor’s report can either refer to the preparation and fair presentation of the f/s or the preparation of the f/s that give a true and fair view. US GAAS does not include any reference to “true and fair view”

Question 16

Differences between Auditor’s report under U.S. GAAS and the ISAs

REquirements in GAAS and not in the ISAs

Answer 16

a requirement that the description of management’s responsibilities for the f/s in the auditor’s report should not be referenced to a separate statement by management about such responsiblities if such a statement is included in a document containing the auditors report.

Question 17

Understanding the component Auditor

Answer 17

The group engagement team must understand the following for each component auditor:

1. whether component auditor is independent and will comply with all ethical requirements
2. the professional competence of the component auditor
3. the extent to which the group engagement team will be involved in the work of the compenent auditor
4. whether the group engagement team will be able to get info need for the consolidation process from the component auditor
5. whether the component auditor operates in a regulatory environment that actively oversees auditors

*note that if the component auditor is not independent or the group engagement team has serious concerns about any of the matters listed above, the group engagement team shoud not use the work of the component auditor or make reference to the component auditor in the auditor’s report.

Question 18

Making Reference to the component Auditor in the Auditor’s report

Answer 18

The Auditor’s report on the group f/s shoud clearly indicate:

1. that the component was not audited by the auditor of the group statements but was audited by the component auditor
2. the magnitude of the portion of the f/s audited by the component auditor
3. when the component’s f/s are prepared using a different financial reportin gframework from the group f/s
   
   • the financial reporting framework used by the component
   • that the auditor of the group f/s is taking responsibility for evaluating the appropriateness of the adjustments to convert the compoenetn’s financial statement to the group financial reporting framework
4. when the component auditor’s report on the component’s financial statements does not state that the audit was performed in accordance wtih GAAS or PCAOB standards and the group engagement partner has determined that the ocmponent auditor peformed addtional procedures to meet the relevant requirements of GAAS:
   
   • the set of auditing standards used by the componenet auditor and
   • that additional audit procedures were performed by the component auditor to meet the relevant requirements of GAAS

Question 19

1. If a component is significant b/c it is likely to include significant risks of material misstatement to the group f/s, the group engagement team or a component auditor should:
2. Components that are not significant

Answer 19

1. perform an audit of the financial information, and/or an audit of the account balances, transactions or disclosures related to the likely significant risk of material misstatement and or perform specified procedures related to the likely significant risks of material misstatement.
2. The group engagement team should perform analytical procedures for components that are not significant components.

Question 20

Types of Opinions

Answer 20

1. Unmodified Opinion-clean opinion-f/s are presented fairly, in all material respects, in accordance with the applicable financial reporting framework
2. Qualified “except for” (GAAP)-material issue;
   
   • accounting policy
   • presentation
   • disclosures
   • estimates
3. Adverse (GAAP)-very material issue (pervasive)
   
   • accounting policy
   • presentation
   • disclosures
   • estimates
4. Qualified “except for” (GAAS)
   
   • insufficient evidence
5. Disclaimer (GAAS)-very material issue (pervasive and significant)
   
   • insufficient evidence
   • significant going concern uncertainty
   • lack of independence
6. Withdraw-false, fraudulent, deceptive, or misleading

Question 21

Unmodified Opinion

Emphasis of Matter and Other Matter Paragraphs

Answer 21

The auditor may determine that it is necessary to add addtional communications to the auditor’s report without modifying the auditor’s opinion.

Question 22

Modifications to the Auditor’s Opinion

Auditor’s report should be modified when:

Answer 22

1. The auditor concludes that the financial statements as a whole are materially misstated (GAAP issue) or
2. the auditor is unable to obtain sufficient appropriate audit evidence to conclude that the f/s as a whole are free from material misstatement (GAAS issue)

Question 23

Emphasis of Matter Paragraphs

Answer 23

Emphasis of matter paragraph is included in aud report when required by GAAS or at auditors discretion. Is used when referring to a matter that is appropriately presented or disclosed in the f/s and is of such importance that it is fundamental to the users’ understanding of the f/s. The inclusion of an emphasis of matter paragraph in the auditor’s report does not affect the auditors opinion.

report requirements:

1. place immediately after the opinion paragraph
2. use the heading “Emphasis of Matter”
3. describe matter being emphasized and the location of relevant disclosures about the matter in the f/s
4. indicate the auditor’s opinion is not modified with respect to the matter emphasize

use is required when

• auditor concludes there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time
• to describe a justified change in accounting principle that has a material effect on the entity’s financial statements
• subsequently discovered facts lead to a change in audit opinion (can use emphasis of matter or other matter paragraph)
• the f/s are prepare din accordance with a applicable special purpose framework

use maybe necessary

• uncertainty related to the outcome of unusually important litigation or regulatory action
• major catastrophe having a significant effect on the entity’s financial position
• signifcant related party disclosures
• unusually important subsequent events

Question 25

Other-Matter Paragraphs

Answer 25

Required by GAAS or at the auditors discretion. Other matter paragraphs refer to matters other than those presented or disclosed in the f/s that are relevant to the user’s understanding of the audit, the auditor’s responsibilities, or the auditor’s report.

report requirements

1. place immediately after the opinion paragraph and after any emphasis of matter paragraph
2. use the heading “Other-Matter”
3. describe the matter being emphasized and the location of relevant disclosures about the matter in the f/s

use required

1. anytime the auditor includes an alert in the audit report that restricts the use of the auditor’s report
2. subsequently discovered facts lead to a change in the audit opinion
3. the f/s of the prior period were audited by a predecessor auditor and the predecessor’s audit report is not reissued
4. current period financial statements are audited and presented in comparative form with compiled or reviewed f/s for the prior period, or in comparative form with prior period f/s that were not audited, reviewed or compiled.
5. Prior to the audit report date, the auditor identifies a material inconsistency in other info that is included in a document containing audited financial statements that requires revision of the other information and mgmnt refuses to make the revision
6. auditor chooses to report on supplementary information presented with the f/s int he auditor’s report, rather than in a separate report
7. to refer to required supplementary information that a designated accounting stds setter requires to accompany an entity’s basic f/s
8. to restict the use of the auditor’s report when special purpose financial statements are prepared in accordance with a contractual or regulatory basis of accounting (except when regulatory basis f/s are intended for general use)
9. a report on compliance is included in the auditor’s report on the f/s

use maybe necessary

1. to describe the reasons why the auditor cannot withdraw from an engagement when the auditor is unable to obtain sufficient appropariate audit evidence due to a management imposed scope limitation and the possible effects on the financial statements of undetected misstatements could be both material and pervaise but the auditor is unable to withdarw from the engagement
2. law, regulation, or generally accepted practice require or permit the auditor to provide further explanation of the auditors responsibilities
3. the auditor has been engaged to report on more than one set of financial statements when each set of financial has been prepared in accordance with a different general purpose framework

Question 26

Emphasis of Matter

Going Concern

Procedures (ADMITS)

Answer 26

1. Analytical procedures
2. Debt compliance-the auditor should review the terms of debt and loan agreements
3. Minutes-the auditor should review minutes from stockholder and board of director meetings
4. Inquiry of client’s legal counsel
5. Third Parties-the auditor should confirm the details of financial support arrangements
6. subsequent events review

Question 27

Emphasis of Matter

Going Concern

Conditions and Events

Answer 27

Based on procedures peformed, the auditor identifies conditions and events that maybe indicative of substantial doubt.

1. Financial difficulties-loan defaults, dividend arrearages, denial of usual trade credit, debt restructuring, noncompliance with capital requirements, new financing sources or methods, disposal of substantial assets
2. Internal Matters-work stoppages, labor difficulties, substantial dependence on a particular project, uneconomic long term commitments, significant revision of operations
3. Negative Trends-recurrent losses, working capital deficiencies, negative cash flows, adverse financial ratios
4. External matters-legal proceedings, new legislation, loss of a key franchise, license, or patent, loss of a principal customer or supplier, natural disasters

Question 28

Emphasis of Matter

Lack of Consistency

stopped on page 29

Answer 28

(acceptable/justified changes in accoutning principle)

Consistency deals with the comparability of the financial statements from year to year. Unless the auditor’s report explicitly states otherswise, the auditors report implies that the financial statements are comparable between periods. Evaluate comparability of the f/s between periods has been affected by a change in accounting principle or by an adjustment to correct a material misstatement in previously issued f/s.