Audit Reports Flashcards
Basic Steps in Audit Process (6)
- Establish understanding with client
- Planning
- Assess risk of material misstatements
- Design and perform procedures
- Evaluate audit evidence
- Form opinion and issue report
Establish Understanding with Client
- objectives and limitations
- services that will be performed
- space and staffing requirements, fees
- auditor’s responsibilities
- client’s responsibilities
- document understanding in engagement letter
Planning
Obtain understanding of entity and its environment, including internal control
-Risk assessment procedures
Observation, Inquiries, Inspection, Walkthroughs, Reperform transactions, analytics
-Will depend on size and complexity of client, and
-previous experience with client
-Discussion among audit team about susceptibility of financial statements to material misstatement
Assess Risk
Assess risk of material misstatements related to specific assertions in financial statements
-This includes considering materiality and probability
Design and perform audit procedures
Design and perform procedures to address the risk of material misstatement (RMM)
- tests of controls
- substantive tests of details
Unmodified Opinion Report
A clean opinion
Requirements:
1. No departures from financial reporting framework
2. Financial reporting framework consistently applied
3. Adequate and complete disclosures
4. No significant uncertainties
5. No significant scope limitations
6. No significant going concern doubt
(1-3) No issues with F/S - GAAP
(4-6) No problems with the audit - GAAS
Report for Unmodified Opinion (Part 1)
MEMORIZE WORD FOR WORD
Independent Auditor’s Report (in fact and appearance in order to provide any type of assurance)
Address: entity, shareholders, or BOD NOT management
Introductory paragraph (Report on the Financial Statements) - We have audited the accompanying balance sheet of XYZ Company as of December 31, year 1, and the related statements of income, changes in stockholder’s equity, and cash flows for the year then ended and the related notes to the financial statements.
Management’s Responsibility - Management is responsibile for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America [or other financial reporting framework standards] this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of the financial statements that are free from material misstatement, whether due to fraud or material error
Report for Unmodified Opinion (Part 2)
Auditor’s Responsibility - Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance fwith auditing standards generally accepted in the United States of America [and other standards]. These standard 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 discloures in the financial statements. The procedures selected depend on the auditor’s judgement, 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 entitiy’s preparation and fair presentation of the financial statements in order to design the 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.
Report for Unmodified Opinion (Part 3)
Opinion paragraph - In our opinion, the financial statements referred to above present fairly, in all material aspects, the financial position of XYZ Compaby as of December 31, year 1, and the results of its operations and its cash flows for the year then ended in accordance with accounting princpals generally accepted in the United States of America [or other framework].
Auditor’s Signature, City & State
Date - No earlier than date on which auditor obtained sufficient appropriate audit evidence to support opinion
Report for Unmodified Opinion - International Standards
First Paragraph: Also refer to summary of significant accounting policies and other explanatory information
Auditor’s responsibility paragraph - state that the auditor is required to comply with ethical standards
Either “fair presentation of financial statements” or “financial statements that give a true and fair view”
Emphasis of Matter Paragraph
Appears immediately after opinion paragraph
Information fully disclosed and fairly presented
Emphasis because Highlights information essential to users’ understanding of financial statements
Required when:
- Going concern doubt
- Justified change in principle with material effect on F/S (old GAAP to new GAAP - inventory costing method- LIFO to FIFO, long-term contracts - completed contract to % of completion; change in entity, correction of error involving misapplied principle, change in estimate inseparable from change in principle - depreciation method)
- F/S prepared in accordance special-purpose framework
- subsequently discovered fact that lead to change in opinion
Optional when:
Uncertainty
natural disaster
Significant related-party transaction
significant subsequent event
Other Matter Paragraph
Appears after opinion paragraph and any emphasis of matter paragraph
Relevant to user’s understanding of audit report or auditor responsibilities
Required when:
- Restrict use
- Subsequently discovered fact that leads to change in opinion (choice between EOM or OM paragraph based on important)
- Prior period F/S audited by different auditor and report not re-issued
- Audited F/S presented with unaudited F/S
- Material inconsistently in other information presented with F/S and mgmt refuses to revise other information
- Auditor reports on supplemental information without separate report
- Auditor refer to required supplemental information
- Restrict use (special purpose F/S)
- auditor reports on compliance without separate report
Option when:
- Auditor cannot withdraw despite mangagement-imposed scope limitation
- Auditor provides further explanation of auditor’s responsibility
- Multiple sets of F/S prepared with different reporting frameworks
Address other auditing responsibilitites other than GAAS
If audit wants to address other auditing/reporting responsibilities other than GAAS, two sets of requirements in same report:
- Title before introductory paragraph: Report on the Financial Statements
- Title after opinion paragraph: Report on Other Legal & Regulatory Requirements
Other Opinions: GAAP Problem
If GAAP problem, material = (except for) qualified opinion; pervasive = adverse opinion
Example:
1. Departure from financial reporting framework
2. Financial reporting framework inconsistently applied
3. Inadequate or incomplete disclosures
Modified/Qualified Opinion Report
First paragraph: Same
MR Paragraph: Same
AR Paragraphs: “a basis for our modified/qualified opinion”
Basis for Qualified Opinion paragraph: before opinion paragraph
The company’s financial statements do not disclose significant related party transactions. In our opinion, disclosure of this information is required by accounting principals generally accepted in the United States of America.
Opinion Paragraph: “In our opinion, except for the omission of the information described in the Basis for Qualified Opinion paragraph, the financial statements referred to above present fairly, in all material respects, the financial position of XYZ Company as of December 31, year 1, and the results of its operations and its cash flows for the year then ended in accordance with accounting principals generally accepted in the United States of America.
Adverse Opinion Report
pervasive
first paragraph: same
MR paragraph: same
AR paragraphs: “a basis for our adverse opinion:
Basis for Adverse Opinion paragraph: before opinion paragraph
As described in Note X to the financial statements, the Company carries its property, plant, and equipment accounts at appraised values, and provides depreciation on the basis of such values. In our opinion, property, plant, and equipment stated at an amount not in excess of cost, reduced by depreciation based on such amount, is required by accounting principles generally accepted in the United States of America.”
Opinion Paragraph: “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,in all material repects, the financial position of XYZ Company as of December 31, year 1, and the results of its operations and its cash flows for the year then ended in accordance with accounting principals generally accepted in the United States of America.”
Other Opinions: GAAS Problem
GAAS Problem
-Significant scope limitation - unavailability of data - material: qualified, pervasive: disclaimer of opinion
If client imposed, request limitation be removed, if not, communicate with those charged with governance. If pervasive, disclaimer of opinion
International standards, auditor would withdraw
- Significant uncertainty
- Significant going concern doubt
Disclaimer of Opinion Report
First paragraph: “We were engaged…”
MR paragraph: Same
AR paragraph: “we were not able to obtain ufficient appropriate”
Basis for Disclaimer of Opinion paragraph: Before opinion paragraph
Ex: “Due to the introduction of a new computerized accounts receivable system, there were a number of misstatements in account receivable. We were unable to confirm by alternate means acccounts receivable which total $X in the balance sheet at December 31, year 1. As a result of these matters, we were unable to determine whether any adjustments might have been found necessary in respect of recorded or unrecorded accounts receivable, and the elements making up the statements of income, changes in stockholders’ equity, and cash flows.
Disclaimer of Opinion Paragraph: “Because of the significance of the matters described in the Basis for Disclaimer of Opinion paragraph, we were not able to obtain sufficient and appropriate audit evidence to provide a basis for an audit opinion. Accordingly, we do not express an opnion on these financial statements.”
Uncertainty
If property reported,
-unmodified opinion, unmodified report or
-unmodified opinion, modified report (auditor emphasizes uncertainty)
optional emphasis of matter paragraph
If uncertainty cases material misstatement in F/S, GAAP problem:
material: qualified opinion
pervasive: adverse opinion
scope limitation: auditor unable to gather sufficient and appropriate audit evidence
material: qualified opinion
pervasive: disclaim opinion
International standards - interaction of several uncertainties could mean auditor is unable to form an opinion, despite having sufficient appropriate evidence
Going Concern problem
Every audit:
Auditor responsible for evaluating whether there is substantial doubt about company’s ability to continue as a going concern for a reasonable period of time (not to exceed 1 year)
Sample evidence sources:
- minutes of meetings
- legal letters
- subsequent events
- negative trends (recurring losses, negative cash flows, adverse financial ratios, defaulting on loans, denial of usual trade credit, arrearages in dividends, legal proceedings, loss of key patent)
Mitigating factors:
- disposal of unproductive assets
- restructure debt
- reduce/delay expenditures
- increase in owner’s equity
- reduce dividend requirements
Substantial Going Concern Doubt:
Assume properly reported and material, unmodified opinion, modified report - required EOM paragraph
“raising substantial doubt about its ability to continue as a going concern”
If so material, auditor cannot gather sufficient evidence, scope limitation - disclaim opinion
Piecemeal Opinion
disclaimer of opinion or adverse opinion on whole, but opinion on part.
If auditor expresses an adverse opinion on a disclaimer on complete set of F/S, then an unmodified opinion on singled F/S is precluded.
Can’t contradict opinion on complete set of F/S
Also, if specified element is far-reaching can’t express unmodified opinion on specified element. If not far reaching, auditor can express unmodified opinion on specified element IF specified element opinion is not published with opinion on complete set of F/S
Not allowed - overshadows
Subsequent Events
Events that occur after the balance sheet date but before statements are issued.
Type 1: Conditions did exist on B/S date
- event occuring afer balance sheet date clarifies conditions existing on B/S date
- adjust financial statement
Type 2: Conditions did not exist on B/S date
- do not adjust financial statements
- Disclosure may be required to keep financial statements from being misleading (casualty loss, purchase or sale of business component, issue stock or debt)
Dual Date Audit Report
Normally audit report is dated no earlier than date on which auditor obtained sufficient appropriate audit evidence to support opinion
Dual dating extends auditor’s resonsibility for work done up to second date for specified subsequent event only
Subsequent Discovery of Fact
Generally auditor not obligated to make inquiries after report issue
Revision: if information comes to auditor’s attention that would have affected opinion if the auditor had known it at the time of the report issuance
Request client to issue revised F/S and issue new audit report
IF client does not issue revised F/S:
- notify client that audit report may no longer be associated with F/S
- notify regulatory agencies
- notify those that auditor knows are relying on F/S
Group Audit / Component Auditor
Client with subsidiary
Subsidiary audited by component auditor
When part of audit is performed by another auditor, group (principal) auditor must decide whether to assume responsibility for work of component (other) auditor(s)
principal auditor must decide:
- assume responsibility
- make no reference in report to work of component auditor
- must be satisfied of component auditor’s independence, professional reputation, and quality and scope of work (i.e. must review work papers)
- divide responsibility
- must be satisfied of component auditor’s independence and professional reputation
- modify report
- include the magnitude of portion covered by component auditor
Report Dividing Responsibility
First paragraph: Same
MR paragraph: Same
AR Paragraphs: “…we did not audit the F/S of XYZ Company, a wholly owned subsidiary, who assets…”
Opinion Paragraph: “In our opinion, based on our audit and the report of other auditors…”
Updating an Opinion
Auditor changes opinion on prior F/S
Choice: Requires EOM or OM paragraph
With either choice, disclose:
- date of previous report
- type of opinion previously expressed
- reason for previous opinion
- changes made
- state updated opinion is different from previous report
Predecessor Auditor
Comparative statements are presented and the prior F/S was audited by another (predecessor) auditor
Predecessor reissues report
- predecessor read current F/S and compares to prior F/S
- predecessor obtains letter of representation from successor
- predecessor obtains letter of representation from management
unrevised: original report date
revised: dual date
If predecessor’s report not presented, successor adds required OM paragraph
- state that prior period F/S were audited by predecessor
- type of opinion and any modifications
- nature of any EOM paragraphs
- date of predecessor’s auditor’s report
Unaudited F/S
Unaudited F/S presented with audited F/S
- review or compilation performed
- no audit, review, or compilation performed
Prior report not re-issued: required OM paragraph
- state level of service performed
- date of prior report
- describe material modifications
- state review or compilation is less in scope than audit and does not provide basis for audit opinion
No prior report: required OM paragraph
- mark F/S “unaudited”
- state f/s not reviewed or compiled
- state no prior service performed
- state assume no responsibility for prior F/S
Other Information Presented alongside audited F/S
Documents containing audited F/S often contain other information
ex. Annual Report to Shareholders
Not responsible to determine if other information is stated properly
Obligated to read the other information and determine if there are any material inconsistencies with F/S
If inconsistency found, if F/S must be revised and management refuses, auditor:
- revises opinion, or
- withholds opinion, or
- withdraws
If the other information must be revised and management refuses,
- communicate problem to those charged with governance
- required OM paragraph describing inconsistency
- may disclaim any opinion on other information
- auditor could withdraw use of audit report or withdraw
Supplemental Information
Auditor may be engaged to report on supplemental information in relation to F/S taken a whole
Two objectives, if so:
- evaluate presentation and
- report whether supplemental information is fairly presented related to F/S
Auditor must audit related F/S; could not have issued adverse or disclaimer of opinion
Management must provide a management representation letter in relation to supplemental information
Management must include report on supplemental information in any document including supplemental information
SI Engagement
- Inquire as to purpose and significant assumptions
- obtain representation letter
- evaluate form and content with respect to established criteria
- reconcile to F/S
- evaluate completeness and appropriateness
Supplemental Information Report
Either OM paragraph in audit report or separate report
Material unrevised misstatement: modify opinion and possibly withhold separate report
Required Supplemental Information (RSI)
Required Limited Procedures
- inquire of management about preparation with established criteria
- determine whether RSI is consistent with F/S
- Obtain management representation letter about RSI
- Required OM paragraph in audit report
Required OM paragraph
- RSI Included (or omitted)
- auditor applied limited procedures
- any material departures from criteria
- any unresolved issues or doubts
- auditor may disclaim on RSI
Engagement steps same as SI Engagement
Audit Objective
To provide reasonable assurance financial statements are free from material misstatements
material misstatements = errors and fraud
Fraud
- Fraud is intentional deception of users of financial statement
- management responsible for detection and prevention of fraud
- auditor responsible to provide reasonable assurance F/S are free from material misstatements
Auditor:
- must be aware of risk of fraud throughout audit
- no preconceptions about management integrity
- high professional skepticism
- audit team discusses how and where fraud could occur
Fraud Risk Factor
change = risk
high turnover
new technology
downturn in economy
aggressive earnings projections
negative cash flows
offshore holding companies
increased competition
Control Risk
Auditors assess control risk in light of risk of fraud
internal control structure is not functioning properly
Professional Skepticism
-Unpredictable audit tests - change them year to year
- procedures to test management override of controls
- journal entries and adjustments
- requirement
- document consideration of risk of fraud in workpapers
Types of Fraud
- Fraudulent financial reporting
- intentional deception of financial information users
- material misstatements or omissions in F/S
- intended to deceive F/S users
- do extensive substantive testing - Asset Misappropriation
- theft
- do extensive test of controls on accounts with high degree of inherent risk
- do targeted analytical procedures
Detection Risk
Audit done under US GAAS might not detect fraud
Risk that auditor will fail to detect errors and fraud that exist
Auditors do not examine everything
Audit Risk
Ultimate Risk
Financial statements are materially misstated, but auditor issues clean opinion
If Fraud does exist
Must Inform:
- appropriate level of management (one level above)
- those charged with governance (ex. Audit committee)
even if fraud is insignificant in amount
IF senior managmenet is involved with fraud or F/S are materially misstated,
- immediately inform those charged with governance
- consult legal counsel regarding obligation to inform 3rd parties
it team discusses how and where fraud could occur
Noncompliance (Illegal Acts) with laws and regulations
Noncompliance with laws and regulations on behalf of company
- BOD
- Management
- other employees
Act of omission or commission
Intentional or unintentional
Can result in fines or litigation
Management responsible for compliance with laws and regulations
Auditor responsibiity:
- provide reasonable assurance that there have been no illegal actts that have a direct effect on financial statements
- violations that have indirect effect are beyond scope of audit
If noncompliance discovered with material effect on F/S
Auditor informs those charged with governance
Consider:
- effect on control environment
- adequacy of disclosures
- impact on audit report
- withdrawing from engagement
How does a client earn an unmodified opinion
6 requirements:
- No significant departures from reporting framework (assume GAAP)
- Reporting framework consistently applied between periods
- Adequate and complete disclosure
- No significant uncertainties
- No significant scope limitations
- No significant going concern issues
First 3, no problems with the financial statements
Last 3, no problems with the audit
Problem with F/S
GAAP Problem or disclosure problem:
- material = “except for” qualified opinion
- very material (pervasive) = adverse
Audit problem:
Scope problem- unable to gather evidence
-material = “except for” qualified opinion”
-very material (pervasive) = disclaim
Going concern problem
material - unmodified opinion
-required EOM paragraph
-raise doubt about entity’s ability to continue as a going concern
-very material (pervasive) = disclaim
Uncertainty causes misstatement
- material - “except for” qualified opinion
- very material (pervasive) = adverse
Uncertainty due to insufficient evidence (same as scope problem)
- material - “except for” qualified opinion
- very material (pervasive) = disclaim
