Auditors’ Reports

Chapter 17

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Audit ReportAudit Report

Providing an independent and expert opinion on the fairness of financial statements through an audit is the most frequent attestation service

An audit provides users of financial statements reasonable assurance that the statements are in conformity with GAAP

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Fourth Standard of ReportingFourth Standard of Reporting Fourth Standard of Reporting:

The auditor must either express an opinion regarding the financial statements, taken as a whole, or state that an opinion cannot be expressed, in the auditor's report. When the auditor cannot express an overall opinion, the auditor should state the reasons therefore in the auditor's report. In all cases where an auditor's name is associated with financial statements, the auditor should clearly indicate the character of the auditor's work, if any, and the degree of responsibility the auditor is taking, in the auditor's report.

The standard report meets the fourth standard by:(1) stating that the audit was performed in conformity with generally

accepted auditing standards and

(2) expressing an opinion that the client’s financial statements are presented fairly in conformity with generally accepted accounting principles.

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Types of ReportsTypes of ReportsReports on the financial statements ordinarily

include: The financial statements themselves:

Balance sheet Income statement Statement of cash flows Statement of retained earnings (equity)

Financial Statement Disclosures The notes to the financial statements are considered an integral

part of the financial statements

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Auditors’ Standard Report – Auditors’ Standard Report – Nonpublic ClientsNonpublic Clients

Details Title includes word independent Addressed to person or audit committee who

retained the auditors Signed with name of CPA firm not individual

partner unless sole practitioner Dated last day of fieldwork or date on which

the auditors obtained sufficient appropriate audit evidence to support their opinion

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We have audited the accompanying balance sheet of XYZ Company as of December 31, 20XX, and the related statements of income, retained earnings, and cash flows for the year 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 audit.

The AICPA Standard Auditors’ Report--Introductory Paragraph

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We conducted our audit in accordance with auditing standards

generally accepted in the United States of America. 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 audit provides a reasonable basis for our opinion.

The AICPA Standard Auditors’ Report--Scope Paragraph

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In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of XYZ Company as of December 31, 20XX, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

The AICPA Standard Auditors’ Report--Opinion Paragraph

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Conditions Required for Issuance of Conditions Required for Issuance of an Unqualified Reportan Unqualified Report

The financial statements are presented in conformity with GAAP, including adequate disclosure.

The audit was performed in accordance with GAAS, and there were no significant scope limitations.

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Auditors’ Standard Report – Auditors’ Standard Report – Public ClientsPublic Clients

Differences from nonpublic Includes the words “Registered” and “Independent” in the title. References standards of the PCAOB rather than generally

accepted auditing standards. Includes the city and state—or city and country in the case of

non–U.S. auditors—where the auditors’ report has been issued. (Historically, auditors have included this information, although it was not required.)

Includes an additional paragraph indicating that the auditors have also issued a report on the client’s internal control over financial reporting.

• The report on internal control may either be presented separately or combined with the report on the financial statements into one overall report

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Types of OpinionsTypes of Opinions

1. An unqualified opinion—standard report. This report expresses a “clean opinion” and may be issued only when the two conditions listed in the preceding section have been met, and when no conditions requiring explanatory language exist.

2. An unqualified opinion—with explanatory language. In certain circumstances explanatory language is added to the auditors’ report with no effect on the auditors’ opinion.

3. A qualified opinion. A qualified opinion states that the financial statements are presented fairly in conformity with generally accepted accounting principles “except for” the effects of some matter.

4. An adverse opinion. An adverse opinion states that the financial statements are not presented fairly in conformity with generally accepted accounting principles.

5. A disclaimer of opinion. A disclaimer of opinion means that due to a significant scope limitation, the auditors were unable to form an opinion or did not form an opinion on the financial statements.

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Modifications of the Auditors’ Modifications of the Auditors’ Report--Unqualified OpinionsReport--Unqualified Opinions

Type of Report Introductory or Scope paragraph

Explanatory Paragraph

Opinion Paragraph

Shared responsibility

Describe work of other auditors

None "…based on our audit and the report of other auditors"

Going concern uncertainty

None Describe uncertainty

None

GAAP not consistent

None Describe change in principle

None

Emphasis of a matter

None Describe matter None

Justified departure from GAAP

None Describe departure

None

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Modifications of Auditors’ Report—Modifications of Auditors’ Report—Qualified OpinionsQualified Opinions

Type of Report

Introductory or Scope

Paragraph

Explanatory Paragraph

Opinion Paragraph

Qualified—GAAP Departure

None

Describe departure and

effects

“except for the effects of the departure the financial statements…”

Qualified—Scope Limitation

“Except as explained in the following paragraph…”

Describe scope

limitation

“except for the effects of such adjustments, if any, as might have been determined to be necessary had we been able to…”

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Modifications of Auditors’ Report—Modifications of Auditors’ Report—Adverse Opinions and DisclaimersAdverse Opinions and Disclaimers

Type of Report Introductory or Scope Paragraph

Explanatory Paragraph

Opinion Paragraph

Adverse None Describe reason for opinion

"The financial statements do not present fairly"

Disclaimer of Opinion--Scope Limitation

"We were engaged"; Omit responsibility.

Omit scope paragraph

Describe scope restriction and any reservations

"we do not express an opinion on the financial statements."

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Shared Responsibility ReportShared Responsibility Report

[Standard introductory paragraph language] We did not audit the financial statements as and for the year ended December 31, 2001 of Glendo, Inc., which statements reflect total sales constituting 27 percent of total consolidated sales for 2001. Those statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to data included for Glendo, Inc. for 2001, is based solely on the report of the other auditors.

[Standard scope paragraph language] We believe that our audits and the reports of other auditors provide a reasonable basis for our opinion.

In our opinion, based on our audits and the reports of other auditors, …

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Going concernGoing concern

SAS 59 Auditor not required to perform procedures

specifically designed to test going-concern assumption but must evaluate the assumption

Conditions• Negative cash flows from operations• Defaults on loan agreements• Adverse financial ratios• Work stoppages• Legal proceedings

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Explanatory Paragraph--Going Explanatory Paragraph--Going Concern ProblemConcern Problem

The accompanying financial statements have been prepared assuming that [America West Airlines, Inc..] will continue as a going concern. As discussed in note 1 to the financial statements, the Company filed a voluntary petition seeking to reorganize under chapter 11 of the federal bankruptcy laws. This event and circumstances relating to this event, including the Company’s significant losses, accumulated deficit, and highly leveraged capital structure, raise substantial doubt about its ability to continue as a going concern. Although the Company is currently operating as debtor-in-possession under the jurisdiction of the Bankruptcy Court, the continuation of the business as a going concern is contingent upon, among other things, the ability to (1) formulate a Plan of Reorganization which will gain approval of the creditors and stockholders and confirmation of the Bankruptcy Court, (2) maintain compliance with all debt covenants under the debtor-in-possession financing agreements, (3) achieve satisfactory levels of future operating results and cash flows, and (4) obtain additional debt and equity. The accompanying financial statements do not include and adjustments that might result from the outcome of these uncertainties.

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Explanatory Paragraphs--Explanatory Paragraphs--ConsistencyConsistency

As discussed in the Notes to the consolidated financial statements, effective January 1, 20X1, the Company changed its method for accounting for derivative financial instruments to conform with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. ____________________________________

As discussed in Note 15, effective January 1, 20X2, the Company changed its method of accounting for goodwill and intangible assetsupon adoption of Statement of Financial Accounting Standards (SFAS)No. 142, “Goodwill and Other Intangible Assets.”

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Qualified OpinionQualified Opinion Departure from GAAP

Immaterial – unqualified Material – qualified or adverse (if overall financial

statements considered misleading) Consider effects of departure(s):

Dollar magnitude of effects Significance of item to particular client Number of financial statement accounts and

disclosures affected Effect on financial statements taken as a whole

Consider inadequate disclosures

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Example of a Qualified Report-- Example of a Qualified Report--

Departure from GAAP Departure from GAAP

(Introductory and Scope Paragraphs are Standard) The Company has excluded from property and debt in the accompanying

balance sheet certain lease obligations that, in our opinion, should be capitalized in order to conform with generally accepted accounting principles. If these lease obligations were capitalized, property would be increased by $__________, long-term debt by $___________, and retained earnings by $__________ as of December 31, 20X1, and net income and earnings per share would be increased (decreased) by $___________ and $_____, respectively, for the year then ended.

In our opinion, except for the effects of not capitalizing lease

obligations, as discussed in the preceding paragraph,, the financial statements referred to above present fairly, in all material respects, the financial position of XYZ Company as of December 31, 20X1, and the results of its operations and cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

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Qualified OpinionQualified Opinion

Scope limitations Auditor unable to perform an essential audit

procedure Imposed by circumstances

• Engaged too late in year to observe client’s beginning inventory

Imposed by client• Client refused to allow auditors to send

confirmations to customers

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Example of a Qualified Report--Example of a Qualified Report--Scope LimitationScope Limitation

Standard Introductory Paragraph

Except as discussed in the following paragraph, we conducted our audit...

We were unable to obtain audited financial statements supporting the Company’s investment in a foreign affiliate stated at $_______, or its equity in earnings of that affiliate of $_______, which is included in net income, as described in Note 8 to the financial statements; nor were we able to satisfy ourselves as to the carrying value of the investment in the foreign affiliate or the equity in earnings by other auditing procedures.

In our opinion, except for the effects of such adjustments, if any, as might have been determined to be necessary had we been able to examine evidence regarding the foreign affiliate investment and earnings, the financial statements referred to above present fairly,...

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AdverseAdverse

Financial statements do not present fairly the financial position, results of operations, and cash flows of client in conformity with GAAP

Very material departures from GAAP Auditor believes departure causes

financial statements taken as a whole to be misleading

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Adverse OpinionAdverse Opinion

In our opinion, because of the effects of the matters discussed in the preceding paragraph, the financial statements referred to above do not present fairly, in conformity with accounting principles generally accepted in the United States of America, the financial position of XYZ Company as of December 31, 20X5, or the results of its operations or its cash flows for the year then ended.

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Disclaimer of OpinionDisclaimer of Opinion Auditor has no opinion Issued whenever unable to form an

opinion as to fairness of financial statements

Circumstances resulting in a disclaimer: Substantial circumstance-imposed scope

restrictions Scope restrictions imposed by the client Uncertainties

Not an alternative to adverse opinion

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Disclaimer of OpinionDisclaimer of Opinion

We were engaged...

The Company did not make a count of its physicalinventory, stated in the accompanying financialstatements at $_____ as of December 31, 20X2.Further, evidence supporting the cost of property andequipment acquired prior to December 31, 20X1, is nolonger available. The Company’s records do not permitthe application of other auditing procedures toinventories or property and equipment.

Since the Company did not take physical inventoriesand we were not able to apply other auditingprocedures to satisfy ourselves as to inventoryquantities and the cost of property and equipment, thescope of our work was not sufficient to enable us toexpress, and we do not express, an opinion on thesefinancial statements.

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Placement of Explanatory ParagraphsPlacement of Explanatory Paragraphs

Before opinion paragraph Qualified opinions Disclaimers Adverse opinions

Following opinion paragraph Consistency Substantial doubt about continued existence

Other types of paragraphs may precede or follow the opinion paragraph

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Two or More Report ModificationsTwo or More Report Modifications

Qualified by two or more Examples: Qualified because of both a scope

limitation and separate departure from GAAP Wording of report would include appropriate

qualifying language and explanatory paragraphs for both types of qualifications

Auditor should consider cumulative effects – disclaimer of opinion may be appropriate

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Different Opinions on Different StatementsDifferent Opinions on Different Statements

Fourth standard: Auditor shall express an opinion on the financial statements “taken as a whole”

Can apply to individual financial statements It is acceptable to express an unqualified opinion on

one statement while expressing a qualified or adverse on the others

Example: Auditors retained after client has taken its beginning inventory. A disclaimer may be issue don the income statement (the auditor doesn't know if income is reasonably stated, but an unqualified opinion on the year-end balance sheet.

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Reporting on Comparative Reporting on Comparative Financial StatementsFinancial Statements

Report should cover current year as well as prior period audited by their firm.

Can express different opinions on different years Auditor should update report for all prior periods

presented for comparison If prior period audited by another (predecessor) CPA firm

Current year opinion only covers years the CPA firm audited For financial statements audited by predecessor auditors either:

• Predecessor auditor reissues report with original date or• Current auditors refer to report of other auditors

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Reports to SECReports to SEC

Forms filed with SEC which include audited financial statements

Forms S-1 through S-11 (registration statements) Forms SB-1 and SB-2 (registration for small

businesses) Form 8-K (current report) Form 10-Q (quarterly report) Form 19-K (annual report)

Auditors should be well versed on requirements of each form