AUD - Notes Chapter 1

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Audited F/S – The Basics
Company’s mgmt responsible to prepare the F/S
Auditors responsible to express an opinion on the F/S and on mgmt’s assertion on internal controls (if public)

The primary assertion is whether the statements are “presented fairly” in accordance with GAAP

Professional Standards
Generally Accepted Accounting Standards – GAAS
Generally Accepted Government Auditing Standards – GAGAS
The Public Company Accounting Oversight Board – PCAOB
- Public accounting firms must register with PCAOB in order to audit public companies
- Registered firms are subject to board inspection, disciplinary proceedings, and sanctions

GAAS – TIP PIE ACDO

General standards – TIP
T – Training
I – Independence (in fact and appearance)
P – Professional Care
Standards of Field Work – PIE
P – Planning and supervision
I – Internal control, entity and environment
Strong controls imply the auditor will require less evidence
Weak controls imply the auditor will require more evidence (more work)
An exam trick; weak internal controls does not equal an adverse opinion
E – Evidence
Standards of Reporting – ACDO
A – Accounting = GAAP
Explicit; Opinion must state that the acctg used was GAAP
C – Consistency between periods
Implicit; Silence is okay cause its implied
D – Disclosure
Implicit; Silence is okay
O – Express Opinion
• Explicit; Opinion must state “In our opinion…”
• Meant to prevent misinterpretation of the degree of responsibility the auditor is assuming when his/her name is
associated with the F/S
• The auditor may express different opinions of different sections (B/S, I/S)
• The auditor may express an opinion on 1 section and not the others as long as information has not been limited

Reports on Audited F/S

The Auditors Standard Report (Unqualified Opinion)
Title
Addressee
Introductory Paragraph – R;R
• Statement that the F/S as identified in the report were audited
• Statement that the F/S are the responsibility of mgmt and the auditors responsibility is to express an opinion
Scope Paragraph – APMEAM; APMEAM
• Statement that the audit was conducted in accordance with U.S. GAAS
• Statement that the audit was planned and performed to obtain reasonable assurance that the F/S are free
from material misstatement
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• Statement that the audit included examining evidence on a test basis; assessing the accounting principles
used and significant estimates made by mgmt; and evaluating the overall presentation
• Statement that the audit provides a reasonable basis for an opinion
Opinion Paragraph
• Statement referring to the F/S specifically identified in the introductory paragraph
• An opinion as to the fair presentation of the F/S (ACDO)
• Statement regarding conformity with U.S. GAAP (ACDO)
Firm Name
Report Date
• The Report should be dated on or after the date on which appropriate audit evidence sufficient to support
the opinion has been obtained
Sample unqualified opinion – A1-14

GAAS in referenced to in the Scope paragraph

GAAP is referenced to in the Opinion paragraph

PCAOB Standards – for publicly traded companies

Audits of Issuers (public companies) – PCAOB auditing standard No. 1 requires the auditor’s report to include
=a reference to the standards of the PCAOB
Audits of nonissuers (private companies) – An auditor may, but is not required to, conduct the audit of a
nonissuer in accordance with both GAAS and PCAOD auditing standards

Unqualified opinion – clean; F/S presented fairly in all material respects, doesn’t mean good investment
Modified Unqualified opinion – additional explanatory language
Qualified opinion – states “except for”; material GAAP or GASS problem
Adverse opinions – very material GAAP problems
Disclaimer of opinion – significant GAAS problem

Chart on A1-17 memorize

Uncertainties – impairments, intangibles, lawsuits, warranties

Management’s responsibility
• Estimate the effect of future events on the F/S and record and present this estimate, or
• Determine that a reasonable estimate cannot be made and make the required disclosures to that effect

Remember under GAAP

Both probable and reasonably estimatable  record
Either probable or reasonably estimatable  disclose

If mgmt’s analysis is supported and properly reported or disclosed, the auditor issues and unqualified opinion
with no reference to the uncertainty in the report
Unqualified opinion: GAAP = ok; GAAS = ok
If the auditor is unable to obtain sufficient evidential matter involving an uncertainty and its presentation or
disclosure, the auditor should consider expressing a qualified (GAAS) opinion or to disclaim an opinion to
scope limitation.
Qualified or Disclaimer: GAAP = ?; GAAS = Problem

If the auditor concludes that the F/S are materially misstated due to a departure from GAAP related to
uncertainty, the auditor should express a qualified (GAAP) or adverse opinion. GAAP departures include

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inadequate disclosures, use of inappropriate accounting principles, and use of unreasonable acctg estimates
Qualified of Adverse: GAAP = problem; GAAS = ok

Pass key chart on A1-19 memorize

Modified Unqualified opinion – still represents an unqualified opinion. The additional language (modified
wording or explanatory paragraph) used to highlight the certain circumstances

Modified wording
• Division of responsibility; auditors opinion is based in part on the report of another
Explanatory paragraph
• Justified departure from GAAP
• Going concern
• To emphasize a matter
• Lack of consistency
• Other;
- Required SEC regulation S-K quarterly financial data has been omitted or has not been reviewed
- Supplementary information required by GAAP has been omitted
- Other information (stuff in 10-K) is inconsistent with F/S

Division of Responsibility (reference in report) – The principal auditor decides to mention the work done by
other auditors, the report will express a division of responsibility. The principal auditor will mention this
division in all three paragraphs. The name of the other auditor is not mentioned unless the auditor gives express
permission and the report of the other auditor is presented. Make other CPA responsible by mentioning them in
the Intro, Scope, and Opinion paragraph.

Assumption of Responsibility (no reference to other CPA) – The principal auditor must assure on the other
auditors, reputation, independence, professional competency, program steps (RIPP). Visit the other auditor to
discuss audit procedures and review audit program, documentation, and evaluation of internal controls
performed by the other auditor

Justified departure from GAAP – The explanatory paragraph should contain a description of the departure, its
approximate effects (if possible) and the reasons why adherence to GAAP would make the F/S misleading

Going Concern – The auditor should perform the following procedures:

A – Analytical procedures
D – Debt compliance
M – Review board minutes
I – Inquiry of client’s legal counsel
T – Confirm third party arrangements/agreements
S – Subsequent events review
Conditions or events that may indicate substantial doubt:
F – Financial difficulties
I – Internal matters
N – Negative trends
E – External matters, legal proceedings, new legislation, loss or expiration of intellectual property
The auditor is not precluded from choosing to disclaim an opinion in cases involving uncertainties

The explanatory paragraph occurs after opinion paragraph

It includes the terms “substantial doubt” and “going concern”
Don’t limit it for a time period

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If, in the auditor’s judgement, the entity’s disclosures are inadequate, a departure from GAAP exists. This may
result in either a qualified or adverse opinion

Emphasis of a matter – auditor may wish to emphasis a particular matter but still express an unqualified
opinion. Emphasis when a company is a RECC
• A related party transaction
• Significant subsequent events
• Entity is a component of a larger business
• Items that affect the comparability (except changes in accounting principles)
An explanatory paragraph is not required

Lack of consistency (justified changes) ACDO – if a change is GAAP has occurred between accounting periods
and the effect is material, the auditor should add an explanatory paragraph to the unqualified report. The
explanatory paragraph comes after the opinion paragraph

When selecting the type of opinion because of a lack of consistency, determine is the change is justified
GAAP: Acceptable/Justified = Modified Unqualified
Not GAAP: Unacceptable/Unjustified = Qualified or Adverse

Qualified “except for” Opinion and Adverse Opinion for very material GAAP problems
1. Non GAAP unjustified/unacceptable change – Issue is consistency (ACDO); an explanatory paragraph
should appear before the opinion paragraph to describe the non-GAAP acctg change and the financial impact
2. Inadequate disclosure – when the auditor believes that the omitted items cause the F/S to be deceptive
3. Departure from GAAP
GAAP: Acceptable/Justified = Modified Unqualified
Not GAAP: Unacceptable/Unjustified = “except for” or Adverse
4. Unreasonable accounting estimates

Qualified “except for” Opinion for material GAAS problems

1. Uncertainty
2. Scope limitation – time constraints, in ability to obtain sufficient competent evidential matter, refusal of
mgmt to provide mgmt letter which acknowledge their responsibility for the fair presentation of the F/S in
conformity with GAAP, refusal of clients attorney to respond to inquiry
The scope limitation should be referred to in the scope and opinion paragraph (as an explanatory
paragraph preceding before the opinion paragraph: Double “except for” whammy

Disclaimer Opinion for significant GAAS problems

1. Uncertainty
2. Scope limitation
3. Lack of independence
4. Unaudited – only an opinion paragraph. States reason of unaudited F/S and “we do not express an opinion”

Changes to the report include

Introductory paragraph
- Use the words “were engaged to audit” instead of “have audited”, and
- Deletion of the reference to the auditor’s responsibility
Scope paragraph – omitted
Explanatory paragraph – is the middle paragraph and describes the reasons for the disclaimer
Opinion paragraph – disclaimer of opinion is given on the F/S taken as a whole

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Reports on Comparative Statements
If the prior year’s financial statements were not audited and that the current year’s financial statements are
being audited, the auditor is facing a scope limitation (because the beginning balances may not be correct) and
may require a disclaimer opinion.

When updating (changing prior) periods the explanatory should disclose the:
D – Date of the auditor’s previous report
O – Opinion type previously issued
R – Reason for prior opinion
C – Changes that have occurred
S – Statement “opinion…is different”
Only DORCS change their mind

Update or change opinion when now in conformity with GAAP (restate prior yr F/S)

Report of a predecessor auditor – presented

The prior (old) CPA should:
• Read the current period statements
• Compare the statements audited with the current period statements
• Obtain a letter of representation from the successor auditor
• Obtain a letter of representation from mgmt
• If the report is unrevised use the original report date in any reissue
• If the report is revised dual date

Report of a predecessor auditor – not presented

The current (new) CPA should:
• Not name the predecessor auditor
• The date of the predecessors auditors report
• The type of opinion expressed by the predecessor auditor
• The substantive reasons for other than an unqualified report

Subsequent Events
Type I events – conditions on or before balance sheet date, accrue, looking backward
Requires a F/S adjustment
Type II events – conditions existing after the balance sheet date, disclose in footnotes, looking forward
May require footnote disclosure

Auditors responsibility for subsequent events – PRIME is included in yr end fieldwork

P – Post balance sheet transactions
R – Representation letter should be obtained from mgmt
I – Inquiry
M – Minutes of stockholders, directors, and other committee meetings should be read
E – Examine latest available interim F/S; compare them with the F/S under audit

Auditors responsibility after the original date of the auditors report

The auditor has no active responsibility. However, if the auditor becomes aware of a subsequent event, auditor
must use professional judgement to decide whether to adjust the F/S or disclosures
If adjusts are made after the original date of the auditors report, the auditor may dual date the report
Ex. “Jan, 21, 2000, except for Note 2, as to which the date is Feb 3, 2000”

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Facts discovered after report is issued (the auditors missed it)
Auditor action
• Advise client to issue revised F/S or make additional disclosures
• Provide notification that the F/S can not be relied upon
If the client refuses to follow procedures
• Notify the board of the directors
• Dissociate with the client
• Inform any regulatory agencies (if applicable)
• Notify parties relying on the F/S

Omitted audit procedures discovered after submission of the audit program (we forgot to do it)
• Auditor should determine whether other audit procedures tended to compensate for the omitted procedures
• Apply the omitted procedures (or alternative procedures)

Reporting on Other Information

Auditor should perform limited procedures on supplementary information and report deficiencies & omissions
1. Inquire of mgmt
2. Determine if the methods uses are consistent with mgmt’s responses, audited F/S and other knowledge
3. Consider whether the client representation letter should refer to the supplementary information

Segment information is required by GAAP

Material misstatement – GAAP problem  qualified or adverse opinion
Scope limitation – GAAS problem  qualified or disclaimer opinion

When an auditor submits a document containing audited F/S to a client or others, the auditor has a
responsibility to report on all information in the document

The auditor must indicate in the report whether the accompanying information is fairly stated in all material
respects in relation to the basic F/S taken as a whole. The report should also describe the character of the
auditor examination and the degree of responsibility the auditor is assuming.

Condensed F/S
The Auditor must indicate:
• That the auditor audited and expresses an opinion on the complete F/S
• Date of the auditors report on the complete F/S
• Type of opinion expressed
• Whether the information in the condensed statements is fairly stated, in all material respects

Selected financial data

The auditor must indicate whether the selected financial data is fairly stated, in all material respects, in relation
to the F/S from which it has been derived.

An accountants report should include

1. Brief description of the nature of the engagement
2. Statement that the engagement was performed in accordance with AICPA standards
3. Identification specific entity, descriptions of the transactions, statement about the source of the information
4. A statement describing the appropriate acctg principles (including country of origin) to be applied
5. Statement that mgmt is responsible
6. A statement that any differences in the facts, circumstances or assumptions may change the report
7. Restrict use of report to mgmt, board of directors, prior and current auditors

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Reporting on F/S prepared for use in other countries
Distribution outside U.S. only: auditor may use either
- The report of the other country
- US style report modified to the accounting principles of another country
Distribution within the US: auditors report should be the US standard report modified as appropriate for
departures from US GAAP.