MODERN

MODERN AUDITING
AUDITING
7th
7th Edition
Edition
William C. Boynton
California Polytechnic State
University at San Luis Obispo

Raymond N. Johnson
Portland State University

Walter G. Kell
University of Michigan
Developed by:
Gregory K. Lowry, MBA,
CPA John Wiley & Sons, Inc.
Saint Paul’s College
 CHAPTER
CHAPTER 20
20
REPORTING
REPORTING ON
ON AUDITED
AUDITED
FINANCIAL
FINANCIAL STATEMENTS
STATEMENTS
Standards of Reporting
The Auditor’s Report
Effects of Circumstances
Causing Departures from
the Standard Report
 CHAPTER
CHAPTER 20
20
REPORTING
REPORTING ON
ON AUDITED
AUDITED
FINANCIAL
FINANCIAL STATEMENTS
STATEMENTS
Other Reporting
Considerations
Standards
Standards of
of Reporting
Reporting
First Standard of Reporting
The first standard of reporting
states:
The report shall state whether
the financial statements are
presented in accordance with
generally accepted accounting
principles.
Standards
Standards of
of Reporting
Reporting
AU 411.04 The meaning of Present Fairly in
Conformity With Generally Accepted Accounting
Principles in the Independent Auditor’s Report (SAS
69), states that the auditor’s opinion as to
conformity with GAAP should be based on his or her
judgment as to whether:
1. The accounting principles selected and applied
have general acceptance
2. The accounting principles are appropriate in the
circumstances
3. The financial statements, including the related
notes, are informative of matters that may affect
their use, understanding, and interpretation
Standards
Standards of
of Reporting
Reporting
4. The information presented in the financial
statements is classified and summarized in a
reasonable manner
5. The statements reflect the underlying events and
transactions in a manner that presents the
financial position, results of operations, and cash
flows within reasonable and practicable limits
Standards
Standards of
of Reporting
Reporting
Second Standard of Reporting
The second standard of reporting
states:
The report shall identify those
circumstances in which such
principles have not been
consistently observed in the current
period in relation to the preceding
period.
Standards
Standards of
of Reporting
Reporting
Accordingly, unless the report contains specific
language to the contrary, the reader can
conclude that accounting principles have been
consistently applied. The objectives of this
standard are:
1. to give assurance that the comparability of
financial statements between accounting
periods has not been materially affected by
changes in accounting principles and
2. to require appropriate reporting by the
auditor when comparability has been
materially affected by such changes.
Standards
Standards of
of Reporting
Reporting
Third Standard of Reporting
The third standard of reporting
states:
Informative disclosures in the
financial statements are to be
regarded as reasonably adequate
unless otherwise stated in the
report.
Standards
Standards of
of Reporting
Reporting
Fourth Standard of Reporting
The third standard of reporting states:
The report shall either contain an expression of
opinion regarding the financial statements, taken
as a whole, or an assertion to the effect that an
opinion cannot be expressed. When an overall
opinion cannot be expressed, the reasons therefor
should be stated. In all cases where an auditor’s
name is associated with financial statements, the
report should contain a clear-cut indication of the
character of the auditor’s work, if any, and the
degree of responsibility the auditor is taking.
 The
The Auditor’s
Auditor’s Report
Report
Standard Report
The auditor’s standard report
consists of an introductory
paragraph, a scope paragraph, an
opinion paragraph, and standard
language. The standard report has a
heading that includes the word
“independent” and contains an
unqualified opinion.
 The
The Auditor’s
Auditor’s Report
Report
Departures from Standard Report
Departures from the standard report
occur when the auditor concludes that:
1. explanatory language should be
added to the report while expressing
an unqualified opinion or
2. a different type of opinion should be
expressed on the financial
statements.
 The
The Auditor’s
Auditor’s Report
Report
Other Types of Opinions
The auditor may conclude that an unqualified opinion
cannot be expressed. In such a case, AU 508.10 indicates
that the auditor may express on of the following other
types of opinions:
1. A qualified opinion which states that, except for the
effects of the matter(s) to which the qualification
relates, the financial statements present fairly … in
conformity with GAAP.
2. An adverse opinion which states that the financial
statements do not present fairly … in conformity with
GAAP.
3. A disclaimer of opinion which states that the auditor
does not express an opinion on the financial statements.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report

Scope Limitation
When the auditor cannot
perform the necessary
procedures or the procedures
do not provide sufficient
evidence, the auditor is said
to have a scope limitation.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
A scope limitation may be imposed by
the client or result from
circumstances. Examples of client
restrictions are refusal to:
1. permit confirmation of receivables,
2. sign a client representation letter,
or
3. Give the auditor access to the
minutes of board of directors’
meetings.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
Disclaimer of Opinion
When a disclaimer of opinion is expressed:
1. The introductory paragraph is modified
2. The scope paragraph is omitted
3. An explanatory paragraph is included
after the introductory paragraph
explaining the reasons for the disclaimer
of opinion
4. The third and concluding paragraph
contains a denial of an opinion
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
Nonconformity with GAAP
When the client’s financial
statements contain a
nonconformity with GAAP, the
effects on the auditor’s report
differ based on whether it is a
necessary nonconformity with
promulgated GAAP or other
nonconformity with GAAP.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
Explanatory Language with Unqualified Opinion
When the auditor concurs that, due to unusual
circumstances, nonconformity with a promulgated
accounting principle is necessary to keep the client’s
financial statements from being misleading, a standard
report with explanatory language is issued.
Specifically, the report contains:
1. Standard introductory and scope paragraphs
2. An explanatory paragraph preceding the opinion
paragraph that explains the circumstances and states
that the use of the alternative principle is justified
3. An unqualified opinion in a standard opinion
paragraph
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
Qualified Opinion
When a qualified opinion is issued, the auditor should:
1. Disclose in an explanatory paragraph(s), preceding
the opinion paragraph, all of the substantive reasons
for the opinion.
2. Disclose in the explanatory paragraph(s) the
principle effects of the subject matter of the
qualification on financial position, results of
operations, and cash flows, if practicable. If not
practicable, the report should so state.
3. Express a qualified opinion in the opinion
paragraph with reference to the explanatory
paragraph(s).
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
Adverse Opinion
The effects on the auditor’s report of issuing an
adverse opinion are similar but not identical to the
effects of a qualified opinion. In this case:
1. the explanatory paragraph(s) should indicate
the substantive reasons for the adverse opinion
and the principal effects of the subject matter of
the adverse opinion, if practicable, and
2. the opinion paragraph should state that,
because of the effects of the matter(s)
described in the explanatory paragraph(s), the
financial statements do not present fairly.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
Inconsistency in Accounting Principles
The effect on the audit report of a change in
accounting principles depends on whether the
change has been accounted for in conformity with
GAAP. A change in principle is made in conformity
with GAAP when:
1. the new principle is a generally accepted
accounting principle,
2. the changeis properly accounted for and
disclosed in the financial statements, and
3. management can justify that the new principle
is preferable.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
Explanatory Language with Unqualified
Opinion
When the change is made in conformity with
GAAP, the auditor should express an
unqualified opinion on the financial statements
and explain the change in an additional
paragraph following the opinion paragraph.
The effects on the standard report, and an
example of the wording of the explanatory
paragraph, are shown in Figure 20-6.
 Standard
Standard Audit
Audit Report
Report with
with Explanatory
Explanatory
Paragraph
Paragraph Because
Because of of Inconsistency
Inconsistency in
in
Accounting
Accounting Principles
Principles in
in Conformity
Conformity with
with GAAP
GAAP
Figure
Figure 20-6
20-6

INDEPENDENT AUDITOR’S REPORT

(Same first three paragraphs as the standard report.)
As discussed in Note X to the financial statements,
the Company changed its method of computing
depreciation in 20X2.
 Auditor’s
Auditor’s Report
Report with
with Qualified
Qualified Opinion
Opinion
Because
Because ofof Inconsistency
Inconsistency in
in Accounting
Accounting
Principles
Principles Not
Not in
in Conformity
Conformity with
with GAAP
GAAP
Figure
Figure 20-7
20-7
INDEPENDENT AUDITOR’S REPORT
(Same first and second paragraphs as the standard report.)
As discussed in Note X to the financial statements, the Company adopted, in
20X2, the first-in, first-out method of accounting for its inventories, whereas
it previously used the last-in, first-out method. Although use of the first-in,
first-out method is in conformity with generally accepted accounting
principles, in our opinion, the Company has not provided reasonable
justification as required by generally accepted accounting principles.
In our opinion, except for the effects of the change in accounting principle
discussed in the preceding paragraph, the financial statements referred to in
the first paragraph present fairly, in all material respects, the financial
position of X Company as of December 31, 20X2 and 20X1, and the results of
its operations and its cash flows for the years then ended in conformity with
generally accepted accounting principles.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
Inadequate Disclosure
If the financial statements and accompanying notes
fail to disclose information required by GAAP, the
statements are not fairly presented. In such a case,
the auditor should express a qualified opinion or an
adverse opinion because of nonconformity with
GAAP, and there is a departure from the standard
report. If a company issued financial statements
that purport to present financial position and and
results of operations but omits the related
statement of cash flows, the auditor will normally
conclude that the omission requires qualification of
the opinion.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
If it is practicable, the essential information should
be provided in one or more explanatory paragraphs
of the auditor’s report, unless its omission from the
report is recognized in an SAS. 2 omissions have
been recognized — the auditor is not required to
present:
1. a statement of cash flows when that statement is
omitted by a client or
2. omitted segment information.
In both instances, however, the auditor should
identify the omitted data in an explanatory
paragraph and express either a qualified or an
adverse opinion on the financial statements.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
The effects on the auditor’s report in
expressing a qualified opinion because
of inadequate disclosure are
illustrated in Figure 20-8. This report
satisfies the third standard of
reporting, which requires comment in
the auditor’s report when
management’s disclosures in the
financial statements are not adequate
for fair presentation.
Auditor’s
Auditor’s Report
Report with
with Qualified
Qualified Opinion
Opinion
Because
Because of
of Inadequate
Inadequate Disclosure
Disclosure
Figure
Figure 20-8
20-8

INDEPENDENT AUDITOR’S REPORT

(Same first and second paragraphs as the standard report.)
The Company’s financial statements do not disclose
[describe the nature of the omitted disclosures]. In our
opinion, disclosure of this information is required by
generally accepted accounting principles.
In our opinion, except for the omission of the information
discussed in the preceding paragraph...
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
Substantial Doubt about Going Concern
Status
In an audit, the entity is usually assumed
to be a going concern that will continue in
existence. However, the auditor has a
responsibility to evaluate whether in fact
the entity has the ability to continue as a
going concern for a reasonable period of
time, not to exceed one year beyond the
date of the financial statements being
audited.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
AU 341.06, The Auditor’s Consideration of an
Entity’s Ability to Continue as a Going Concern
(SAS 59), indicates that information contrary to
the going concern assumption includes:
1. Negative trends such as recurring operating
losses, working capital deficiencies, negative
cash flows from operations, and adverse key
financial ratios.
2. Other indications of possible financial
difficulties such as defaulting on loan
agreements, arrearages in dividends,
restructuring of debt, and noncompliance with
statutory capital requirements.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
3. Internal matters such as work stoppages,
substantial dependence on the success of a
particular project, and uneconomic long-term
commitments.
4. External matters such as the loss of a key
franchise, and uninsured losses from
earthquake or flood.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
The auditor is required to consider
management’s plans for dealing with
the adverse effects of the foregoing
conditions and events. Management
may plan to:
1. dispose of assets,
2. borrow money or restructure debt,
3. reduce or delay expenditures, or
4. increase ownership equity.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
Explanatory Language with Unqualified
Opinion
When the circumstances about the entity’s
ability to continue as a going concern are
adequately disclosed in the notes to the
financial statements, the auditor should:
1. express an unqualified opinion and
2. add an explanatory paragraph after the
opinion paragraph that refers to the notes.
The effects on the standard report are
illustrated in Figure 20-9.
 Standard
Standard Audit
Audit Report
Report with
with Explanatory
Explanatory
Language
Language Because
Because ofof Doubt
Doubt About
About the
the Entity’s
Entity’s
Ability
Ability to
to Continue
Continue as
as aa Going
Going Concern
Concern
Figure
Figure 20-9
20-9
INDEPENDENT AUDITOR’S REPORT
(Same first three paragraphs as the standard report.)
The accompanying financial statements have been
prepared assuming that the Company will continue as a
going concern. As discussed in Note X to the financial
statements, the Company has suffered recurring losses
from operations and has a net capital deficiency that raise
substantial doubt about its ability to continue as a going
concern. Management’s plans in regard to these matters
are also described in Note X. The financial statements do
not include any adjustments that might result from the
outcome of this uncertainty.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
Decision Not to Make Reference
If the principal auditor is able to obtain
satisfaction as to the:
1. independence and professional
reputation of the other auditors and
2. scope and quality of the other
auditors’ examination,
reference to the other auditors is not
normally made.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
The principal auditor is would be able to
reach this decision when:
1. The other auditors are associated or
correspondent firms whose work is well
known to the principal auditor.
2. The work is performed under the
principal auditor’s guidance and control.
3. The principal auditor reviews the audit
programs and working papers of the other
auditors.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
Decision to Make Reference
The principal auditor may decide to
make reference to another auditor when
one or more of the foregoing factors are
not present. The principal auditor may
also decide to make reference whenever
the portion of the financial statements
examined by another auditor is material
to the financial statements taken as a
whole.
 Effects
Effects of
of Circumstances
Circumstances Causing
Causing
Departures
Departures from
from the
the Standard
Standard Report
Report
Explanatory Language with Unqualified Opinion
When the auditor decides to make reference to another
auditor, the report should clearly indicate the division
of responsibility that exists between the auditors. This
is accomplished by the following changes in the report:
1. In the introductory paragraph, the magnitude of the
portion of the financial statements audited by the
other auditors should be indicated.
2. In the scope paragraph, the reports of other auditors
should be included in the sources of the auditor’s
reasonable basis for an opinion.
3. In the opinion paragraph, reference should be made
to the other auditor’s report.
 Other
Other Reporting
Reporting
Considerations
Considerations
This section discusses reporting
responsibilities relating to 4 additional
situations:
1. reporting when the CPA is not independent,
2. circumstances concerning comparative
financial statements,
3. information accompanying audited financial
statements, and
4. financial statements prepared for use in
other countries.
 CHAPTER
CHAPTER 20
20
REPORTING
REPORTING ON
ON AUDITED
AUDITED
FINANCIAL
FINANCIAL STATEMENTS
STATEMENTS
 Copyright
Copyright
Copyright 2001 John Wiley & Sons, Inc. All rights
reserved. Reproduction or translation of this work
beyond that permitted in Section 117 of the 1976
United States Copyright Act without the express
written permission of the copyright owner is
unlawful. Request for further information should
be addressed to the Permissions Department, John
Wiley & Sons, Inc. The purchaser may make backup
copies for his/her own use only and not for
distribution or resale. The Publisher assumes no
responsibility for errors, omissions, or damages,
caused by the use of these programs or from the
use of the information contained herein.