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Auditors Reports David T. Michalkiewicz Auditing II Dr. Wendy Achilles Keiser University August 18, 2013

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Abstract It is the responsibility of the auditor to plan and conduct an audit, in accordance with generally accepted auditing standards, in order to gather sufficient evidence upon which to base an opinion as to whether a clients financial statements are free of material misstatement, and fairly present the companys financial position, as of the balance sheet date. The auditor expresses his or her opinion in an audit report, which takes one of five forms, depending upon the opinion arrived at. The most common audit report is the auditors standard report, or the unqualified report; it is used to issue the financial statements a clean bill of health, to denote that there is reasonable assurance that the statements are free of material misstatements. The four other forms of the auditors report the unqualified report with explanatory language, the qualified report, the adverse report, and the disclaimer of opinion are all used in circumstances when an unqualified report cannot be issued. Users of the companys financial reports may base their decisions, regarding the company, upon the auditors report. Because of this, it is possible that the auditor may be liable, under common or statutory law, to those users, should they suffer a loss due to reliance upon the auditors opinion. In addition, proposed rules changes, by the PCAOB, may increase the responsibilities of the auditor, both in disclosure and examination for material misstatements in areas other than the financial statements. This could open the door to even more legal liabilities for the auditor. Only time will tell.

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Introduction Auditors are responsible for expressing an opinion as to whether a companys financial statements are fairly stated, or free of material misstatements, or not. To this end, the auditor plans and conducts an audit, in accordance with generally accepted auditing standards, in order to gather evidence upon which to form an opinion. This opinion is expressed in the auditors report, which takes one of five forms (AU Section 508, 1989). Those five forms include the standard, or unqualified, report, which is the equivalent of a clean bill of health, and four reports which are based upon the unqualified reports three paragraph format. Those reports are the unqualified report with explanatory language, the unqualified report, the adverse report, and the disclaimer of opinion (AU Section 508). Auditors Standard Report The standard, three paragraph, unqualified report is used to express the opinion that the clients financial statements are, indeed, fairly stated (AU Section 508.07, 1989). This is the most common type of audit report (Center for Audit Quality, n.d.). In the opening paragraph, the standard report identifies the financial statements audited. In the second paragraph, the standard report describes the nature and scope of the audit. In the final paragraph of the standard report, the auditor expresses his or her opinion of the financial statements. There are ten basic elements of the standard report, which include (AU Section 508.08): a title, which must include the word independent a statement that the financial statements identified were audited a statement that the financial reports are the responsibility of the client, and that the auditors responsibility is to express an opinion on those financial statements

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a statement that the audit was conducted in accordance with U.S. Generally Accepted Auditing Standards

a statement that U.S. GAAP requires that the audit be planned and performed to obtain reasonable assurance that the financial statements contain no material misstatements

a statement that an audit includes examining evidence supporting the financial statements, assessing the clients use of generally accepted accounting principles, and evaluating the overall presentation of the statements

a statement that the audit provides reasonable basis for the opinion expressed an opinion on whether or not the financial statements are fairly presented and represent, in all material aspects, the financial position of the company, as of the balance sheet date

the signature of the auditing firm the date of the report

All other reports build upon the standard three paragraph report. Explanatory Language Added to the Auditors Standard Report The unqualified report with an explanatory paragraph is used when circumstances such as when there has been a change in accounting principles, when there is doubt that the business can continue to function, or when the auditors opinion is based, in part, upon the report of another auditor (AU Section 508.11, 1989). In the case of an auditor basing his or her opinion upon the report of another auditor, this fact should be disclosed in the introductory paragraph of the report; in all other cases, and when the auditor wishes to emphasize some point, the auditors explanation, or emphasis, is contained in an additional paragraph (AU Section 508.12-508.19).

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Qualified Opinions A qualified opinion is used when the financial statements are fairly stated, except for a specific matter, such as when there is a lack of audit sufficient evidence or the scope of the audit has been, in some way, restricted (AU Section 508.20, 1989). This opinion is used when some matter causes the auditor to feel that he or she cannot make an unqualified report, but does not feel that a disclaimer is necessary(AU Section 508.20). It is also used when there has been a departure from generally accepted accounting principles which, in some way, causes a material effect, but the auditor does not feel that an adverse report is warranted (AU Section 508.20). In the case of a qualified report, a separate paragraph, describing the qualifying matters, precedes the opinion paragraph (AU Section 508.21). Adverse Opinions An adverse opinion is used when the auditor feels that the financial statements do not fairly present the financial position of the company in accordance with generally accepted accounting principles (AU Section 508.58, 1989). As with the qualified report, an explanatory paragraph, describing the reasons for the adverse opinion, precedes the opinion paragraph (AU Section 508.59). In the case of an adverse opinion, the opinion paragraph must include reference to the paragraph describing the reasons for the opinion (AU Section 508.60). Disclaimer of Opinion A disclaimer of opinion is used when the auditor does not feel that he or she can express an opinion on the financial statements (AU Section 508.61, 1989). In the case of a disclaimer of opinion, a paragraph describing the reasons for the disclaimer replaces the opinion paragraph of the standard report (AU Section 508.62). When the auditor does not feel that he or she can

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express an opinion because of limitations to the scope of the audit, this fact should be stated in a separate paragraph which replaces the paragraph describing the characteristics of the audit (AU Section 508.62). This is done so that the description of the audit does not overshadow the disclaimer paragraph. Auditor Responsibilities and Liabilities The responsibilities of the auditor, under AU Section 110 (1972), include the planning and performance of the audit in order to obtain reasonable assurance as to whether or not the financial statements are free of material misstatement. In other words, it is one of the auditors responsibilities to plan and conduct the audit in order to obtain evidence upon which to base his or her opinion. It should be noted that auditing standards call for reasonable, not absolute, assurance. Just as the auditor is not required to obtain absolute assurance, neither is he or she required to conduct the audit in order to obtain any assurance that the financial statements are free of misstatements which are not material. Under AU Section 316.79 (2002), the auditor is responsible for communicating to the appropriate level of management, when there is evidence that fraud may exist. AU Section 316.82 is quite specific, though; the auditor is not responsible for communicating to any other party, aside from management, that there is evidence that fraud may exist. Exceptions to this include the auditors successor, in response to a subpoena, or in order to comply with legal or regulatory requirements, or the funding body, when the client receives financial aid from the government (AU Section 316.82). In addition to the auditors responsibilities, the auditor is liable, under common and statutory law, to any user of the financial statements who suffer a loss due to the reliance upon

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the auditors opinion, should it be found that the auditor did not perform his or her duties with due care (Messier, Glover, & Prawitt, 2012, pp. 692-718). The auditor may also be liable to the client when/if he or she fails to fulfill their contractual obligations, and it only stands to reason that the auditor can be held liable to both the client, and to third parties, if the auditor is found to have engaged in fraud, or is found to be grossly negligent (Messier, Glover, & Prawitt). Into the Future It is entirely possible, however, that the auditors responsibilities may increase, significantly, in the near future (and with it, his or her liability). The PCAOB has proposed a rules change that, if passed, will require auditors to disclose more information, in their reports (Eavis, 2013). This additional information would include details of the audit which caused the auditor difficulty in forming judgments. The new rules will also require auditors to examine other information, in addition to the financial statements, for material misstatements (Eavis). Critics of the proposed rules believe that the extra information required will bring about extra expenses and that companies will fear that the new disclosures may be interpreted negatively by investors (Eavis). Only time will tell if these new rules actually help investors, as the PCAOB believes they will, or only hinder auditors and their clients.

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References AICPA Auditing Standards Board. (2002, December 15). AU Section 316 Consideration of fraud in a financial statement audit.. Retrieved from http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU00316.pdf AICPA Auditing Standards Board. (1989, January 1). AU Section 508 Reports on Audited Financial Statements. Retrieved from http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU00508.pdf Center for Audit Quality. (n.d.). Guide to Public Company Auditing. Retrieved from http://www.thecaq.org/publications/GuidetoPublicCompanyAuditing.pdf Eavis, P. (2013, August 13). U.S. accounting regulator proposes more in-depth reports from auditors. Retrieved from http://dealbook.nytimes.com/2013/08/13/major-overhaul-ofcompany-audits-is-proposed/?_r=0 Messier, W., Glover, S., & Prawitt, D. (2012), Auditing & assurance services (8th ed.). New York, NY: McGraw-Hill/Irwin Public Company Accounting Oversight Board. (1972, November). AU Section 110 Responsibilities and functions of the independent auditor. Retrieved from http://pcaobus.org/Standards/Auditing/Pages/AU110.aspx