Audit Reports

MULTIPLE CHOICE: 1. An auditor would issue an adverse opinion if a. The audit was begun by other independent auditors who withdrew from the engagement. b. A qualified opinion cannot be given because the auditor lacks independence. c. The restriction on the scope of the audit was significant. d. The statements taken as a whole do not fairly present the financial condition and results of operations of the company. ANSW !" $. #

An audit report contains the following paragraph" %&ecause of the inadequacies in the company's accounting records during the year ended (une )*+ $**)+ it was not practicable to e,tend our auditing procedures to the e,tent necessary to enable us to obtain certain evidential matter as it relates to classification of certain items in the consolidated statements of operations.% This paragraph most likely describes a. A material departure from -AA. requiring a qualified audit opinion. b. An uncertainty that should not lead to a qualified opinion. c. A matter that the auditor wishes to emphasi/e and that does not lead to a qualified audit opinion. d. A material scope restriction requiring a qualification of the audit opinion. ANSW !" #

).

A limitation on the scope of the auditor's e,amination sufficient to preclude an unqualified opinion will always result when management a. Asks the auditor to report on the balance sheet and not on the other basic financial statements. b. !efuses to permit its lawyer to respond to the letter of audit inquiry. c. #iscloses material related party transactions in the footnotes to the financial statements.

231

232

Chapter 14 Audit Reports d. 0nows that confirmation of accounts receivable is not feasible. &

ANSW !" 1.

The auditor issued a qualified opinion covering the financial statements of 2lient A for the year ended #ecember )1+ $**$. The reason for the qualification was a departure from -AA.. 3n presenting comparative statements for the years ended #ecember )1+ $**$ nd $**)+ the client revised the $**$ financial statements to correct the previous departure from -AA.. The auditor's $**) report on the 1$4)14*$ and 1$4)14*) comparative financial statements will a. ,press a qualified opinion on the $**$ financial statements and an unqualified opinion on the $**) statements. b. ,press unqualified opinions on both the $**$ and $**) financial statements. c. !etain the qualified opinion covering the $**$ statements+ but add an e,planatory paragraph describing the correction of the prior departure from -AA.. d. !ender qualified audit opinions for both $**$ and $**) financial statements given the $**) carryover effect of the $**$ error. ANSW !" &

5. an

When financial statements are presented that are not in conformity with generally accepted accounting principles+ auditor may issue a6an7 % ,cept for% #isclaimer opinion of an opinion a. 8es No b. 8es 8es c. No 8es d. No No ANSW !" A

9.

:nder which of the following circumstances would a disclaimer of opinion not be appropriate; a. The auditor is engaged after fiscal year<end and is unable to observe physical inventories or apply alternative procedures to verify their balances. b. The auditor is unable to determine the amounts

Chapter 14 Audit Reports

233

c. d.

associated with illegal acts committed by the client's management. The financial statements fail to contain adequate disclosure concerning related party transactions. The client refuses to permit its attorney to furnish information requested in a letter of audit inquiry. 2

ANSW !" =.

An auditor may reasonably issue an %e,cept for% qualified opinion for 3nadequate Scope disclosure limitation a. 8es 8es b. 8es No c. No 8es d. No No ANSW !" A

>.

An auditor's report would be designated as a special report when it is issued in connection with financial statements that are a. ?or an interim period and are sub@ected to a limited review. b. :naudited and are prepared from a client's accounting records. c. .repared in accordance with a comprehensive basis of accounting other than generally accepted accounting principles. d. .urported to be in accordance with generally accepted accounting principles but do not include a presentation of the Statement of 2ash ?lows. ANSW !" 2

A.

A limitation on the scope of an auditor's e,amination sufficient to preclude an unqualified opinion will usually result when management a. .resents financial statements that are prepared in accordance with the cash receipts and disbursements basis of accounting. b. States that the financial statements are not intended to be presented in conformity with generally accepted accounting principles. c. #oes not make the minutes of the &oard of #irectors'

234

Chapter 14 Audit Reports meetings available to the auditor. Asks the auditor to report on the balance sheet and not on the other basic financial statements. 2

d.

ANSW !" 1*.

When there is a significant change in accounting principle+ an auditor's report should refer to the lack of consistency in a. The scope paragraph. b. An e,planatory paragraph between the second paragraph and the opinion paragraph. c. The opinion paragraph. d. An e,planatory paragraph following the opinion paragraph. ANSW !" #

11.

Which of the following subsequent events will be least likely to result in an ad@ustment to the financial statements; a. 2ulmination of events affecting the reali/ation value of accounts receivable owned as of the balance sheet date. b. 2ulmination of events affecting the reali/ation of inventories owned as of the balance sheet date. c. Baterial changes in the settlement of liabilities which were estimated as of the balance sheet date. d. Baterial changes in the quoted market prices of listed investment securities since the balance sheet date. ANSW !" #

1$.

Soon after &oyd's audit report was issued+ &oyd learned of certain related party transactions that occurred during the year under audit. These transactions were not disclosed in the notes to the financial statements. &oyd should a. .lan to audit the transactions during the ne,t engagement. b. !ecall all copies of the audited financial statements. c. #etermine whether the lack of disclosure would affect the auditor's report. d. Ask the client to disclose the transactions in subsequent interim statements. ANSW !" 2

Chapter 14 Audit Reports 1).

235

:nder which of the following circumstances would a disclaimer of opinion not be appropriate; a. The financial statements fail to contain adequate disclosure concerning related party transactions. b. The client refuses to permit its attorney to furnish information requested in a letter of audit inquiry. c. The auditor is engaged after fiscal year<end and is unable to observe physical inventories or apply alternative procedures to verify their balances. d. The auditor is unable to determine the amounts associated with illegal acts committed by the client's management. ANSW !" A

11.

An auditor concludes that there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. 3f the entity's disclosures concerning this matter are adequate+ the audit report may include a6an7 #isclaimer % ,cept for% of opinion qualified opinion a. 8es 8es b. No No c. No 8es d. 8es No ANSW !" #

15.

Banagement of &lue 2ompany has decided not to account for a material transaction in accordance with the provisions of an ?AS& Standard. 3n setting forth its reasons in a note to the financial statements+ management has clearly demonstrated that due to unusual circumstances the financial statements presented in accordance with the ?AS& Standard would be misleading. The auditor's report should include an e,planatory separate paragraph and contain a6an7 a. Adverse opinion. b. :nqualified opinion. c. % ,cept for% qualified opinion. d. %Sub@ect to% qualified opinion. ANSW !" &

19.

3n the %management discussion and analysis% contained in the $**$ annual report of #ermicile 2orporation+ management stated that total sales were C1.A5 billion and net profit

236

Chapter 14 Audit Reports was C5** million. The audited sales and net profit+ however+ were C).> billion and C15* million respectively. The financial statements+ contained in the annual report+ reflected the audited figures and the 2.A planned to issue an unqualified opinion. :pon noting the inconsistencies between the B#DA and the audited financial statements+ however+ the 2.A should a. !efer to the inconsistency in the audit report and issue a qualified audit opinion. b. 3ssue an unqualified opinion without an e,planatory paragraph+ because the B#DA is not covered in the audit report. c. 3ssue an unqualified audit opinion with an e,planatory paragraph describing the inconsistency. d. !ender an adverse opinion on the basis that management had intentionally misrepresented reported sales and net profit. ANSW !" 2

1=.

When the audited financial statements of the prior year are presented together with those of the current year+ the continuing auditor's report should cover a. &oth years. b. Enly the current year. c. Enly the current year+ but the prior year's report should be presented. d. Enly the current year+ but the prior year's report should be referred to. ANSW !" A

1>.

3f the auditor believes that financial statements which are prepared on a comprehensive basis of accounting other than generally accepted accounting principles are not suitably titled+ the auditor should a. Bodify the auditor's report to disclose any reservations. b. 2onsider the effects of the titles on the financial statements taken as a whole. c. 3ssue a disclaimer of opinion. d. Add a footnote to the financial statements which e,plains alternative terminology. ANSW !" A

Chapter 14 Audit Reports 1A.

237

Borgan+ 2.A+ is the principal auditor for a multi<national corporation. Another 2.A has e,amined and reported on the financial statements of a significant subsidiary of the corporation. Borgan is satisfied with the independence and professional reputation of the other auditor+ as well as the quality of the other auditor's e,amination. With respect to Borgan's report on the consolidated financial statements+ taken as a whole+ Borgan a. Bust not refer to the e,amination of the other auditor. b. Bust refer to the e,amination of the other auditor. c. Bay refer to the e,amination of the other auditor. d. Bay refer to the e,amination of the other auditor+ in which case Borgan must include in the auditor's report on the consolidated financial statements a qualified opinion with respect to the e,amination of the other auditor. ANSW !" $*. 2

A post<audit review+ conducted by another audit partner+ discovered that the audit team had failed to e,amine or confirm securities held in safekeeping. The amounts involved were material in relation to reported net assets. The unqualified audit report+ along with the audited financial statements+ had been released two months earlier. &ased on this information+ the audit team should a. !equest the client for permission to e,amine or confirm the securities. b. Notify persons known to be relying on the audit report that the report can no longer be relied upon. c. #raft a revised audit report containing an opinion qualified for a scope restriction. d. 3gnore the finding inasmuch as the financial statements and audit report have already been released. ANSW !" A

$1.

The auditor's report should be dated as of the date on which the a. !eport is delivered to the client. b. ?ield work is completed. c. ?iscal period under audit ends. d. !eview of the working papers is complete. ANSW !" &

238

Chapter 14 Audit Reports After issuing the audit report+ the auditor may become aware of information that would have affected the audit report had it been known at the time. -iven discovery of such information+ the auditor must take appropriate action. Which of the following actions would be considered inappropriate under these circumstances; a. #etermine whether the information is reliable and whether the facts e,isted at the date of the audit report. b. !equest the client to disclose+ to financial statement users+ the newly discovered facts and their impact on the financial statements. c. 3f the client refuses to inform third parties+ the auditor should notify the board of directors and regulatory agencies having @urisdiction over the client that the auditors' report can no longer be relied upon. d. #raft a revised audit report e,pressing a qualified or adverse opinion+ depending on the materiality of the effect+ and transmit the report to the stockholders. ANSW !" #

$$.

$).

Which of the following best describes the auditor's responsibility for %other information% included in the annual report to stockholders which contains financial statements and the auditor's report; a. The auditor has no obligation to read the %other information.% b. The auditor has no obligation to corroborate the %other information+% but should read the %other information% to determine whether it is materially inconsistent with the financial statements. c. The auditor should e,tend the e,amination to the e,tent necessary to verify the %other information.% d. The auditor must modify the auditor's report to state that the %other information is unaudited% or %not covered by the auditor's report.% ANSW !" &

$1.

When an auditor conducts an e,amination in accordance with generally accepted auditing standards and concludes that the financial statements are fairly presented in accordance with a comprehensive basis of accounting other than generally accepted accounting principles such as the cash basis of accounting+ the auditor should issue a

Chapter 14 Audit Reports a. b. c. d. #isclaimer of opinion. !eview report. Fualified opinion. Special report. #

239

ANSW !" $5.

3n which of the following circumstances would an auditor be most likely to e,press an adverse opinion; a. The statements are not in conformity with the ?AS& Statements regarding the capitali/ation of leases. b. 3nformation comes to the auditor's attention that raises substantial doubt about the entity's ability to continue in e,istence. c. The chief e,ecutive officer refuses the auditor access to minutes of board of directors' meetings. d. 2ontrol tests show that the entity's internal control is so poor that the financial records cannot be relied upon. ANSW !" A

$9.

:nder which of the following circumstances would an unqualified audit opinion+ followed by an e,planatory paragraph+ not be appropriate; a. The auditor wishes to emphasi/e that the client has entered into material transactions with related parties. The substance of the related party transactions is properly disclosed in the audited financial statements. b. The client has completed material transactions with related parties and the auditor is unable to persuade management to properly reflect the economic substance of the transactions in the financial statements. c. The client has used a method of revenue recognition that is at variance with promulgated accounting standards. The auditor+ however+ agrees with the departure on the basis that use of the promulgated standard would make the financial statements materially misleading. d. The auditor believes that substantial doubt e,ists concerning the ability of the client to continue as a going concern. ANSW !" &

240

Chapter 14 Audit Reports

$=.

#oe+ an independent auditor+ was engaged to perform an e,amination of the financial statements of Ally 3ncorporated one month after its fiscal year had ended. Although the inventory count was not observed by #oe+ and accounts receivable were not confirmed by direct communication with debtors+ #oe was able to gain satisfaction by applying alternative auditing procedures. #oe's auditor's report will probably contain a. A standard unqualified opinion. b. An unqualified opinion and an e,planatory middle paragraph. c. ither a qualified opinion or a disclaimer of opinion. d. An %e,cept for% qualification. ANSW !" A

$>.

The adverse effects of events causing an auditor to believe there is substantial doubt about an entity's ability to continue as a going concern would most likely be mitigated by evidence relating to the a. Ability to e,pand operations into new product lines in the future. b. ?easibility of plans to purchase leased equipment at less than market value. c. Barketability of assets that management plans to sell. d. 2ommitted arrangements to convert preferred stock to long<term debt. ANSW !" 2

$A.

2omparative financial statements include the financial statements of a prior period which were e,amined by a predecessor auditor whose report is not presented. 3f the predecessor auditor's report was qualified+ the successor auditor must a. Ebtain written approval from the predecessor auditor to include the prior year's financial statements. b. 3ssue a standard comparative audit report indicating the division of responsibility. c. ,press an opinion on the current year statements alone and make no reference to the prior year statements. d. #isclose the reasons for any qualification in the predecessor auditor's opinion.

Chapter 14 Audit Reports ANSW !" #

241

30. When reporting on financial statements prepared on a comprehensive basis of accounting other than generally accepted accounting principles+ the independent auditor should include in the report a paragraph that a. States that the financial statements are not intended to be in conformity with generally accepted accounting principles. b. States that the financial statements are not intended to have been e,amined in accordance with generally accepted auditing standards. c. !efers to the authoritative pronouncements that e,plain the comprehensive basis of accounting being used. d. (ustifies the comprehensive basis of accounting being used. ANSW !" )1. A

After an audit report containing an unqualified opinion on a non<public client's financial statements was issued+ the client decided to sell the shares of a subsidiary that accounts for )*G of its revenue and $5G of its net income. The auditor should a. #etermine whether the information is reliable and+ if determined to be reliable+ request that revised financial statements be issued. b. Notify the entity that the auditor's report may no longer be associated with the financial statements. c. #escribe the effects of this subsequently discovered information in a communication with persons known to be relying on the financial statements. d. Take no action because the auditor has no obligation to make any further inquiries. ANSW !" # An audit report contained the following wording" %3n our opinion+ e,cept for the omission of the segment information referred to in the preceding paragraph...% This e,cerpt was taken from a6n7 a. :nqualified audit opinion with an e,planatory paragraph added to emphasi/e a matter. b. :nqualified audit opinion with an e,planatory paragraph added to describe a material uncertainty. c. Audit opinion qualified due to a departure from -AA.. d. Adverse audit opinion.

)$.

242

Chapter 14 Audit Reports

ANSW !" )).

An auditor includes a separate paragraph in an otherwise unqualified report to emphasi/e that the entity being reported upon had significant transactions with related parties. The inclusion of this separate paragraph a. Hiolates generally accepted auditing standards if this information is already disclosed in footnotes to the financial statements. b. Necessitates a revision of the opinion paragraph to include the phrase %with the foregoing e,planation.% c. 3s appropriate and would not negate the unqualified opinion. d. 3s considered an %e,cept for% qualification of the report. ANSW !" 2

)1.

An audit report contains the following paragraph" %Since the company did not take physical inventories and we were not able to apply auditing procedures to satisfy ourselves as to inventory quantities and the cost of property and equipment+ the scope of our work was not sufficient to enable us to e,press+ and we do not e,press+ an opinion on these financial statements.% This paragraph illustrates a6n7 a. #isclaimer of opinion due to uncertainty. b. #isclaimer of opinion due to scope restrictions. c. Adverse audit opinion. d. Audit opinion qualified for material scope restrictions. ANSW !" &

)5.

An auditor's e,amination reveals a misstatement in segment information that is material in relation to the financial statements taken as a whole. 3f the client refuses to make modifications to the presentation of segment information+ the auditor should issue a6n7 a. % ,cept for% opinion. b. Adverse opinion. c. :nqualified opinion. d. #isclaimer of opinion. ANSW !" A

Chapter 14 Audit Reports )9.

243

An auditor's report on financial statements that are prepared in accordance with a comprehensive basis of accounting other than generally accepted accounting principles should preferably include all of the following+ e,cept a. #isclosure of the fact that the financial statements are not intended to be presented in conformity with generally accepted accounting principles. b. An opinion as to whether the use of the disclosed method is appropriate. c. An opinion as to whether the financial statements are presented fairly in conformity with the basis of accounting described. d. A description of a change in accounting principles. ANSW !" &

)=.

When the financial statements are prepared on the going concern basis but the auditor concludes there is substantial doubt whether the client can continue in e,istence and also believes there are uncertainties about the recoverability of recorded asset amounts on the financial statements+ the auditor may issue a6an7 a. Adverse opinion. b. % ,cept for% qualified opinion for scope limitation. c. % ,cept for% qualified opinion for departure from -AA.. d. :nqualified opinion with an e,planatory separate paragraph. ANSW !" )>. #

2lient A reports property+ plant+ and equipment at appraisal values and records depreciation based on the appraised amounts. Also+ the company does not defer income ta,es for temporary differences arising from using the installment method of recogni/ing gross profit for ta, purposes. The company uses the accrual method for financial reporting purposes. :nder these circumstances+ the auditor will probably issue a6n7 a. Audit opinion qualified for a departure from -AA.. b. Adverse audit opinion. c. #isclaimer of opinion. d. :nqualified audit opinion with an e,planatory paragraph describing the client's unique accounting practices. ANSW !" &

244

Chapter 14 Audit Reports

39. A 2.A engaged to e,amine financial statements observes that the accounting for a certain material item is not in conformity with generally accepted accounting principles+ and that this fact is prominently disclosed in a footnote to the financial statements. The 2.A should a. ,press an unqualified opinion and insert a middle paragraph emphasi/ing the matter by reference to the footnote. b. #isclaim an opinion. c. Not allow the accounting treatment for this item to affect the type of opinion because the deviation from generally accepted accounting principles was disclosed. d. Fualify the opinion because of the deviation from generally accepted accounting principles. ANSW !" 1*. #

When a principal auditor decides to make reference to another auditor's e,amination+ the principal auditor's report should always indicate clearly+ in the introductory+ scope+ and opinion paragraphs+ the a. Bagnitude of the portion of the financial statements e,amined by the other auditor. b. #isclaimer of responsibility concerning the portion of the financial statements e,amined by the other auditor. c. Name of the other auditor. d. #ivision of responsibility. ANSW !" #

41. An auditor may issue a qualified opinion under which of the following circumstances; Iack of sufficient competent evidential matter 8es 8es No No A !estrictions on the scope of the audit 8es No 8es No

a. b. c. d. ANSW !" 1$.

3n which of the following circumstances may the auditor issue the standard audit report;

Chapter 14 Audit Reports a. b. c. d.

245

The principal auditor assumes responsibility for the work of another auditor. The financial statements are affected by a departure from a generally accepted accounting principle. Substantial doubt e,ists concerning the ability of the entity to continue as a going concern. The auditor wishes to emphasi/e a matter regarding the financial statements. A

ANSW !" 1).

#oes the auditor make the following representations e,plicitly or implicitly when issuing the standard auditor's report on comparative financial statements; 2onsistent ,amination of application of evidence on a accounting principles test basis a. ,plicitly ,plicitly b. 3mplicitly 3mplicitly c. d. ANSW !" 2 3mplicitly ,plicitly ,plicitly 3mplicitly

11.

When there is a significant change in accounting principle+ an auditor's report should refer to the lack of consistency in a. The scope paragraph. b. An e,planatory paragraph between the second paragraph and the opinion paragraph. c. The opinion paragraph. d. An e,planatory paragraph following the opinion paragraph. ANSW !" #

15.

3n which of the following situations would an auditor ordinarily issue an unqualified audit opinion without an e,planatory paragraph; a. The auditor wishes to emphasi/e that the entity had significant related party transactions. b. The auditor decides to make reference to the report of another auditor as a basis+ in part+ for the auditor's opinion. c. The entity issues financial statements that present

246

Chapter 14 Audit Reports financial position and results of operations+ but

omits d. the statement of cash flows. The auditor has substantial doubt about the entity's ability to continue as a going concern+ but the circumstances are fully disclosed in the financial statements. &

ANSW !" 19.

Jow are management's responsibility and the auditor's responsibility represented in the standard auditor's report; Banagement's Auditor's responsibility responsibility a. b. c. d. ANSW !" 1=. A ,plicitly 3mplicitly 3mplicitly ,plicitly ,plicitly 3mplicitly ,plicitly 3mplicitly

An auditor should disclose the substantive reasons for e,pressing an adverse opinion in an e,planatory paragraph a. .receding the scope paragraph. b. .receding the opinion paragraph. c. ?ollowing the opinion paragraph. d. Within the notes to the financial statements. ANSW !" &

1>.

When the financial statements contain a departure from generally accepted accounting principles+ the effect of which is material+ the auditor should a. Fualify the opinion and e,plain the effect of the departure from generally accepted accounting principles in a separate paragraph. b. Fualify the opinion and describe the departure from generally accepted accounting principles within the opinion paragraph. c. #isclaim an opinion and e,plain the effect of the departure from generally accepted accounting principles in a separate paragraph. d. #isclaim an opinion and describe the departure from generally accepted accounting principles within the opinion paragraph.

Chapter 14 Audit Reports

247

ANSW !" 1A.

Tread 2orp. accounts for the effect of a material accounting change prospectively when the inclusion of the cumulative effect of the change is required in the current year. The auditor would choose between e,pressing a6an7 a. Fualified opinion or a disclaimer of opinion. b. #isclaimer of opinion or an unqualified opinion with c. d. e,planatory paragraph. :nqualified opinion with an e,planatory paragraph and an adverse opinion. Adverse opinion and a qualified opinion. #

an

ANSW !" 5*.

The Securities and ,change 2ommission has authority to a. .rescribe specific auditing procedures to detect fraud concerning inventories and accounts receivable of companies engaged in interstate commerce. b. #eny lack of privity as a defense in third<party actions for gross negligence against the auditors c. d. public companies. #etermine accounting principles for the purpose of financial reporting by companies offering securities to the public. !equire a change of auditors of governmental entities after a given period of years as a means of ensuring auditor independence. 2

of

ANSW !" 51.

An auditor has previously e,pressed a qualified opinion on the financial statements of a prior period because of a departure from generally accepted accounting principles. The prior<period financial statements are restated in the current period to conform with generally accepted accounting principles. The auditor's updated report on the prior<period financial statements should a. ,press an unqualified opinion concerning the restated financial statements. b. &e accompanied by the original auditor's report on the prior period. c. &ear the same date as the original auditor's report on the prior period.

248

Chapter 14 Audit Reports d. Fualify the opinion concerning the restated financial statements because of a change in accounting A

principle. ANSW !" 5$.

An auditor's report includes the following statement" %The financial statements do not present fairly the financial position+ results of operations+ or cash flows in conformity with generally accepted accounting principles.% This auditor's report was most likely issued in connection with financial statements that are a. 3nconsistent. b. .repared in accordance with another comprehensive basis of accounting. c. Bisleading d. Affected by a material uncertainty. ANSW !" 5). 2

An auditor who qualifies an opinion because of an insufficiency of evidential matter should describe the limitation in an e,planatory paragraph. The auditor should also refer to the limitation in the Scope Epinion Notes to the paragraph paragraph financial statements a. 8es No 8es b. No 8es No c. 8es 8es No d. 8es 8es 8es ANSW !" 2

51.

!estrictions imposed by a client prohibit the observation of physical inventories+ which account for )5G of all assets. Alternative audit procedures cannot be applied+ although the auditor was able to e,amine satisfactory evidence for all other items in the financial statements. The auditor should issue a6an7 a. % ,cept for% qualified opinion. b. #isclaimer of opinion. c. :nqualified opinion with a separate e,planatory paragraph. d. :nqualified opinion with an e,planation in the scope paragraph.

Chapter 14 Audit Reports ANSW !" 55. &

249

An auditor may not issue a qualified opinion when a. A scope limitation prevents the auditor from completing an important audit procedure. b. The auditor's report refers to the work of a specialist. c. An accounting principle at variance with generally accepted accounting principles is used. d. The auditor lacks independence with respect to the audited entity. ANSW !" #

COMPLETION: 59. The nature of the e,amination is described in the KKKKKKKKKKKK paragraph of the audit report. ANSW !" 57. S2E.

-enerally accepted auditing standards are addressed in the paragraph of the audit report+ whereas generally accepted accounting principles are the evaluation standard used in the paragraph. ANSW !" S2E. + E.3N3EN

58.

The two relevant dates in a dual<dated audit report are the date of completion of audit field work and the date of the . ANSW !" S:&S F: NT H NT

5A.

An unqualified audit opinion may be rendered only when the financial statements contain no material departures from -AA.+ and when no material have prevented the auditor from collecting sufficient+ competent evidence. ANSW !" S2E. I3B3TAT3ENS 6! ST!32T3ENS7

250

Chapter 14 Audit Reports The statement %in our opinion the financial statements do not present fairly% is included in a6n7 KKKKKKKKKKKK opinion. ANSW !" A#H !S

9*.

61.

The responsibilities of management and the auditors with respect to the financial statements are described in the paragraph of the audit report. ANSW !" 3NT!E#:2TE!8

9$.

An audit report+ in a separate paragraph following the opinion paragraph+ describes the impact of related party transactions that have been properly reflected and disclosed in the financial statements. This form of report illustrates KK . ANSW !" B.JAS3S E? A BATT !

9).

A 2.A who audited the financial statements for the preceding year+ and will also be auditing the current year+ is said to be a auditor. ANSW !" 2ENT3N:3N-

91.

3f a scope restriction is material and client<imposed+ the auditor should render a6an7 6qualified+ adverse+ disclaimer of7 opinion. ANSW !" #3S2IA3B ! E?

65.

A fourth paragraph making reference to omission of supplemental data required by ?AS& is categori/ed as . ANSW !" B.JAS3S E? A BATT !

99.

3f financial statements have been prepared utili/ing a comprehensive basis of accounting other than -AA.+ the auditor will evaluate fairness within the framework of KKKK KKKKKKKKKK KKKKKKKK. ANSW !" TJ ETJ ! &AS3S

MATCHING:

Chapter 14 Audit Reports

251

9=. ?rom the following types of audit reports+ select the one that best fits each of the listed situations. A given selection may be used once+ more than once+ or not at all. A. Standard audit report &. !eport qualified because of scope restriction 2. !eport qualified because of departure from -AA. #. Adverse opinion . #isclaimer of opinion ?. :nqualified opinion with e,planatory paragraph following opinion paragraph KKKKK1. Banagement refuses to permit the audit team to confirm accounts receivable which comprise )*G of current assets. The auditors are unable to satisfy themselves by other means. KKKKK$. Although significant related party transactions have occurred+ they are fully e,plained in the notes to the financial statementsL and related party receivables and payables are separately reflected on the balance sheet. A ma@or legal action+ fully described in Note ) to the financial statements+ was been brought against the client during the year being audited. Although outcome is unknown+ a significant loss could result. KKKKK1. A patent infringement lawsuit+ that could produce a significant damage award+ was filed against the client during the year being audited. To maintain confidentiality+ the company elected not to disclose the lawsuit in the notes to the financial statements. KKKKK5. Although the financial statements appear to be fairly presented in all other respects+ the auditors have been unable to satisfy themselves regarding the future economic benefit of certain intangible assets. The aggregate balance in these accounts is considered to be material. The auditors did not review the quarterly financial data of 2lient A+ a publicly held company. The data is

KKKKK). the

KKKKK9.

252

Chapter 14 Audit Reports included in the annual report to stockholders as part of the supplemental financial data.

KKKKK=.

-iven significant appreciation of its plant assets+ 2lient & elects to report them at current replacement cost. The dollar amount of these assets accounts for 9*G of total assets. The offsetting credit resulting from the write<up was to an account entitled Mappreciation surplusN and is reflected as part of stockholdersO equity. Although the client has applied an accounting principle not in accordance with -AA.+ the audit team is satisfied that conforming to -AA. would make the financial statements materially misleading.

KKKKK>.

KKKKKA.

2lient ? has suffered recurring losses over the past few years+ along with negative cash flows. 3n the auditorsO opinion+ management has not demonstrated a viable plan for getting the company Mback on track.N The financial statements adequately disclose the companyOs financial position+ results of operations+ and cash flows. KKKKK1*. The auditors were appointed by 2lient - after year<end+ and therefore were unable to observe the taking of the companyOs physical inventory. -iven adequate perpetual inventory records and documentation of transactions+ the audit team was able to satisfy themselves as to the reasonableness of the ending inventory. SEI:T3EN" 1. $. ). 1. 5. 9. =. >. A. 1*. A A 2 & ? # ? ? A

PROBLEM/ESSAY

Chapter 14 Audit Reports 9>. (onathon Jershey+ 2.A+ is the senior auditor for Web Stores+ 3nc.+ a company that markets products on the 3nternet. The current year<end is (anuary )1+ $**). Iast year's audit report contained an e,planatory paragraph because of doubt regarding the ability of Web Stores to continue as a going concern. The company had defaulted on two ma@or loan agreements+ and appeared to be losing the race to develop a solid commercial presence on the 3nternet. Since the date of last year's audit report+ however+ company management has changed. A new advertising campaign and innovative marketing techniques+ have proven successful. 2reditors have agreed to ma@or debt restructuring agreements+ and the client appears to be %out of the woods.% Required:

253

Assuming the company presents comparative financial statements for $**) and $**$+ e,plain how the current audit report+ as it relates to $**$+ will differ from the original report on the $**$ statements. #o not draft an audit report. SEI:T3EN" Iast yearOs audit report covering the year ended (anuary )1+ $**$+ included a fourth paragraph following the opinion paragraph. ,planatory in nature+ this paragraph e,pressed the auditorOs doubt as to the ability of Web Stores+ 3nc. to continue as a going concern. -iven the favorable developments during the past year+ the current report should omit the fourth paragraph. 9A. -eneral (oeOs Wholesale .roduce changed its method for depreciating plant assets from historical cost straight<line to replacement cost straight<line at the beginning of its fiscal year ended Barch )1+ $**). .lant assets were also written up to reflect replacement cost. Required: a. What type of accounting change is presented in this case; b. #iscuss the possible audit report modifications resulting from this change. SEI:T3EN"

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a. This is an error since replacement cost accounting for plant assets is at variance with -AA.. b. #epending on the materiality of the amounts involved+ the auditor should either qualify the audit opinion or render an adverse opinion. =*. Audit reports frequently contain an e,planatory paragraph following the scope paragraph or the opinion paragraph. Required: a. #escribe the conditions under which one might e,pect to find an e,planatory paragraph following the opinion paragraph of the audit report. b. #escribe the conditions under which an e,planatory paragraph is mandatory. c. #raft an e,planatory paragraph for the following situation" #oria -ray+ the chief e,ecutive officer of #oriaOs &eauty &otiques+ 3nc.+ also owns a large cosmetics supply company+ -rayOs 2osmetics+ Itd. Several material transactions have been completed between #oriaOs &eauty &otiques and -rayOs 2osmetics. A si/eable receivable from -rayOs 2osmetics appears on #oriaOs &eauty &otiquesO balance sheet. As auditor for #oriaOs &eauty &otiques+ you have concluded that the transactions have been properly reflected in the financial statements+ and adequately described in Note 1 to the financial statements. SOLUTION: a. The auditor may elect to add an e,planatory paragraph under any one or more of the following conditions." 1. #eparture from a designated principle and the auditor agrees with the departureL $. #oubt as to going concern abilityL ). 2hange in accounting principle properly accounted for and disclosedL 1. mphasis of a matter 3n addition+ omission of supplemental information required by ?AS&+ discovered errors or inconsistencies in the data+ or failure of the auditor to apply limited procedures to the data+ may require an e,planatory paragraph. The e,planatory paragraph does not in any way qualify the auditor's opinion. b. 3n some cases the e,planatory paragraph is optionalL in other cases it is required. 3n the above listing+ only 617+

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emphasis of a matter permits auditor discretion as to whether or not to add the paragraph. 3n all of the other categories+ including supplemental information required by ?AS&+ the paragraph is mandatory. c. The 2ompany is under common control with an affiliate and has had significant transactions with this company 6See Note 17.