CHAPTER

20 WRITING THE AUDIT REPORT

20-1. The purposes of the scope paragraph in the auditors report are to inform the
financial statement users that the audit was conducted in accordance with
generally accepted auditing standards, in general terms what those standards
mean, and whether the audit provides a reasonable basis for an opinion.

The information in the scope paragraph includes:

1. The auditor followed generally accepted auditing standards.
2. The audit is designed to obtain reasonable assurance about whether the
statements are free of material misstatement.
3. Discussion of the audit evidence accumulated.
4. Statement that the auditor believes the evidence accumulated was appropriate
for the circumstances to express the opinion presented.

20-2. The purpose of the opinion paragraph is to state the auditors conclusions based
upon the results of the audit evidence. The most important information in the
opinion paragraph includes:
1. The words in our opinion which indicate that the conclusions are based on
professional judgment.
2. A restatement of the financial statements that have been examined and the
dates thereof or a reference to the introductory paragraph.
3. A statement about whether the financial statements were presented fairly and
in accordance with generally accepted accounting principles.

20-3. The common definition of materiality as it applies to accounting and, therefore, to

audit reporting is:
A misstatement in the financial statements can be considered material if
knowledge of the misstatement would affect a decision of a reasonable user
of the statements. Auditors must have knowledge of the likely uses of their
clients statements and the decisions that are being made. Materiality
involves both quantitative and qualitative considerations. In assessing the
quantitative importance of a misstatement, it is necessary to relate the peso
amount of the error to the financial statements under examination.
Qualitative considerations, on the other hand, relate to the causes of the
20-2 Solutions Manual to Accompany Applied Auditing, 2006 Edition

misstatement. An error that may not be material quantitatively, may be

material qualitatively. This may occur, for instance, when the misstatement is
attributed to an irregularity or an illegal act by the client.

20-4. Materiality for lack of independence in audit reporting is easiest to define. If the
auditor lacks independence as defined by the Code of Professional Ethics, it is
always considered highly material and therefore a disclaimer of opinion is always
necessary. For failure to follow GAAP, there are three levels of materiality:
immaterial, material, and highly material.

20-5. The auditors opinion may be qualified by scope limitations caused by client
restrictions or by limitations resulting from conditions beyond the clients control.
The former occurs when the client will not, for example, permit the auditor to
confirm material receivables or physically observe inventories. The latter may
occur when the engagement is not agreed upon until after the clients year end
when it may not be possible to physically observe inventories or confirm
receivables.

A disclaimer of opinion is issued if the scope limitation is so material that the

auditor cannot determine if the overall financial statements are fairly presented. If
the scope limitation is caused by the clients restriction the auditor should be
aware that the reason for the restriction may be to deceive the auditor. For that
reason a disclaimer is more likely for client restrictions than for conditions beyond
anyones control.

When there is a scope restriction that results in the failure to verify material, but
not pervasive accounts, a qualified opinion may be issued. This is more likely
when the scope limitation is for conditions beyond the clients control than for
restrictions by the client.

20-6. When another CPA has performed part of the audit, the primary auditor issues one
of the following types of reports based on the circumstances.
1. No reference is made to the other auditor. This will occur if the other
auditor examined an immaterial portion of the statement, the other auditor is
known or closely supervised, or if the principal auditor has thoroughly
reviewed the other auditors work.
2. Issue a shared opinion in which reference is made to the other auditor. This
type of report is issued when it is impractical to review the work of the other
auditor or when a portion of the financial statements audited by the other
CPA is material in relation to the total.
3. The report may be qualified if the principal auditor is not willing to assume
any responsibility for the work of the other auditor. A disclaimer may be
issued if the segment audited by the other CPA is highly material.
 Writing the Audit Report 20-3
20-7. 1) Disclaimer of opinion. Because the client refuses to allow the auditor to
expand the scope of his examination, a disclaimer of opinion is appropriate
rather than a qualified as to scope and opinion.
2) Disclaimer of opinion. The auditor cannot issue an unqualified opinion on
the income statement or the statement of cash flows because a disclaimer of
opinion is necessary for the beginning balance sheet. The auditor may issue
an unqualified opinion on the ending balance sheet and a disclaimer of
opinion on the income statement, statement of cash flows, and the beginning
balance sheet.
3) Unqualified opinion. The auditor is able to satisfy him or herself that with the
use of alternative procedures, a qualified opinion is not necessary.
4) Qualified opinion or adverse opinion for failure to follow generally accepted
accounting principles. The materiality of twenty per cent of net earnings
before taxes would be sufficient for many auditors to require an adverse
opinion. That materiality question is a matter of auditor judgment.
5) Disclaimer of opinion. Lack of independence by audit personnel on the
engagement mandates a disclaimer for lack of independence.
6) Unqualified opinion. The company has made a decision to follow a different
financing method which is adequately disclosed. There is no change of
accounting principle.

20-8.
a. b.
CONDITION TYPE OF REPORT COMMENT
1. Failure to (4) Qualified opinion only Disclosure of this
follow GAAP. except for or information is required in a
(7) Adverse footnote. Failure to do so is
a violation of GAAP and is
likely to be a qualified
opinion, or it could be so
important as to require an
adverse.
2. Scope of the (1) Unqualified standard Because the auditor was
auditors able to obtain alternative
examination has evidence, no scope
been restricted. qualification is necessary.
If there were such a
qualification, it would be a
qualified scope and opinion
or a disclaimer, depending
on materiality.
20-4 Solutions Manual to Accompany Applied Auditing, 2006 Edition

3. Failure to (4) Qualified opinion only Retail Auto Parts has used a
follow GAAP. except for replacement cost inventory
rather than lower of cost or
market. It is not
sufficiently material to
require an adverse opinion.
4. Failure to (7) Adverse FASB No. 2 requires the
follow GAAP. expending in the current
period of all research and
development costs
regardless of the benefit in
future years. Given the
materiality of the amount,
an adverse opinion would
be required.
5. Scope of the (5) Qualified scope and Because the auditor was
auditors opinion unable to satisfy himself
examination has about beginning
been restricted. inventories, it would be
necessary to issue either a
qualified or disclaimer of
opinion on the income
statement and statement of
cash flows as well as the
beginning balance sheet.
The use of a qualified or
disclaimer would depend
upon the opinion given in
the prior year. An
unqualified opinion could
be issued for the current
period balance sheet.
6. Scope of the (6) Disclaimer Failure of the client to
auditors allow the auditor to inspect
examination has the minutes book would be
been restricted. a material client-imposed
restriction. Due to the
importance of the minutes
book, a disclaimer would
be necessary. The certified
copy of all resolutions and
actions would not be a
satisfactory alternative
procedure.
 Writing the Audit Report 20-5

7. Accounting (1) Unqualified standard The change of estimated

principles used wording life is a change of condition
in the financial and not a change in
statements have accounting principles.
not been Therefore, an unqualified
consistently opinion is appropriate since
applied. there is adequate
disclosure.

20-9. Young Manufacturing Corporation

The auditors report on his examination of the financial statements of the Young
Manufacturing Corporation includes the following deficiencies:

1. The audit report has no title. It should include a phrase such as independent
auditors report.
2. The audit report is addressed to the president. It is usually more appropriate
to address it to the stockholders or board of directors.
3. The date of the auditors report should be the date of the completion of the
auditors field work, not the balance sheet date.
4. The report includes only two paragraphs. It should be three paragraphs if it
is standard wording, or more if there is a violation of GAAP, which there is.
5. There must be reference to both the 2007 and 2006 financial statements in
the scope and opinion paragraphs, including a statement about the degree of
responsibility the auditor is taking for each years statements.
6. The auditors report is deficient because the dates of the balance sheet and
the period covered by the income statement are not given. These dates
should be given so that the reader will clearly understand that the opinion is
limited to specific financial statements. Clarification as to the statements
covered by the opinion is imperative because comparative financial
statements are presented.
7. The title Balance Sheet is used in the report, but statements of condition
is employed as the title of the financial statement. Different titles should not
be used because a criterion of professional work is that uniform and accurate
terminology be used.
8. Although the auditors report states that he or she examined the Statement of
Income and Retained Earnings, the attached financial statements do not
include the Retained Earnings statement. All financial statements referred to
in the auditors report should be appended to the report.
The difference of P66,481 between the opening and closing balances of the
Retained Earnings account is not reconcilable to the reported net income for
20-6 Solutions Manual to Accompany Applied Auditing, 2006 Edition

the year of P52,924. Because an amount of P13,557 in the Retained

Earnings account is not accounted for, the auditors report should contain at
least a qualification on the grounds of inadequate disclosure. If the auditors
examination disclosed that the P13,557 is a net amount of charges and
credits to the Retained Earnings account, some of which bear directly upon
the current years income statement, the auditor may be compelled to render
an adverse opinion.
9. There is no reference in the introductory paragraph to the responsibilities of
the auditor and management.
10. The mandatory standard scope paragraph is excluded.
11. Two items in the Statements of Condition, Accounts receivable and
Inventories, are listed as pledged, but no footnotes or comments disclose
the nature or extent of the commitments. The item other liabilities
probably represents the liability for which the assets serve as security; its
nature should be appropriately disclosed in the statements. Also, the terms
of the long-term mortgage should be disclosed. Therefore, the auditor
should disclose this information in a separate paragraph in the report and his
or her opinion should be appropriately qualified.
12. The auditors report is written in the first person apparently because the
auditor is an individual practitioner. Although some CPAs contend that it is
inappropriate for an individual to practice under a style that denotes a
partnership, individual practitioners generally use we rather than I in
writing their reports. The we used in the report is the so-called editorial
we and it is used because it is more formal, impersonal, and carries more
dignity. As used in auditors reports we is not to be taken in its literal
(plural) sense.
13. The opinion paragraph should contain the phrase in our opinion to clearly
disclose that the statement as to fair presentation is a professional opinion,
not a statement of fact.
14. A statement of cash flows is not included in the financial statements of the
audit reports introductory paragraphs. A qualified opinion is required when
no statement of cash flows is included.
15. There is not inclusion of the phrase in all material respects in the opinion.
16. There should be no reference to consistency in the opinion paragraph.
17. The opinion paragraph should include no reference to what is done on the
audit. That should be in the scope paragraph.
18. As stated above, the opinion paragraph should not be unqualified, because of
the missing statements or retained earnings and cash flow and the omitted
footnotes.