Auditor's Reports and Circumstances

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Solutions for Chapter 16

Auditors’ Reports

Review Questions:

16-1.The five basic types of audit reports and the circumstances under which each is expressed are: 1.Standard three paragraph unqualified report- expressed when there are no material departures from GAAP, the auditor has been able to follow GAAS without significant scope limitation, disclosures in the financial statements are adequate, and there are no going concern uncertainties or changes in accounting principles that need an explanatory paragraph. 2.Unqualified report with explanatory paragraph explains a change in accounting principles, substantial going concern doubt, justified departure from GAAP or emphasizes some matter. 3.Qualified report expressed when there is a material departure from GAAP, a significant scope limitation, or inadequate disclosures. 4.Adverse report expressed when there is a very material departure from GAAP, including grossly inadequate disclosures, that pervades the financial statements such that they are misleading. 5.Disclaimer report issued when a significant scope limitation has been imposed on the auditor by the client or circumstances that prohibit the auditor from forming an opinion on the financial statements, the auditor lacks independence, or, at the auditor's discretion, when there is very significant going concern question.

16-2.A scope limitation prohibits the auditor from performing audit procedures due to client instructions or circumstances. Examples are (1) the client telling the auditor not to confirm receivables, or (2) being hired to perform a first-time audit and, because of inadequate records, being unable to become satisfied with beginning inventory and the accounting principles used in the previous year. An uncertainty is a situation in which there are no audit procedures that can be performed because the evidence does not yet exist. Examples are (1) pending litigation, the outcome depending on the court's decision in the future, and (2) the ability of the client to continue in business for a reasonable period of time.

16-3.The SEC will not accept qualified or adverse opinions or disclaimers resulting from actions or inactions of the client, such as GAAP violations, inadequate disclosures, and placing scope limitations on the auditor. This environment creates advantages and disadvantages for the auditor. The SEC's position provides a powerful tool for the auditor when discussing with the client the need to correct GAAP violations or inadequate disclosures or the inadvisability of placing scope limitations on the auditor. This SEC position also creates pressure on the auditor to issue an unqualified opinion even when there are GAAP violations, inadequate disclosures, or scope limitations. The client may insist on such an opinion, or threaten to not rehire the auditors for the next audit. The auditor should not submit to such pressure.

16-4.The auditor must consider:
• Whether the accounting principles used by the client have general acceptance, • The appropriateness of the principles in the circumstances, • Whether the financial statements, including the related notes, are informative of matters that may affect their use, understanding, and interpretations, • Whether the information presented is classified and summarized in a reasonable manner, that is, neither too detailed nor too condensed, and • Whether the financial statements reflect the underlying events and transactions in a manner that presents the financial position, results of operations, and cash flows stated within a range of reasonable and practicable limits.

16-5.An unqualified opinion may be expressed when the auditor is convinced that following GAAP would be misleading and the reasons are disclosed in the audit report. Such situations are very rare, but are permitted by Rule of Conduct 203.

16-6.The auditor must add a...
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