The Audit Report Was Timely, but at What Cost?

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CHAPTER
AUDIT REPORTS
THE AUDIT REPORT WAS TIMELY, BUT AT WHAT COST?

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LEARNING OBJECTIVES
After studying this chapter, you should be able to
3-1 Describe the parts of the standard unqualified audit report. Specify the conditions required to issue the standard unqualified audit report. Understand combined reporting on financial statements and internal control over financial reporting under Section 404 of the Sarbanes–Oxley Act. Describe the five circumstances when an unqualified report with an explanatory paragraph or modified wording is appropriate. Identify the types of audit reports that can be issued when an unqualified opinion is not justified. Explain how materiality affects audit reporting decisions. Draft appropriately modified audit reports under a variety of circumstances. Determine the appropriate audit report for a given audit situation. Discuss the impact of e-commerce on audit reporting. 3-2 3-3

Halvorson & Co., CPAs was hired as the auditor for Machinetron, Inc., a company that manufactured high-precision, computer-operated lathes. The owner, Al Trent, thought that Machinetron was ready to become a public company, and he hired Halvorson to conduct the upcoming audit and assist in the preparation of the registration statement for a securities offering. Because Machinetron’s machines were large and complex, they were expensive. Each sale was negotiated individually by Trent, and the sales often transpired over several months. As a result, improper recording of one or two machines could represent a material misstatement of the financial statements. The engagement partner in charge of the Machinetron audit was Bob Lehman, who had significant experience auditing manufacturing companies. He recognized the risk for improper recording of sales, and he insisted that his staff confirm all receivables at year-end directly with customers. Lehman conducted his review of the Machinetron audit files the same day that Trent wanted to make the company’s registration statement for the initial public stock offering effective. Lehman saw that a receivable for a major sale at year-end was supported by a fax, rather than the usual written confirmation reply. Apparently, relations with this customer were “touchy,” and Trent had discouraged the audit staff from communicating with the customer. At the end of the day, there was a meeting in Machinetron’s office. It was attended by Lehman, Trent, the underwriter of the stock offering, and the company’s attorney. Lehman indicated that a better form of confirmation would be required to support the receivable. After hearing this, Trent blew his stack. Machinetron’s attorney stepped in and calmed Trent down. He offered to write a letter to Halvorson & Co. stating that in his opinion, a fax had legal substance as a valid confirmation reply. Lehman, feeling tremendous pressure, accepted this proposal and signed off on an unqualified audit opinion. Six months after the stock offering, Machinetron issued a statement indicating that its revenues for the prior year had been overstated as a result of improperly recorded sales, including the sale supported by the fax confirmation. The subsequent SEC investigation uncovered that the fax had been sent by Trent, not the customer. Halvorson & Co. recalled their unqualified audit report, but this was too late to prevent the harm done to investors. Halvorson & Co. was forced to pay substantial damages, and Bob Lehman was forbidden to practice before the SEC. He subsequently left public accounting. ISBN: 0-536-35831-1

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Auditing and Assurance Services: An Integrated Approach, Eleventh Edition by Alvin A. Arens, Randal J. Elder, and Mark S. Beasley. Published by Prentice Hall. Copyright © 2006 by Pearson Education, Inc.

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eports are essential to audit and assurance engagements because they communicate the auditor’s findings. Users of financial statements rely on the auditor’s report to provide assurance on the...
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