McGraw-Hill/Irwin. Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

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1 McGraw-Hill/Irwin Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

2 Chapter 12 Reports on Audited Financial Statements The television industry doesn t like to see the complexity of the world. It prefers simple reporting, with simple ideas: this is white, that s black; this is good, that s bad. Filmmaker Krisztof Kieslowski 12-2

3 Reports on Audited Financial Statements In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Enron Corp. and subsidiaries as of December 31, 2000 and 1999, and the results of their operations, cash flows, and changes in shareholders equity for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. The opinion paragraph from Arthur Andersen s final audit of Enron Corp. (dated February 23, 2001) 12-3

4 Chapter 12 Objectives 1. Provide an overview of the types of reports that accompany an entity's financial statements. 2. Identify three general functions of the auditors report on an entity s financial statements. 3. Explain the significance of each of the paragraphs in the auditors standard report on an entity s financial statements. 4. Describe the types of auditors reports that may be issued if an entity s financial statements contain a departure from GAAP. 5. Describe the types of auditors reports that may be issued if scope limitations exist. 6. Describe how the standard report is modified when auditors issue unqualified opinions but reference other matters affecting the audit or the client. 7. Identify other circumstances affecting auditors reporting responsibilities and explain how they affect auditors reports on an entity s financial statements. 12-4

5 Major Topics I. Overview of Reporting II. The Standard Report III. Reasons for Departing from Standard Report Departures from GAAP Scope limitations IV. Other matters affecting the audit Other Issues and Reporting 12-5

6 Reports Accompanying Financial Statements Prepared by Auditor Opinion on financial statements and related disclosures: Are F/S presented per applicable financial reporting framework (GAAP)? Opinion on internal control over financial reporting: Is I/C effective? [SOX 404b] Prepared by Management Opinion on internal control over financial reporting: Is I/C effective? [SOX 404a] 12-6

7 The Purpose of the Auditors Report Are F/S in conformity with GAAP? *Client s overarching assertion.] Provide indication of what the F/S would be like if GAAP were followed Provide any entity-omitted disclosures Any unusual aspects of the audit examination? Scope limitations Division of responsibility Any unusual matters related to the entity? Going-concern uncertainty Consistency Emphasis of a matter 12-7

8 Types of Auditors Reports 1. Standard report Expresses an unqualified opinion *a clean opinion+ Can t file Form 10-k with less than an unqualified opinion 2. Unqualified opinion with modified wording F/S are in conformity with GAAP Additional matters are disclosed in report 3. Qualified opinion Except for some matter, F/S are in conformity with GAAP 4. Adverse opinion F/S are not in conformity with GAAP 5. Disclaimer of opinion No opinion is issued by auditors 12-8

9 Major Topics I. Overview of Reporting II. The Standard Report III. Reasons for Departing from Standard Report Departures from GAAP Scope limitations IV. Other matters affecting the audit Other Issues and Reporting 12-9

10 The Standard Report (Paragraphs) Introductory F/S and years examined Responsibility of auditors and management Scope Audit conducted in accordance with PCAOB standards Description of an audit (specific references to test basis, materiality, and significant estimates ) Audit provides reasonable assurance Opinion Are F/S presented in conformity with applicable financial reporting framework (GAAP)? Internal Control References examination, report, and opinion on internal control 12-10

11 The Standard Report (Other Elements) 1. Title includes the word independent 2. Addressed to the client (normally, shareholders and board) 3. Dated when auditors have obtained sufficient appropriate evidence (date of the auditors report) 4. Signed by the accounting firm *not partner s name; unlike some other countries] 12-11

12 Independent Auditors Report (AS 5) Report Title Report Address Introductory Paragraph Scope Paragraph Opinion Paragraph Internal Control Paragraph Signature Report Date To the Board of Directors and Shareholders DUNDER-MIFFLIN, INC. Report of Independent Registered Public Accounting Firm We have audited the accompanying balance sheets of DUNDER-MIFFLIN, INC. as of December 31, 2012 and 2011, and the related statements of income, shareholders equity, and cash flows for each of the years in the three-year period ended December 31, These financial statements are the responsibility of DUNDER- MIFFLIN, INC.'s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of DUNDER-MIFFLIN, INC. as of December 31, 2012 and 2011, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), DUNDER-MIFFLIN, INC. S internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated January 29, 2012 expressed an unqualified opinion thereon. Michael Scarn, LLP Scranton, PA January 29,

13 Reports on Internal Control Options Separate reports on F/S and I/C, with each reports referencing the other Combined report on F/S and I/C 12-13

14 Major Topics I. Overview of Reporting II. The Standard Report III. Reasons for Departing from Standard Report Departures from GAAP Scope limitations IV. Other matters affecting the audit Other Issues and Reporting 12-14

15 Departures from GAAP Is the Departure Material? NO Standard Report (Unqualified Opinion) YES YES Is the Departure Pervasive? NO Qualified Opinion Adverse Opinion 12-15

16 Qualified Opinion Issued when departure is material, yet not pervasive Report Modifications: Introductory and scope paragraphs remain the same Add paragraph preceding the opinion paragraph explaining departure and detailing $ amounts involved Modify opinion paragraph ( In our opinion, except for the matter discussed in the preceding paragraph,. ) 12-16

17 Adverse Opinion Issued when F/S do not present fairly according to GAAP (i.e., a serious, pervasive departure from GAAP). Report Modifications: Introductory and scope paragraphs remain the same Add paragraph preceding the opinion paragraph explaining the departure and detailing $ amounts involved Change opinion paragraph ( financial statements do not present fairly ) 12-17

18 Major Topics I. Overview of Reporting II. The Standard Report III. Reasons for Departing from Standard Report Departures from GAAP Scope limitations IV. Other matters affecting the audit Other Issues and Reporting 12-18

19 Scope Limitations Is the Limitation Material? NO Standard Report (Unqualified Opinion) YES Alternative Procedures Available? YES Standard Report (Unqualified Opinion) NO Is the Limitation Pervasive? NO Qualified Opinion YES Disclaimer of Opinion 12-19

20 Type of Scope Limitations Circumstance-Imposed Situation in which matters beyond auditors and client s control limit procedures performed by auditor Example: inability to observe year-end inventory because of late appointment Client-Imposed Situation in which client specifically limits auditors procedures Should be viewed as a significant restriction and a disclaimer is ordinarily issued 12-20

21 Scope Limitation: Qualified Opinion Issued when scope limitations are material, but not pervasive Report Modifications: Introductory paragraph remains the same Scope paragraph: Except as discussed in the following paragraph [the scope limitation], we conducted our audit Add paragraph preceding the opinion paragraph describing the scope limitation Modify opinion paragraph ( In our opinion, except for ) 12-21

22 Scope Limitation: Disclaimer of Opinion Pervasive scope limitation, usually client-imposed Significance of the limitation is such that auditors cannot gather sufficient appropriate evidence to form an opinion Report Modifications: Introductory paragraph: ( We were engaged to audit. ; omit auditors responsibility) Omit scope paragraph Add paragraph preceding the opinion paragraph describing the scope limitation Modify opinion paragraph ( we do not express an opinion. ) May still issue opinion on internal control if no scope limitation on the examination of internal control 12-22

23 Lack of Independence Scenario: Auditors begin engagement but independence subsequently compromised Report Single paragraph Indicates auditors are not independent Does not indicate why independence lacking 12-23

24 Major Topics I. Overview of Reporting II. The Standard Report III. Reasons for Departing from Standard Report Departures from GAAP Scope limitations IV. Other matters affecting the audit Other Issues and Reporting 12-24

25 General Approach for Other Matters Issue unqualified opinion but add paragraph to report to discuss the matter Emphasis-of-matter paragraphs provide information related to users understanding of F/S Other-matter paragraphs provide information related to users understanding of audit, auditors responsibility, or auditors report Situations Consistency Going-concern Rule 203 departures from GAAP Division of responsibility Emphasis of a matter 12-25

26 Consistency Relates to: Change in accounting principles Adjustments to correct misstatements in previously-issued F/S Type of changes in accounting principles: Accounting principles (GAAP to GAAP) Form of reporting entity Accounting principles (non-gaap to GAAP) Accounting principle inseparable from changes in estimates 12-26

27 Consistency: Effect on Report Add explanatory paragraph following the opinion paragraph May issue a qualified opinion (GAAP departure) if: Change is not justified Change is not accounted for in conformity with GAAP 12-27

28 Going-Concern Uncertainties Auditors are responsible to evaluate whether substantial doubt exists about ability of entity to continue in existence for one year beyond date of F/S Options Add explanatory paragraph following opinion paragraph (still unqualified opinion) If serious uncertainty, may issue disclaimer of opinion Modified language must include the words substantial doubt and going concern 12-28

29 Rule 203 Report Rule 203 allows for unqualified opinions on F/S that are not in conformity with GAAP if GAAP would be misleading Add explanatory paragraph either preceding or following the opinion paragraph 12-29

30 Division of Responsibility Group financial statements: Financial statements comprised of more than one division/subsidiary/segment/component Group auditors: Conduct audit of material portion of the entity Component auditors: May be engaged by group auditors to audit divisions, subsidiaries, or components 12-30

31 Division of Responsibility Take Responsibility for Component Auditors Work? NO Refer to Component Auditors by Name? NO YES YES Standard Report (Unqualified Opinion) Obtain permission and present component auditors report Indicate Division of Responsibility in Unqualified Opinion 12-31

32 Effect on Report Group auditors should Verify component auditors reputation and independence Communicate and coordinate with component auditors Options Take responsibility for work: Standard report Name component auditors Present report of component auditors, only with their permission Refer to component auditors Modify introductory, scope, and opinion paragraphs of report Still express unqualified opinion, if appropriate 12-32

33 Emphasis of a matter Call user attention to important matters Add explanatory paragraph after opinion paragraph discussing the matter 12-33

34 Major Topics I. Overview of Reporting II. The Standard Report III. Reasons for Departing from Standard Report Departures from GAAP Scope limitations Other matters affecting the audit IV. Other Issues and Reporting 12-34

35 Association with Unaudited F/S Auditors permit use of name in communication including F/S Issue disclaimer of opinion (one paragraph) Do not mention auditing procedures performed Must identify any known departures from GAAP in the report Should cover all unaudited prior-years financial statements 12-35

36 Comparative F/S Continuing Auditors Update opinion by considering if previously-issued opinions still appropriate If previously-issued opinions not appropriate, revise opinion in current report Predecessor auditors With permission, auditors may present reissued report from predecessor on prior-years F/S along with their report on current F/S If predecessors report not presented, auditors report must reference predecessors report and opinion on prior-years F/S 12-36

37 Information Accompanying F/S Summary financial statements Expand report on full F/S to provide conclusion on summary F/S (in relation to full F/S) Other information (includes President s letter, MD&A, and other information) Exception-based reporting Consider whether any inconsistencies affect opinion on F/S Required supplementary information Required to perform limited procedures Expand report on F/S to discuss procedures and issues encountered with engagement or information (if any) Disclaim an opinion on supplementary information 12-37

38 Reporting Summary Opinion Paragraphs modified/added Material Pervasive Intro Scope Opinion Add l Departure from GAAP Qualified Adverse X X Scope Limitation Qualified Disclaimer X X X Other matters (Consistency, Going-concern, Rule 203, Emphasis of a matter) Other matters (Division of responsibility when referencing work of component auditors) Unqualified Unqualified X Unqualified Unqualified X X X May issue disclaimer if: Lack of independence Associated with financial statements Material and pervasive going-concern uncertainty 12-38