Question

[Audit Reports]

Presented below are independent audit scenarios involving nonpublic clients that prepare GAAP-basis
financial statements. You are assumed to be the reporting auditor on all these engagements, and they are
for the current year only, i.e., the client is presenting single-year (rather than comparative) financials.

Required—Indicate the type of report you should issue in each scenario assuming that the matter
described is material but not pervasively so (unless otherwise implied), and do so by using one of the
options below accompanied by a brief explanation:

SR = auditor’s standard report
UOREM = unqualified opinion with required emphasis-of-matter paragraph
UODEM = unqualified opinion with discretionary emphasis-of-matter paragraph
UOROM = unqualified opinion with required other-matter paragraph
UODOM = unqualified opinion with discretionary other-matter paragraph
QOGD = qualified opinion due to a GAAP departure
QOSL = qualified opinion due to a scope limitation
AO = adverse opinion
DO = disclaimer of opinion

1. A significant portion of the revenues of Child Company come from a single customer, Parent Company,
a business owned by the parents of Child’s CEO. Child has disclosed these transactions and the CEO’S
relationship to Parent’s owners.
2. Switched Company used current (“marked-to-market”) prices to value its inventory in prior years but
this year changed to FIFO.
3. Just Us Company has decided not to prepare a statement of cash flows because as a family owned
business with no outside investors, it believes that its shareholders do not find the statement useful.
4. XY&Z Company learned that it is being sued for breach of contract over a dispute that arose prior to
year-end. XY&Z has made no disclosure of the case, but the company’s legal counsel has confirmed
XY&Z’s position in the attorneys’ letter, specifically, that the likelihood of XY&Z losing the case is
remotely possible but not probable.
5. X&YZ Company learned that it is being sued for breach of contract over a dispute that arose prior to
year-end. X&YZ has made no disclosure of the case, but the company’s legal counsel has confirmed
X&YZ’s position in the attorneys’ letter, specifically, that the likelihood of X&YZ losing the case is
reasonably possible but not probable.
6. During your audit of AB&C Company, you were unable to observe the physical inventory because
you were hired after the company’s year-end. You were not able to satisfy yourself as to the fair
presentation of AB&C’s inventories through other audit procedures.
7. During your audit of A&BC Company, you were unable to confirm accounts receivable because
management did not allow you to do so out of concern about complaints from customers. You were not
able to satisfy yourself as to the fair presentation of A&BC’s receivables through other audit procedures.

Answer 1

Explain the terms

A. GAAP - Generally accepted Accounting Principles.

All the companies are required to follow US GAAP in preparation and presentation of financial statements.

B. GAAS - Generally accepted auditing standards.

The auditors are required to follow set of standards during the planning and conducting the audit of the financial statements and also preparing audit report and expressing opinion on the financial statements of the company.

Answer - Type of report under each scenario with brief explanation

Scenario 1.

Type of report : Standard Report.

As child company has disclosed it's relationship with parent company. The child has disclosed the transactions between both companies. Additionally it has mentioned the relationship of child's CEO and parents owners. Such explanation is required as per the standards and the same is made by child company.

Scenario 2.

Type of report - Qualified opinion due to GAAP departure.

The change of inventory method by current prices to FIFO is change in accounting policy the company is allowed to make changes in inventory method but company has to separately disclosed this fact with quantum of difference due to change in inventory method. As per above question it is not done the company so auditor will express qualified opinion due to GAAP departure as it material but not pervasive.

Scenario 3.

Type of report - Qualified opinion due to GAAP departure.

The just us company didn't prepare the cash flow statement this is departure of GAAP AS GAAP requires the preparation of income statement, balance sheet, cash flow statement, notes to accounts at the end of financial period. As mentioned in question every situation is material but not pervasive stated otherwise so qualified opinion due to GAAP departure in case of pervasive adverse opinion.

Scenario 4

Type of report - unmodified opinion with discretionary emphasis of matter paragraph.

XYZ company is being sued for brench of contract but likelihood of losing case in remotely possible so it is ok for the company to not disclose as per GAAP .But auditor can explain above uncertainty in discretionary emphasis of matter paragraph without modification of opinion as the company treatment for the situation is accurate as per GAAP.

Scenario 5

Type of report - Qualified opinion due to GAAP DEPARTURE.

In this situation the likelihood of XYZ company losing the case is reasonable possible.in this case the XYZ is required to DISCLOSE the matter in notes to accounts but XYZ didn't disclose the same. This departure of GAAP but as it is material but not pervasive stated otherwise. Auditor shall give qualified opinion and not adverse opinion.

Scenario 6

Type of report - Qualified opinion due to GAAS departure.

Auditor is not able to observe the physical inventory because of late hiring and can not satisfied himself by conducting alternative procedure regarding inventory existence and valuation. This amounts to scope limitations due to circumstances in such cases auditor will express qualified opinion with GAAS DEPARTURE.

Scenario 7

Type of report - Disclaimer of opinion.

In given case the management didn't allow the auditor to confirm the balances from accounts receivables. This is scope limitations imposed by client management in such circumstances auditor shall give disclaimer of opinion instead of qualified opinion due to GAAS as scope limitations imposed by client management.