Question

Review the external auditor's report on the integrated audit, presented in Exhibit 5.12. What are the important elements in that report related to internal control?

Exhibit 5.12

Example of Adverse Opinion on Internal Control and Unqualified Opinion on the Financial Statements (bold emphasis added in report)

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Diamond Foods, Inc.

In our opinion, the accompanying consolidated balance sheet as of July 31, 2013 and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for the year then ended present fairly, in all material respects, the financial position of Diamond Foods, Inc. and its subsidiaries at July 31, 2013, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company did not maintain, in all material respects, effective internal control over financial reporting as of July 31, 2013, based on criteria established in Internal Control—Integrated Frame work issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) because material weaknesses in internal control over financial reporting related to the accounting for complex and non-routine transactions and due to certain key accounting personnel who have the ability to prepare and post journal entries without an independent review by someone without the ability to prepare and post journal entries existed as of that date. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weaknesses referred to above are described in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. We considered these material weaknesses in determining the nature, timing, and extent of audit tests applied in our audit of the July 31, 2013 consolidated financial statements, and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in management’s report referred to above. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audit.

We conducted our audit 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 and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

San Francisco, California

October 9, 2013

Answer 1

Following are the important element related to internal control in the Auditor's Report:

1. The Company did not maintain, in all material respects, effective internal control over financial reporting as of July 31, 2013, with respect to COSO framework.

2. Material weaknesses in internal control over financial reporting related to the accounting for complex and non-routine transactions were noted pertaining to independent review control.

3. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting.

4. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting.

5. Internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations.

There are 5 component of internal control system:

A system of internal control has five components. An accountant must be aware of these five components when designing an accounting system, as does a person who audits the system. The components of an internal control system are as follows:

• Control environment. This is the attitude of management and their employees regarding the need for internal controls. If the controls are taken seriously, this greatly enhances the robustness of the system of internal control.
• Risk assessment. This is the process of reviewing the business to see where the most critical risks lie, and then designing controls to address those risks. This assessment must be conducted on a regular basis, to take into account any new risks introduced by changes in the business.
• Control activities. This is the use of accounting systems, information technology, and other resources to ensure that appropriate controls are put in place and operating properly. For example, there may be accounting systems in place to periodically conduct inventory auditsand fixed asset audits. In addition, there may be off-site backups to minimize the risk of lost data.
• Information and communication. Information about controls should be communicated to management in a timely manner, so that shortfalls can be addressed promptly. The amount of information communicated should be appropriate to the needs of the recipient.
• Monitoring. This is the set of processes used by management to examine and assess whether its internal controls are functioning properly. Ideally, management should be able to spot control failures and make adjustments to improve the control environment.