Question

Identifies the appropriate type of audit report from the list below (a. through f.) and briefly explain the rationale for selecting the report.

Appropriate type of audit report:

Unqualified, standard

1. Unqualified, explanatory paragraph

2. Qualified opinion because of departure from GAAP

3. Qualified scope and opinion

4. Disclaimer

5. Adverse

Case: During the course of the audit of Sail-Away Company, the auditor noted that the current ratio had dropped to 1.75. The company’s loan covenant requires the maintenance of a current ratio of 2.0, or the company’s debt is all immediately due. The auditor and the company have contacted the bank, which is not willing to waive the loan covenant because the company has been experiencing operating losses for the past few years and has an inadequate capital structure. The auditor has substantial doubt that the company can find adequate financing elsewhere and may encounter difficulties staying in operation. Management, however, is confident that it can overcome the problem. The company does not deem it necessary to include any additional disclosure because management members are confident that an alternative source of funds will be found by pledging their personal assets.

Answer 1

Audit reports are required by law if a company is publicly traded or in an industry regulated by the Securities and Exchange Commission (SEC). Companies seeking funding, as well as those looking to improve internal controls, also find this information valuable. There are four types of audit reports.

Unqualified Opinion

Often called a clean opinion, an unqualified opinion is an audit report that is issued when an auditor determines that each of the financial records provided by the small business is free of any misrepresentations. In addition, an unqualified opinion indicates that the financial records have been maintained in accordance with the standards known as Generally Accepted Accounting Principles (GAAP). This is the best type of report a business can receive.

Typically, an unqualified report consists of a title that includes the word “independent.” This is done to illustrate that it was prepared by an unbiased third party. The title is followed by the main body. Made up of three paragraphs, the main body highlights the responsibilities of the auditor, the purpose of the audit and the auditor’s findings. The auditor signs and dates the document, including his address.

Qualified Opinion

In situations when a company’s financial records have not been maintained in accordance with GAAP but no misrepresentations are identified, an auditor will issue a qualified opinion. The writing of a qualified opinion is extremely similar to that of an unqualified opinion. A qualified opinion, however, will include an additional paragraph that highlights the reason why the audit report is not unqualified.

Adverse Opinion

The worst type of financial report that can be issued to a business is an adverse opinion. This indicates that the firm’s financial records do not conform to GAAP. In addition, the financial records provided by the business have been grossly misrepresented. Although this may occur by error, it is often an indication of fraud. When this type of report is issued, a company must correct its financial statement and have it re-audited, as investors, lenders and other requesting parties will generally not accept it.

Disclaimer of Opinion

On some occasions, an auditor is unable to complete an accurate audit report. This may occur for a variety of reasons, such as an absence of appropriate financial records. When this happens, the auditor issues a disclaimer of opinion, stating that an opinion of the firm’s financial status could not be determined.

Here in the given case the  auditor has substantial doubt that the company can find adequate financing elsewhere and may encounter difficulties staying in operation, But the management is confihe company dent that it can overcome the problem. So here therre is a difference of opinion between mangement and Auditors. So we have to express an modified opinion.

But the type of modified opinion is based on the intensity of the item whether it is material or pervaisive

Here it is given that the company is ex[eriencing operating losses for past few years, so if it does not get the loan it canot continue its operations, So the Auditors has to express an Adverse opinion based on materiality and pervaisiveness as per my view