Question

In: Accounting

Two situations that may result in a modification of the auditor's report are (a) scope limitations...

Two situations that may result in a modification of the auditor's report are (a) scope limitations and (b) departures from GAAP. For each of these situations, identify how the auditors' report would be modified to reflect the work performed and responsibility assumed by auditors. In addition, indicate what type of opinion(s) could be used in the circumstances.

Solutions

Expert Solution

: The three alternative opinions that may be appropriate when the client's financial statements are not in accordance with GAAP are an unqualified opinion, qualified as to opinion only and adverse opinion. Determining which is appropriate depends entirely upon materiality. An unqualified opinion is appropriate if the GAAP departure is immaterial (standard unqualified) or if the auditor agrees with the client's departure from GAAP (unqualified with explanatory paragraph). A qualified opinion is appropriate when the deviation from GAAP is material but not highly material; the adverse opinion is appropriate when the deviation is highly material.

Qualified Reports for GAAP Measurement Departures When the financial statements are materially affected by a GAAP measurement departure and auditors have audited the statements in accordance with generally accepted auditing standards, they should express a qualified opinion or, if the departure is pervasive, an adverse opinion. A disclaimer of opinion never is an appropriate substitute when auditors have reached an affirmative conclusion that audited financial statements are not fairly presented in conformity with GAAP

Adverse Opinions for GAAP Measurement Departures An adverse opinion states that the financial statements do not present fairly the financial position, results of operations, and cash flows of the company in conformity with GAAP. An adverse opinion is expressed when auditors conclude that the financial statements, taken as a whole, are not fairly presented because of the materiality of a GAAP departure. Auditors seldom, if ever, issue an adverse opinion. When faced with that alternative, they have two courses of action: a. Persuade the client to adjust the financial statements b. Set forth the facts and express an adverse opinion Normally alternative (a) may be achieved once the consequences of alternative (b) are explained to the client. If asked to withdraw, auditors should explain to the client their responsibility to communicate the facts surrounding the dismissal, when asked, to a successor auditor (as required by SAS No. 84 at AU 315). In addition, SAS No. 114 (AU 380.23.25) requires auditors to communicate certain matters to those charged with governance, including significant findings from the audit and disagreements with management. If the statements are not adjusted, auditors should set forth the facts concerning the departures from GAAP in an explanatory paragraph of their report.

The main objective of an audit is to give a true and fair view of a company's state of affairs at a given date. Preparation of the audit report is the last step of an audit cycle. The report renders the auditor's opinion about the truth and fairness of the financial statements. In line with the International Audit Standards, IAS, the report should have a paragraph on the scope of the audit that follows the introductory paragraph.

Circumstances Where Limitation of Scope Arises

Generally, when the auditor does not receive all information and explanations that he deems necessary for the completion of the audit, limitation of scope arises. The auditor can, therefore, not give an objective conclusion of his analysis with regard to the company's economic status. Management may contribute to the auditor's limitation by refusing to render all information required. Destruction of accounting records also limits the auditor's capability to deliver a judgment.

Qualified Opinion

Limitation of scope may lead to either a qualified opinion or a disclaimer by the auditor in the report. When the limitation is material, but not fundamental, the auditor renders a qualified opinion. This means that all other matters in the audit are okay except for the limitation of scope in the audit process. The auditor, therefore, has some reservations about the truth and fairness of the financial statements as a reflection of the firm's economic status.

Disclaimer of Opinion

A disclaimer of opinion arises when the limitation is so fundamental that the auditor is not able to give an opinion. Due diligence is one of the duties of an auditor; if the auditor feels that there are important records, materials or explanations missing that are crucial to the audit, a disclaimer of opinion is imperative. The auditor should expressly state the nature of the limitation and possible adjustments to the financial statements that can remove the limitation.

Materiality and Fundamentality

Before issuing a modified report -- qualified or disclaimer of opinion -- the auditor must evaluate the materiality and fundamentality of the limitation. Limitation of scope is material if the inadequacy may alter the view given by the financial statements on the economic status of the firm. Limitation of scope is fundamental when the inadequacy is crucial and can totally alter the interpretation of the financial statements or even make them meaningless.


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