Question

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.

Answer 1

1. Scope Limitation.

1. Scope limitations may be imposed by the client or circumstances:

• Timing of the work.

• Inability to obtain sufficient competent evidence.

• Inadequacy of the accounting records.

• Unaudited information included in financial statements that should be audited

2. Qualification versus disclaimer depends on the significance (materiality) of the item(s) and its effect on the financial statements.

3. In addition to the explanatory paragraph that precedes the opinion paragraph, the scope limitation needs to be referred to in both the scope and opinion paragraphs. CANNOT be explained in a financial statement disclosure.

4. Reference needs to be to the financial statements potentially affected not to the scope limitation itself.

(B) Departure from GAAP.

1. Explanatory paragraph, which comes before the opinion paragraph, includes:

• Substantive reasons for qualification.

• Disclosure of the principal effects of the subject matter of the qualification, if practicable. If not practical to estimate effects must say so in report.

• An allowable reference to financial statement footnote explaining situation, such as “As more fully described in Note X . . .” With this type of reference the explanatory paragraph may be shortened.

2. Introductory and scope paragraphs are usually unchanged.

3. Omission of a Statement of Cash Flows requires the issuance of an qualified report. The introductory paragraph should omit the reference to the Cash Flow Statement. Auditor does not need to prepare this statement.

4. Inappropriate accounting change (newly adopted accounting principle not GAAP, improper accounting for effect of change in principle, or management’s justification for change not reasonable). Qualification always sticks with year change occurred but not necessarily subsequent years.