Question

For the following independent situations, assume that you are the audit partner on the engagement:

1. You found that the depreciation is calculated on the total of land and buildings. In previous years it was only charged on buildings. Total depreciation is $5m and the element charged to land only is $1.4m. Profit before tax is $20m.

2. Fortune Co has 20% inventory held by Just Department Store on a consignment basis. Confirmation request has been already sent to them after the year end. However, no reply has been received after repeated follow-ups. Total Inventory represents 30% of the total asset.

3. Your client, Harrison Automotive, has changed from straight-line to sum-of-the years’ digits depreciation. The effect on this year’s income is material, and no information is disclosed in footnotes related to the change. You believed the change aligns with change in usage pattern of the automobile.

4. The client has a subsidiary in the USA and another in Canada, which this year together accounted for 8% of the group’s revenue, profits and net assets. Neither subsidiary is audited although both use external professional accountant to prepare the financial statements. The client’s management was unwilling to ask local accountants to perform a full audit.

5. The client has inventory costing $300,000 in the warehouse that is held for over 2 years. Management determined that the inventory would be sold next year in the big sale of the company. It is expected that the inventory would be sold to the customers at only 50% of the cost. The client has a net income of $100,000. Management claimed that the inventory has not been sold and therefore it should be continued to record at cost.

6. If all things are the same as situation 3, except that adequate disclosure is made relating to the change of depreciation method after your advice, will your opinion be different?

Discuss the most appropriate type of opinion the auditor should issue. Explain briefly the reason for the opinion.

For the situations 1 and 2, draft the opinion paragraph and any corresponding basis of opinion paragraph (if any).

Answer 1

1. You found that the depreciation is calculated on the total of land and buildings. In previous years it was only charged on buildings. Total depreciation is $5m and the element charged to land only is $1.4m. Profit before tax is $20m.

1. Qualified opinion-qualified report - The auditors expressed satisfactory opinion about the true and fairness of the accounting statements subject to a particular transaction which is not in accordance with GAAP. Described below in detail -
   1. a) The XXX and co are charging depreciation wrongly on land for the current year. As land is a non depreciable and the treatment is not inline with the GAAP, the auditors would like to qualify the opinion. Further it need to noted that out of total dpreciation of $5m for the year the non qualifying amount charged on land is $1.4m which needs to be reversed as income. Hence the correct PBT is +20+1.4 = 21.4 Million $.

2.  Fortune Co has 20% inventory held by Just Department Store on a consignment basis. Confirmation request has been already sent to them after the year end. However, no reply has been received after repeated follow-ups. Total Inventory represents 30% of the total asset.

Qualified opinion-qualified report - due to lack of any information it is not easy to express unqualified opinion on the material amount of inventory. The amount is material since this represents 6% (20% of 30% of total assets) of total assets. Hence if other areas are fair and accurate then auditor can issue qualified opinion

3. Qualified opinion-qualified report - although it aligns with industry the disclosure is important for the readers of the financials. Further due to its materiality it needs to be given qualified opinion

4. Disclaimer of opinion - Since the management is unwilling to get information auditted it is advised that the auditors shall distance themselves from providing the report. In case of lack of infomartion provided to auditor, the auditor shall always provide disclaimer of opinion.