AUDIT

REPORTS
CHAPTER 3

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 CHAPTER 3 LEARNING OBJECTIVES

3-1 Describe the parts of the standard unmodified opinion audit

report for nonpublic entities under AICPA auditing standards.
3-2 Specify the conditions required to issue the standard unmodified
opinion audit report.
3-3 Understand reporting on financial statements and internal
control under PCAOB auditing standards.
3-4 Describe the five circumstances when an emphasis-of-matter
explanatory paragraph or nonstandard wording is appropriate to
include in an unmodified opinion audit report.

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 CHAPTER 3 LEARNING OBJECTIVES (CONT.)
3-5 Identify the types of audit reports that can be issued when
an unmodified opinion is not justified.
3-6 Explain how materiality affects audit reporting decisions.
3-7 Draft appropriately modified opinion audit reports under a
variety of circumstances.
3-8 Determine the appropriate audit report for a given audit
situation.
3-9 Understand use of international accounting and auditing
standards by U.S. companies.

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 OBJECTIVE 3-1
Describe the parts of the standard unmodified
opinion audit report for nonpublic entities
under AICPA auditing standards.

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 PARTS OF STANDARD UNMODIFIED OPINION
AUDIT REPORT
1. Report title
2. Audit report address
3. Introductory paragraph
4. Management’s responsibility
5. Auditor’s responsibility
6. Opinion paragraph
7. Signature and address of CPA firm
8. Audit report date

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 OBJECTIVE 3-2
Specify the conditions required to issue the
standard unmodified opinion audit report.

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 CONDITIONS FOR STANDARD UNMODIFIED
OPINION AUDIT REPORT
1. Includes all financial statements
2. Sufficient appropriate evidence accumulated
3. Financial statements are presented fairly in
accordance with GAAP or other framework
4. No circumstances requiring the addition of an
emphasis-of-matter paragraph or modification

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 OBJECTIVE 3-3
Understand reporting on financial
statements and internal control under
PCAOB auditing standards.

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 STANDARD AUDIT REPORT AND REPORT ON
INTERNAL CONTROL OVER FINANCIAL REPORTING
UNDER PCAOB AUDITING STANDARDS

Two significant audit reporting differences for

public companies.
1. The standard unmodified opinion audit report
is different. The differences are detailed in
Figure 3-3.
2. Auditors of larger public companies must also
issue an opinion on internal control over
financial reporting.

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STANDARD AUDIT REPORT AND REPORT ON INTERNAL
CONTROL OVER FINANCIAL REPORTING UNDER PCAOB
AUDITING STANDARDS (CONT.)

Section 404(b) of the Sarbanes-Oxley Act requires the auditor of a

public company to report on the effectiveness of internal control
over financial reporting.
PCAOB Auditing Standard 5 requires the audit of internal control
to be integrated with the audit of financial statements.
However, the auditor may issue separate reports, such as the
separate report on internal control over financial reporting shown
in Figure 3-4, or a combined report.
Separate reporting is more common.

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 OBJECTIVE 3-4
Describe the five circumstances when an
emphasis-of-matter explanatory paragraph or
nonstandard wording is appropriate to
include in an unmodified opinion audit report.

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 UNMODIFIED OPINION AUDIT REPORT WITH
EMPHASIS-OF-MATTER EXPLANATORY PARAGRAPH
OR NONSTANDARD REPORT WORDING

The unmodified opinion audit report with

emphasis-of-matter paragraph or nonstandard
report wording
• Meets the criteria of a complete audit with
financial statements that are fairly presented
• But, auditor wants to draw attention to certain
matters or is required to provide additional
information.

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 UNMODIFIED OPINION AUDIT REPORT WITH
EMPHASIS-OF-MATTER EXPLANATORY PARAGRAPH OR
NONSTANDARD REPORT WORDING

The most important causes of the addition of an emphasis-of-matter

paragraph or a modification of wording under both AICPA and PCAOB
audit standards:
• Lack of consistent application of generally accepted accounting
principles as illustrated in Figure 3-5
• Substantial doubt about going concern as illustrated in Figure 3-6
• Auditor agrees with departure from promulgated accounting principles
• Emphasis of other matters
• Reports involving other auditors as illustrated in Figure 3-7

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 UNMODIFIED OPINION AUDIT REPORT WITH
EMPHASIS-OF-MATTER EXPLANATORY PARAGRAPH OR
NONSTANDARD REPORT WORDING (CONT.)
Examples of emphasis of other matters include the following:
• The existence of material related party transactions
• Important events occurring subsequent to the balance sheet date
• The description of accounting matters affecting the comparability of the
financial statements with those of the prior year
• Material uncertainties disclosed in the footnotes such as unusually
important litigation or regulatory action
• A major catastrophe that has had or continues to have a significant effect on
the entity’s financial position

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 EMPHASIS OF A MATTER

Under certain circumstances, the CPA may

want to emphasize specific matters regarding
the financial statements, even though the
CPA intends to express an unqualified opinion.

Subsequent Related Party

Events Transactions

Financial Material
Statement Uncertainties
Comparability Major catastrophe
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 OBJECTIVE 3-5
Identify the types of audit reports that can
be issued when
an unmodified opinion is not justified.

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 MODIFICATIONS TO THE OPINION IN THE
AUDIT REPORT
Three conditions requiring a modification to the
audit opinion:
1. The scope of the audit has been restricted (scope
limitation).
2. The financial statements have not been prepared
in accordance with generally accepted accounting
principles (GAAP departure).
3. The auditor is not independent.

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 MODIFICATIONS TO THE OPINION IN THE
AUDIT REPORT (CONT.)
Three types of reports may be appropriate:
• Qualified opinion—Can be used for a scope limitation or departure
from GAAP, but only when the auditor concludes that the overall
financial statements are fairly stated.
• Adverse opinion—Used when financial statements are so materially
misstated or misleading that they do not present fairly the financial
position of the entity. This is uncommon and is rarely used.
• Disclaimer of opinion—Used when the auditor cannot form an opinion
on the financial statement due to a severe scope limitation, lack of
knowledge on the part of the auditor, or lack of independence.

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 OBJECTIVE 3-6
Explain how materiality affects audit
reporting decisions.

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 MATERIALITY
A common definition of materiality as it applies to accounting and
auditing is:
A misstatement in the financial statements can be considered material if
knowledge of the misstatement will affect a decision of a reasonable user of the
statements.
Three levels of materiality are used for determining the type of opinion to
issue:
• Amounts are immaterial: A standard unmodified opinion audit report is
appropriate.
• Amounts are material but do not overshadow the financial statements as a
whole: A qualified opinion using “except for” is appropriate.
• Amounts are so material or so pervasive that overall fairness of the
statements is in question: A disclaimer or adverse opinion is appropriate.

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 MATERIALITY (CONT.)
Materiality Decisions
Decisions regarding materiality in specific audit situations involves
judgment on the part of the auditor. These decisions are based on the
following:
• Materiality decisions—Non-GAAP condition
• Dollar amounts compared with a benchmark
• Measurability
• Nature of the item
• Materiality decisions—Scope limitations conditions

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 OBJECTIVE 3-7
Draft appropriately modified opinion
audit reports under a
variety of circumstances.

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 DISCUSSION OF CONDITIONS REQUIRING A
MODIFICATION OF OPINION
Modification of the audit opinion can arise from several different
circumstances:
• Auditor’s Scope Has Been Restricted—
• Caused by the client or by conditions beyond the control of either the
client or the auditor.
• A scope restriction can lead to a qualified report (as illustrated in Figure
3-8) or a disclaimer of opinion (as illustrated in Figure 3-9), depending
on the facts in the situation.
• Statements Are Not in Conformity with GAAP—
• A departure from GAAP may result in a qualified report (as illustrated in
Figure 3-10) or an adverse opinion (as illustrated in Figure 3-11)
depending on the facts in the situation.

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 DISCUSSION OF CONDITIONS REQUIRING A
MODIFICATION OF OPINION (CONT.)

Auditor Is Not Independent

If the auditor is not independent as specified by the AICPA Code of
Professional Conduct, a disclaimer of opinion is required even though
necessary audit procedures were performed. The wording in Figure 3-12
is recommended in this situation.

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 OBJECTIVE 3-8
Determine the appropriate audit
report for a given audit situation.

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AUDITOR’S DECISION PROCESS FOR AUDIT REPORTS
• Determine whether any condition exists requiring a departure from a
standard unmodified opinion report.
• Decide the materiality for each condition.
• Decide the appropriate type of report for the condition, given the
materiality level.
• Write the audit report.
• Determine if more than one condition requiring a departure or
modification exists.
• Table 3-2 summarizes the conditions requiring a departure from a
standard unmodified opinion report.

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 OBJECTIVE 3-9
Understand use of international accounting
and auditing standards by U.S. companies.

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 INTERNATIONAL ACCOUNTING AND AUDITING
STANDARDS
U.S. public companies are required to prepare financial statements that
are filed with the Securities and Exchange Commission (SEC) in
accordance with U.S. GAAP.
An auditor may be engaged to report on financial statements prepared
in accordance with IFRS. In that situation, the auditor refers to those
standards rather than GAAP in the audit report as follows:

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