Reporting Addendum

&
Problems

Non-Audit Engagements
Review services and compilation engagements

What types of companies?

Review standards
i.

Adequate planning and proper execution

ii. Possess or acquire sufficient knowledge of the

business

iii. Plausibility

REVIEW ENGAGEMENT REPORT

To [person engaging the public accountant]:

We have reviewed the balance sheet of XYZ Limited as at 200X, and the
statements of income retained earnings, and cash flows for the year then ended. Our review
was made in accordance with generally accepted standards for review engagements and
accordingly consisted of enquiry, analytical procedures and discussion related to information
supplied to us by the company.
A review does not constitute an audit, and consequently, we do not express an audit opinion on
these financial statements.
Nothing has come to our attention as a result of our review that causes us to believe that these
financial statements are not, in all material respects, in accordance with generally accepted
accounting principles.
Carney, Black and Heath, LLP
Chartered Accountants
Toronto, Canada
Date

Compilation services.

A compilation involves

The purpose

Not intended to provide any assurance

NOTICE TO READER

To [person engaging the public accountant]

We have compiled the balance sheet of Client Limited as at December 31, 200X, and the statements of
income, retained earnings, and cash flows for the [period] then ended from information provided by
management (the proprietor). We have not audited, reviewed or otherwise attempted to verify the accuracy or
completeness of such information. Readers are cautioned that these statements may not be appropriate for
their purposes.
Carney, Black and Heath, LLP
Chartered Accountants
Toronto, Canada
Date

Lack of Independence
I am not independent of X Limited because my spouse owns 25 percent of the shares of the company.

Problem 1:
Types of report. What types of report (unqualified, qualified, adverse, denial) should
the auditors generally issue in each of the following situations?
a.

Client-imposed restrictions limit very significantly the scope of the auditors

procedures.

b.

The auditors decide that it is necessary to make reference in their report of another
public accounting firm (the secondary auditor).

c.

The auditors believe that the financial statements have been stated in conformity
with generally accepted accounting principles in all respects other than a disclosure
of a material uncertainty.

Problem 2:
Rowe & Myers are the primary auditors of Dunbar Electronics. During the audit,
Rowe & Myers engaged Jones & Abbot, an American public accounting firm, to
audit Dunbars wholly owned U.S. subsidiary.
a.

Must Rowe & Myers make reference to the other auditors in their audit report?

b.

Assume that Jones & Abbot issued a qualified report on the U.S. subsidiary. Must
Rowe & Myers include the same qualification in their report on Dunbar electronics?

Problem 3:
While performing your audit of Williams Paper limited, you discover evidence that
indicates that Williams may not have the ability to continue as a going concern.
a.

Discuss the types of information that may indicate a going-concern problem.

b.

Explain the auditors reporting obligation in such situations.

Problem 2-22.
Roscoe, public accountant, has completed the examination of the financial
statements of Excelsior Corporation as of and for the year ended December 31, 2001. Roscoe also
examined and reported on the Excelsior financial statements for the prior year. Roscoe drafted the
following report for 2001.

We have audited the balance sheet and statements of income and retained earnings of
Excelsior Corporation as of December 31, 2001. We conducted our audit in accordance with
generally accepted accounting standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free of misstatement.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly the financial position
of Excelsior Corporation as of December 31, 2001, and the results of its operations for the year then
ended in conformity with generally accepted auditing standards, applied on a basis consistent with
those of the preceding year.
(Signed)
Roscoe, Public Accountant
Other Information:

Excelsior is presenting comparative financial statements.

Excelsior does not wish to present a cash flow statement for either year.

During 2001, Excelsior changed its method of accounting for long-term construction
contracts, properly reflected the effect of the change in the current years financial statements,
and restated the prior years statements. Roscoe is satisfied with Excelsiors justification for
making the change. The change is discussed in footnote 12.

Roscoe was unable to perform normal accounts receivable confirmation procedures, but
alternate procedures were used to satisfy Roscoe as to the existence of the receivables.

Excelsior Corporation is the defendant in a lawsuit, the outcome of which is highly uncertain.
If the case is settled in favour of the plaintiff, Excelsior will be required to pay a substantial
amount of cash which might require the sale of certain capital assets. The litigation and the
possible effects have been properly disclosed in footnote 11.

Excelsior issued debentures on January 31, 1999, in the amount of $10,000,000. The funds
obtained from the issuance were used to finance the expansion of plant facilities. The
debenture agreement restricts the payment of future cash dividends to earnings after
December 31, 2000. Excelsior declined to disclose this essential data in the footnotes to the
financial statements.

Required:
a. Identify and explain any items included in Other Information that need not be part of the
auditors report.
b. Explain the deficiencies in Roscoes auditors report as drafted.

Problem 2-23.
engagement.

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

1.

During your examination of Debold Brothers Ltd., you conclude there is a possibility that
inventory is materially overstated. The client refuses to allow you to expand the scope of your
examination sufficiently to verify whether the balance is actually misstated.

2.

You are auditing Woodcolt Linen Services, Inc., for the first time. Woodcolt has been in
business for several years but has never had an audit before. After the audit is completed, you
conclude that the current year balance sheet is stated correctly in accordance with GAAP. The
client did not authorize you to do test work for any of the previous years.

3.

You were engaged to examine Cutter Steel Corp.s financial statements after the close of the
corporations fiscal year. Because you were not engaged until after the balance sheet date,
you were not able to physically observe inventory, which is very material. On the completion
of your audit, you are satisfied that Cutters financial statements are presented fairly,
including inventory about which you were able to satisfy yourself by the use of alternative
audit procedures.

4.

Four weeks after the year-end date, a major customer of Prince Construction Ltd. Declared
bankruptcy. Because the customer had confirmed the balance due to Prince at the balance
sheet date, management refuses to charge off the account or otherwise disclose the
information. The receivable represents approximately 10 percent of accounts receivable and
20 percent of net earnings before taxes.

5.

You complete the audit of Johnson Department Store Ltd., and, in your opinion, the financial
statements are fairly presented. On the last day of the examination, you discover that one of
your supervisors assigned to the audit had a material investment in Johnson. If you decide no
auditors report can be issued, explain your decision.

6.

Auto Delivery Company Ltd. has a fleet of several trucks. In the past, Auto Delivery had
followed the policy of purchasing all equipment. In the current year, they decided to lease the
trucks. This change in policy is fully disclosed in the notes.

Required:
For each situation, state the type of auditors report that should be issued. If your decision
depends on additional information, state the alternative reports you are considering and the
additional information you need to make the decision.

Problem 2-24.
For the following independent situations, assume you are the audit partner on the engagement.
1. Kieko Corporation has prepared financial statements but has decided to exclude the cash flow
statement. Management explains to you that the users of their financial statements find that
particular statement confusing and prefer not to have it included.
2. Jet Stream Airlines, Inc. has been audited by your firm for ten years. In the past three years
their financial condition has steadily declined. In the current year, for the first time, the current
ratio is below 2:1, which is the minimal requirement specified in Jet Stream's major loan
agreement. You now have reservations about the ability of Jet Stream to continue in operation
for the next year.
3. Approximately 20 percent of the audit for Furtney Farms, Inc. was performed by a

different public accounting firm, selected by you. You have reviewed its working
papers and believe it did an excellent job on its portion of the audit. Nevertheless,
you are unwilling to take complete responsibility for its work.
4. The controller of Fair City Hotels Company Ltd. Will not allow you to confirm the
receivable balance for two of its major customers. The amount of the receivable is
material in relation to Fair Citys financial statements. You are unable to satisfy
yourself as to the receivable balance by alternative procedures.

5.

In the last three months of the current year, Oil Refining Corp. decide to change direction and
go significantly into the oil-drilling business. Management recognizes that this business is
exceptionally risky and could jeopardize the success of its existing refining business, but
there are significant potential rewards. During the short period of operation in drilling, the
company has had three dry wells and no successes. The facts are adequately disclosed in the
footnotes.

Required:
a. For each situation, identify which of the conditions requiring modification of or a deviation
from an unqualified standard report is applicable.
b. State the level of materiality as immaterial, material, or material and pervasive. If you cannot
decide the level of materiality, state the additional information needed to make the decision.
c. Given your answers in parts (a) and (b), identify the appropriate auditors report from the
following:
(1) Unqualified
(2) Qualified opinion only except for
(3) Scope and opinion qualified
(4) Denial
(5) Adverse

Problem 2-25.
The following are independent situations for which you will recommend an appropriate auditors report:
1.

2.

3.

4.

Subsequent to the date of the financial statements as part of the [post-balance sheet date audit procedures, a
public accountant learned of heavy damages to one of a clients two plants due to a recent fire; the loss will not
be reimbursed by insurance. The newspapers described the event in detail. The financial statements and
appended notes prepared by the client did not disclose the loss caused by the fire.
A public accountant is engaged in the examination of the financial statements of a large manufacturing company
with branch offices in may widely separate cities. The public accountant was not able to count the substantial
undeposited cash receipts at the close of business on the last day of the fiscal year at all the branch offices.
As an alternative to this auditing procedure used to verify the accurate cutoff of cash receipts, the public
accountant observed that deposits in transit as shown on the year-end bank reconciliation appeared as credits on
the bank statement on the first business day of the new year. The public accountant was satisfied as to the cutoff
of cash receipts by the use of the alternative procedure.
On January 2, 2002, the Retail Auto Parts Company Limited received a notice from its primary supplier that,
effective immediately, all wholesale prices would be increased by 10 percent. On the basis of the notice, Retail
Auto Parts revalued its December 31, 2001, inventory to reflect the higher costs. The inventory constituted a
material proportion of total assets; however, the effect of the revaluation was material to current assets but not to
total assets or net income. The increase in valuation is adequately disclosed in the footnotes.
During 2001, the research staff of Scientific Research Corporation devoted its entire efforts toward developing a
new pollution-control device. All costs that could be attributed directly to the project were accounted for as
deferred charges and classified on the balance sheet at December 31, 2001, as a noncurrent asset. In the course
of her audit of the corporation's 2001 financial statements, Marika Vlasic, public accountant, found persuasive
evidence that the research conducted to date would probably result in a marketable product. The deferred
research charges are significantly material in relation to both income an total assets.

5.

6.

For the past five years, a public accountant has audited the financial statements of a manufacturing
company. During this period, the examination scope was limited by the client as to the observation of the
annual physical inventory. Since the public accountant considered the inventories to be of a material
amount and he was not able to satisfy himself by other auditing procedures, he was not able to express an
unqualified opinion on the financial statements in each of the five years.
The public accountant was allowed to observe physical inventories for the current year ended December
31, 2001, because the clients banker would no longer accept the qualified auditors reports. In the interest
of economy, the client requested that the public accountant not extend his audit procedures to the inventory
as of January 1, 2001.
During the course of the examination of the financial statements of a corporation for the purpose of
expressing an opinion on the statements, a public accountant is refused permission to inspect the minute
books. The corporation secretary instead offers to give the public accountant a certified copy of all
resolutions and actions relating to accounting matters.

Required:
a. For each situation, identify which of the conditions requiring a deviation from or modification of an
unqualified standard report is applicable.
b. State the level of materiality as immaterial, material, or material and pervasive. If you cannot decide the
level of materiality, state the additional information need to make a decision.
c. Given your answers in parts (a) and (b), identify the appropriate auditors report from the following
alternatives:
(1)
Unqualified standard wording
(2)
Qualified opinion only except for
(3)
Qualified scope and opinion
(4)
Denial
(5)
Adverse

Problem 2-28. The following are two unrelated situations:

1.

You are the auditor of Xact Ltd., a company which at December 31, 2001, had working capital of
$200,000, total assets of $2,500,000, and total liabilities of $2,200,000. During the three years ended
December 31, 2001, the company has sustained operating losses totaling $700,000.
Management has been informed that Butler Inc. will not renew a debenture they hold issued by Xact in
the amount of $500,000 and maturing September 30,2002. The debenture is presently classed as a longterm liability. Although preliminary discussions have already been held with various commercial
lenders, it presently appears uncertain as to whether Xact will be able to refinance this debt. In
addition, it appears doubtful that Xact will be able to obtain short-term borrowing to finance the debt.

2.

Your client, Bat Ltd., owns 15 percent of the shares of Bird Ltd. The 2001 pre-tax net income of Bat is
$1,000,000 and its shareholder's equity is $3,000,000.
The investment in Bird is carried on Bats balance sheet (as of December 31, 2001) at $250,000, which
represents original cost. Bird has incurred significant loses in the past few years. A current appraisal by
a qualified business valuator indicates that the current market value of 100 percent of the issued and
outstanding shares of Bird is $1,000,000. You are also aware that an investor who held 20 percent of
the shares of Bird recently sold those shares for $180,000.
Your client, Bat Ltd., insists that the shares be shown at their original cost of $250,000 but is willing to
expand note disclosure.

Required:
a.
Outline possible deviations (if any) from a standard auditors report that may be necessary, and give
reasons. State your assumptions.
b.
Outline the minimum note disclosure you would consider in the circumstances. What additional
disclosure would be desirable?

Problem 2-32. The following is an auditors report, except for the opinion paragraph,
of Tri-Nation Corp.
We have audited the accompanying consolidated balance sheet of Tri-Nation Corp. and
subsidiaries as of July 31, 1999, and the related statements of income, shareholders equity, and
cash flow for the year then ended. These financial statements are the responsibility of
management. Our responsibility is to express an opinion on these financial statements based on
our audit.
Except as explained in the following paragraph, we conducted our audit in accordance with
generally accepted auditing standards. Those standards require that we plan and perform an audit
to obtain a reasonable assurance as to whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the overall financial
statement presentation.
The company had significant deficiencies in internal control, including the lack of detailed
records and certain supporting data which were not available for our examination. Therefore, we
were not able to obtain sufficient evidence in order to form an opinion on the accompanying
financial statements, including whether the inventory at July 31, 1999, ($670,490) was stated at
lower of cost or market, or whether the deferred subscription revenue ($90,260) is an adequate
estimate for the applicable liability, as discussed in notes 5 and 12, respectively.

Required:
Write the opinion paragraph for this auditors report. State any assumptions you have
made.