Chapter 3 Solutions Manual

Chapter 3 Audit Reports  Review Questions 3-1 Auditor's reports are important to users of financial statements because they inform users of the auditor's opinion as to whether or not the statements are fairly stated or whether no conclusion can be made with regard to the fairness of their presentation. Users especially look for any deviation from the wording of the standard unqualified report and the reasons and implications of such deviations. Having standard wording improves communications for the benefit of users of the auditor’s report. When there are departures from the standard wording, users are more likely to recognize and consider situations requiring a modification or qualification to the auditor’s report or opinion. 3-2 The unqualified audit report consists of: 1. 2. 3. 4. 5. 6. 7. Report title Auditing standards require that the report be titled and that the title includes the word independent. Audit report address The report is usually addressed to the company, its stockholders, or the board of directors. Introductory paragraph The first paragraph of the report does three things: first, it makes the simple statement that the CPA firm has done an audit. Second, it lists the financial statements that were audited, including the balance sheet dates and the accounting periods for the income statement and statement of cash flows. Third, it states that the statements are the responsibility of management and that the auditor's responsibility is to express an opinion on the statements based on an audit. Scope paragraph. The scope paragraph is a factual statement about what the auditor did in the audit. The remainder briefly describes important aspects of an audit. Opinion paragraph. The final paragraph in the standard report states the auditor's conclusions based on the results of the audit. Name of CPA firm. The name identifies the CPA firm or practitioner who performed the audit. Audit report date. The appropriate date for the report is the end of fieldwork, when the auditor has gathered sufficient appropriate evidence to support the opinion. The same seven parts are found in a qualified report as in an unqualified report. There are also often one or more additional paragraphs explaining reasons for the qualifications. 3-3 The purposes of the scope paragraph in the auditor's report are to inform the financial statement users that the audit was conducted in accordance with generally accepted auditing standards, in general terms what those standards mean, and whether the audit provides a reasonable basis for an opinion. 3-1 3-3 (continued) The information in the scope paragraph includes: 1. The auditor followed generally accepted auditing standards. 2. The audit is designed to obtain reasonable assurance about whether the statements are free of material misstatement. 3. Discussion of the audit evidence accumulated. 4. Statement that the auditor believes the evidence accumulated was appropriate for the circumstances to express the opinion presented. 3-4 The purpose of the opinion paragraph is to state the auditor's conclusions based upon the results of the audit evidence. The most important information in the opinion paragraph includes: 1. The words "in our opinion" which indicate that the conclusions are based on professional judgment. 2. A restatement of the financial statements that have been audited and the dates thereof or a reference to the introductory paragraph. 3. A statement about whether the financial statements were presented fairly and in accordance with generally accepted accounting principles. 3-5 The auditor's report should be dated February 17, 2008, the date on which the auditor completed the most important auditing procedures in the field. 3-6 An unqualified circumstances: report may be issued under the following five 1. All statements—balance sheet, income statement, statement of retained earnings, and statement of cash flows—are included in the financial statements. 2. The three general standards have been followed in all respects on the engagement. 3. Sufficient evidence has been accumulated and the auditor has conducted the engagement in a manner that enables him or her to conclude that the three standards of field work have been met. 4. The financial statements are presented in accordance with generally accepted accounting principles. This also means that adequate disclosures have been included in the footnotes and other parts of the financial statements. 5. There are no circumstances requiring the addition of an explanatory paragraph or modification of the wording of the report. 3-2 3-7 The introductory, scope and opinion paragraphs are modified to include reference to management’s report on internal control over financial reporting, and the scope of the auditor’s work and opinion on internal control over financial reporting. The introductory and opinion paragraphs also refer to the framework used to evaluate internal control. Two additional paragraphs are added between the scope and opinion paragraphs that define internal control and describe the inherent limitations of internal control. 3-8 When adherence to generally accepted accounting principles would result in misleading financial statements there should be a complete explanation in a separate paragraph. The separate paragraph should fully explain the departure and the reason why generally accepted accounting principles would have resulted in misleading statements. The opinion should be unqualified, but it should refer to the separate paragraph during the portion of the opinion in which generally accepted accounting principles are mentioned. 3-9 An unqualified report with an explanatory paragraph or modified wording is the same as a standard unqualified report except that the auditor believes it is necessary to provide additional information about the audit or the financial statements. For a qualified report, either there is a scope limitation (condition 1) or a failure to follow generally accepted accounting principles (condition 2). Under either condition, the auditor concludes that the overall financial statements are fairly presented. Two examples of an unqualified report with an explanatory paragraph or modified wording are: 1. 2. The entity changed from one generally accepted accounting principle to another generally accepted accounting principle. A shared report involving the use of other auditors. 3-10 When another CPA has performed part of the audit, the primary auditor issues one of the following types of reports based on the circumstances. 1. 2. 3. No reference is made to the other auditor. This will occur if the other auditor audited an immaterial portion of the statement, the other auditor is known or closely supervised, or if the principal auditor has thoroughly reviewed the other auditor's work. Issue a shared opinion in which reference is made to the other auditor. This type of report is issued when it is impractical to review the work of the other auditor or when a portion of the financial statements audited by the other CPA is material in relation to the total. The report may be qualified if the principal auditor is not willing to assume any responsibility for the work of the other auditor. A disclaimer may be issued if the segment audited by the other CPA is highly material. 3-3 3-11 Even though the prior year statements have been restated to enhance comparability, a separate explanatory paragraph is required to explain the change in generally accepted accounting principles in the first year in which the change took place. 3-12 Changes that affect the consistency of the financial statements may involve any of the following: a. Change in accounting principle b. Change in reporting entity c. Corrections of errors involving accounting principles. An example of a change that affects consistency would be a change in the method of computing depreciation from straight line to an accelerated method. A separate explanatory paragraph is required if the amounts are material. Comparability refers to items such as changes in estimates, presentation, and events rather than changes in accounting principles. For example, a change in the estimated life of a depreciable asset will affect the comparability of the statements. In that case, no explanatory paragraph for lack of consistency is needed, but the information may require disclosure in the statements. 3-13 The three conditions requiring a departure from an unqualified opinion are: 1. 2. 3. The scope of the audit has been restricted. One example is when the client will not permit the auditor to confirm material receivables. Another example is when the engagement is not agreed upon until after the client's year-end when it may be impossible to physically observe inventories. The financial statements have not been prepared in accordance with generally accepted accounting principles. An example is when the client insists upon using replacement costs for fixed assets. The auditor is not independent. An example is when the auditor owns stock in the client's business. 3-14 A qualified opinion states that there has been either a limitation on the scope of the audit or a departure from GAAP in the financial statements, but that the auditor believes that the overall financial statements are fairly presented. This type of opinion may not be used if the auditor believes the exceptions being reported upon are extremely material, in which case a disclaimer or adverse opinion would be used. An adverse opinion states that the auditor believes the overall financial statements are so materially misstated or misleading that they do not present fairly in accordance with GAAP the financial position, results of operations, or cash flows. A disclaimer of opinion states that the auditor has been unable to satisfy him or herself as to whether or not the overall financial statements are fairly presented because of a significant limitation of the scope of the audit, or a nonindependent relationship under the Code of Professional Conduct between the auditor and the client. 3-4 3.14 (continued) Examples of situations that are appropriate for each type of opinion are as follows: OPINION TYPE Disclaimer EXAMPLE SITUATION Material physical inventories not observed and the inventory cannot be verified through other procedures. Lack of independence by the auditor. Adverse A highly material departure from GAAP. Qualified Inability to confirm the existence of an asset which is material but not extremely material in value. 3-15 The common definition of materiality as it applies to accounting and, therefore, to audit reporting is: A misstatement in the financial statements can be considered material if knowledge of the misstatement would affect a decision of a reasonable user of the statements. Conditions that affect the auditor's determination of materiality include:    Potential users of the financial statements Dollar amounts of the following items: net income before taxes, total assets, current assets, current liabilities, and owners' equity Nature of the potential misstatements—certain misstatements, such as fraud, are likely to be more important to users of the financial statements than other misstatements. 3-16 Materiality for lack of independence in audit reporting is easiest to define. If the auditor lacks independence as defined by the Code of Professional Conduct, it is always considered highly material and therefore a disclaimer of opinion is always necessary. That is, either the CPA is independent or not independent. For failure to follow GAAP, there are three levels of materiality: immaterial, material, and highly material. 3-17 The auditor's opinion may be qualified by scope limitations caused by client restrictions or by limitations resulting from conditions beyond the client's control. The former occurs when the client will not, for example, permit the auditor to confirm material receivables or physically observe inventories. The latter may occur when the engagement is not agreed upon until after the client's year-end when it may not be possible to physically observe inventories or confirm receivables. 3-5 3-17 (continued) A disclaimer of opinion is issued if the scope limitation is so material that the auditor cannot determine if the overall financial statements are fairly presented. If the scope limitation is caused by the client's restriction the auditor should be aware that the reason for the restriction might be to deceive the auditor. For this reason, a disclaimer is more likely for client restrictions than for conditions beyond anyone's control. When there is a scope restriction that results in the failure to verify material, but not pervasive accounts, a qualified opinion may be issued. This is more likely when the scope limitation is for conditions beyond the client's control than for restrictions by the client. 3-18 A report with a scope and an opinion qualification is issued when the auditor can neither perform procedures that he or she considers necessary nor satisfy him or herself by using alternative procedures, usually due to the existence of conditions beyond the client's or the auditor's control, but the amount involved in the financial statements is not highly material. An important part of a scope and opinion qualification is that it results from not accumulating sufficient audit evidence, either because of the client's request or because of circumstances beyond anyone's control. A report qualified as to opinion only results when the auditor has accumulated sufficient appropriate evidence but has concluded that the financial statements are not correctly stated. The only circumstance in which an opinion only qualification is appropriate is for material, but not highly material, departures from GAAP. 3-19 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. 3-20 The AICPA has such strict requirements on audit opinions when the auditor is not independent because it is important that stockholders and other third parties be absolutely assured that the auditor is unbiased throughout the entire engagement. If users develop the attitude that auditors are not independent of management, the value of the audit function will be greatly reduced, if not eliminated. 3-21 When the auditor discovers more than one condition that requires a departure from or a modification of a standard unqualified report, the report should be modified for each condition. An exception is when one condition neutralizes the other condition. An example would be when the auditor is not independent and there is also a scope limitation. In this situation the lack of independence overshadows the scope limitation. Accordingly, the scope limitation should not be mentioned. 3-6 3-22 Under current auditing standards, auditors are not required to read information contained in electronic sites, such as the company’s Web site, that also contain the company’s audited financial statements and the auditor’s report. Auditing standards do not consider electronic sites to be “documents.” This is different from the auditor’s responsibility for published (hard copy) documents that contain information in addition to audited financial statements and the auditor’s report. In this latter example, the auditor is responsible for reading other information that is published with audited financial statements and the auditor’s report to determine whether it is materially inconsistent with information in the audited financial statements.  Multiple Choice Questions From CPA Examinations 3-23 a. (2) b. (3) c. (3) 3-24 a. (3) b. (4) c. (1) 3-25 a. (2) b. (3) c. (3)  Discussion Questions and Problems 3-26 a. "Correctly stated" implies absolute accuracy, whereas the alternative report states that no material misstatements exist. b. The reference to generally accepted accounting principles specifies rules that were followed in accounting for the transactions to date; whereas "the true economic conditions" does not identify the specific accounting procedures applied. c. The opinion paragraph is not intended to be a certification or a guarantee of the accuracy and correctness of the financial statements, but rather is intended to be an expression of professional judgment based upon a reasonable audit of the statements and underlying records. d. The name of the CPA firm rather than that of the individual practitioner should appear on the accountant's report because it is the entire firm that accepts responsibility for the report issued. e. "Our audit was performed to detect material misstatements in the financial statements" is flawed because the purpose of the audit is to determine whether financial statements are fairly stated, not to specifically search for material errors and fraud. It also fails to recognize the audit standards followed by the auditor. "We conducted our audit in accordance with auditing standards generally accepted in the United States of America" identifies the auditor's responsibilities for conduct of the audit, accumulation of evidence and reporting requirements. It is a much broader statement than the alternative clause. It also implies that if the auditor has conducted the audit in accordance with generally accepted auditing standards but does not uncover certain material errors or fraud, the auditor is unlikely to have responsibility for failing to do so. 3-7 3-27 a. 1. 2. 3. 4. Items that need not be included in the auditor's report are: That Optima is presenting comparative financial statements. (Both years' statements will be referred to in the audit report.) Specific description of the change in method of accounting for longterm construction contracts need not be included in the report since it is discussed in the footnotes. The auditor's report must state that there is a change in accounting principles and refer to the footnote. The fact that normal receivable confirmation procedures were not used should not be disclosed since the auditor was able to satisfy him or herself through alternate audit procedures. The lawsuit need not be discussed in the report since it has been included in a footnote. [Note: prior to the issuance of SAS 79, the auditor would have been required to add an explanatory paragraph to the audit report that referred to the footnote.] b. The following deficiencies are in Allison's report: 1. 2. 3. 4. 5. 6. 7. 8. The audit report is neither addressed nor dated and it does not contain a title. The audit report date should be the last day of field work. The balance sheet is as of a specific date, whereas the income statement and the statement of retained earnings are for a period of time. The scope paragraph should identify the period of time (usually one year). There are comparative statements, but the audit report identifies and deals with only the current year's financial statements. An opinion must also be included for the prior period financial statements. There is no separate introductory paragraph that states the financial statements audited, dates, and the responsibilities of management and the auditor. There is no separate scope paragraph that describes what an audit is. Two required sentences are completely omitted: "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 audit was made in accordance with auditing standards generally accepted in the United States of America rather than generally accepted accounting standards. The word material is excluded from the scope paragraph (free of material misstatement). An additional paragraph should be included which describes the dividend restrictions and the refusal of the client to present a statement of cash flows. 3-8 3-27 (continued) 9. 10. 11. 12. 13. The opinion paragraph states that accounting principles were consistent with those used in the prior year. The opinion paragraph should make no reference to consistency. The opinion paragraph excludes the required phrase, "in all material respects." The opinion paragraph includes the words "generally accepted auditing standards" rather than the phrase " accounting principles generally accepted in the United States of America." A separate paragraph should be included stating that generally accepted accounting principles were not consistently applied. The opinion should be qualified rather than being unqualified. Qualifications are caused by the: (a) failure to present a statement of cash flows. (b) failure to disclose the dividend restrictions. 3-9 3-28 (a) (b) MATERIALITY LEVEL Highly material (c) TYPE OF REPORT Disclaimer Highly material or material. We need additional information regarding the auditor's preliminary judgment about materiality Not applicable Adverse (if highly material) or Qualified (if material) Not applicable Unqualified 5. Scope of the audit has been restricted Highly material Disclaimer 6. Scope of the audit has been restricted Highly material Unqualified CONDITION 1. Scope of the audit has been restricted 2. Failure to follow GAAP 3. Lack of independence 4 None Disclaimer 3-10 COMMENTS Because the client refuses to allow the auditor to expand the scope of his audit, a disclaimer of opinion is appropriate rather than a qualified as to scope and opinion. The materiality of twenty percent of net earnings before taxes would be sufficient for many auditors to require an adverse opinion. That materiality question is a matter of auditor judgment. Lack of independence by audit personnel on the engagement mandates a disclaimer for lack of independence. The company has made a decision to follow a different financing method, which is adequately disclosed. There is no change of accounting principle. The auditor cannot issue an unqualified opinion on the income statement or the statement of cash flows because a disclaimer of opinion is necessary for the beginning balance sheet. The auditor may issue an unqualified opinion on the ending balance sheet and a disclaimer of opinion on the income statement, statement of cash flows, and the beginning balance sheet. The auditor is able to satisfy him or herself that with the use of alternative procedures, a qualified opinion is not necessary. 3-29 (a) (b) MATERIALITY LEVEL Highly material (c) TYPE OF REPORT Disclaimer 2. None Not applicable Unqualified— standard wording 3. None Immaterial 4. Failure to follow GAAP Material Unqualified— standard wording Qualified opinion only —except for 5. Substantial doubt about going concern Material Unqualified— explanatory paragraph 6. Report involving other auditors Material Unqualified— modified wording CONDITION 1. Scope of the audit has been restricted 3-11 (d) MODIFIED WORDING / ADDITIONAL PARAGRAPHS (& OTHER COMMENTS) The client has restricted the scope of the audit and the auditor was not able to satisfy him or herself by alternative procedures. Because it was a client restriction rather than a condition beyond the client’s control causing the limitation, and because the limitation is highly material, a disclaimer is appropriate. Introductory paragraph is modified, second paragraph is added describing the scope restriction, scope paragraph is omitted, and opinion paragraph is a disclaimer of opinion. There is no indication questioning the ability of the business to continue operations. The auditor does not automatically add an explanatory paragraph simply because there is a risky business. The amount is immaterial. The facts are adequately disclosed in the footnote. The standards require the use of a qualified opinion for the failure to include a statement of cash flows. Third paragraph must be added stating the omission. There is a question about the ability of the company to continue as a going concern. The auditor therefore must issue an unqualified report with an explanatory paragraph following the opinion. This is a shared audit report in which the auditor will identify the portion of work done by the other auditor in the introductory paragraph and still issue an unqualified opinion. The absolute dollar amounts of assets and revenues or percentages must be stated in the introductory paragraph. Introductory paragraph, scope paragraph, and opinion paragraph are all modified. 3-30 (a) CONDITION 1. Failure to follow GAAP. 2. Failure to follow GAAP. 3. Scope of the audit has been restricted. (b) MATERIALITY LEVEL Highly material or material, depending upon the amount of the loss and the auditor's preliminary judgment about materiality Immaterial Highly material or material, depending upon the auditor’s preliminary judgment about materiality. (c ) TYPE OF REPORT Adverse (if highly material) or (4) Qualified opinion only —except for (if material) Unqualified— standard wording Disclaimer (if highly material) or Qualified scope and opinion (if material) 4. Scope of the audit has been restricted. Highly material Disclaimer 5. Scope of the audit has been restricted. Not applicable Unqualified— standard wording 6 Material Qualified opinion only—except for Not applicable Unqualified— standard wording .Failure to follow GAAP. 7. None 3-12 COMMENT Disclosure of this information is required in a footnote. Failure to do so is a violation of GAAP and is likely to result in a qualified opinion, or it could be so material that it requires an adverse opinion. The amount is immaterial. Because the auditor was unable to satisfy himself about beginning inventories, it would be necessary to issue either a qualified or disclaimer of opinion on the income statement and statement of cash flows as well as the beginning balance sheet. The use of a qualified or disclaimer would depend upon materiality. An unqualified opinion could be issued for the current period balance sheet. Failure of the client to allow the auditor to inspect the minutes book would be a material clientimposed restriction. Due to the importance of the minutes book, a disclaimer would be necessary. The certified copy of all resolutions and actions would not be a satisfactory alternative procedure. Because the auditor was able to obtain alternative evidence, no scope qualification is necessary. If there were such a qualification, it would be a qualified scope and opinion or a disclaimer, depending on materiality. Retail Auto Parts has used a replacement cost inventory rather than lower of cost or market. It is not sufficiently material to require an adverse opinion. The change of estimated life is a change of condition and not a change in accounting principles. Therefore, an unqualified opinion is appropriate since there is adequate disclosure. 3-31 ITEM NO. 1 2 3 4 5 TYPE OF CHANGE An error correction not involving an accounting principle. An accounting change involving a correction of an error in principle, which is accounted for as a correction of an error. An accounting change involving a change in the reporting entity, which is a special type of change in accounting principles. An accounting change involving both a change in accounting principle and a change in accounting estimate. Although the effect of the change in each may be inseparable and the accounting for such a change is the same as that for a change in estimate only, an accounting principle is involved. An accounting change involving a change from one generally accepted accounting principle to another generally accepted accounting principle. SHOULD AUDITOR'S REPORT BE MODIFIED? No Yes Yes Yes Yes 6 An accounting change involving a change in an accounting estimate. No 7 Not an accounting change but rather a change in classification. No 8 An accounting change from one generally accepted accounting principle to another generally accepted accounting principle. Yes 3-32 The following opinion should be issued: Because there were significant deficiencies in internal control that resulted in the lack of detailed records and other supporting data being available for our audit, the scope of our work was not sufficient to enable us to express, and we do not express, an opinion on these financial statements. The opinion paragraph should immediately follow the paragraph that discusses the scope restriction. 3-13 3-33 Deficiencies in the staff accountant's tentative report include the following: 1. Report title must include the word “independent.” 2. The report should generally be addressed to the board of directors or stockholders, not to the audit committee. 3. The introductory paragraph should state, "we have audited," not "we have examined." 4. When the principal auditor decides to make reference to the audit of another auditor, the report should indicate clearly in the introductory paragraph the division of responsibility regarding the portions of the financial statements audited by each. Also, the opinion paragraph should state that the opinion is based in part on the reports of other auditors. Neither of these was done. 5. When the principal auditor decides to make reference to the audit of the other auditor, the report should disclose the dollar amounts or percentages of the portion of the financial statements audited by the other auditor. This was not done. 6. The second paragraph is an inappropriately worded scope paragraph. It should be stated as follows: We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about 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. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion. 7. Although the introductory paragraph referred to an audit of the financial statements for the years ended December 31, 2007 and 2006, an opinion was expressed only on the 2007 financial statements. 8. The statement of cash flows was not identified in the opinion paragraph, and financial statements were not referred to in the opinion paragraph as "consolidated." 9. The explanatory sentence for consistency should follow the opinion paragraph, not precede it. Also, the second sentence in the third paragraph should be omitted. 10. There is no inclusion of the phrase, "in all material respects" in the opinion paragraph. 3-14  Internet Problem Solution: Research Annual Reports 3-1 The U.S. Securities and Exchange Commission (SEC) makes available in electronic form via the Internet most of the forms and reports it receives from publicly traded companies through EDGAR. This problem explores information available on the SEC’s Web site. 1. The EDGAR Web site describes many SEC-required forms. Find and describe the following SEC forms: Answer:    Form 8-K - This is the form that must be filed whenever a registrant encounters a significant event (e.g., a change in control of ownership, disposition or acquisition of a significant amount of assets, filing for bankruptcy, change in independent auditors). Form 10-K - This is the annual report that most reporting companies file with the Commission. It provides a comprehensive overview of the registrant's business. The report must be filed within 90 days after the end of the company's fiscal year. This form is required by the Securities Exchange Act of 1934. Form 10-KSB - This is the annual report filed by reporting "small business issuers." It provides a comprehensive overview of the company's business, although its requirements call for slightly less detailed information than required by Form 10-K. The report must be filed within 90 days after the end of the company's fiscal year. 2. Search EDGAR for the 10-K filings of the three companies listed below. Within the 10-K filings locate the independent auditor's report and identify what type of opinion it is (e.g., unqualified, qualified, disclaimer, adverse) and what type of explanatory paragraph, if any, the opinion contains (e.g., consistency, going concern, emphasis). (Hint: You may be able to search the company’s 10-K by using the Internet browser's "Find" command typically located in the "Edit" menu.) Answer:  General Motors Corporation (10-K filed 3-13-2003) Unqualified audit report with an explanatory paragraph due to a change in accounting principle We have audited the Consolidated Balance Sheets of General Motors Corporation and subsidiaries as of December 31, 2002 and 2001, and the related Consolidated Statements of Income, Cash Flows, and Stockholders' Equity for each of the three years in the period ended December 31, 2002. Our audits also included the Supplemental Information to the Consolidated Balance Sheets and Consolidated Statements of Income and Cash Flows and financial statement schedule listed at Item 15 (collectively, the financial 3-15 3-1 (continued) statement schedules). These financial statements and the financial statement schedules are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about 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. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of General Motors Corporation and subsidiaries at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. As discussed in Note 1 to the financial statements, effective January 1, 2002, General Motors Corporation changed its method of accounting for goodwill and other intangible assets to conform to Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets." DELOITTE & TOUCHE LLP Detroit, Michigan January 16, 2003 (March 12, 2003, as to Note 26)  Ford Motor Company (10-K filed 3-14-2003) - Unqualified audit report with an explanatory paragraph due to a change in accounting principle In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income, stockholders' equity and cash flows present fairly, in all material respects, the financial position of Ford Motor Company and its subsidiaries at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31 , 2002 in conformity with accounting principles 3-16 3-1 (continued) generally accepted in the United States of America. In addition, in our opinion, the accompanying sector balance sheet and the related sector statements of income and cash flows, presented for purposes of additional analysis, present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. The consolidated and sector financial statements (collectively, the "financial statements") are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 7 to the consolidated financial statements, on January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets", which changed the method of accounting for goodwill and other intangible assets. In addition, as discussed in Note 3 to the consolidated financial statements, on January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which changed the method of accounting for discontinued operations. Also, as discussed in Note 17 to the consolidated financial statements, on January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities". PricewaterhouseCoopers LLP Detroit, Michigan January 17, 2003  The Home Depot (10-K filed 4-21-2003) - Unqualified audit report We have audited the accompanying consolidated balance sheets of The Home Depot, Inc. and subsidiaries as of February 2, 2003 and February 3, 2002 and the related consolidated statements of earnings, stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended February 2, 2003. These consolidated financial 3-17 3-1 (continued) statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about 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. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Home Depot, Inc. and subsidiaries as of February 2, 2003 and February 3, 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended February 2, 2003, in conformity with accounting principles generally accepted in the United States of America. KPMG LLP Atlanta, Georgia February 24, 2003 (Note: Internet problems address current issues using Internet sources. Because Internet sites are subject to change, Internet problems and solutions may change. Current information on Internet problems is available at www.prenhall.com/arens). 3-18
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Chapter 3

Audit Reports

Review Questions

3-1
Auditor's reports are important to users of financial statements because
they inform users of the auditor's opinion as to whether or not the statements are
fairly stated or whether no conclusion can be made with regard to the fairness of
their presentation. Users especially look for any deviation from the wording of the
standard unqualified report and the reasons and implications of such deviations.
Having standard wording improves communications for the benefit of users of the
auditor’s report. When there are departures from the standard wording, users are
more likely to recognize and consider situations requiring a modification or
qualification to the auditor’s report or opinion.
3-2

The unqualified audit report consists of:
1.
2.
3.

4.
5.
6.
7.

Report title Auditing standards require that the report be titled and
that the title includes the word independent.
Audit report address The report is usually addressed to the
company, its stockholders, or the board of directors.
Introductory paragraph The first paragraph of the report does three
things: first, it makes the simple statement that the CPA firm has
done an audit. Second, it lists the financial statements that were
audited, including the balance sheet dates and the accounting
periods for the income statement and statement of cash flows.
Third, it states that the statements are the responsibility of
management and that the auditor's responsibility is to express an
opinion on the statements based on an audit.
Scope paragraph. The scope paragraph is a factual statement
about what the auditor did in the audit. The remainder briefly
describes important aspects of an audit.
Opinion paragraph. The final paragraph in the standard report
states the auditor's conclusions based on the results of the audit.
Name of CPA firm. The name identifies the CPA firm or practitioner
who performed the audit.
Audit report date. The appropriate date for the report is the end of
fieldwork, when the auditor has gathered sufficient appropriate
evidence to support the opinion.

The same seven parts are found in a qualified report as in an unqualified
report. There are also often one or more additional paragraphs explaining
reasons for the qualifications.
3-3
The purposes of the scope paragraph in the auditor's report are to inform
the financial statement users that the audit was conducted in accordance with
generally accepted auditing standards, in general terms what those standards
mean, and whether the audit provides a reasonable basis for an opinion.
3-1

This also means that adequate disclosures have been included in the footnotes and other parts of the financial statements. The three general standards have been followed in all respects on the engagement. 4. The most important information in the opinion paragraph includes: 1. 3-2 . 2. 3-6 An unqualified circumstances: report may be issued under the following five 1. 4. 2. The financial statements are presented in accordance with generally accepted accounting principles. statement of retained earnings. Statement that the auditor believes the evidence accumulated was appropriate for the circumstances to express the opinion presented. 3. A restatement of the financial statements that have been audited and the dates thereof or a reference to the introductory paragraph. Discussion of the audit evidence accumulated. 2008. 5. The auditor followed generally accepted auditing standards. 2. The words "in our opinion" which indicate that the conclusions are based on professional judgment. 3. income statement. and statement of cash flows—are included in the financial statements. All statements—balance sheet. Sufficient evidence has been accumulated and the auditor has conducted the engagement in a manner that enables him or her to conclude that the three standards of field work have been met. The audit is designed to obtain reasonable assurance about whether the statements are free of material misstatement. 3-4 The purpose of the opinion paragraph is to state the auditor's conclusions based upon the results of the audit evidence. 3. 3-5 The auditor's report should be dated February 17. There are no circumstances requiring the addition of an explanatory paragraph or modification of the wording of the report.3-3 (continued) The information in the scope paragraph includes: 1. A statement about whether the financial statements were presented fairly and in accordance with generally accepted accounting principles. the date on which the auditor completed the most important auditing procedures in the field.

and the scope of the auditor’s work and opinion on internal control over financial reporting. 3-8 When adherence to generally accepted accounting principles would result in misleading financial statements there should be a complete explanation in a separate paragraph. Under either condition. either there is a scope limitation (condition 1) or a failure to follow generally accepted accounting principles (condition 2). The entity changed from one generally accepted accounting principle to another generally accepted accounting principle.3-7 The introductory. The opinion should be unqualified. 2. No reference is made to the other auditor. The report may be qualified if the principal auditor is not willing to assume any responsibility for the work of the other auditor. 1. the auditor concludes that the overall financial statements are fairly presented. 3. but it should refer to the separate paragraph during the portion of the opinion in which generally accepted accounting principles are mentioned. 3-10 When another CPA has performed part of the audit. Issue a shared opinion in which reference is made to the other auditor. Two examples of an unqualified report with an explanatory paragraph or modified wording are: 1. scope and opinion paragraphs are modified to include reference to management’s report on internal control over financial reporting. A shared report involving the use of other auditors. A disclaimer may be issued if the segment audited by the other CPA is highly material. The separate paragraph should fully explain the departure and the reason why generally accepted accounting principles would have resulted in misleading statements. This type of report is issued when it is impractical to review the work of the other auditor or when a portion of the financial statements audited by the other CPA is material in relation to the total. The introductory and opinion paragraphs also refer to the framework used to evaluate internal control. the primary auditor issues one of the following types of reports based on the circumstances. This will occur if the other auditor audited an immaterial portion of the statement. 2. or if the principal auditor has thoroughly reviewed the other auditor's work. 3-9 An unqualified report with an explanatory paragraph or modified wording is the same as a standard unqualified report except that the auditor believes it is necessary to provide additional information about the audit or the financial statements. the other auditor is known or closely supervised. For a qualified report. Two additional paragraphs are added between the scope and opinion paragraphs that define internal control and describe the inherent limitations of internal control. 3-3 .

3-13 The three conditions requiring a departure from an unqualified opinion are: 1. This type of opinion may not be used if the auditor believes the exceptions being reported upon are extremely material. 3-14 A qualified opinion states that there has been either a limitation on the scope of the audit or a departure from GAAP in the financial statements. presentation. An example of a change that affects consistency would be a change in the method of computing depreciation from straight line to an accelerated method. in which case a disclaimer or adverse opinion would be used. Change in reporting entity c. no explanatory paragraph for lack of consistency is needed. An example is when the auditor owns stock in the client's business. In that case. but the information may require disclosure in the statements. results of operations. Comparability refers to items such as changes in estimates. 2. 3-12 Changes that affect the consistency of the financial statements may involve any of the following: a. An example is when the client insists upon using replacement costs for fixed assets. The auditor is not independent. Corrections of errors involving accounting principles. a separate explanatory paragraph is required to explain the change in generally accepted accounting principles in the first year in which the change took place. and events rather than changes in accounting principles. 3. An adverse opinion states that the auditor believes the overall financial statements are so materially misstated or misleading that they do not present fairly in accordance with GAAP the financial position. or a nonindependent relationship under the Code of Professional Conduct between the auditor and the client. Another example is when the engagement is not agreed upon until after the client's year-end when it may be impossible to physically observe inventories. 3-4 .3-11 Even though the prior year statements have been restated to enhance comparability. The financial statements have not been prepared in accordance with generally accepted accounting principles. but that the auditor believes that the overall financial statements are fairly presented. or cash flows. One example is when the client will not permit the auditor to confirm material receivables. The scope of the audit has been restricted. Change in accounting principle b. a change in the estimated life of a depreciable asset will affect the comparability of the statements. For example. A disclaimer of opinion states that the auditor has been unable to satisfy him or herself as to whether or not the overall financial statements are fairly presented because of a significant limitation of the scope of the audit. A separate explanatory paragraph is required if the amounts are material.

such as fraud. 3-15 The common definition of materiality as it applies to accounting and. 3-17 The auditor's opinion may be qualified by scope limitations caused by client restrictions or by limitations resulting from conditions beyond the client's control. current liabilities. and highly material. for example. The former occurs when the client will not. Conditions that affect the auditor's determination of materiality include:    Potential users of the financial statements Dollar amounts of the following items: net income before taxes. 3-16 Materiality for lack of independence in audit reporting is easiest to define. For failure to follow GAAP. and owners' equity Nature of the potential misstatements—certain misstatements.14 (continued) Examples of situations that are appropriate for each type of opinion are as follows: OPINION TYPE Disclaimer EXAMPLE SITUATION Material physical inventories not observed and the inventory cannot be verified through other procedures. total assets. therefore.3. permit the auditor to confirm material receivables or physically observe inventories. are likely to be more important to users of the financial statements than other misstatements. If the auditor lacks independence as defined by the Code of Professional Conduct. there are three levels of materiality: immaterial. either the CPA is independent or not independent. The latter may occur when the engagement is not agreed upon until after the client's year-end when it may not be possible to physically observe inventories or confirm receivables. material. to audit reporting is: A misstatement in the financial statements can be considered material if knowledge of the misstatement would affect a decision of a reasonable user of the statements. That is. Lack of independence by the auditor. it is always considered highly material and therefore a disclaimer of opinion is always necessary. Qualified Inability to confirm the existence of an asset which is material but not extremely material in value. current assets. Adverse A highly material departure from GAAP. 3-5 .

3-20 The AICPA has such strict requirements on audit opinions when the auditor is not independent because it is important that stockholders and other third parties be absolutely assured that the auditor is unbiased throughout the entire engagement. A report qualified as to opinion only results when the auditor has accumulated sufficient appropriate evidence but has concluded that the financial statements are not correctly stated. If users develop the attitude that auditors are not independent of management. The only circumstance in which an opinion only qualification is appropriate is for material. For this reason. If the scope limitation is caused by the client's restriction the auditor should be aware that the reason for the restriction might be to deceive the auditor. a qualified opinion may be issued. An important part of a scope and opinion qualification is that it results from not accumulating sufficient audit evidence. a disclaimer is more likely for client restrictions than for conditions beyond anyone's control. usually due to the existence of conditions beyond the client's or the auditor's control. departures from GAAP. A qualified opinion is appropriate when the deviation from GAAP is material but not highly material. 3-21 When the auditor discovers more than one condition that requires a departure from or a modification of a standard unqualified report.3-17 (continued) A disclaimer of opinion is issued if the scope limitation is so material that the auditor cannot determine if the overall financial statements are fairly presented. In this situation the lack of independence overshadows the scope limitation. the scope limitation should not be mentioned. if not eliminated. An exception is when one condition neutralizes the other condition. qualified as to opinion only and adverse opinion. 3-18 A report with a scope and an opinion qualification is issued when the auditor can neither perform procedures that he or she considers necessary nor satisfy him or herself by using alternative procedures. the report should be modified for each condition. Determining which is appropriate depends entirely upon materiality. Accordingly. An example would be when the auditor is not independent and there is also a scope limitation. but not highly material. either because of the client's request or because of circumstances beyond anyone's control. but the amount involved in the financial statements is not highly material. When there is a scope restriction that results in the failure to verify material. This is more likely when the scope limitation is for conditions beyond the client's control than for restrictions by the client. 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). 3-6 . the adverse opinion is appropriate when the deviation is highly material. the value of the audit function will be greatly reduced. but not pervasive accounts. 3-19 The three alternative opinions that may be appropriate when the client's financial statements are not in accordance with GAAP are an unqualified opinion.

(2) b. that also contain the company’s audited financial statements and the auditor’s report. whereas "the true economic conditions" does not identify the specific accounting procedures applied. (3) b. accumulation of evidence and reporting requirements. (1) 3-25 a. "Our audit was performed to detect material misstatements in the financial statements" is flawed because the purpose of the audit is to determine whether financial statements are fairly stated. not to specifically search for material errors and fraud. In this latter example. "We conducted our audit in accordance with auditing standards generally accepted in the United States of America" identifies the auditor's responsibilities for conduct of the audit. (3)  Discussion Questions and Problems 3-26 a. The reference to generally accepted accounting principles specifies rules that were followed in accounting for the transactions to date. It also fails to recognize the audit standards followed by the auditor. (4) c. The opinion paragraph is not intended to be a certification or a guarantee of the accuracy and correctness of the financial statements.3-22 Under current auditing standards. the auditor is unlikely to have responsibility for failing to do so.” This is different from the auditor’s responsibility for published (hard copy) documents that contain information in addition to audited financial statements and the auditor’s report.  Multiple Choice Questions From CPA Examinations 3-23 a. (2) b. e. It is a much broader statement than the alternative clause. auditors are not required to read information contained in electronic sites. (3) 3-24 a. 3-7 . (3) c. d. "Correctly stated" implies absolute accuracy. but rather is intended to be an expression of professional judgment based upon a reasonable audit of the statements and underlying records. the auditor is responsible for reading other information that is published with audited financial statements and the auditor’s report to determine whether it is materially inconsistent with information in the audited financial statements. c. whereas the alternative report states that no material misstatements exist. It also implies that if the auditor has conducted the audit in accordance with generally accepted auditing standards but does not uncover certain material errors or fraud. (3) c. such as the company’s Web site. Auditing standards do not consider electronic sites to be “documents. b. The name of the CPA firm rather than that of the individual practitioner should appear on the accountant's report because it is the entire firm that accepts responsibility for the report issued.

The balance sheet is as of a specific date. 4. The audit report is neither addressed nor dated and it does not contain a title. 2. 2. 3. 6. There is no separate introductory paragraph that states the financial statements audited. Two required sentences are completely omitted: "An audit includes examining. the auditor would have been required to add an explanatory paragraph to the audit report that referred to the footnote.3-27 a. An additional paragraph should be included which describes the dividend restrictions and the refusal of the client to present a statement of cash flows. evidence supporting the amounts and disclosures in the financial statements. There are comparative statements. 7. as well as evaluating the overall financial statement presentation. The scope paragraph should identify the period of time (usually one year). An audit also includes assessing the accounting principles used and significant estimates made by management. 8. Items that need not be included in the auditor's report are: That Optima is presenting comparative financial statements. 4. There is no separate scope paragraph that describes what an audit is. 3-8 . The auditor's report must state that there is a change in accounting principles and refer to the footnote. whereas the income statement and the statement of retained earnings are for a period of time. 3. dates. (Both years' statements will be referred to in the audit report. on a test basis. The following deficiencies are in Allison's report: 1. The lawsuit need not be discussed in the report since it has been included in a footnote. An opinion must also be included for the prior period financial statements.) Specific description of the change in method of accounting for longterm construction contracts need not be included in the report since it is discussed in the footnotes. The word material is excluded from the scope paragraph (free of material misstatement). and the responsibilities of management and the auditor. [Note: prior to the issuance of SAS 79." The audit was made in accordance with auditing standards generally accepted in the United States of America rather than generally accepted accounting standards. The fact that normal receivable confirmation procedures were not used should not be disclosed since the auditor was able to satisfy him or herself through alternate audit procedures. 1. The audit report date should be the last day of field work. but the audit report identifies and deals with only the current year's financial statements.] b. 5.

3-27 (continued) 9. 3-9 . The opinion paragraph should make no reference to consistency." A separate paragraph should be included stating that generally accepted accounting principles were not consistently applied. "in all material respects. 12. (b) failure to disclose the dividend restrictions. 13. Qualifications are caused by the: (a) failure to present a statement of cash flows. 10." The opinion paragraph includes the words "generally accepted auditing standards" rather than the phrase " accounting principles generally accepted in the United States of America. 11. The opinion should be qualified rather than being unqualified. The opinion paragraph excludes the required phrase. The opinion paragraph states that accounting principles were consistent with those used in the prior year.

Lack of independence by audit personnel on the engagement mandates a disclaimer for lack of independence. a disclaimer of opinion is appropriate rather than a qualified as to scope and opinion.3-28 (a) (b) MATERIALITY LEVEL Highly material (c) TYPE OF REPORT Disclaimer Highly material or material. Failure to follow GAAP 3. and the beginning balance sheet. That materiality question is a matter of auditor judgment. Scope of the audit has been restricted Highly material Unqualified CONDITION 1. The auditor is able to satisfy him or herself that with the use of alternative procedures. a qualified opinion is not necessary. The company has made a decision to follow a different financing method. There is no change of accounting principle. The auditor may issue an unqualified opinion on the ending balance sheet and a disclaimer of opinion on the income statement. The auditor cannot issue an unqualified opinion on the income statement or the statement of cash flows because a disclaimer of opinion is necessary for the beginning balance sheet. Lack of independence 4 None Disclaimer 3-10 COMMENTS Because the client refuses to allow the auditor to expand the scope of his audit. The materiality of twenty percent of net earnings before taxes would be sufficient for many auditors to require an adverse opinion. We need additional information regarding the auditor's preliminary judgment about materiality Not applicable Adverse (if highly material) or Qualified (if material) Not applicable Unqualified 5. Scope of the audit has been restricted Highly material Disclaimer 6. . statement of cash flows. Scope of the audit has been restricted 2. which is adequately disclosed.

scope paragraph is omitted. There is no indication questioning the ability of the business to continue operations. None Not applicable Unqualified— standard wording 3. This is a shared audit report in which the auditor will identify the portion of work done by the other auditor in the introductory paragraph and still issue an unqualified opinion. and because the limitation is highly material. The absolute dollar amounts of assets and revenues or percentages must be stated in the introductory paragraph. The auditor therefore must issue an unqualified report with an explanatory paragraph following the opinion. Substantial doubt about going concern Material Unqualified— explanatory paragraph 6. a disclaimer is appropriate. Introductory paragraph. Report involving other auditors Material Unqualified— modified wording CONDITION 1. and opinion paragraph are all modified. scope paragraph. There is a question about the ability of the company to continue as a going concern. None Immaterial 4. The facts are adequately disclosed in the footnote. . The standards require the use of a qualified opinion for the failure to include a statement of cash flows. The auditor does not automatically add an explanatory paragraph simply because there is a risky business. Because it was a client restriction rather than a condition beyond the client’s control causing the limitation. second paragraph is added describing the scope restriction. Scope of the audit has been restricted 3-11 (d) MODIFIED WORDING / ADDITIONAL PARAGRAPHS (& OTHER COMMENTS) The client has restricted the scope of the audit and the auditor was not able to satisfy him or herself by alternative procedures. The amount is immaterial.3-29 (a) (b) MATERIALITY LEVEL Highly material (c) TYPE OF REPORT Disclaimer 2. Failure to follow GAAP Material Unqualified— standard wording Qualified opinion only —except for 5. Introductory paragraph is modified. Third paragraph must be added stating the omission. and opinion paragraph is a disclaimer of opinion.

If there were such a qualification. no scope qualification is necessary. Scope of the audit has been restricted.Failure to follow GAAP. 7. (c ) TYPE OF REPORT Adverse (if highly material) or (4) Qualified opinion only —except for (if material) Unqualified— standard wording Disclaimer (if highly material) or Qualified scope and opinion (if material) 4. an unqualified opinion is appropriate since there is adequate disclosure. Failure to do so is a violation of GAAP and is likely to result in a qualified opinion. (b) MATERIALITY LEVEL Highly material or material. 3. Retail Auto Parts has used a replacement cost inventory rather than lower of cost or market.3-30 (a) CONDITION 1. The amount is immaterial. Scope of the audit has been restricted. Because the auditor was able to obtain alternative evidence. The certified copy of all resolutions and actions would not be a satisfactory alternative procedure. The use of a qualified or disclaimer would depend upon materiality. Failure to follow GAAP. or it could be so material that it requires an adverse opinion. Not applicable Unqualified— standard wording 6 Material Qualified opinion only—except for Not applicable Unqualified— standard wording . . Failure of the client to allow the auditor to inspect the minutes book would be a material clientimposed restriction. depending upon the amount of the loss and the auditor's preliminary judgment about materiality Immaterial Highly material or material. None 3-12 COMMENT Disclosure of this information is required in a footnote. An unqualified opinion could be issued for the current period balance sheet. Failure to follow GAAP. depending on materiality. Due to the importance of the minutes book. 2. Highly material Disclaimer 5. The change of estimated life is a change of condition and not a change in accounting principles. Because the auditor was unable to satisfy himself about beginning inventories. a disclaimer would be necessary. Therefore. depending upon the auditor’s preliminary judgment about materiality. it would be a qualified scope and opinion or a disclaimer. It is not sufficiently material to require an adverse opinion. Scope of the audit has been restricted. it would be necessary to issue either a qualified or disclaimer of opinion on the income statement and statement of cash flows as well as the beginning balance sheet.

An accounting change involving a change in the reporting entity. An accounting change involving a change from one generally accepted accounting principle to another generally accepted accounting principle. Although the effect of the change in each may be inseparable and the accounting for such a change is the same as that for a change in estimate only. 1 2 3 4 5 TYPE OF CHANGE An error correction not involving an accounting principle. and we do not express. No 7 Not an accounting change but rather a change in classification. which is a special type of change in accounting principles. No 8 An accounting change from one generally accepted accounting principle to another generally accepted accounting principle. Yes 3-32 The following opinion should be issued: Because there were significant deficiencies in internal control that resulted in the lack of detailed records and other supporting data being available for our audit. An accounting change involving a correction of an error in principle. the scope of our work was not sufficient to enable us to express. 3-13 . An accounting change involving both a change in accounting principle and a change in accounting estimate. an opinion on these financial statements. SHOULD AUDITOR'S REPORT BE MODIFIED? No Yes Yes Yes Yes 6 An accounting change involving a change in an accounting estimate. The opinion paragraph should immediately follow the paragraph that discusses the scope restriction. which is accounted for as a correction of an error. an accounting principle is involved.3-31 ITEM NO.

an opinion was expressed only on the 2007 financial statements. not to the audit committee. 3." not "we have examined. not precede it. 3-14 . Neither of these was done. "we have audited. "in all material respects" in the opinion paragraph. The introductory paragraph should state. It should be stated as follows: We conducted our audits in accordance with auditing standards generally accepted in the United States of America. When the principal auditor decides to make reference to the audit of another auditor. 10. The report should generally be addressed to the board of directors or stockholders. Report title must include the word “independent. the opinion paragraph should state that the opinion is based in part on the reports of other auditors. An audit also includes assessing the accounting principles used and significant estimates made by management. 7. the report should disclose the dollar amounts or percentages of the portion of the financial statements audited by the other auditor. 5. The explanatory sentence for consistency should follow the opinion paragraph. The statement of cash flows was not identified in the opinion paragraph.3-33 Deficiencies in the staff accountant's tentative report include the following: 1. the second sentence in the third paragraph should be omitted. Also. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. 6. When the principal auditor decides to make reference to the audit of the other auditor. Also. on a test basis. Although the introductory paragraph referred to an audit of the financial statements for the years ended December 31.” 2." 4. 2007 and 2006. as well as evaluating the overall financial statement presentation. An audit includes examining. and financial statements were not referred to in the opinion paragraph as "consolidated. the report should indicate clearly in the introductory paragraph the division of responsibility regarding the portions of the financial statements audited by each. 8. The second paragraph is an inappropriately worded scope paragraph. There is no inclusion of the phrase. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion." 9. This was not done. evidence supporting the amounts and disclosures in the financial statements.

S. going concern. emphasis).This is the form that must be filed whenever a registrant encounters a significant event (e. Internet Problem Solution: Research Annual Reports 3-1 The U.This is the annual report filed by reporting "small business issuers. Within the 10-K filings locate the independent auditor's report and identify what type of opinion it is (e. a change in control of ownership..g. (Hint: You may be able to search the company’s 10-K by using the Internet browser's "Find" command typically located in the "Edit" menu. Search EDGAR for the 10-K filings of the three companies listed below. The report must be filed within 90 days after the end of the company's fiscal year. This problem explores information available on the SEC’s Web site. Securities and Exchange Commission (SEC) makes available in electronic form via the Internet most of the forms and reports it receives from publicly traded companies through EDGAR. the opinion contains (e. consistency. filing for bankruptcy.. It provides a comprehensive overview of the registrant's business. 2." It provides a comprehensive overview of the company's business. Find and describe the following SEC forms: Answer:    Form 8-K . change in independent auditors). and Stockholders' Equity for each of the three years in the period ended December 31. 2002. 2002 and 2001. if any. and the related Consolidated Statements of Income. the financial 3-15 . Form 10-KSB .This is the annual report that most reporting companies file with the Commission. disclaimer. adverse) and what type of explanatory paragraph. 1. unqualified. Our audits also included the Supplemental Information to the Consolidated Balance Sheets and Consolidated Statements of Income and Cash Flows and financial statement schedule listed at Item 15 (collectively.) Answer:  General Motors Corporation (10-K filed 3-13-2003) Unqualified audit report with an explanatory paragraph due to a change in accounting principle We have audited the Consolidated Balance Sheets of General Motors Corporation and subsidiaries as of December 31. The report must be filed within 90 days after the end of the company's fiscal year.. disposition or acquisition of a significant amount of assets. qualified.g. This form is required by the Securities Exchange Act of 1934. Form 10-K . Cash Flows.g. although its requirements call for slightly less detailed information than required by Form 10-K. The EDGAR Web site describes many SEC-required forms.

2002. in conformity with accounting principles generally accepted in the United States of America. on a test basis. An audit also includes assessing the accounting principles used and significant estimates made by management. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. evidence supporting the amounts and disclosures in the financial statements." DELOITTE & TOUCHE LLP Detroit. As discussed in Note 1 to the financial statements.Unqualified audit report with an explanatory paragraph due to a change in accounting principle In our opinion. "Goodwill and Other Intangible Assets. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. We believe that our audits provide a reasonable basis for our opinion. Also. These financial statements and the financial statement schedules are the responsibility of the Corporation's management. General Motors Corporation changed its method of accounting for goodwill and other intangible assets to conform to Statement of Financial Accounting Standards No. 2003. 2002 and 2001. such financial statement schedules. 2002 and 2001. Michigan January 16. effective January 1. 142. in our opinion.3-1 (continued) statement schedules). present fairly. and the results of their operations and their cash flows for each of the three years in the period ended December 31 . 2002 in conformity with accounting principles 3-16 . when considered in relation to the basic consolidated financial statements taken as a whole. the accompanying consolidated balance sheet and the related consolidated statements of income. and the results of their operations and their cash flows for each of the three years in the period ended December 31. 2002. stockholders' equity and cash flows present fairly. In our opinion. the financial position of Ford Motor Company and its subsidiaries at December 31. An audit includes examining. in all material respects. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. 2003 (March 12. in all material respects. such consolidated financial statements present fairly. the information set forth therein. in all material respects. the financial position of General Motors Corporation and subsidiaries at December 31. as well as evaluating the overall financial statement presentation. as to Note 26)  Ford Motor Company (10-K filed 3-14-2003) .

2003  The Home Depot (10-K filed 4-21-2003) .Unqualified audit report We have audited the accompanying consolidated balance sheets of The Home Depot. "Goodwill and Other Intangible Assets". In addition. Also. stockholders' equity and comprehensive income. As discussed in Note 7 to the consolidated financial statements. the "financial statements") are the responsibility of the Company's management. which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. which changed the method of accounting for goodwill and other intangible assets. and evaluating the overall financial statement presentation. assessing the accounting principles used and significant estimates made by management. The consolidated and sector financial statements (collectively. 142. 133. the accompanying sector balance sheet and the related sector statements of income and cash flows. our responsibility is to express an opinion on these financial statements based on our audits. presented for purposes of additional analysis. the Company adopted Statement of Financial Accounting Standards No. evidence supporting the amounts and disclosures in the financial statements. 2002. in all material respects. as discussed in Note 17 to the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. In addition. Inc. 2002. on January 1. 144. 2003. These consolidated financial 3-17 . which changed the method of accounting for discontinued operations.3-1 (continued) generally accepted in the United States of America. 2002 and the related consolidated statements of earnings. 2001. 2003 and February 3. in our opinion. on January 1. and cash flows for each of the years in the three-year period ended February 2. and subsidiaries as of February 2. "Accounting for the Impairment or Disposal of Long-Lived Assets". on a test basis. as discussed in Note 3 to the consolidated financial statements. the Company adopted Statement of Financial Accounting Standards No. An audit includes examining. the Company adopted Statement of Financial Accounting Standards No. "Accounting for Derivative Instruments and Hedging Activities". present fairly. the information set forth therein when read in conjunction with the related consolidated financial statements. on January 1. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States of America. PricewaterhouseCoopers LLP Detroit. Michigan January 17.

In our opinion. Because Internet sites are subject to change. as well as evaluating the overall financial statement presentation. in all material respects. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining. Inc. 3-18 . Internet problems and solutions may change. An audit also includes assessing the accounting principles used and significant estimates made by management. evidence supporting the amounts and disclosures in the financial statements. and subsidiaries as of February 2. 2002. 2003. Current information on Internet problems is available at www. on a test basis. the financial position of The Home Depot. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. and the results of their operations and their cash flows for each of the years in the three-year period ended February 2. the consolidated financial statements referred to above present fairly. We believe that our audits provide a reasonable basis for our opinion.prenhall. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. Georgia February 24. in conformity with accounting principles generally accepted in the United States of America. KPMG LLP Atlanta.com/arens). 2003 (Note: Internet problems address current issues using Internet sources. 2003 and February 3.3-1 (continued) statements are the responsibility of the Company's management.