This chapter covers audit report and opinion including unmodified opinion, unmodified opinion, scope limitation, adverse opinion, disclaimer of opinion.
Standard Unmodified Opinion
Standard Unmodified Opinion under PCAOB
Standard Unmodified Opinion Under AICPA Non-Issuers
Audit Opinion under PCAOB
Unmodified Opinion with Emphasis of a Matter or Other Matter Explanatory Paragraph
Summary of Various Audit Opinions
Modified Audit Opinion Due to Scope Limitation
Modified Audit Opinion Due to GAAP Financial Statement Disclosures Issue
The standard unmodified opinion audit report for a nonpublic entity contains the following eight parts:
- 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 introductory paragraph of the report 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.
- Management’s responsibility: This paragraph indicates that the financial statements are the responsibility of management, including selecting appropriate accounting principles and maintaining internal control over financial reporting. The paragraph must be preceded by the heading “Management’s Responsibility for the Financial Statements”.
Auditor’s responsibility: The auditor’s responsibility section of the report includes three paragraphs and it must include the heading “Auditor’s Responsibility”. The first paragraph indicates that the auditor’s responsibility is to express an opinion on the statements based on an audit conducted in accordance with auditing standards, and that the audit provides reasonable assurance that the financial statements are free of material misstatement.
The second paragraph is the scope paragraph and is a factual statement about what the auditor did in the audit. The paragraph briefly describes important aspects of an audit, including that the procedures depend on the auditor’s judgment and assessment of the risks of material misstatements. The scope paragraph also indicates that the auditor considers the entity’s internal control, but not for the purposes of expressing an opinion on the effectiveness of internal control over financial reporting. The last sentence of the paragraph indicates that the audit includes evaluating the appropriateness of accounting policies selected, the reasonable-ness of accounting estimates, and the overall financial statement presentation.
The third paragraph indicates that the auditor believes the audit evidence is sufficient and appropriate to provide a basis for the audit opinion.
Opinion paragraph: The final paragraph in the standard report states the auditor’s conclusions based on the results of the audit. The paragraph must include the title “Opinion”.
Signature and Address of CPA firm: The name identifies the CPA firm or practitioner who performed the audit, and the city and state where the auditor is located.
Audit report date: The appropriate date for the report is the one on which the auditor completed the auditing procedures needed to obtain sufficient appropriate evidence to support the opinion.
The auditor should include an explanatory paragraph in an unmodified opinion audit report when the audit is completed with satisfactory results and the financial statements are fairly presented, but the auditor believes it is important to draw the reader’s attention to certain matters or the auditor is required to provide additional information. The following are the most important causes of the addition of an emphasis of matter explanatory paragraph or a modification in the wording of the standard unmodified opinion audit report:
- Lack of consistent application of generally accepted accounting principles
- Substantial doubt about going concern
- Auditor agrees with a departure from promulgated accounting principles
- Emphasis of other matters
- Reports involving other auditors
- The three conditions requiring a departure from an unmodified opinion are:
- 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.
The three alternative opinions that may be appropriate when the client’s financial statements are not in accordance with GAAP are an unmodified opinion, qualified as to opinion only, and adverse opinion. Determining which is appropriate depends entirely upon materiality. An unmodified opinion is appropriate if the GAAP departure is immaterial (standard unmodified) or if the auditor agrees with the client’s departure from GAAP (unmodified 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.
Auditors’ reports are important to users of financial statements because they inform users of the auditor’s opinion as to whether or not the financial 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 unmodified 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.
The purpose of the scope paragraph under the auditor’s responsibility is to inform the financial statement users of the nature of the audit procedures performed. The information in the scope paragraph includes:
- An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements.
- The audit procedures selected depend on the auditor’s judgment, and consider the auditor’s assessment of the risks of material misstatement, whether due to fraud or error.
- As part of this risk assessment, the auditor considers internal control over financial reporting in the design of the audit procedures. The assessment is not for the purpose of expressing an opinion on internal control over financial reporting, and the auditor does not express such an opinion.
- An audit includes evaluating the appropriateness of the accounting policies used, the reasonableness of significant estimates, and the overall presentation of the financial statements.
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:
- The words “in our opinion,” which indicate that the conclusions are based on professional judgment.
- A statement about whether the financial statements were presented fairly and in accordance with generally accepted accounting principles along with indication of the fiscal year(s) associated with those statements.
The auditor’s report should be dated February 17, 2017, the date on which the auditor concluded that he or she had sufficient appropriate evidence to support the auditor’s opinion.
A standard unmodified opinion audit report may be issued under the following circumstances:
- All statements—balance sheet, income statement, statement of retained earnings, and statement of cash flows—are included in the financial statements.
- Sufficient appropriate evidence has been accumulated and the auditor has conducted the engagement in a manner that enables him or her to conclude that the audit was performed in accordance with auditing standards.
- The financial statements are presented in accordance with appropriate accounting standards such as U.S. generally accepted accounting principles or IFRS. This also means that adequate disclosures have been included in the footnotes and other parts of the financial statements.
- There are no circumstances requiring the addition of an explanatory paragraph or modification of the wording of the report.
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.
The standard unmodified opinion audit report for a non-public entity under AICPA auditing standards and the standard unqualified report for a public company under PCAOB auditing standards are very similar in substance. The introductory paragraphs are similar, although the public company report includes the responsibilities of management and the auditor. In contrast, the report for the non-public entity in Figure 3-1 has separate paragraphs for management’s and the auditor’s responsibility. These paragraphs provide additional information on the nature of these responsibilities.
The scope paragraphs in each report are similar. However, there are differences in the description of the nature of the auditor’s testing. The report for the non-public company indicates that the procedures are based on the auditor’s judgment and consider the risks of material misstatement. The report for the non-public company also indicates that the auditor considers internal control in designing the audit procedures, and not for the purpose of expressing an opinion on internal control.
An unmodified opinion audit report with an explanatory paragraph or modified wording is the same as a standard unmodified opinion 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 unmodified opinion audit report with an explanatory paragraph or modified wording are:
- The entity changed from one generally accepted accounting principle to another generally accepted accounting principle.
- A shared report involving the use of other auditors.
When another CPA has performed part of the audit, the primary auditor issues one of the following types of reports based on the circumstances.
- No reference is made to the other auditor. This will occur if the other auditor audited an immaterial portion of the financial statements, 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 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.
Even though this change has been reflected in the financial statements, 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.
Changes that affect the consistency of the financial statements may involve any of the following:
- Change in accounting principle
- Change in reporting entity
- 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 because the same method of depreciation is used in both years, but the information may require disclosure in the statements.
When the audit report contains a qualified opinion, the eight elements of the standard audit report are as follows:
- Report title: Same as standard unmodified opinion report.
- Audit report address: Same as standard unmodified opinion report.
- Introductory paragraph: Same as standard unmodified opinion report.
- Management’s responsibility: Same as standard unmodified opinion report.
- Auditor’s responsibility: The first two auditor responsibility paragraphs are the same as the standard unmodified opinion report. The third paragraph is modified to state that the audit evidence obtained provides a sufficient and appropriate basis for the qualified audit opinion.
That paragraph is following by a new paragraph that describes the basis for the qualified opinion.
- Opinion paragraph: The opinion paragraph is modified to include the term except for in the opinion paragraph.
- Signature and Address of CPA firm: Same as standard unmodified opinion report.
- Audit report date: Same as standard unmodified opinion report.
A qualified opinion states that there has been either a limitation on the scope of the audit of material accounts, transactions, or disclosures or a material 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 himself 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 non-independent relationship under the AICPA Code of Professional Conduct between the auditor and the client.