Auditing- I: Audit Reports 2022

CHAPTER SIX
Audit Reports
Reports are essential to audit and assurance engagements because they communicate the
auditor’s findings. Users of financial statements rely on the auditor’s report to provide assurance
on the company’s financial statements. As we discussed in chapter four, the auditor will likely be
held responsible if an incorrect audit report is issued. The audit report is the final step in the
entire audit process.
7.1 Contents of standard unqualified auditor's report
Standard unqualified audit report enable users to understand audit report, professional standards
provide uniform wording for auditor's report. Standard unqualified reports have seven parts.

1) Report title
Auditing standards require that the report be titled and that the title include the word indepen-
dent. For example, appropriate titles include “independent auditor’s report,” “report of indepen-
dent auditor,” or “independent accountant’s opinion.” The requirement that the title include the
word independent conveys to users that the audit was unbiased in all aspects.
2) Audit report address
The report is usually addressed to the company, its stockholders, or the board of directors. In
recent years, it has become customary to address the report to the board of directors and
stockholders to indicate that the auditor is independent of the company
3) 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. This is intended to
distinguish the report from a compilation or review report.
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.
The wording of the financial statements in the report should be identical to those used by
management on the financial statements.
Third, the introductory paragraph 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.
The purpose of these statements is to communicate that management is responsible for selecting

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the appropriate accounting principles and making the measurement decisions and disclosures in
applying those principles and to clarify the respective roles of management and the auditor.
4) Scope paragraph
It is a factual statement about what the auditor did in the audit. The statements in this paragraph
should consist: -
 Compliance of with GAAS
 The audit design to obtain reasonable assurance about the freedom from material
misstatement
 Discuss audit evidence
 Included the word ‘test basis’ to indicate sampling.
5) Opinion Paragraph
The final paragraph includes conclusion. The opinion should be expressed as opinion rather than
the absolute facts (guarantee). This term "present fairly" is used to show the investigation is
beyond GAAP.
6) Name of CPA Firm
The name identifies the CPA firm or practitioner who performed the audit. Typically, the firm’s
name is used because the entire CPA firm has the legal and professional responsibility to ensure
that the quality of the audit meets professional standards.
7) Audit Report date
The appropriate date for the report is the one on which the auditor completed the auditing
procedures in the field. This date is important to users because it indicates the last day of the
auditor’s responsibility for the review of significant events that occurred after the date of the
financial statements
7.2 Types of Audit Report
There are four types of Audit Report:
1. Unqualified Audit Report 3. Adverse
2. Qualified 4. Disclaimer
1. Unqualified audit Report
Unqualified Audit Report Can be Standard or with explanations:
The standard unqualified audit report is issued when the following conditions have been met:

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a) All statements—balance sheet, income statement, statement of retained earnings, and
statement of cash flows—are included in the financial statements.
b) The three general standards have been followed in all respects on the engagement.
c) 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 three standards of
field work have been met.
d) The financial statements are presented in accordance with U.S. generally accepted
accounting principles or international financial reporting standards (IFRS). This also
means that adequate disclosures have been included in the footnotes and other parts of the
financial statements.
e) There are no circumstances requiring the addition of an explanatory paragraph or
modification of the wording of the report.
When these conditions are met, the standard unqualified audit report is issued. The standard
unqualified audit report is sometimes called a clean opinion because there are no circumstances
requiring a qualification or modification of the auditor’s opinion. The standard unqualified report
is the most common audit opinion. Sometimes circumstances beyond the client’s or auditor’s
control prevent the issuance of a clean opinion. However, in most cases, companies make the
appropriate changes to their accounting records to avoid a qualification or modification by the
auditor.
If any of the five requirements for the standard unqualified audit report are not met, the standard
unqualified report cannot be issued.
Unqualified Audit Report with explanatory paragraph /modified wording
This meets the criteria of complete audit with satisfactory results and financial statements that
are fairly presented, but the auditor believes it is important or is required to provide additional
information. This requires additional explanatory paragraph. The causes for the addition of
explanatory paragraph are:-
a) Lack of consistent application of GAAP
In case of material change, explanatory paragraph is added after opinion paragraph to show the
change. The changes must affect consistency instead of comparability to be included in the
fourth (explanatory) paragraph.

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Consistency Versus Comparability The auditor must be able to distinguish between changes
that affect consistency and those that may affect comparability but do not affect consistency. The
following are examples of changes that affect consistency and therefore require an explanatory
paragraph if they are material:
1) Changes in accounting principles, such as a change from FIFO to LIFO inventory
valuation
2) Changes in reporting entities, such as the inclusion of an additional company in
combined financial statements
3) Corrections of errors involving principles, by changing from an accounting principle that
is not generally acceptable to one that is generally acceptable, including correction of the
resulting error
Changes that affect comparability but not consistency and therefore need not be included in the
audit report include the following:
1) Changes in an estimate, such as a decrease in the life of an asset for depreciation
purposes
2) Error corrections not involving principles, such as a previous year’s mathematical error
3) Variations in format and presentation of financial information
4) Changes because of substantially different transactions or events, such as new endeavors
in research and development or the sale of a subsidiary
Items that materially affect the comparability of financial statements generally require disclosure
in the footnotes. A qualified audit report for inadequate disclosure may be required if the client
refuses to properly disclose the items.
b) Substantial doubt about going concern
Recurring operating losses, deficiencies of working capital, inability to pay obligation, loss of
major customers and legal proceedings are major cause of this doubt. The reasonable period of
continuation is 1 year from the date of financial statements.
c) Auditor agrees with a departure from standard
Rule 203 of the AICPA Code of Professional Conduct states that in unusual situations, a
departure from a generally accepted accounting principle may not require a qualified or adverse
opinion. However, to justify an unqualified opinion, the auditor must be satisfied and must state

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and explain, in a separate paragraph or paragraphs in the audit report, that adhering to the
principle would produce a misleading result in that situation.
Emphasis of Matter
Under certain circumstances, the CPA may want to emphasize specific matters regarding the
financial statements, even though he or she intends to express an unqualified opinion. Normally,
such explanatory information should be included in a separate paragraph in the report. Examples
of explanatory information the auditor may report as an emphasis of a matter include the
following:
 The existence of significant related party transactions
 Important events occurring subsequent to the balance sheet date
 The description of accounting matters affecting the comparability of the financial
statements with those of the preceding year
 Material uncertainties disclosed in the footnotes
d) Reports involving other auditors
In many companies having different branches may give the audit engagement to more than one
CPA firm. Each units (branches) audit results are compiled to form an overall report about the
company as a whole. The principal auditor, the one who does most of the audit, prepares this
report in three different ways: -
I. No reference of the other auditor in the report
When the principal auditor knows or closely supervises the other auditor or the other auditor
audited an immaterial portion of the audit, the principal auditor doesn't refer the other auditor.
II. Make reference in the report (modified wording)
This report is called a Shared Opinion (Report). If the other auditor audits immaterial portion of
the statement and it is difficult to review his/her work, the principal auditor refers him/her in the
introductory, scope and opinion paragraphs.
III. Qualify the opinion
If the principal auditor isn't willing to assume any responsibility for the work of the other
opinion, he/she may give a qualified or disclaimer opinion.
7.3 Reasons for departure from unqualified opinion
The auditor may issue a type of report other than unqualified opinion (qualified, disclaimer or
adverse)

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For the following reasons:-
1) The Scope of the Audit Has Been Restricted (Scope Limitation): When the auditor has not
accumulated sufficient appropriate evidence to conclude whether financial statements are
stated in accordance with GAAP, a scope restriction exists. There are two major causes of
scope restrictions: restrictions imposed by the client and those caused by circumstances
beyond either the client’s or auditor’s control. An example of a client restriction is
management’s refusal to permit the auditor to confirm material receivables or to physically
examine inventory. An example of a restriction caused by circumstances is when the auditor
is not appointed until after the client’s year-end. It may not be possible to physically observe
inventories, confirm receivables, or perform other important procedures after the balance
sheet date.
2) The Financial Statements Have Not Been Prepared in Accordance with Generally
Accepted Accounting Principles (GAAP Departure): For example, if the client insists on
using replacement costs for fixed assets or values inventory at selling price rather than
historical cost as required by generally accepted accounting principles, a departure from the
unqualified report is required. When U.S. generally accepted accounting principles or
international financial reporting standards are referred to in this context, consideration of the
adequacy of all informative disclosures, including footnotes, is especially important.
3) The Auditor Is Not Independent: Independence ordinarily is determined by Rule 101 of the
rules of the Code of Professional Conduct.
When any of the three conditions requiring a departure from an unqualified report exists and is
material, a report other than an unqualified report must be issued. Three main types of audit
reports are issued under these conditions: qualified opinion, adverse opinion, and disclaimer
of opinion.
a) Qualified opinion
This is when there is a limitation on the scope of the audit or when GAAP isn't followed, this
opinion may results. In fact the auditor must believe that the overall financial statements are
fairly stated. The qualification may be both the scope and the opinion or the opinion alone. The
former arises only when all evidences as required by GAAS aren't accumulated, while the later is
issued when GAAP is violated.

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The unique feature of a qualified opinion is the inclusion of the term ' except for ' in opinion
paragraph.
b) Adverse opinion
This is used only when the auditor believes that overall financial statements are so materially
misstated or misleading. This happens only when the auditor knows or believes, after adequate
investigation, that lack of conformity with GAAP. This opinion, however, is rare.
c) Disclaimer Opinion
This is issued when the auditor has been unable to satisfy herself that the overall financial
statements are fairly presented. Disclaimer happens when sever limitation on the scope and non-
independent relationship arises. It can be issued in case of going concern problem.

In the adverse opinion, the auditor must have the knowledge that financial statements are
materially misstated while in disclaimer he lacks such knowledge.
7.4 Materiality
If the misstatement is immaterial, unqualified opinion can be given. Otherwise, adverse or
disclaimer opinion should be issued. Materiality is a misstatement of financial statements that
would affect a decision of reasonable uses of statements.
Levels of materiality
There are three levels:-
i. Immaterial amount
If the misstatement is immaterial, unqualified report could be issued.
ii. Material amount that doesn't overshadow the financial statements
Here qualified opinion (using "except for") is issued. This affects decision only in specific areas
and the overall statements are presented fairly.
iii. Material amount that affects the overall fairness of financial statements.
This affects users to make incorrect decisions. So, disclaimer or adverse opinion may be issued.
In addition, in the extent to which the misstatement affects different parts of financial statements
must be considered. This is called pervasiveness.
If misstatement is pervasive, adverse opinion is appropriate while lack of independence mach to
disclaim opinion. Any deviation from independence is considered material.
Materiality can also be looked in terms of failure to follow GAAP or scope Limitations.

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Illustrations of Types of Audit Repots.

I. Standard Unqualified Audit Report.

A. Pure/clean Version

Report Title

Audit Report Address

Introductory Paragraph
(Factual Statement)

Scope Paragraph
(Factual Statement)

Opinion Paragraph
(Conclusions)

Name of CPA Firm

Audit Report Date (Date

Audit Field Work is
Completed)

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B. Unqualified Audit Report With Explanatory Paragraph or Modified Wording.

1. Explanatory paragraph because of change in Accounting Principles.

Independent Auditor’s Report

(The same introductory, scope, and opinion paragraphs as the standard report)

Fourth Paragraph- Explanatory paragraph

As discussed in Note 8 to the financial statements, the company changed its method of
computing depreciation in 19998.

2. Explanatory paragraph because of Substantial Doubt about Going Concern

Independent Auditor’s Report

(The same introductory, scope, and opinion paragraphs as the standard report)

Fourth Paragraph- Explanatory paragraph

The accompanying financial statements have been prepared assuming that X- Company
will continue as a going concern. As discussed in Note 11 to the financial statements, X-
Company has suffered recurring losses from operations and has a net capital deficiency
that raise substantial doubt about the company’s ability to continue as a going concern.
Management’s plans in regard to these matters are described in Note 11. The financial
statements do not include any adjustment that might result from the outcome of this
uncertainty.

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II. Qualified Audit Report Due to scope restriction..

Scope Paragraph
(Qualified)

Third paragraph-Added

Opinion paragraph
(Qualified)

III. Adverse opinion Due to Non-GAAP.

Independent Auditor’s Report

(Same introductory and scope paragraphs as the standard report)
(Same Third paragraph as in qualified report)
Opinion Paragraph
In our opinion, because of the effects of the matters discussed in the preceding paragraph, the
financial statements referred to above do not present fairly, in conformity with generally
accepted accounting principles, the financial statements of B-company as of December 31,
1999,or the results of its operations and its cash flows for the year then ended.

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