Audit Reports

MULTIPLE CHOICE: 1. An auditor would issue an adverse opinion if a. The audit was begun by other independent auditors who withdrew from the engagement. b. A qualified opinion cannot be given because the auditor lacks independence. c. The restriction on the scope of the audit was significant. d. The statements taken as a whole do not fairly present the financial condition and results of operations of the company. ANSWER: 2. D

An audit report contains the following paragraph: "Because of the inadequacies in the company's accounting records during the year ended June 30, 2003, it was not practicable to extend our auditing procedures to the extent necessary to enable us to obtain certain evidential matter as it relates to classification of certain items in the consolidated statements of operations." This paragraph most likely describes a. A material departure from GAAP requiring a qualified audit opinion. b. An uncertainty that should not lead to a qualified opinion. c. A matter that the auditor wishes to emphasize and that does not lead to a qualified audit opinion. d. A material scope restriction requiring a qualification of the audit opinion. ANSWER: D

3.

A limitation on the scope of the auditor's examination sufficient to preclude an unqualified opinion will always result when management a. Asks the auditor to report on the balance sheet and not on the other basic financial statements. b. Refuses to permit its lawyer to respond to the letter of audit inquiry. c. Discloses material related party transactions in the footnotes to the financial statements.

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Chapter 14 Audit Reports d. Knows that confirmation of accounts receivable is not feasible. B

ANSWER: 4.

The auditor issued a qualified opinion covering the financial statements of Client A for the year ended December 31, 2002. The reason for the qualification was a departure from GAAP. In presenting comparative statements for the years ended December 31, 2002 nd 2003, the client revised the 2002 financial statements to correct the previous departure from GAAP. The auditor's 2003 report on the 12/31/02 and 12/31/03 comparative financial statements will a. Express a qualified opinion on the 2002 financial statements and an unqualified opinion on the 2003 statements. b. Express unqualified opinions on both the 2002 and 2003 financial statements. c. Retain the qualified opinion covering the 2002 statements, but add an explanatory paragraph describing the correction of the prior departure from GAAP. d. Render qualified audit opinions for both 2002 and 2003 financial statements given the 2003 carryover effect of the 2002 error. ANSWER: B

5. an

When financial statements are presented that are not in conformity with generally accepted accounting principles, auditor may issue a(an) "Except for" Disclaimer opinion of an opinion a. Yes No b. Yes Yes c. No Yes d. No No ANSWER: A

6.

Under which of the following circumstances would a disclaimer of opinion not be appropriate? a. The auditor is engaged after fiscal year-end and is unable to observe physical inventories or apply alternative procedures to verify their balances. b. The auditor is unable to determine the amounts

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c. d.

associated with illegal acts committed by the client's management. The financial statements fail to contain adequate disclosure concerning related party transactions. The client refuses to permit its attorney to furnish information requested in a letter of audit inquiry. C

ANSWER: 7.

An auditor may reasonably issue an "except for" qualified opinion for Inadequate Scope disclosure limitation a. Yes Yes b. Yes No c. No Yes d. No No ANSWER: A

8.

An auditor's report would be designated as a special report when it is issued in connection with financial statements that are a. For an interim period and are subjected to a limited review. b. Unaudited and are prepared from a client's accounting records. c. Prepared in accordance with a comprehensive basis of accounting other than generally accepted accounting principles. d. Purported to be in accordance with generally accepted accounting principles but do not include a presentation of the Statement of Cash Flows. ANSWER: C

9.

A limitation on the scope of an auditor's examination sufficient to preclude an unqualified opinion will usually result when management a. Presents financial statements that are prepared in accordance with the cash receipts and disbursements basis of accounting. b. States that the financial statements are not intended to be presented in conformity with generally accepted accounting principles. c. Does not make the minutes of the Board of Directors'

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Chapter 14 Audit Reports meetings available to the auditor. Asks the auditor to report on the balance sheet and not on the other basic financial statements. C

d.

ANSWER: 10.

When there is a significant change in accounting principle, an auditor's report should refer to the lack of consistency in a. The scope paragraph. b. An explanatory paragraph between the second paragraph and the opinion paragraph. c. The opinion paragraph. d. An explanatory paragraph following the opinion paragraph. ANSWER: D

11.

Which of the following subsequent events will be least likely to result in an adjustment to the financial statements? a. Culmination of events affecting the realization value of accounts receivable owned as of the balance sheet date. b. Culmination of events affecting the realization of inventories owned as of the balance sheet date. c. Material changes in the settlement of liabilities which were estimated as of the balance sheet date. d. Material changes in the quoted market prices of listed investment securities since the balance sheet date. ANSWER: D

12.

Soon after Boyd's audit report was issued, Boyd learned of certain related party transactions that occurred during the year under audit. These transactions were not disclosed in the notes to the financial statements. Boyd should a. Plan to audit the transactions during the next engagement. b. Recall all copies of the audited financial statements. c. Determine whether the lack of disclosure would affect the auditor's report. d. Ask the client to disclose the transactions in subsequent interim statements. ANSWER: C

Chapter 14 Audit Reports 13.

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Under which of the following circumstances would a disclaimer of opinion not be appropriate? a. The financial statements fail to contain adequate disclosure concerning related party transactions. b. The client refuses to permit its attorney to furnish information requested in a letter of audit inquiry. c. The auditor is engaged after fiscal year-end and is unable to observe physical inventories or apply alternative procedures to verify their balances. d. The auditor is unable to determine the amounts associated with illegal acts committed by the client's management. ANSWER: A

14.

An auditor concludes that there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time. If the entity's disclosures concerning this matter are adequate, the audit report may include a(an) Disclaimer "Except for" of opinion qualified opinion a. Yes Yes b. No No c. No Yes d. Yes No ANSWER: D

15.

Management of Blue Company has decided not to account for a material transaction in accordance with the provisions of an FASB Standard. In setting forth its reasons in a note to the financial statements, management has clearly demonstrated that due to unusual circumstances the financial statements presented in accordance with the FASB Standard would be misleading. The auditor's report should include an explanatory separate paragraph and contain a(an) a. Adverse opinion. b. Unqualified opinion. c. "Except for" qualified opinion. d. "Subject to" qualified opinion. ANSWER: B

16.

In the "management discussion and analysis" contained in the 2002 annual report of Dermicile Corporation, management stated that total sales were $4.95 billion and net profit

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Chapter 14 Audit Reports was $500 million. The audited sales and net profit, however, were $3.8 billion and $450 million respectively. The financial statements, contained in the annual report, reflected the audited figures and the CPA planned to issue an unqualified opinion. Upon noting the inconsistencies between the MD&A and the audited financial statements, however, the CPA should a. Refer to the inconsistency in the audit report and issue a qualified audit opinion. b. Issue an unqualified opinion without an explanatory paragraph, because the MD&A is not covered in the audit report. c. Issue an unqualified audit opinion with an explanatory paragraph describing the inconsistency. d. Render an adverse opinion on the basis that management had intentionally misrepresented reported sales and net profit. ANSWER: C

17.

When the audited financial statements of the prior year are presented together with those of the current year, the continuing auditor's report should cover a. Both years. b. Only the current year. c. Only the current year, but the prior year's report should be presented. d. Only the current year, but the prior year's report should be referred to. ANSWER: A

18.

If the auditor believes that financial statements which are prepared on a comprehensive basis of accounting other than generally accepted accounting principles are not suitably titled, the auditor should a. Modify the auditor's report to disclose any reservations. b. Consider the effects of the titles on the financial statements taken as a whole. c. Issue a disclaimer of opinion. d. Add a footnote to the financial statements which explains alternative terminology. ANSWER: A

Chapter 14 Audit Reports 19.

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Morgan, CPA, is the principal auditor for a multi-national corporation. Another CPA has examined and reported on the financial statements of a significant subsidiary of the corporation. Morgan is satisfied with the independence and professional reputation of the other auditor, as well as the quality of the other auditor's examination. With respect to Morgan's report on the consolidated financial statements, taken as a whole, Morgan a. Must not refer to the examination of the other auditor. b. Must refer to the examination of the other auditor. c. May refer to the examination of the other auditor. d. May refer to the examination of the other auditor, in which case Morgan must include in the auditor's report on the consolidated financial statements a qualified opinion with respect to the examination of the other auditor. ANSWER: 20. C

A post-audit review, conducted by another audit partner, discovered that the audit team had failed to examine or confirm securities held in safekeeping. The amounts involved were material in relation to reported net assets. The unqualified audit report, along with the audited financial statements, had been released two months earlier. Based on this information, the audit team should a. Request the client for permission to examine or confirm the securities. b. Notify persons known to be relying on the audit report that the report can no longer be relied upon. c. Draft a revised audit report containing an opinion qualified for a scope restriction. d. Ignore the finding inasmuch as the financial statements and audit report have already been released. ANSWER: A

21.

The auditor's report should be dated as of the date on which the a. Report is delivered to the client. b. Field work is completed. c. Fiscal period under audit ends. d. Review of the working papers is complete. ANSWER: B

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Chapter 14 Audit Reports After issuing the audit report, the auditor may become aware of information that would have affected the audit report had it been known at the time. Given discovery of such information, the auditor must take appropriate action. Which of the following actions would be considered inappropriate under these circumstances? a. Determine whether the information is reliable and whether the facts existed at the date of the audit report. b. Request the client to disclose, to financial statement users, the newly discovered facts and their impact on the financial statements. c. If the client refuses to inform third parties, the auditor should notify the board of directors and regulatory agencies having jurisdiction over the client that the auditors' report can no longer be relied upon. d. Draft a revised audit report expressing a qualified or adverse opinion, depending on the materiality of the effect, and transmit the report to the stockholders. ANSWER: D

22.

23.

Which of the following best describes the auditor's responsibility for "other information" included in the annual report to stockholders which contains financial statements and the auditor's report? a. The auditor has no obligation to read the "other information." b. The auditor has no obligation to corroborate the "other information," but should read the "other information" to determine whether it is materially inconsistent with the financial statements. c. The auditor should extend the examination to the extent necessary to verify the "other information." d. The auditor must modify the auditor's report to state that the "other information is unaudited" or "not covered by the auditor's report." ANSWER: B

24.

When an auditor conducts an examination in accordance with generally accepted auditing standards and concludes that the financial statements are fairly presented in accordance with a comprehensive basis of accounting other than generally accepted accounting principles such as the cash basis of accounting, the auditor should issue a

Chapter 14 Audit Reports a. b. c. d. Disclaimer of opinion. Review report. Qualified opinion. Special report. D

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ANSWER: 25.

In which of the following circumstances would an auditor be most likely to express an adverse opinion? a. The statements are not in conformity with the FASB Statements regarding the capitalization of leases. b. Information comes to the auditor's attention that raises substantial doubt about the entity's ability to continue in existence. c. The chief executive officer refuses the auditor access to minutes of board of directors' meetings. d. Control tests show that the entity's internal control is so poor that the financial records cannot be relied upon. ANSWER: A

26.

Under which of the following circumstances would an unqualified audit opinion, followed by an explanatory paragraph, not be appropriate? a. The auditor wishes to emphasize that the client has entered into material transactions with related parties. The substance of the related party transactions is properly disclosed in the audited financial statements. b. The client has completed material transactions with related parties and the auditor is unable to persuade management to properly reflect the economic substance of the transactions in the financial statements. c. The client has used a method of revenue recognition that is at variance with promulgated accounting standards. The auditor, however, agrees with the departure on the basis that use of the promulgated standard would make the financial statements materially misleading. d. The auditor believes that substantial doubt exists concerning the ability of the client to continue as a going concern. ANSWER: B

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27.

Doe, an independent auditor, was engaged to perform an examination of the financial statements of Ally Incorporated one month after its fiscal year had ended. Although the inventory count was not observed by Doe, and accounts receivable were not confirmed by direct communication with debtors, Doe was able to gain satisfaction by applying alternative auditing procedures. Doe's auditor's report will probably contain a. A standard unqualified opinion. b. An unqualified opinion and an explanatory middle paragraph. c. Either a qualified opinion or a disclaimer of opinion. d. An "except for" qualification. ANSWER: A

28.

The adverse effects of events causing an auditor to believe there is substantial doubt about an entity's ability to continue as a going concern would most likely be mitigated by evidence relating to the a. Ability to expand operations into new product lines in the future. b. Feasibility of plans to purchase leased equipment at less than market value. c. Marketability of assets that management plans to sell. d. Committed arrangements to convert preferred stock to long-term debt. ANSWER: C

29.

Comparative financial statements include the financial statements of a prior period which were examined by a predecessor auditor whose report is not presented. If the predecessor auditor's report was qualified, the successor auditor must a. Obtain written approval from the predecessor auditor to include the prior year's financial statements. b. Issue a standard comparative audit report indicating the division of responsibility. c. Express an opinion on the current year statements alone and make no reference to the prior year statements. d. Disclose the reasons for any qualification in the predecessor auditor's opinion.

Chapter 14 Audit Reports ANSWER: D

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30. When reporting on financial statements prepared on a comprehensive basis of accounting other than generally accepted accounting principles, the independent auditor should include in the report a paragraph that a. States that the financial statements are not intended to be in conformity with generally accepted accounting principles. b. States that the financial statements are not intended to have been examined in accordance with generally accepted auditing standards. c. Refers to the authoritative pronouncements that explain the comprehensive basis of accounting being used. d. Justifies the comprehensive basis of accounting being used. ANSWER: 31. A

After an audit report containing an unqualified opinion on a non-public client's financial statements was issued, the client decided to sell the shares of a subsidiary that accounts for 30% of its revenue and 25% of its net income. The auditor should a. Determine whether the information is reliable and, if determined to be reliable, request that revised financial statements be issued. b. Notify the entity that the auditor's report may no longer be associated with the financial statements. c. Describe the effects of this subsequently discovered information in a communication with persons known to be relying on the financial statements. d. Take no action because the auditor has no obligation to make any further inquiries. ANSWER: D An audit report contained the following wording: "In our opinion, except for the omission of the segment information referred to in the preceding paragraph..." This excerpt was taken from a(n) a. Unqualified audit opinion with an explanatory paragraph added to emphasize a matter. b. Unqualified audit opinion with an explanatory paragraph added to describe a material uncertainty. c. Audit opinion qualified due to a departure from GAAP. d. Adverse audit opinion.

32.

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ANSWER: 33.

An auditor includes a separate paragraph in an otherwise unqualified report to emphasize that the entity being reported upon had significant transactions with related parties. The inclusion of this separate paragraph a. Violates generally accepted auditing standards if this information is already disclosed in footnotes to the financial statements. b. Necessitates a revision of the opinion paragraph to include the phrase "with the foregoing explanation." c. Is appropriate and would not negate the unqualified opinion. d. Is considered an "except for" qualification of the report. ANSWER: C

34.

An audit report contains the following paragraph: "Since the company did not take physical inventories and we were not able to apply auditing procedures to satisfy ourselves as to inventory quantities and the cost of property and equipment, the scope of our work was not sufficient to enable us to express, and we do not express, an opinion on these financial statements." This paragraph illustrates a(n) a. Disclaimer of opinion due to uncertainty. b. Disclaimer of opinion due to scope restrictions. c. Adverse audit opinion. d. Audit opinion qualified for material scope restrictions. ANSWER: B

35.

An auditor's examination reveals a misstatement in segment information that is material in relation to the financial statements taken as a whole. If the client refuses to make modifications to the presentation of segment information, the auditor should issue a(n) a. "Except for" opinion. b. Adverse opinion. c. Unqualified opinion. d. Disclaimer of opinion. ANSWER: A

Chapter 14 Audit Reports 36.

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An auditor's report on financial statements that are prepared in accordance with a comprehensive basis of accounting other than generally accepted accounting principles should preferably include all of the following, except a. Disclosure of the fact that the financial statements are not intended to be presented in conformity with generally accepted accounting principles. b. An opinion as to whether the use of the disclosed method is appropriate. c. An opinion as to whether the financial statements are presented fairly in conformity with the basis of accounting described. d. A description of a change in accounting principles. ANSWER: B

37.

When the financial statements are prepared on the going concern basis but the auditor concludes there is substantial doubt whether the client can continue in existence and also believes there are uncertainties about the recoverability of recorded asset amounts on the financial statements, the auditor may issue a(an) a. Adverse opinion. b. "Except for" qualified opinion for scope limitation. c. "Except for" qualified opinion for departure from GAAP. d. Unqualified opinion with an explanatory separate paragraph. ANSWER: 38. D

Client A reports property, plant, and equipment at appraisal values and records depreciation based on the appraised amounts. Also, the company does not defer income taxes for temporary differences arising from using the installment method of recognizing gross profit for tax purposes. The company uses the accrual method for financial reporting purposes. Under these circumstances, the auditor will probably issue a(n) a. Audit opinion qualified for a departure from GAAP. b. Adverse audit opinion. c. Disclaimer of opinion. d. Unqualified audit opinion with an explanatory paragraph describing the client's unique accounting practices. ANSWER: B

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39. A CPA engaged to examine financial statements observes that the accounting for a certain material item is not in conformity with generally accepted accounting principles, and that this fact is prominently disclosed in a footnote to the financial statements. The CPA should a. Express an unqualified opinion and insert a middle paragraph emphasizing the matter by reference to the footnote. b. Disclaim an opinion. c. Not allow the accounting treatment for this item to affect the type of opinion because the deviation from generally accepted accounting principles was disclosed. d. Qualify the opinion because of the deviation from generally accepted accounting principles. ANSWER: 40. D

When a principal auditor decides to make reference to another auditor's examination, the principal auditor's report should always indicate clearly, in the introductory, scope, and opinion paragraphs, the a. Magnitude of the portion of the financial statements examined by the other auditor. b. Disclaimer of responsibility concerning the portion of the financial statements examined by the other auditor. c. Name of the other auditor. d. Division of responsibility. ANSWER: D

41. An auditor may issue a qualified opinion under which of the following circumstances? Lack of sufficient competent evidential matter Yes Yes No No A Restrictions on the scope of the audit Yes No Yes No

a. b. c. d. ANSWER: 42.

In which of the following circumstances may the auditor issue the standard audit report?

Chapter 14 Audit Reports a. b. c. d.

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The principal auditor assumes responsibility for the work of another auditor. The financial statements are affected by a departure from a generally accepted accounting principle. Substantial doubt exists concerning the ability of the entity to continue as a going concern. The auditor wishes to emphasize a matter regarding the financial statements. A

ANSWER: 43.

Does the auditor make the following representations explicitly or implicitly when issuing the standard auditor's report on comparative financial statements? Consistent Examination of application of evidence on a accounting principles test basis a. Explicitly Explicitly b. Implicitly Implicitly c. d. ANSWER: C Implicitly Explicitly Explicitly Implicitly

44.

When there is a significant change in accounting principle, an auditor's report should refer to the lack of consistency in a. The scope paragraph. b. An explanatory paragraph between the second paragraph and the opinion paragraph. c. The opinion paragraph. d. An explanatory paragraph following the opinion paragraph. ANSWER: D

45.

In which of the following situations would an auditor ordinarily issue an unqualified audit opinion without an explanatory paragraph? a. The auditor wishes to emphasize that the entity had significant related party transactions. b. The auditor decides to make reference to the report of another auditor as a basis, in part, for the auditor's opinion. c. The entity issues financial statements that present

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Chapter 14 Audit Reports financial position and results of operations, but

omits d. the statement of cash flows. The auditor has substantial doubt about the entity's ability to continue as a going concern, but the circumstances are fully disclosed in the financial statements. B

ANSWER: 46.

How are management's responsibility and the auditor's responsibility represented in the standard auditor's report? Management's Auditor's responsibility responsibility a. b. c. d. ANSWER: 47. A Explicitly Implicitly Implicitly Explicitly Explicitly Implicitly Explicitly Implicitly

An auditor should disclose the substantive reasons for expressing an adverse opinion in an explanatory paragraph a. Preceding the scope paragraph. b. Preceding the opinion paragraph. c. Following the opinion paragraph. d. Within the notes to the financial statements. ANSWER: B

48.

When the financial statements contain a departure from generally accepted accounting principles, the effect of which is material, the auditor should a. Qualify the opinion and explain the effect of the departure from generally accepted accounting principles in a separate paragraph. b. Qualify the opinion and describe the departure from generally accepted accounting principles within the opinion paragraph. c. Disclaim an opinion and explain the effect of the departure from generally accepted accounting principles in a separate paragraph. d. Disclaim an opinion and describe the departure from generally accepted accounting principles within the opinion paragraph.

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ANSWER: 49.

Tread Corp. accounts for the effect of a material accounting change prospectively when the inclusion of the cumulative effect of the change is required in the current year. The auditor would choose between expressing a(an) a. Qualified opinion or a disclaimer of opinion. b. Disclaimer of opinion or an unqualified opinion with c. d. explanatory paragraph. Unqualified opinion with an explanatory paragraph and an adverse opinion. Adverse opinion and a qualified opinion. D

an

ANSWER: 50.

The Securities and Exchange Commission has authority to a. Prescribe specific auditing procedures to detect fraud concerning inventories and accounts receivable of companies engaged in interstate commerce. b. Deny lack of privity as a defense in third-party actions for gross negligence against the auditors c. d. public companies. Determine accounting principles for the purpose of financial reporting by companies offering securities to the public. Require a change of auditors of governmental entities after a given period of years as a means of ensuring auditor independence. C

of

ANSWER: 51.

An auditor has previously expressed a qualified opinion on the financial statements of a prior period because of a departure from generally accepted accounting principles. The prior-period financial statements are restated in the current period to conform with generally accepted accounting principles. The auditor's updated report on the prior-period financial statements should a. Express an unqualified opinion concerning the restated financial statements. b. Be accompanied by the original auditor's report on the prior period. c. Bear the same date as the original auditor's report on the prior period.

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Chapter 14 Audit Reports d. Qualify the opinion concerning the restated financial statements because of a change in accounting A

principle. ANSWER: 52.

An auditor's report includes the following statement: "The financial statements do not present fairly the financial position, results of operations, or cash flows in conformity with generally accepted accounting principles." This auditor's report was most likely issued in connection with financial statements that are a. Inconsistent. b. Prepared in accordance with another comprehensive basis of accounting. c. Misleading d. Affected by a material uncertainty. ANSWER: 53. C

An auditor who qualifies an opinion because of an insufficiency of evidential matter should describe the limitation in an explanatory paragraph. The auditor should also refer to the limitation in the Scope Opinion Notes to the paragraph paragraph financial statements a. Yes No Yes b. No Yes No c. Yes Yes No d. Yes Yes Yes ANSWER: C

54.

Restrictions imposed by a client prohibit the observation of physical inventories, which account for 35% of all assets. Alternative audit procedures cannot be applied, although the auditor was able to examine satisfactory evidence for all other items in the financial statements. The auditor should issue a(an) a. "Except for" qualified opinion. b. Disclaimer of opinion. c. Unqualified opinion with a separate explanatory paragraph. d. Unqualified opinion with an explanation in the scope paragraph.

Chapter 14 Audit Reports ANSWER: 55. B

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An auditor may not issue a qualified opinion when a. A scope limitation prevents the auditor from completing an important audit procedure. b. The auditor's report refers to the work of a specialist. c. An accounting principle at variance with generally accepted accounting principles is used. d. The auditor lacks independence with respect to the audited entity. ANSWER: D

COMPLETION: 56. The nature of the examination is described in the ____________ paragraph of the audit report. ANSWER: 57. SCOPE

Generally accepted auditing standards are addressed in the paragraph of the audit report, whereas generally accepted accounting principles are the evaluation standard used in the paragraph. ANSWER: SCOPE, OPINION

58.

The two relevant dates in a dual-dated audit report are the date of completion of audit field work and the date of the . ANSWER: SUBSEQUENT EVENT

59.

An unqualified audit opinion may be rendered only when the financial statements contain no material departures from GAAP, and when no material have prevented the auditor from collecting sufficient, competent evidence. ANSWER: SCOPE LIMITATIONS (RESTRICTIONS)

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Chapter 14 Audit Reports The statement "in our opinion the financial statements do not present fairly" is included in a(n) ____________ opinion. ANSWER: ADVERSE

60.

61.

The responsibilities of management and the auditors with respect to the financial statements are described in the paragraph of the audit report. ANSWER: INTRODUCTORY

62.

An audit report, in a separate paragraph following the opinion paragraph, describes the impact of related party transactions that have been properly reflected and disclosed in the financial statements. This form of report illustrates __ . ANSWER: EMPHASIS OF A MATTER

63.

A CPA who audited the financial statements for the preceding year, and will also be auditing the current year, is said to be a auditor. ANSWER: CONTINUING

64.

If a scope restriction is material and client-imposed, the auditor should render a(an) (qualified, adverse, disclaimer of) opinion. ANSWER: DISCLAIMER OF

65.

A fourth paragraph making reference to omission of supplemental data required by FASB is categorized as . ANSWER: EMPHASIS OF A MATTER

66.

If financial statements have been prepared utilizing a comprehensive basis of accounting other than GAAP, the auditor will evaluate fairness within the framework of ____ __________ ________. ANSWER: THE OTHER BASIS

MATCHING:

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67. From the following types of audit reports, select the one that best fits each of the listed situations. A given selection may be used once, more than once, or not at all. A. Standard audit report B. Report qualified because of scope restriction C. Report qualified because of departure from GAAP D. Adverse opinion E. Disclaimer of opinion F. Unqualified opinion with explanatory paragraph following opinion paragraph _____1. Management refuses to permit the audit team to confirm accounts receivable which comprise 30% of current assets. The auditors are unable to satisfy themselves by other means. _____2. Although significant related party transactions have occurred, they are fully explained in the notes to the financial statements; and related party receivables and payables are separately reflected on the balance sheet. A major legal action, fully described in Note 3 to the financial statements, was been brought against the client during the year being audited. Although outcome is unknown, a significant loss could result. _____4. A patent infringement lawsuit, that could produce a significant damage award, was filed against the client during the year being audited. To maintain confidentiality, the company elected not to disclose the lawsuit in the notes to the financial statements. _____5. Although the financial statements appear to be fairly presented in all other respects, the auditors have been unable to satisfy themselves regarding the future economic benefit of certain intangible assets. The aggregate balance in these accounts is considered to be material. The auditors did not review the quarterly financial data of Client A, a publicly held company. The data is

_____3. the

_____6.

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Chapter 14 Audit Reports included in the annual report to stockholders as part of the supplemental financial data.

_____7.

Given significant appreciation of its plant assets, Client B elects to report them at current replacement cost. The dollar amount of these assets accounts for 60% of total assets. The offsetting credit resulting from the write-up was to an account entitled appreciation surplus and is reflected as part of stockholders equity. Although the client has applied an accounting principle not in accordance with GAAP, the audit team is satisfied that conforming to GAAP would make the financial statements materially misleading.

_____8.

_____9.

Client F has suffered recurring losses over the past few years, along with negative cash flows. In the auditors opinion, management has not demonstrated a viable plan for getting the company back on track. The financial statements adequately disclose the companys financial position, results of operations, and cash flows. _____10. The auditors were appointed by Client G after year-end, and therefore were unable to observe the taking of the companys physical inventory. Given adequate perpetual inventory records and documentation of transactions, the audit team was able to satisfy themselves as to the reasonableness of the ending inventory. SOLUTION: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. E A A C B F D F F A

PROBLEM/ESSAY

Chapter 14 Audit Reports 68. Jonathon Hershey, CPA, is the senior auditor for Web Stores, Inc., a company that markets products on the Internet. The current year-end is January 31, 2003. Last year's audit report contained an explanatory paragraph because of doubt regarding the ability of Web Stores to continue as a going concern. The company had defaulted on two major loan agreements, and appeared to be losing the race to develop a solid commercial presence on the Internet. Since the date of last year's audit report, however, company management has changed. A new advertising campaign and innovative marketing techniques, have proven successful. Creditors have agreed to major debt restructuring agreements, and the client appears to be "out of the woods." Required:

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Assuming the company presents comparative financial statements for 2003 and 2002, explain how the current audit report, as it relates to 2002, will differ from the original report on the 2002 statements. Do not draft an audit report. SOLUTION: Last years audit report covering the year ended January 31, 2002, included a fourth paragraph following the opinion paragraph. Explanatory in nature, this paragraph expressed the auditors doubt as to the ability of Web Stores, Inc. to continue as a going concern. Given the favorable developments during the past year, the current report should omit the fourth paragraph. 69. General Joes Wholesale Produce changed its method for depreciating plant assets from historical cost straight-line to replacement cost straight-line at the beginning of its fiscal year ended March 31, 2003. Plant assets were also written up to reflect replacement cost. Required: a. What type of accounting change is presented in this case? b. Discuss the possible audit report modifications resulting from this change. SOLUTION:

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Chapter 14 Audit Reports

a. This is an error since replacement cost accounting for plant assets is at variance with GAAP. b. Depending on the materiality of the amounts involved, the auditor should either qualify the audit opinion or render an adverse opinion. 70. Audit reports frequently contain an explanatory paragraph following the scope paragraph or the opinion paragraph. Required: a. Describe the conditions under which one might expect to find an explanatory paragraph following the opinion paragraph of the audit report. b. Describe the conditions under which an explanatory paragraph is mandatory. c. Draft an explanatory paragraph for the following situation: Doria Gray, the chief executive officer of Dorias Beauty Botiques, Inc., also owns a large cosmetics supply company, Grays Cosmetics, Ltd. Several material transactions have been completed between Dorias Beauty Botiques and Grays Cosmetics. A sizeable receivable from Grays Cosmetics appears on Dorias Beauty Botiques balance sheet. As auditor for Dorias Beauty Botiques, you have concluded that the transactions have been properly reflected in the financial statements, and adequately described in Note 4 to the financial statements. SOLUTION: a. The auditor may elect to add an explanatory paragraph under any one or more of the following conditions.: 1. Departure from a designated principle and the auditor agrees with the departure; 2. Doubt as to going concern ability; 3. Change in accounting principle properly accounted for and disclosed; 4. Emphasis of a matter In addition, omission of supplemental information required by FASB, discovered errors or inconsistencies in the data, or failure of the auditor to apply limited procedures to the data, may require an explanatory paragraph. The explanatory paragraph does not in any way qualify the auditor's opinion. b. In some cases the explanatory paragraph is optional; in other cases it is required. In the above listing, only (4),

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emphasis of a matter permits auditor discretion as to whether or not to add the paragraph. In all of the other categories, including supplemental information required by FASB, the paragraph is mandatory. c. The Company is under common control with an affiliate and has had significant transactions with this company (See Note 4).