auditors and their

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The Auditor’s Role - According to Mother-in-Law

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Jack, the Auditor

Mother-in-Law

Jack, what do you do?

I’m an auditor!

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Friend of Mother-in-Law Mother-in-Law

He snoops around in

other peoples books.

What does Jack do?

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Audit ReportsThe auditor’s reportauditor’s report is the

CPA’s end product, which is intended to describe the results of the examination.

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Historical PerspectiveThe accounting profession was

introduced in the US by British accountants.

Thus, early audit reports were heavily influenced by the reports used in Britain.

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Historical PerspectiveThe wording of these reports

was not uniform, but they were generally referred to as “Auditor’s Certificates.”“Auditor’s Certificates.”

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Early Audit ReportWe have examined the above accounts with the books and vouchers of the company and find the same to be correct.We approve and certify the above balance sheet correctly sets forth the position of the company.Price Waterhouse and Company For St. Louis Breweries, Ltd, 1900

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Historical PerspectiveIn the absence of statutory

requirements for audits, early public accounting practitioners had to justify each engagement on the basis of its economic benefit to the client.

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Historical PerspectiveBecause auditing standards

had not been developed, audits were not uniform.

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Historical PerspectiveBoth the Federal Reserve

Board (FRB) and the Federal Trade Commission (FTC) were dissatisfied with public accounting practice because of the quality of statements being issued.

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Historical PerspectiveAs a result of discussions

between the FRB, the FTC and the American Institute of Accountants (AIA), the forerunner of the AICPA, the FRB issued a suggested auditors report in 1917.

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I have audited the accounts of Blank and Company for the period from … to … and I certify that the above balance sheet and statement of profit and loss have been made in accordance with the plan suggested and advised by the Federal Reserve Board and in my opinion set forth the financial condition of the firm at … and the results of its operations for the period.

/s/ Auditor

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Historical PerspectiveThis report marked the beginning

of a series of recommended reports that ultimately led to today’s standard audit report.

Since 1917, the wording of the standard auditor’s report has been revised eight times.

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Audit Report RevisionsThe development of GAAS;An evolution in the types of

procedures auditors perform;Added efforts to describe the

nature of an audit; andThe development of GAAP.

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Today’s Report . . .Emphasize management’s

responsibility for the statements;Briefly describe an audit; andExpress an opinion about

management’s presentation (the financial statements).

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Historical PerspectiveBefore 1934, the auditor’s report

read

““We We certifycertify that in our that in our opinion . . .”opinion . . .”

This led to reports being referred to as auditor’s certificates.

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Historical PerspectiveHowever, the word certificate

seemed to imply more exactnessexactness than could be achieved in the financial statements, and

The profession has shifted to the more appropriate term auditor’s auditor’s reportreport.

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Historical PerspectiveThe term auditor’s reportauditor’s report is

more consistent with the idea that the auditor is . . .expressing an opinionopinion on, rather than certifyingcertifying the financial

statements.

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Historical PerspectiveBy permitting auditors to exercise

judgment (express an opinion on), users can expect to be able to rely on

the auditor’s reports. . .as providing reasonable assurancereasonable assurance

that no material misstatements have been included in the accounts.

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Historical PerspectiveMaterial misstatementsMaterial misstatements are those

errors that are sufficiently important that they could alter a prudent investor’s decision.

Materiality pertains to both . . .Quantitative, andQualitative judgments.

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An OverviewExhibit 1 (p. 3-9) shows a standard

auditor’s report.This exhibit is sometimes called a

short-form report and is the most common report issued for inclusion in clients’ annual reports.

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Generally Accepted Auditing Standards (GAAS)

The Standards The Standards of Reporting of Reporting

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Format of Audit ReportsThe most common standard

(short-form) audit report has three components . . .The introductory paragraph;The scope section; andThe opinion section

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Report Title . . .Auditing standards require the

report be titled and include the word ““independentindependent” ” which conveys to users that the audit is unbiased.Independent auditor’s report;Report of independent auditor;Independent accountant’s opinion.

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Audit Report AddressAuditor’s reports may be

addressed to:The company;The stockholders; orThe Board of Directors

Typically addressed to one of these.

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Introductory ParagraphWe have audited the

accompanying Balance SheetBalance Sheet of XYZ Company as of December 31, December 31, 1995, and 19941995, and 1994, and the related Statements of IncomeStatements of Income, Retained Retained EarningsEarnings, and Cash FlowsCash Flows for the years then ended.

Refer to Exhibit 1 (p. 3-9)

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These financial statements are These financial statements are the responsibility of the the responsibility of the company’s management.company’s management.Our responsibility is to express Our responsibility is to express an opinion on these financial an opinion on these financial statements based on our audits.statements based on our audits.

Introductory Paragraph

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Applicable Dates and Periods of Financial Statements . . .The report is typically issued

for comparative financial comparative financial statementsstatements, as reflected by the dates of the reports cited in the first sentence of the first paragraph. (SAS 58, Section 5081).

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The profession’s reporting standards require an expression of opinion regarding the financial statements taken as a taken as a wholewhole.

Applicable Dates and Periods of Financial Statements . . .

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Basic Financial StatementsThe term basic financial statements

is used in the professional literature to refer to . . .The four main statements;Descriptions of accounting policies;Notes to the financial statements;Schedules and explanatory material.

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The Scope ParagraphThe scope paragraph is a factual

statement about what the auditor did in the audit.

The paragraph begins with reference to the generally accepted auditing standards.

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The Scope ParagraphWe conducted our audits in

accordance with generally generally accepted auditing standardsaccepted auditing standards. These standards require that we plan and perform the audit to obtain reasonable assurancereasonable assurance about whether the financial statements are free of material misstatements.

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The Scope ParagraphAn audit includes

examining, on a test basison a test basis, evidence supporting the amounts and disclosures in the financial statements.

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The Scope ParagraphAn 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.

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The Opinion ParagraphIn our opinionIn our opinion, the financial statements referred to above present fairlypresent fairly, in all material all material respectsrespects, the financial position of X Company as of [at] December 31, 1995, and 1994, and the results of its operations and its cash flows for the years then ended in conformity in conformity with generally accepted accounting with generally accepted accounting principlesprinciples.

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Present Fairly . . .Present fairly, in all material

respects, means . . .. . . That the statements provide . . . That the statements provide an objective, candid, and an objective, candid, and equitable representation of the equitable representation of the entity’s financial position.entity’s financial position.

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Unqualified OpinionTwo types of opinions contain

the ““unqualifiedunqualified”” opinion.The standard unqualified audit report;

andThe standard unqualified report with

explanatory language or an explanatory paragraph.

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Standard Unqualified ReportThe auditor has audited a setset of

financial reports (statements).The auditor accepts responsibilityresponsibility

for expressing an opinion on these reports.

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Standard Unqualified ReportThe auditor has conducted an

audit in accordance with GAASGAASThe statements are presented in

accordance with GAAPGAAP.

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The report basically implies that the audited financial statements contain no significant problems or deficiencies

Hence, it is often referred to as a ““Clean OpinionClean Opinion.”.”

Standard Unqualified Report

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Qualified Opinion . . .Three conditions require a departure

from the “unqualified” report . ..The scope of the audit has been

restricted;The financial statements have not been

prepared in accordance with GAAP; andThe auditor is not independent.

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Qualified Opinion . . .Another way of saying this is that a

qualified opinion arises from either:The auditor’s being unable to gather

sufficient evidence to serve as a basis for an opinion; or

The client’s failure to follow GAAP in preparing the financial statements.

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The Qualified Opinion says:. . . . . . Except for the effects of the Except for the effects of the matter(s) to which the matter(s) to which the qualification relatesqualification relates, the financial , the financial statements presented fairly, in statements presented fairly, in all material respects, the all material respects, the financial position, results of financial position, results of operations, and cash flows of the operations, and cash flows of the entity in conformity with GAAP.entity in conformity with GAAP.

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Qualified Opinion . . .When issuing a qualified opinion,

the auditor states in the scope the auditor states in the scope paragraph that a limitation paragraph that a limitation existsexists . . . then . . .

Indicates in an added paragraphadded paragraph pre-ceding the opinion the effect of the limitation on his/her opinion on the financial statements, and modifies the opinion paragraph.

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Qualified Opinion . . .When the statements are not not

presented in accordance with GAAPpresented in accordance with GAAP, and the auditor issues a qualified opinion . . .

The auditor must generally describe the deviation in a paragraph preceding the opinion paragraph and modify the opinion paragraph.

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Adverse Opinion . . .When an auditor issues an adverse adverse

opinionopinion, the report states that the the financial statements are not financial statements are not presented in conformity with GAAPpresented in conformity with GAAP.

In one or more paragraphs preceding the opinion paragraph, the report indicates the reasons why the statements are not presented fairly.

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Disclaimer of OpinionWhen issuing a disclaimer of disclaimer of

opinionopinion, the auditor states that he/she does not express an opinion

on the financial statements, and takes no responsibility for reporting

on them.

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Disclaimer of OpinionA disclaimer of opiniondisclaimer of opinion is generally

issued when . . .The auditor is not independentauditor is not independent and

thus could not add credibility to the financial statements by performing an audit; or

The auditor has not been able to not been able to obtain sufficient evidenceobtain sufficient evidence on which to base an opinion.