Chapter 18 – Reports on Audited Financial Statements
18-1
CHAPTER 18
REPORTS ON AUDITED FINANCIAL STATEMENTS
Answers to Review Questions
18-1 An auditor is associated with financial statements when he or she has consented to the
use of his or her name in a document such as an annual report.
18-2 Accounting changes can be categorized into changes that affect consistency and those
that do not affect consistency. The word “consistency” refers to the application of
accounting principles. If a change in accounting principle or in the method of its
application has a material effect on the comparability and consistency of the financial
depreciation expense will not be comparable to that of the previous year due to the
change in estimate.
18-3 An example of a client-imposed scope limitation is where a client requests that the
auditor not confirm accounts receivable because of concerns about creating conflicts with
customers over amounts owed. An example of a circumstances-imposed scope limitation
is when the auditor is not engaged to conduct the audit until after year-end. Under such
18-4 The concept of materiality plays a major role in the auditor’s choice of audit reports. If
the departure from GAAP is immaterial, the auditor issues an unqualified/unmodified
opinion. If the departure from GAAP is material but not pervasive, the auditor issues a
qualified (“except for”) opinion. If the departure is so pervasive that its effects are highly
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18-5 The auditor should issue an unmodified report on the 2014 financial statements and a
qualified report on the 2015 financial statements because the current year is not in
conformity with GAAP. The non-GAAP accounting for the lease transaction should be
18-6 The auditor has no responsibility beyond the financial information contained in the
report, and he or she has no obligation to perform any audit procedures to corroborate the
other information. However, auditing standards (AU 720) requires that the auditor read
18-7 If the auditor determines that other information contained with audited financial
statements is incorrect, the auditor should request that the client correct the other
information. If the other information is not revised, the auditor should include an
18-8 Examples of special reports include reports on
• Financial statements prepared on a basis of accounting other than GAAP (e.g. The
cash basis of accounting)
(In addition to these, there are others that are beyond the scope of this book, such as
financial presentations to comply with contractual agreements or regulatory provisions,
and financial information presented in prescribed forms or schedules that require a
prescribed form of auditor’s report.)
18-9 Four bases for special purpose financial statements are
• Regulatory basis.
• Tax basis.
Chapter 18 – Reports on Audited Financial Statements
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Answers to Multiple-Choice Questions
18-10
b
18-16
c
18-11
c
18-17
b
18-12
a
18-18
b
18-13
a
18-19
b
18-14
a
18-20
c
18-15
c
18-21
c
Solutions to Problems
18-22 a. The auditor would issue an unqualified audit report with modified wording for the
reliance on the other auditors. In this case, the principal auditor does not intend to
take responsibility for the other auditor’s work.
b. The auditor should issue a qualified audit report because management has not
the future and perhaps its own survival. Thus, an adverse opinion is very likely the
most appropriate response.
d. Because the client wouldn’t allow the confirmations to be sent, the appropriate
response would generally be either a qualified opinion or a disclaimer of opinion for a
scope limitation imposed by the client’s management, depending on the materiality of
client’s failure to disclose the related parties means that the financial statements do
not comply with GAAP.
Chapter 18 – Reports on Audited Financial Statements
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g. Recall that the instructions to the problem indicate the assumption that all matters
listed are at least material. Since the change in accounting principle is properly
accounted for, the auditor should issue an unqualified audit report with an
explanatory paragraph for a lack of consistency in the application of GAAP.
18-23 a. The auditor should issue a standard unmodified audit report. It is acceptable for an
entity to use different inventory methods in different international regions. Many
countries do not allow LIFO, and it can be costly for the entity to maintain inventory
records using both valuation methods.
b. The auditor should issue a standard unmodified audit report. As long as this
change from replacement cost to FIFO for valuing inventory.
e. This is a change in accounting estimate. Such a change does not affect consistency in
the application of accounting principles, and the auditor should thus issue a standard
unmodified audit report.
f. The auditor should issue a standard unmodified audit report because the client
corrected the mistake before issuing the financial statements.
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18-24 a. May & Marty needs to satisfy itself about the independence and professional
reputation of Dey & Dee and assure itself that there has been coordination of
activities between the two auditors in order to achieve a proper review of matters
affecting consolidation. Whether or not it makes reference to Dey & Dee’s
examination, May & Marty should consider performing the following procedures:
• Make inquiries about the professional reputation and standing of Dey & Dee to
one or more of the following:
grantors.
• Obtain a representation from Dey & Dee that it is independent under the
requirements of the AICPA and, if appropriate, the requirements of the SEC.
• Ascertain through communication with Dey & Dee that
• Dey & Dee is aware that the BGI-Western financial statements are to be
included in the BGI consolidated financial statements on which May & Marty
uniformity of accounting practices among components included in the
financial statements.
b. May & Marty could adopt the position of not making reference to Dey & Dee‘s
examination of BGI-Western if May & Marty is able to satisfy itself about the
independence and professional reputation of Dey & Dee and takes steps it considers
appropriate to satisfy itself as to Dey & Dee’s examination of BGI-Western.
about the reasonableness of the statements of BGI-Western for purposes of inclusion
in BGI’s consolidated financial statements; or BGI-Western’s financial statements are
not a material part of BGI’s consolidated financial statements.
Chapter 18 – Reports on Audited Financial Statements
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18-25
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors of Devon Incorporated
We have audited the consolidated balance sheet of Devon Incorporated as of
December 31, 2015, and the related consolidated statement of operations, stockholders’
equity, and cash flows for the period ended December 31, 2015. These 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. The financial
statements of Devon Incorporated for the year ended December 31, 2014, were audited
by other auditors, whose report dated March 30, 2015, expressed an unqualified opinion
on those statements.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). 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.
During the year, Devon changed its method of valuing inventory from the first-in,
first-out method to the last-in, first-out method. This change was made because
$0.75, respectively, for the year then ended.
In our opinion, except for the effects of not capitalizing lease obligations, and
except for not disclosing the change in inventory methods as discussed in the preceding
paragraphs, the financial statements referred to above present fairly, in all material
respects, the financial position of Devon Incorporated as of December 31, 2015, and the
results of its operations and its cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Devon Incorporated’s
internal control over financial reporting as of December 31, 2015, based on criteria
established in Internal Control—Integrated Framework issued by the Committee of
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Sponsoring Organizations of the Treadway Commission (COSO), and our report dated
February 28, 2016 expressed an unqualified opinion that Devon Incorporated maintained,
in all material respects, effective internal control over financial reporting.
Rao, CPA
February 28, 2016
18-26
INDEPENDENT AUDITOR’S REPORT
We have audited the accompanying statements of assets, liabilities, and fund balances arising
from modified cash transactions of Modern Museum, Inc., as of December 31, 2015 and 2014,
and the related statements of support, revenue, and expenses and changes in fund balances—
modified cash basis and changes in financial resources—modified cash basis for the years then
ended.
Management’s Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these consolidated
financial statements in accordance with accounting principles generally accepted in the United
material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and
disclosures in the consolidated financial statements. The procedures selected depend on the
auditor’s judgment, including the assessment of the risks of material misstatement of the
consolidated financial statements, whether due to fraud or error. In making those risk
assessments, the auditor considers internal control relevant to the entity’s preparation and fair
presentation of the consolidated financial statements in order to design audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit
Chapter 18 – Reports on Audited Financial Statements
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Opinion
In our opinion, the financial statements referred to above present fairly, in all material respects,
the assets, liabilities, and fund balances arising from modified cash transactions of Modern
Museum, Inc., as of December 31, 2015 and 2014, and its support, revenue, and expenses and
the changes in its fund balances and changes in financial resources for the years then ended, on
the basis of accounting described in Note X.
Basis of Accounting
We draw attention to Note X of the financial statements, which describes the basis of accounting.
The financial statements are prepared on the basis of modified cash receipts and disbursements,
which is a basis of accounting other than accounting principles generally accepted in the United
States of America. Our opinion is not modified with respect to this matter.
Kristen & Valentine, CPAs
March 12, 2016
18-27 Report of Independent Registered Public Accounting Firm
To the Board of Directors of Kim Company:
We have audited the accompanying balance sheets of Kim Company as of
December 31, 2015 and 2014, and the related statements of income, retained earnings,
and cash flows for the years then ended. These 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.
Except as explained in the following paragraph, we conducted our audits in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform our 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
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In our opinion, the balance sheets of Kim Company as of December 31, 2015 and
2014, and the related statements of income, retained earnings, and cash flows for the year
ended December 31, 2015, present fairly, in all material respects, the financial position of
Kim Company as of December 31, 2015 and 2014, and the results of its operations and its
cash flows for the year ended December 31, 2015, in conformity with accounting
principles generally accepted in the United States of America.
Friday & Co., CPAs
March 12, 2016
18-28 The auditors’ report contains the following deficiencies:
Report title:
• “Independent” is omitted from the title of the auditors’ report.
Introductory paragraph:
• No deficiencies.
Management’s responsibility paragraph:
• Paragraph has been omitted completely.
Auditor’s responsibility paragraph:
• The auditor’s responsibility to express an opinion on the financial statements is
omitted.
• “Generally accepted auditing standards” should be referred to, not standards
established by the AICPA.
Scope paragraph:
• There is no mention that the auditor considers internal control in making risk
assessments and in designing appropriate audit procedures.
• Reference to assessing “significant estimates made by management” is omitted.
Opinion paragraph:
• The income tax basis of accounting “described in Note 2″ should be referred to, not
“generally accepted accounting principles.”
• There should be no reference to consistency unless the accounting principles have not
been applied consistently.
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Emphasis-of-matter (Basis of accounting) paragraph:
• Reference to the income tax basis of accounting as “basis of accounting other than
generally accepted accounting principles” is omitted.
• The statement that the financial statements are “not designed for those who do not
have access to the Partnership tax returns” is inappropriate.
Solution to Discussion Case
18-29 a. Auditing standards provide guidance to the auditor for evaluating an entity’s ability to
continue as a going concern. This standard states specifically that the auditor has a
responsibility to evaluate whether the entity will be able “to continue as a going
concern for a reasonable period of time,” which is defined in that paragraph as “not to
exceed one year beyond the date of the financial statements being audited.” SAS No.
59 provides that in the process of the audit, the auditor has to consider whether certain
conditions and events that have been identified might indicate that there is substantial
doubt about the entity’s ability to continue as a going concern (see Ch. 17). It states
further that the conditions and events “depend on the circumstances,” which may not
be significant in and of themselves but may be significant in combination with other
conditions and events, such as the following:
• Negative trends.
adverse effects of the conditions and events. The auditor should consider the
following:
b. In this case, the situation is somewhat different, because the auditor knows that for
the year ended March 31, 2015, the previous auditor had determined that there was
substantial doubt about Paper Packaging’s ability to continue as a going concern and
consequently the auditor’s report included an explanatory paragraph discussing a
going-concern uncertainty. That report identified the conditions and events, which
added.)
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It appears, then, that the burden of proof has shifted. The auditor needs to evaluate
whether the conditions and events that caused the auditor to modify the report for a
going-concern uncertainty continue to exist or whether the auditor can be satisfied
that there has been sufficient improvement in Paper Packaging’s financial condition
that there is no longer a substantial doubt about the company’s ability to continue as a
going concern.
c. In making the determination of whether to modify the report, the auditor must
consider how successful management has been in overcoming the conditions that
existed at March 31, 2015. In this case, the following positive events have occurred
since the March 31, 2015, year-end:
cash inflow to the company.
Although most of the adverse conditions that existed at the 2015 year-end have
been resolved favorably, at March 31, 2016, the company is still in default on $4.6
million of the 2015 debentures. This alone may be sufficient grounds for including a
going concern modification in the report on the March 31, 2016, financial statements.
On the other hand, positive indications should be considered. For example, the
company had a cash balance of $5.5 million at year-end and expects to generate net