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374 Independent Auditors™ Reports


The Standard Auditors™ Report (Unqualified Opinion)
The report shall either contain an expression of opinion regarding the financial state-
ments, taken as a whole,2 or an assertion to the effect that an opinion cannot be ex-
pressed. When an overall opinion cannot be expressed, the reasons therefor should
be stated. In all cases where an auditor™s name is associated with financial state-
ments, the report should contain a clear-cut indication of the character of the audi-
tor™s work, if any, and the degree of responsibility the auditor is taking.3

A particular report, the Standard Auditors™ Report (Unqualified Opinion), is used
by the auditors when they have no exceptions regarding management™s representa-
tions in the financial statements. In practice, such a report is often described as a
“clean opinion.” An example of this report was illustrated and discussed in Chap-
ter 2. Explicit in the auditors™ unqualified report is that their examination has been
performed within the general auditing guidelines or standards as set forth by the
AICPA. Moreover, their unqualified opinion informs the users of the finan-
cial statements that such statements have been prepared by management in confor-
mity with generally accepted accounting principles applied on a consistent basis.
Such an unqualified opinion is based not only on their examination of the financial
statements but also on tests of the accounting records that underlie such statements.
While the auditors™ report is not explicit with respect to the system of internal
control, it implies that the entity™s internal control structure is adequate. However,
since the inception of the Foreign Corrupt Practices Act, this audit report has been
reevaluated in terms of its content because it is argued that the auditors should
make their report explicit with respect to management™s adherence to the ac-
counting provision in the act. For example, in April 1979, the SEC in its Release
No. 34-15772 announced its proposed rules for requiring a statement of manage-
ment on internal accounting control in the annual reports of all publicly held cor-
porations. Such a statement should disclose management™s compliance with the
internal accounting control provision of the Foreign Corrupt Practices Act as well
as uncorrected material weaknesses in the controls as reported by the independent
auditors. Furthermore, the Commission™s proposal requires the independent audi-
tors to modify their audit report to disclose management™s inaction in disclosing or
correcting such material weaknesses. While this proposal is applicable to fiscal
years that end between December 16, 1979, and December 15, 1980, the Com-
mission also proposes that the auditors express an opinion on management™s report
on the system of internal accounting control for fiscal years that end after Decem-
ber 15, 1980.4


2
According to the Auditing Standards Board, the phrase “taken as a whole” with respect to the finan-
cial statements applies to the statements of both the current period and one or more prior periods pre-
sented on a comparative basis. See Statement on Auditing Standards No. 58 “Reports on Audited
Financial Statements” (New York: AICPA, 1988), par. 04.
3
The reader may wish to review Chapter 5 at this point.
4
In May 1980, the SEC decided to withdraw this proposed rule; however, it will continue to monitor
private sector initiatives and reconsider the need for new rules over the next three years.
The Auditors™ Reports on Audited Financial Statements 375


Independent Auditor™s Reports
As discussed in Chapter 8, Section 302 of the Sarbanes-Oxley Act of 2002 re-
quires specific representation on the system of internal control. (See Section
302(a)(4) regarding the signing by the officers.)
Additionally, Section 404 of the Sarbanes-Oxley Act requires management to
report annually on its assessment of the effectiveness of internal controls. The act
also requires the company to file a report from its independent auditors regarding
the expression of an opinion as to whether management™s assessment is fairly
stated. Thus it is evident that the users of the financial statements rely on the au-
ditors™ report to determine whether the statements are fairly presented. As a result,
the auditors™ report must be clear and concise with respect to the findings and re-
sults of the audit examination. To achieve this objective, the Auditing Standards
Board has developed audit reports or opinions, which are summarized here:

• Unqualified opinion. An unqualified opinion states that the financial state-
ments present fairly, in all material respects, the financial position, results of
operations, and cash flows of the entity in conformity with generally accepted
accounting principles. This is the opinion expressed in the standard report.
• Explanatory language added to the auditor™s standard report. Certain circum-
stances, while not affecting the auditor™s unqualified opinion on the financial
statements, may require that the auditor add an explanatory paragraph (or other
explanatory language) to his report.
• Qualified opinion. A qualified opinion states that, except for the effects of the
matter(s) to which the qualification relates, the financial statements present
fairly, in all material respects, the financial position, results of operations,
and cash flows of the entity in conformity with generally accepted accounting
principles.
• Adverse opinion. An adverse opinion states that the financial statements do not
present fairly the financial position, results of operations, or cash flows of the
entity in conformity with generally accepted accounting principles.
• Disclaimer of opinion. A disclaimer of opinion states that the auditor does not
express an opinion on the financial statements.5

As discussed in Chapter 8, the Auditing Standards Board has issued Statement
on Standards for Attestation Engagements No. 2, “Reporting on the Entity™s In-
ternal Control Structure over Financial Reporting,” now recodified in SSAE No.
10. Given the demand from the investing public for management™s assertions
about the effectiveness of the entity™s internal control and the requirements of the


5
Statement on Auditing Standards No. 58, “Reports on Audited Financial Statements” (New York:
AICPA, 1988), par. 10. For additional reference, see Robert S. Roussey, Ernest L. Ten Eyck, and Mimi
Blanco-Best, “Three New SASs: Closing the Communication Gap,” Journal of Accountancy 166, No.
6 (December 1988), pp. 44“52.
376 Independent Auditors™ Reports


Sarbanes-Oxley Act, it is reasonable to expect that the audit committee understand
this type of attestation engagement. Thus it is important for the audit committee to
review closely and discuss the recommendations in the annual management letter
from the independent auditors.

Explanatory Language with the Auditor™s Standard Report
The Auditing Standards Board requires independent auditors to modify their stan-
dard audit report under certain circumstances. Such a modification may require the
addition of an explanatory paragraph or other explanatory language. More specif-
ically, the circumstances include instances when:

a. The auditor™s opinion is based in part on the report of another auditor.
b. To prevent the financial statements from being misleading because of unusual
circumstances, the financial statements contain a departure from an account-
ing principle promulgated by a body designated by the AICPA Council to es-
tablish such principles.*
c. There is substantial doubt about the entity™s ability to continue as a going
concern.
d. There has been a material change between periods in accounting principles or
in the method of their application.
e. Certain circumstances relating to reports on comparative financial statements
exist.
f. Selected quarterly financial data required by SEC Regulation S-K has been
omitted or has not been reviewed.
g. Supplementary information required by the Financial Accounting Standards
Board (FASB) or the Governmental Accounting Standards Board (GASB) has
been omitted, the presentation of such information departs materially from
FASB or GASB guidelines, the auditor is unable to complete prescribed pro-
cedures with respect to such information, or the auditor is unable to remove
substantial doubts about whether the supplementary information conforms to
FASB or GASB guidelines.
h. Other information in a document containing audited financial statements is
materially inconsistent with information appearing in the financial statements.6

Certain circumstances may arise, for example, when the auditors must rely on
the report of another auditor or the auditors may not be independent. With respect
to the former, the auditors™ reporting obligations are based on their decisions
whether to make reference to the other auditors™ report. Therefore, if the auditors
decide “to make reference to the report of another auditor as a basis, in part,” for


*For further reference, see “Departures from the New Standard Auditor™s Report on Financial State-
ments of Business Enterprises: A Survey of the Application of Statement on Auditing Standards, No.
58,” Financial Report Survey (New York: AICPA, 1990).
6
American Institute of Certified Public Accountants, Professional Standards, U.S. Auditing Standards/
Attestation Standards, Vol. 1 (New York: AICPA, 2003), AU Sec. 508.11.
Other Auditing Opinions 377


their opinion, their report should disclose this fact.7 When auditors decide to make
no reference to the report of another auditor because of their acceptance of the au-
ditor™s independence and reputation, the standard short-form unqualified report is
acceptable.
However, when the auditors are not independent”for example, there is a conflict
of interest between the public accounting firm and the client”they should “disclaim
an opinion with respect to the financial statements and should state specifically” that
they are not independent.8 Such an action is necessary on the part of the auditors, be-
cause of the auditing standard of independence discussed in Chapter 5.
Furthermore, in addition to their expression of an unqualified opinion, the au-
ditors may wish to emphasize certain matters regarding the financial statements.
For example, they may wish to indicate that the corporation has had “significant
transactions with related parties,” such as transactions between the entity and the
officers or directors.9 In addition, they may wish to disclose “an unusually impor-
tant subsequent event” that occurred after the date of the financial statements. Ob-
viously, such matters are disclosed based on the professional judgment of the
auditors. However, while the auditors may wish to emphasize certain matters, they
can express an unqualified opinion.
To familiarize the audit committee with various examples of the wording in the
auditors™ modified unqualified report, a model report is presented in Exhibit 13.1.


OTHER AUDITING OPINIONS
The Qualified Opinion
According to the Auditing Standards Board, the auditors may express a qualified
opinion that “ ˜except for™ the effects of the matter to which the qualification re-
lates, the financial statements” are presented fairly.10 Concerning the “exceptions”
noted by the auditors, the Board delineated these circumstances:

There is a lack of sufficient competent evidential matter or there are restrictions on
the scope of the audit that have led the auditor to conclude that he cannot express an
unqualified opinion and he has concluded not to disclaim an opinion.
The auditor believes, on the basis of his audit, that the financial statements contain a
departure from generally accepted accounting principles, the effect of which is ma-
terial, and he has concluded not to express an adverse opinion.11

With respect to the aforementioned circumstances, an example of the auditors™
report is illustrated in Exhibit 13.2.


7
American Institute of Certified Public Accountants, Professional Standards, U.S. Auditing Stan-
dards/Attestation Standards, Vol. 1 (New York: AICPA, 2003), AU Sec. 508.12.
8
Ibid., AU Sec. 504.09.
9
Ibid., AU Sec. 508.19.
10
Ibid., AU Sec. 508.20.
11
Ibid., AU Sec. 20.
378 Independent Auditors™ Reports



Exhibit 13.1 Independent Auditor™s Report: Example 1

Opinion Based in Part on Report of Another Auditor
We have audited the consolidated balance sheets of ABC Company as of December 31,
20X2 and 20X1, and the related consolidated 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. We did not audit the financial statements of B Company, a
wholly-owned subsidiary, which statements reflect total assets of $______ and $______ as
of December 31, 20X2 and 20X1, respectively, and total revenues of $______ and
$______ for the years then ended. Those statements were audited by other auditors whose
report has been furnished to us, and our opinion, insofar as it relates to the amounts in-
cluded for B Company, is based solely on the report of the other auditors.
We conducted our audits in accordance with auditing standards generally accepted in
the United States of America. 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 and the
report of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the consolidated fi-
nancial statements referred to above present fairly, in all material respects, the financial po-
sition of ABC Company as of December 31, 20X2 and 20X1, and the results of its
operations and its cash flows for the years then ended in conformity with accounting prin-
ciples generally accepted in the United States of America.a

Lack of Consistency
As discussed in Note X to the financial statements, the Company changed its method of
computing depreciation in 20X2.b

An Entity™s Ability to Continue as a Going Concern
The accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in Note X to the financial statements,
the Company has suffered recurring losses from operations and has a net capital deficiency
that raises substantial doubt about its ability to continue as a going concern. Management™s
plans in regard to these matters are also described in Note X. The financial statements do
not include any adjustments that might result from the outcome of this uncertainty.c




a
Statement on Auditing Standards No. 58, par. 13, as amended by ASB interpretation.
b
Professional Standards, U.S. Auditing Standards/Attestation Standards, Vol. 1, AU Sec. 508.17.
c
Statement on Auditing Standards No. 59, “The Auditor™s Consideration of an Entity™s Ability to
Continue as a Going Concern” (New York: AICPA, 1988), par. 13. For further discussion, see John
E. Ellingsen, Kurt Pany, and Peg Fagan, “SAS No. 59: How to Evaluate Going Concern,” Journal of
Accountancy 168, No. 1 (January 1989), 24“31.
Other Auditing Opinions 379



Exhibit 13.2 Independent Auditor™s Report: Example 2

Scope Limitations
[Same first paragraph as the standard report]
Except as discussed in the following paragraph, we conducted our audits in accordance
with auditing standards generally accepted in the United States of America. Those stan-
dards require that we plan and perform the audit to obtain reasonable assurance about

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