Question

17-38 For each of the following brief scenarios, assume that you are reporting on a client’s current year financial statements. Reply as to the type or types of opinion possible in the circumstance.

                S              Unmodified – Standard

                U             Unmodified with emphasis-of-matter or other-matter paragraph

                Q             Qualified

                D             Disclaimer

                A             Adverse

Since more than one report may be possible in several of the circumstances, a second “opinion” column is added for each circumstance. In certain cases, you will not need to use the second column. Do not read more into the circumstance than what is presented, and do not consider the possibility of an auditors’ discretionary emphasis-of-matter paragraph being added to the audit report. Unless stated otherwise, assume that the information presented is material to the financial statements. If the situation doesn’t tell you whether a misstatement pervasively misstates the financial statements or doesn’t list a characteristic that indicates pervasiveness, two reports may be possible.

Situation                                                                                                                                              Opinion                                Opinion

1. A company in its first year of existence values its inventory at current replacement cost. Although you believe that the inventory costs do not approximate any GAAP inventory valuation method.                                                                                                                                                                                                                                                                                                         The difference involved is material, but not pervasively to the financial statements.

2. Due to recurring operating losses and working capital deficiencies, you have substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time. The notes to the financial statements adequately disclose the substantial doubt situation.                                                                                                                                                                                                                                                             

3. You have discovered that a client made illegal payoffs to a candidate for president of the United States. You are unable to determine the amounts associated with the payoffs because of the client’s inadequate record retention policies. The client has added a note to the financial statements                                                                                                                                                                                                                                                                                                            to describe this information, and has stated that the amounts of the payments are not determinable.                                                                    

4. In auditing the long-term investments account of a new client, you find that a 2,000,000 contingent liability exists that is material to the consolidated company. It is probable that this contingent liability will be resolved with a material loss in the future. Although, no adjusting entry has been made, the client has provided a note to the financial statements that describes the matter in detail and includes the $2 million estimate.                                                                         

5. A client is issuing two years of comparative financial statements. The first year was audited by other auditors who are not being asked to reissue their audit report.

6. An entity changes its depreciation method for production equipment from the straight line to the units-of-production method based on hours of utilization. You concur with the change.                                                                                                                                                                                                                                 

7. A client has changed the method it uses to calculate postemployment benefits from one acceptable method to another acceptable method. The effect of the change is immaterial this year, but is expected to be material in the future.

8. Component auditors have audited a subsidiary of your client as part of a group audit. You have decided to rely upon the component auditors’ work.                                                            

9. A client omits note disclosure related to significant accounting policies that the auditors believe to be fundamental to users’ understanding of the financial statements.                                                                                                                                               

10. A client does not count its year-end inventory. The auditors are unable to obtain sufficient appropriate audit evidence related to the inventory, and they consider inventory to represent an extremely substantial proportion of the financial statements.                                                                                                                                                                                

Answer 1

A company in its first year of existence values inventory at current replacement cost. Although you this case, Auditor may qualify the audit report with reason stating that inventory should been valued at lower of cost or net realisable value as per the mandates of US GAAP believe that the inventory costs do not approximate any However, Cormpany has valued it at replacerment cost which is resulting in higherientory GAAP inventory valuation method. The dfference involved and since arount is malerial but not pervasive to the financial stalements, we are s material, but not pervasively to the financial statements. g our report. This opinion is given when financial statements are not in accordance to US GAAP. Opinion would be Q Qualified 2. Due to recurring operating losses and working capital deficiencies, you have substantial doubt about an entity's ability to continue as a qoing concern for a reasonable periad of time. The notes to the financial statements adequately disclose the substantial doubt will issue unquaified opinion alongwith emphasis matter paragraph. Merely having stantial doubt about entity's ability to continue as going concern does not result in However, such situation may require th at User of financial statements must be aware of such situations and hence Auditor will emphasis the same in separate para called as emphasis mater paragraph. Opinion would be -Unmodified with emphasis-of-matter or other-matter paragraph U 3. You have discovered that a client made illegal payoffs to While this situations involve uncertainly in determination of amounts associated with illegal a candidate for president of the United States. You are unable to determine the amournts associated with he payolTs because of the client's inadequate record retentio aqualified opinion policies. The clent has added a note to the financial statements to describe this information, and has stated Opinion Q Qualified ff due to clients inadequate record retention policies, this may result in qualified Hoev, since sae is not pervasive to finaicial staternents, the Auditor wil issue 4 In auditing the long-term investments account of a new client, you find that a 2,000,000 contingent liability exists that is material to the cansolidated company. It is probabla that this contingent liability will be resolved with a material loss in the future. Although, no adjusting entry has been made, the cient has provided a note to the financial taternents that describes the malter in detail and includes may express an unmodified opinion if sufficient disclosure has been made for liabiity However, when contingent liability is probable and reasonable to US GAAP requires that such liability should be provided in the financials and e disclosure is not enough. Since, liability is material but appears that not pervasive to cial statements and non disclosure of the same will lead to mislead of financial staterments, an Auditor may issuc a Qualfied opinion in this case. nion Q - Qualified 5. A client is issuing two years of comparative finan Te requirement to reissue aucit is required only if there is substantial change in the current statements. The first year was audted by cther auditors r reporting requirements or US GAAP requirements which requires to reissue report so t earlier year financials can be presented in comparative forms with current yean aucit report and hence Auditor ill issue Unmodified Opinion Opinion U-Unmodified with emphasis-of-matter or other-matter paragraph Changing depreciation methad fom Straight line to Units af production is permitted subject who are not being asked to reissue their audit report cials From the situation, it appears that there was no requirement to reissue thein 6. An entity changes its depreciation method for production equipment from the straight line to the units-of- toadequate disclosure in the financial statements and such change should not lead to production melhod based on hours of utilization. Yoru g finaricial statements. In this case, as Auditor has concur with the change, it s that this change is in accordance to US GAAP and adequate disclosure has been an Auditor wil issue a unmodified opinion in this case. concur with the change pinio nU-Unmodified with emphasis-of-matter or other-matter paragraph 7. A client has changed the method it uses to calculate U GAAP permits to change financial statements method if such change will result in better pastemployment benefits from one acceptable methad to presentation of financial statements and does not give any misleading results to the User another acceptable method. The effect of the change is Since, Cient is changing postemployment benefit method from one to anotheracceptable immaterial this year, but is expected to be material in the future. and effect is immaterial and also assumed to be not pervasive to financial staterments, unmodified opinion will be issued in this case by the Auditor. However, if effect expected to be materia in future, disclosure of the same should be made in notes forming part of the financials statements. U - Unmodified with emphasis-of-matter or other-matter paragraph 8 Component auditors have audited a subsidiary of your client as part of a group audit You have decided to rely upon the component auditors work. When Component aucitor are appointed to undertake audit of the particular component, auditor of the Company can rely on the work of component auditor (provided they understood quaification and skills of the component auditor). Therefore, this may not n and hence Auditor may issue u opinion material and misstatement in Financial statements or does not have any crtainty in gathering the evidence i.c.. audit issue). pinionU U Unmodified with em sis-of-matter or other-matter paragraph 9. A client omits note disclosure related to significant accounting policies that the auditors believe to be fundamental to users' understanding of the financial This may result in qualified or adverse opinion depending upon the efect of such non- on the financial statements usability. It non-disclosure is material and pervasive an Auditor may issue Adverse Opinion n Q-Qualifiedi A Adverse 0. A client does nat count its year end inventory. The When the Auditor is unable to obtain sufficient appropriate audit evidence an which to base auditors are unable to obtain sufficient appropriate audit an opinion and auditor concludes that the possible effects of any undetected evidence related to the inventory, and they consider could be both material and pervasive, Auditor issues Disclaimer of substantial proficient appropriate In this casc, since audtor is unable to count of year end inventory in the absencc of the financial staterients. evidence and inventory represent an extrermey substantial proportion of the financial statements. Theretore, same is material and pervasve in nature, llissue Disclaimer Opinion D Disclaimer