CHAPTER SIX

AUDIT REPORTS

Reports are essential to audit and assurance engagements because they communicate the
auditor’s findings. Users of financial statements rely on the auditor’s report to provide assurance
on the company’s financial statements. The auditor will likely be held responsible if an incorrect
audit report is issued. The audit report is the final step in the entire audit process.

Audit report is the end product of auditing. It contains the auditor’s opinion about the fairness of
the financial statements. The audit report is an explanation of the audit process and conclusions
reached. The report is the formal communication between the auditor and the external users of
the financial statements, primarily the shareholders. There are four types of audit reports. These
are unqualified report, qualified report, adverse report, and disclaimer of opinion.
6.1. STANDARD UNQUALIFIED AUDIT REPORT
To allow users to understand audit reports, auditing standards provide uniform wording for the
auditor’s report. Different auditors may alter the wording or presentation slightly, but the
meaning will be the same.
A. Parts of standard unqualified audit report
The auditor’s standard unqualified audit report contains seven distinct parts.
INDEPENDENT AUDITOR'S REPORT
TO THE STOCKHOLDERS OF ABC COMPANY
We have audited the accompanying balance sheet of ABC Corporation as of December 31, 2011, and the
related statement of income, and cash flows for the year then ended. These financial statements are the
responsibility of the company's management. Our responsibility is to express an opinion on these statements
base on our audit.
We conducted our audit in accordance with generally accepted auditing standards. 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 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 audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial
position of ABC corporation as of December 31, 2011, and the results of its operations and its cash flows for
the year then ended in conformity with generally accepted accounting principles.
Beka and Co, CPA
MARCH 14, 2012

Fig. 6.1. Standard unqualified audit report

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 1. Report title
Auditing standards require that the report be titled and that the title include the word
independent. For example, appropriate titles include “independent auditor’s report,” “report of
independent auditor,” or “independent accountant’s opinion.” The requirement that the title
include the word independent conveys to users that the audit was unbiased in all aspects.
2. Audit report address
The report is usually addressed to the company, its stockholders, or the board of directors.
Sometimes, it has become customary to address the report to the board of directors and
stockholders to indicate that the auditor is independent of the company. In our example, the
report address is “To the shareholders of ABC Company.”
3. Introductory paragraph
The first paragraph of the report does three things: First, it makes the simple statement that the
audit firm has done an audit. This is intended to distinguish the report from a compilation or
review report. The scope paragraph clarifies what is meant by an audit. Second, it lists the
financial statements that were audited, including the balance sheet dates and the accounting
periods for the income statement and statement of cash flows. The wording of the financial
statements in the report should be identical to those used by management on the financial
statements. Third, the introductory paragraph states that the statements are the responsibility of
management and that the auditor’s responsibility is to express an opinion on the statements based
on an audit.
4. Scope paragraph
The scope paragraph (the second paragraph) is a factual statement about what the auditor did in
the audit. This paragraph first states that the auditor followed the appropriate generally accepted
auditing standards. In the above auditor report, the relevant standards are International Standards
on Auditing (ISA). The scope paragraph states that the audit is designed to obtain reasonable
assurance about whether the statements are free of material misstatement. The inclusion of the
word material conveys that auditors are responsible only to search for significant misstatements,
not minor misstatements that do not affect users’ decisions. The use of the term reasonable
assurance is intended to indicate that an audit cannot be expected to completely eliminate the
possibility that a material misstatement will exist in the financial statements. In other words, an
audit provides a high level of assurance, but it is not a guarantee. The remainder of the scope
paragraph discusses the audit evidence accumulated and states that the auditor believes that the
evidence accumulated was appropriate for the circumstances to express the opinion presented.
The words test basis indicates that sampling was used rather than an audit of every transaction
and amount on the statements.
 The scope paragraph states that the auditor evaluates the appropriateness of those
accounting principles, estimates, and financial statement disclosures and presentations given.

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 5. Opinion paragraph
The final paragraph (the third paragraph) in the standard report states the auditor’s conclusions
based on the results of the audit. This part of the report is so important that often the entire audit
report is referred to simply as the auditor’s opinion. The opinion paragraph is stated as an
opinion rather than as a statement of absolute fact or a guarantee. The intent is to indicate that the
conclusions are based on professional judgment. The phrase in our opinion indicates that there
may be some information risk associated with the financial statements, even though the
statements have been audited. The opinion paragraph is directly related to the first and fourth
generally accepted auditing reporting standards.
Most auditors believe that financial statements are “presented fairly” when the statements are in
accordance with generally accepted accounting principles, but that it is also necessary to examine
the substance of transactions and balances for possible misinformation.
6. Name of audit firm
The name identifies the audit firm or practitioner who performed the audit. Typically, the firm’s
name is used because the entire audit firm has the legal and professional responsibility to ensure
that the quality of the audit meets professional standards. In our example, the name of audit firm
is Beka and Co.
7. Audit report date
The appropriate date for the report is the one on which the auditor completed the auditing
procedures in the field. This date is important to users because it indicates the last day of the
auditor’s responsibility for the review of significant events that occurred after the date of the
financial statements. In the above audit report, the balance sheet is dated December 31, 2011,
and the audit report is dated March 14, 2012. This indicates that the auditor has searched for
material unrecorded transactions and events that occurred up to March 14, 2012

B. Conditions for standard unqualified Report

The standard unqualified audit report is issued when the following conditions have been met:

1. All statements (i.e. balance sheet, income statement, statement of retained earnings, and
statement of cash flows) are included in the financial statements.
2. The three general standards (i.e. technical proficiency and training, independence, and
due professional care) have been followed in all respects on the engagement.
3. Sufficient appropriate evidence has been accumulated, and the auditor has conducted the
engagement in a manner that enables him or her to conclude that the three standards of
field work have been met.
4. The financial statements are presented in accordance with the relevant generally accepted
accounting principles. This also means that adequate disclosures have been included in
the footnotes and other parts of the financial statements.

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 5. There are no circumstances requiring the addition of an explanatory paragraph or
modification of the wording of the report.

When these conditions are met, the standard unqualified audit report is issued. The standard
unqualified audit report is sometimes called a clean opinion because there are no circumstances
requiring a qualification or modification of the auditor’s opinion. The standard unqualified report
is the most common audit opinion.

Audit reports contain the auditor’s opinion on the fairness of the client’s financial statements.
There are four types of audit reports: unqualified, qualified, adverse, and disclaimer of opinion.
Unqualified report can be of two types; namely, standard unqualified report and unqualified
report with explanatory paragraph or modification of wordings. Standard unqualified report is a
clean report which is issued when financial statements are free of material misstatements in all
material respects.

6.2. UNQUALIFIED AUDIT REPORT WITH EXPLANATORY PARAGRAPH OR

MODIFICATION OF WORDINGS

In certain situations, an unqualified audit report on the financial statements is issued, but the
wording deviates from the standard unqualified report. The unqualified audit report with
explanatory paragraph or modified wording meets the criteria of a complete audit with
satisfactory results and financial statements that are fairly presented, but the auditor believes it is
important or is required to provide additional information. In a qualified, adverse, or disclaimer
report, the auditor either has not performed a satisfactory audit, is not satisfied that the financial
statements are fairly presented, or is not independent. The most important causes of the addition
of an explanatory paragraph or a modification in the wording of the standard unqualified report
are lack of consistent application of generally accepted accounting principles, substantial doubt
about going concern, auditor agrees with a departure from promulgated accounting principles,
emphasis of a matter, and reports involving other auditors. The first four reports all require an
explanatory paragraph. In each case, the three standard report paragraphs are included without
modification, and a separate explanatory paragraph follows the opinion paragraph. Only reports
involving the use of other auditors use a modified wording report. This report contains three
paragraphs, and all three paragraphs are modified.

A. Lack of Consistent Application of GAAP

According to the second reporting standard, the auditor is required to call attention to
circumstances in which accounting principles have not been consistently observed in the current
period in relation to the preceding period. Generally accepted accounting principles require that
changes in accounting principles or their method of application be to a preferable principle and
that the nature and impact of the change be adequately disclosed. When a material change
occurs, the auditor should modify the report by adding an explanatory paragraph after the
opinion paragraph that discusses the nature of the change and points the reader to the footnote
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that discusses the change. The materiality of a change is evaluated based on the current year
effect of the change. An explanatory paragraph is required for both voluntary changes and
required changes due to a new accounting pronouncement. Figure 3.2 presents such an
explanatory paragraph.
INDEPENDENT AUDITOR'S REPORT
TO THE STOCKHOLDERS OF ABC COMPANY
We have audited the accompanying balance sheet of ABC Corporation as of December 31, 2011, and the
related statement of income, and cash flows for the year then ended. These financial statements are the
responsibility of the company's management. Our responsibility is to express an opinion on these
statements base on our audit.

We conducted our audit in accordance with generally accepted auditing standards. 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 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 audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the
financial position of ABC corporation as of December 31, 2011, and the results of its operations and its
cash flows for the year then ended in conformity with generally accepted accounting principles.
As discussed in note IV to the financial statements, the company changed its method of computing
depreciation in 2011.

Beka & Co., CPA

MARCH 14, 2012

Fig. 6.2: Unqualified audit report (Lack of consistency)

As you can see in figure 3.2, the address, introductory paragraph, scope paragraph, and opinion
paragraph are the same as figure 3.1. The only thing new is the fourth paragraph which is
indicated in italic and bold.
B. Substantial doubt about going concern
Does the auditor have the mandate to evaluate the going concern assumption of the client? Even
though the purpose of an audit is not to evaluate the financial health of the business, the auditor
has a responsibility under auditing standards to evaluate whether the company is likely to
continue as a going concern. For example, the existence of one or more of the following factors
causes uncertainty about the ability of a company to continue as a going concern:
 Significant recurring operating losses
 Working capital deficiencies
 Inability of the company to pay its obligations as they come due

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  Loss of major customers
 the occurrence of uninsured catastrophes such as an earthquake or flood
 Unusual labor difficulties (strike)
 Legal proceedings, legislation, or similar matters that have occurred that might jeopardize
the entity’s ability to operate
The auditor’s concern in such situations is the possibility that the client may not be able to
continue its operations or meet its obligations for a reasonable period. For this purpose, a
reasonable period is considered not to exceed one year from the date of the financial statements
being audited. When the auditor concludes that there is substantial doubt about the entity’s
ability to continue as a going concern, an unqualified opinion with an explanatory paragraph is
required, regardless of the disclosures in the financial statements. The fourth paragraph is added
after opinion paragraph. Figure 3.3 provides an example in which there is substantial doubt about
going concern.

INDEPENDENT AUDITOR'S REPORT

TO THE STOCKHOLDERS OF ABC COMPANY
We have audited the accompanying balance sheet of ABC Corporation as of December 31, 2011, and the
related statement of income, and cash flows for the year then ended. These financial statements are the
responsibility of the company's management. Our responsibility is to express an opinion on these
statements base on our audit.
We conducted our audit in accordance with generally accepted auditing standards. 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 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 audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the
financial position of ABC corporation as of December 31, 2011, and the results of its operations and its
cash flows for the year then ended in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that ABC Company will continue
as a going concern. As discussed in note V to the financial statements, ABC Company has suffered
recurring losses from operations and has net capital deficiency that raises substantial doubt about the
company's ability to continue as a going concern. Management’s plans in regard to these matters are
also described in note y. The financial statements do not include any adjustments that might result from
the outcome of this uncertainty.

Beka & Co., CPA

MARCH 14, 2012
Fig. 6.3: Unqualified audit report (Going concern)

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C. Auditors Concur (Agree) Departure from GAAP
In unusual situations, a departure from a generally accepted accounting principle may not require
a qualified or adverse opinion. However, to justify an unqualified opinion, the auditor must be
satisfied and must state and explain, in a separate paragraph or paragraphs in the audit report,
that adhering to the principle would produce a misleading result in that situation. This requires
adding an explanatory paragraph before or after opinion paragraph by referring to management
footnote and discuss non-GAAP item.

INDEPENDENT AUDITOR'S REPORT

TO THE STOCKHOLDERS OF ABC COMPANY
We have audited the accompanying balance sheet of ABC Corporation as of December 31, 2011, and the
related statement of income, and cash flows for the year then ended. These financial statements are the
responsibility of the company's management. Our responsibility is to express an opinion on these
statements base on our audit.
We conducted our audit in accordance with generally accepted auditing standards. 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 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 audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the
financial position of ABC corporation as of December 31, 2011, and the results of its operations and its
cash flows for the year then ended in conformity with generally accepted accounting principles.
As described in note VI, in May 2011, the company exchanged shares of its common stock for Birr
5,060,000 of its outstanding public debt. The fair value of the common stock issued exceeded the
carrying amount of the debt by Birr 466,000, which has been shown as an extraordinary loss in the 2008
statement of operations. Because a portion of the debt exchanged was convertible debt, a literal
application of statement of financial accounting standards no. 84"induced conversions of convertible
debt," would have resulted in a further reduction in net income of Birr 3,611,000, which would have been
offset by a corresponding Birr 3,611,000 credit to additional paid in capital; accordingly, there would
have been no net effect on stockholders' investment. In the opinion of company management, with
which we agree, a literal application of accounting literature would have resulted in misleading financial
statements that do not properly portray the economic consequences of the exchange.

Fig. 6.4: Unqualified audit report (GAAP Departure auditor Concurs)

D. Emphasis of a matter

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Under certain circumstances, the auditor may want to emphasize specific matters regarding the
financial statements, even though he or she intends to express an unqualified opinion. Normally,
such explanatory information should be included in a separate paragraph in the report. Examples
of explanatory information the auditor may report as an emphasis of a matter include the
following:
• The existence of significant related party transactions
• Important events occurring subsequent to the balance sheet date
• The description of accounting matters affecting the comparability of the financial
statements with those of the preceding year
• Material uncertainties disclosed in the footnotes
INDEPENDENT AUDITOR'S REPORT
TO THE STOCKHOLDERS OF ABC COMPANY
We have audited the accompanying balance sheet of ABC Corporation as of December 31, 2011, and the
related statement of income, and cash flows for the year then ended. These financial statements are the
responsibility of the company's management. Our responsibility is to express an opinion on these
statements base on our audit.
We conducted our audit in accordance with generally accepted auditing standards. 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 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 audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the
financial position of ABC corporation as of December 31, 2011, and the results of its operations and its
cash flows for the year then ended in conformity with generally accepted accounting principles.
As discussed in note VI to the financial statements, the company has had numerous dealings with
businesses controlled by, and people who are related to, the officers of the company.

Beka & Co., CPA

MARCH 14, 2012

Fig. 6.5: Unqualified audit report (Emphasis of a Matter)

E. Reports involving Other Auditors

When the auditor relies on a different audit firm to perform part of the audit, which is common
when the client has several widespread branches or subdivisions, the principal audit firm has
three alternatives. Only the second is an unqualified report with modified wording.

a. Make no Reference in the Audit Report

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When no reference is made to the other auditor, a standard unqualified opinion is given unless
other circumstances require a departure. This approach is typically followed when the other
auditor audited an immaterial portion of the statements, the other auditor is well known or
closely supervised by the principal auditor, or the principal auditor has thoroughly reviewed the
other auditor’s work.
b. Make Reference in the Report (Modified Report Wording)
This type of report is called a shared opinion or report. A shared unqualified report is appropriate
when it is impractical to review the work of the other auditor or when the portion of the financial
statements audited by the other auditor is material in relation to the whole.

c. Qualify the Opinion

A qualified opinion or disclaimer, depending on materiality, is required if the principal auditor is
not willing to assume any responsibility for the work of the other auditor.

Qualified audit report with explanatory paragraph or a modification in the wording of the
standard unqualified report is issued under the following conditions: lack of consistent
application of generally accepted accounting principles, substantial doubt about going concern,
auditor agrees with a departure from promulgated accounting principles, emphasis of a matter,
and reports involving other auditors.
INDEPENDENT AUDITOR'S REPORT
TO THE STOCKHOLDERS OF ABC COMPANY
We have audited the accompanying balance sheet of ABC Corporation as of December 31, 2011, and the
related statement of income, and cash flows for the year then ended. These financial statements are the
responsibility of the company's management. Our responsibility is to express an opinion on these
statements base on our audit. We did not Audit the Financial Statements of XYZ Company a wholly
owned subsidiary, which statements reflect total assets of Birr 2,500,000 as of December 31, 2011 and
total revenues of Birr 6,500,000 for the year 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
included for XYZ Company, is based solely on the report of the other auditors.
We conducted our audit in accordance with generally accepted auditing standards. 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 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 audit and the report of other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audit and the report of other auditors, the financial statements referred to
above present fairly, in all material respects, the financial position of ABC corporation as of December 31,
2011, and the results of its operations and its cash flows for the year then ended in conformity with
generally accepted accounting principles.

Beka & Co., CPA

MARCH 14, 2012 9
Fig. 6.6: Unqualified audit report (Report involving other auditors)

6.3. DEPARTURE FROM UNQUALIFIED AUDIT REPORT

It is essential that auditors and readers of audit reports understand the circumstances when an
unqualified report is inappropriate and the type of audit report issued in each circumstance. In the
study of audit reports that depart from an unqualified report, there are three closely related
topics: the conditions requiring a departure from an unqualified opinion, the types of opinions
other than unqualified, and materiality.

6.3.1. Conditions for departure from Unqualified Audit Report

There are three conditions requiring a departure from unqualified audit report. These are:
a. The scope of the audit has been restricted (Scope Limitation)
When the auditor has not accumulated sufficient appropriate evidence to conclude whether
financial statements are stated in accordance with GAAP, a scope restriction exists. There are
two major causes of scope restrictions: restrictions imposed by the client (client-imposed
restrictions) and those caused by circumstances beyond either the client’s or auditor’s control
(circumstance-imposed). An example of a client restriction is management’s refusal to permit the
auditor to confirm material receivables or to physically examine inventory. An example of a
restriction caused by circumstances is when the auditor is not appointed until after the client’s
year-end. It may not be possible to physically observe inventories, confirm receivables, or
perform other important procedures after the balance sheet date.

2. The Financial statements have not been prepared in accordance with generally accepted
accounting principles (GAAP Departure)
If the client insists on using replacement costs for fixed assets or values inventory at selling price
rather than historical cost as required by generally accepted accounting principles, a departure
from the unqualified report is required. When generally accepted accounting principles or
international financial reporting standards are referred to in this context, consideration of the
adequacy of all informative disclosures, including footnotes, is especially important.
3. The Auditor is not independent
When the auditor lacks independence, he/she issues a different report than unqualified one.
Therefore, when any of the three conditions requiring a departure from an unqualified report
exists and is material, a report other than an unqualified report must be issued. Three main types
of audit reports are issued under these conditions: qualified opinion, adverse opinion, and
disclaimer of opinion.

3.1. QUALIFIED AUDIT REPORT

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A qualified opinion report can result from a limitation on the scope of the audit or failure to
follow generally accepted accounting principles. A qualified opinion report can be used only
when the auditor concludes that the overall financial statements are fairly stated with some
exceptions. A disclaimer or an adverse report must be used if the auditor believes that the
condition being reported on is highly material. Therefore, the qualified opinion is considered the
least severe type of departure from an unqualified report.

A qualified report can take the form of a qualification of both the scope and the opinion or of the
opinion alone. A scope and opinion qualification can be issued only when the auditor has been
unable to accumulate all of the evidence required by generally accepted auditing standards.
Therefore, this type of qualification is used when the auditor’s scope has been restricted by the
client or when circumstances exist that prevents the auditor from conducting a complete audit.
The use of a qualification of the opinion alone is restricted to situations in which the financial
statements are not stated in accordance with GAAP.

When an auditor issues a qualified report, he or she must use the term except for in the opinion
paragraph. The implication is that the auditor is satisfied that the overall financial statements are
correctly stated “except for” a specific aspect of them. Examples of this qualification are given in
figures 3.7 and 3.8 below. It is unacceptable to use the phrase except for with any other type of
audit opinion.

From figure 3.7, we can see that three changes have been made to the standard unqualified report
to produce qualified report. The second paragraph (the scope paragraph) has been modified to
include the phrase indicated in italic and bold. Three is a new paragraph added before the
opinion paragraph to explain the reason for issuing the qualified report. There has been also a
change in the opinion paragraph as indicated by the phrase written in italic and bold.

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 INDEPENDENT AUDITOR'S REPORT
TO THE STOCKHOLDERS OF ABC COMPANY
We have audited the accompanying balance sheet of ABC Corporation as of December 31, 2011, and the
related statement of income, and cash flows for the year then ended. These financial statements are the
responsibility of the company's management. Our responsibility is to express an opinion on these
statements base on our audit.

Except as discussed in the following paragraph, we conducted our audit in accordance with generally
accepted auditing standards. 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 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 audit provides a reasonable basis for our opinion.
Fig. 3.7 : Qualified report under scope limitation
We were unable to obtain audited financial statements supporting the company's investment in a
foreign affiliate stated at Birr 250,000 at December 31, 2011 or its equity in earnings of that affiliate of
Birr 650,000, which is included in net income for the year then ended as described in note VII to the
financial statements; nor were we able to satisfy ourselves as the carrying value of the investment in
the foreign affiliate or equity in its earnings by other auditing procedures.

In our opinion, Except for the effects of such adjustment, if any, as might have been determined to be
necessary had we been able to examine evidence regarding the foreign affiliate investment and
earnings, the financial statements referred to above present fairly, in all material respects, the financial
position of ABC Corporation as of December 31, 2011, and the results of its operations and its cash flows
for the year then ended in conformity with generally accepted accounting principles.

Beka & Co., CPA

MARCH 14, 20112

From figure 6.8, we can see that two modifications were made to the standard unqualified report.
These are the addition of the new paragraph before the opinion paragraph state the fact that there
is departure from GAAP which is considered not pervasive. The opinion paragraph has included
the phrase “Except-for” which is the unique phrase used in qualified audit report.

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 INDEPENDENT AUDITOR'S REPORT
TO THE STOCKHOLDERS OF ABC COMPANY
We have audited the accompanying balance sheet of ABC Corporation as of December 31, 2011, and the
related statement of income, and cash flows for the year then ended. These financial statements are the
responsibility of the company's management. Our responsibility is to express an opinion on these statements
base on our audit.

We conducted our audit in accordance with generally accepted auditing standards. 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 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 audit provides a reasonable basis for our opinion.

The company has excluded from property and debt in the accompanying balance sheet, certain lease
obligations that, in our opinion, should be capitalized in order to conform to generally accepted accounting
principles. If these lease obligations were capitalized, property would be increased by Birr 300,000, long
term debt by Birr 250,000, and retained earnings by Birr 50,000 as of December 31, 2011. Additionally, net
income would be increased by Birr 50,000 and earnings per share would be decreased by Birr 0.50 for the
year then ended.

In our opinion, except for the effects of not capitalizing certain lease obligations, as discussed in the
preceding paragraph, the financial statements referred to above present fairly, in all material respects, the
financial position of ABC Corporation as of December 31, 2011, and the results of its operations and its cash
flows for the year then ended in conformity with generally accepted accounting principles.

Beka & Co., CPA

Fig. 3.8:
MARCH 14, Qualified
2012 report with GAAP departure

Fig. 3.8: Qualified report under GAAP Departure

6.3.2. Adverse Audit Report

An adverse opinion is used only when the auditor believes that the overall financial statements
are so materially misstated or misleading that they do not present fairly the financial position or
results of operations and cash flows in conformity with GAAP. The adverse opinion report can
arise only when the auditor has knowledge, after an adequate investigation, of the absence of
conformity. Figure 3.9 shows an example of adverse opinion report.

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INDEPENDENT AUDITOR'S REPORT
TO THE STOCKHOLDERS OF ABC COMPANY

We have audited the accompanying balance sheet of ABC Corporation as of December 31, 2011, and the
related statement of income, and cash flows for the year then ended. These financial statements are the
responsibility of the company's management. Our responsibility is to express an opinion on these
statements base on our audit.

We conducted our audit in accordance with generally accepted auditing standards. 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 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 audit provides a reasonable basis for our opinion.

As discussed in note VII to the financial statements, the company carries its property, plant, and
equipment accounts at appraisal values, and provides depreciation on the basis of such values.
Generally accepted accounting principles require that property, plant, and equipment be stated at an
amount not in excess of cost, reduced by depreciation based on such amount. Because of this departure,
as of December 31, 2011 inventories have been increased by Birr 450,000 by inclusion in manufacturing
overhead of depreciation in excess of that based on cost; property, plant, and equipment, less
accumulated depreciation is carried at Birr 12,500,000 in excess of an amount based on cost; resulting
on an increase in retained earnings of Birr 450,000 and appraisal surplus of Birr 12,500,000. For the
year ended December 31, 2008 cost of goods sold has been increased by Birr 350,000 because of the
effects of the depreciation accounting referred to above, resulting in a decrease in net income of Birr
117,000.
In our opinion, because of the effects of the matter discussed in the preceding paragraph, the financial
statements referred to above do not present fairly, in all material respects, the financial position of ABC
Corporation as of December 31, 2011, and the results of its operations and its cash flows for the year
then ended in conformity with generally accepted accounting principles.
Beka & Co., CPA
MARCH 14, 2012

Fig. 6.9: Adverse Opinion Report

The unique feature of adverse opinion report is that it indicates in the opinion paragraph a phrase
which says “do not present fairly.”

6.3.2. Disclaimer of Opinion Report

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A disclaimer of opinion is issued when the auditor has been unable to satisfy him- or- herself that
the overall financial statements are fairly presented. The necessity for disclaiming an opinion
may arise because of a severe limitation on the scope of the audit or a non independent
relationship between the auditor and the client. Either of these situations prevents the auditor
from expressing an opinion on the financial statements as a whole. The auditor also has the
option to issue a disclaimer of opinion for a going concern problem. The example of disclaimer
of opinion report is shown in figure 3.10.
The disclaimer is distinguished from an adverse opinion in that it can arise only from a lack of
knowledge by the auditor, whereas to express an adverse opinion, the auditor must have
knowledge that the financial statements are not fairly stated. Both disclaimers and adverse
opinions are used only when the condition is highly material.
a. Disclaimer of Opinion –Scope Limitation
It requires modifying the first sentence and deleting the last sentence of the introductory
paragraph. The scope paragraph is also deleted. The explanatory paragraph is added before the
opinion paragraph.

INDEPENDENT AUDITOR'S REPORT

TO THE STOCKHOLDERS OF ABC COMPANY
We were engaged to audit the balance sheet of ABC Corporation as of December 31, 2011, and the
related statement of income, and cash flows for the year then ended. These financial statements are the
responsibility of the company's management.
We did not observe the taking of the physical inventory as of December 31, 2011 or 2010, since those
dates were prior to our appointment as auditors for the company, and we were unable to satisfy
ourselves regarding inventory quantities by means of other auditing procedures. The December 31,
2011 and 2010 inventory amounts enter into the determination of net income and cash flows for the
year ended December 31, 2011.
Since the company did not take physical inventories and we were unable to apply other auditing
procedures to satisfy ourselves as to inventory quantities, the scope of our work was not sufficient to
enable us to express, and we do not express, an opinion on these financial statements.
Beka & Co., CPA
MARCH 14, 2012

Fig. 3.10: Disclaimer of opinion report-scope limitation

b. Disclaimer of Opinion –Lack of Independence
When there is sufficient justification that the auditors did not maintain their independence, the audit
report contains only one paragraph.
INDEPENDENT AUDITOR'S REPORT
TO THE STOCKHOLDERS OF ABC COMPANY
We are not independent with respect to ABC corporation, and the accompanying balance sheet as of
December 31, 2011, and the related statements of income, and cash flows for the year then ended
15 an opinion on them.
were not audited by us. Accordingly, we do not express
Beka & Co., CPA
MARCH 14, 2012
 Can you identify conditions under which the auditor issues disclaimer of opinion report?

Fig. 3.11: Disclaimer of opinion report –Lack of independence

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