Chapter MODIFICATIONS TO THE OPINION IN THE INDEPENDENT AUDITOR’S REPORT Expected. Learning Outcomes After studying this chapter, you should be able to: 1. Explain the circumstances that would require modifications to the opinion in the auditor's report. 2. Understand with the form and content of the auditor's report when the opinion is modified 3. Know the auditor's responsibility in relation to other information in documents containing audited financial statements. sara chA Scanned with CansCHAPTER 23 MODIFICATIONS TO THE OPINION In THE INDEPENDENT AUDITOR'S REPORT INTRODUCTION PSA 705 (Revised) "Mo tions to the Opinion in the Independe Report,” deals with the auditor's responsibilty to issue an appropriate "i circumstances when in forming an opinion in accordance with poeta (Revised) "Forming an Opinion and Reporting on Financial Stems! auditor concludes that a modification to the auditors opinion on the pe statements is necessary. Modi Imani : d opinion is a qualified opinion, opinion or a disclaimer of opinion oS TYPES OF MODIFIED OPINIONS The three types of modified opinions are: a) a qualified opinion b) an adverse opinion ¢) a disclaimer of opinion The decision regarding which type of modified opinion is appropriate depends upon a) The nature of the matter giving rise to the modification, that is, whether the financial statements are materially misstated or, in the case of an inability to obtain sufficient appropriate audit evidence, may te materially misstated; and The auditor's judgment about the pervasiveness of the effects or possible b effects of the matter on the financial statements. cones is the term used, in the context of misstatements, to descrite Pervasive the effects on the financial statements of misstatements or the possible effects od due on the financial statements of misstatements. if any, that are undetecte to an inability to obtain sufficient appropriate audit evidence. ‘Seanad wth CamS:aner675 “Modifications to the Opinion F ; itor’s Pervasive effects on the financial statements are those that, in the audito Nature of Material Misstatements k judgment: jal | + Are not confined to specific elements, accounts or items of the financ! statements; . jon of the + If so confined, represent or could represent a substantial proportion © financial statements: or t 7 i the + In relation to disclosures, are fundamental to users’ understanding of | financial statements. When is Modified Opinion expressed? : . A he | The auditor shall express clearly an appropriately modified opinion on \ f financial statements that is necessary when: | a) The auditor concludes, based on the audit evidence obtained, that ue I financial statements as a whole are not free from material misstatement, f or ; | b) The auditor is unable to obtain sufficient appropriate audit evidence to t conclude that the financial statements as a whole are free from material I misstatement, I } PSA 700 (Revised) requires the auditor, in order to form an opinion on the } financial statements, to conclude as to whether reasonable assurance has been obtained about whether the financial statements as a whole are free from material misstatement. This conclusion takes into account the auditor's evaluation of uncorrected misstatements, if any, on the financial statements in accordance with PSA 450. . . PSA 450 defines a misstatement as a difference between the amount, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be in accordance with the applicable financial reporting framework. Accordingly, a material misstatement of the financial statements may arise m relation to: a) The appropriateness of the selected accounting policies; b) The application of the selected accounting policies; or c) The appropriateness or adequacy of disclosures in the financial statements. ‘Seana wth CamS:anerDetermining the Type of Modification (o the Auditor's Opinion Qualified Opinion The auditor shall express a qualified opinion when: a) The auditor, having obtained sufficient appropriate. q concludes that misstatements, individually or in the material, but not pervasive, to the financial statements; or Nit evi Aeerepate at b). The auditor is unable to obtain sufficient appropriate au which to base the opinion, but the auditor concludes effects on the financial statements of undetected misst could be material but not pervasive it evi Hen hat the _ latements, ip fad Adverse Opinion The auditor shall express an adverse opinion when the auditor having ob sufficient appropriate audit evidence, concludes that misstatements, jee $ individu or in the aggregate, are both material and pervasive to the financial statements.” Disclaimer of Opinion The auditor shall disclaim an opinion when the auditor is una suffisient appropriate audit evidence on which to base the opinion, ag and the auditor concludes that the possible effects on the financial Statements of undetected misstatements, if any, could be both material and pervasive, ble 10 obtain The auditor shall disclaim an opinion when, in extremely rare circumst involving multiple uncertainties, the auditor concludes that, notwithstandig having obtained sufficient appropriate audit evidence regarding each of ihe individual uncertaimies, it is not possible (o form an opinion on the finan statements due to the potential interaction of the uncertainties and their possible cumulative effect on the financial statements. The table below illustrates how the auditor's judgment about 1) the nature of the matter giving rise to the modification, and 2) the pervasiveness of its effects or possible effects on the financial statements. ‘Auditor's Judgment about the Pervasiveness ofthe Efeas | Nature of Matter Giving Rise to or Possible Effects on the Financial Statements | the Modification ‘Material but Not Pervasive | _ Material and Pervasive _) Financial statements are Qualified opinion ‘Adverse opinion | materially misstated os | Inability to obtain sufficient Qualified opinion Disclaimer of opinion | appropriate audit evidence J 4 ‘Seana wth CamS:anerTy The appropriate use of the three = of modifi liability enough to require an adverse or disclaimer Of Opinion. This apples where © sufficient appropriate audit evidence was Obtained, but the auditor concludes that misstatements exist . individually or in the aggregate, that are material but not Pervasive to the financial statements, of the auditor is unable to oblain sufficient Qualified Opinion ‘appropriate audit evidence on which to base the opinion. The auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive. ia is Se a aa pase ey om Opinion paragraph | } Adverse Opinion When the effects if misstatements are both material and pervasive. This applies where sufficient appropriate audit evidence was obtained, but the auditor concludes that misstatements, individually or in the aggregate, are both material and pervasive to the financial statements. in our opinion, because | a the significance ¢ of the | matter discussed in the | Basis for Adverse | Opinion paragraph the financial statements | do not present fairly.” Disclaimer of Opinion When the possible effect of undetected misstatements, if any, could be both material and pervasive. This applies where the auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, and concludes that the possible effects of undetected misstatements, if any, could be both material and pervasive. This also applies to extremely rare circumstances where it is not possible to form an opinion die to the potential interaction of multiple uncertainties and their possible cumulative effect on the financial statements. This applies even where the auditor has obtained sufficient audit evidence regarding each of the individual uncertainties. significance on matter described in the Basis for Disclaimer of Opinion paragraph, we | have not been able to | obtain - sufficient | appropriate audit | evidence to provide a! basis for an -audit opinion. Accordingly, we do not express an opinion on the financial statements.” | “Because | | | ‘Seana wth CamS:aner678 Chapter 23 Consequence of an Inability to Obtain Su c Evidence Due to a Management-Imposed i Accepted the Engagement If, after accepting the ei ment, the auditor becomes aware that mana, has imposed a limitation on the scope of the audit that the auditor conside, to result in the need to express a qualified opinion or to disclaim an opi the financial statements, the auditor shall request that management re limitation. 5 likey inion Move the If management refuses to remove the limitation referred to in paragraph UL auditor shall communicate the matter to those charged with governance” determine whether it is possible to perform alternative procedures to obs! sufficient appropriate audit evidence. . If the auditor is unable to obtain sufficient appropriate audit evidence, the r b auditor shall determine the implications as follows: a) If the auditor concludes that the possible effects on the finan statements of undetected misstatements, if any, could be material but Not pervasive, the auditor shall qualify the opinion; or b) If the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be both materia and pervasive so that a qualification of the opinion would be inadequate to communicate the gravity of the situation, the auditor shall: (i) Resign from the audit, where practicable and not prohibited by law or regulation; or (ii) If resignation from the audit before issuing the auditor's report isnot practicable of possible, disclaim an opinion on the financial ‘statements. If the auditor withdraws as contemplated by paragraph 13(b)(i), before resigning the auditor shall communicate to those charged with governance any matters regarding misstatements identified during the audit that would have given rise to a modification of the opinion. _— ‘Seanad wth ComS:anerthe Opinion — other Considerations Relating to an Adverse Opinion or Disclaimer of Opinion When the auditor considers it necessary to express an adverse opinion or disclaim gn opinion on the financial statements as a whole, the auditor's report shall not also include an unmodified opinion with respect to the same Financial reporting framework on a single financial statement or one of more specific elements accounts or items of a financial statement. To include such an unmodified opinion in the same report in these circumstances would contradict the auditors adverse opinion or disclaimer of opinion on the financial statements as a whole HEN THE FORM AND CONTENT OF THE AUDITOR'S REPORT W! OPINION IS MODIFIED ‘Auditor's Opinion When the auditor modifies the audit opinion, the auditor shall use the heading "Qualified Opinion," "Adverse Opinion,” oF “Disclaimer of Opinion.” as appropriate, for the opinion paragraph. (Ref: Para. AL7—AI9) Opinion Paragraph auditor shall use the 1. When the auditor modifies the audit opinion, the or "Disclaimer of heading "Qualified Opinion." "Adverse Opinion." Opinion,” as appropriate, for the opinion paragraph: opinion due to a material the auditor shall state in the s of the v When the auditor expresses a qualified misstatement in the financial statements, opinion paragraph that, in the auditor's opinion, except for the eff matter(s) described in the Basis for Qualified Opinion paragraph: a) The financial statements present fairly, in all material respects in accordance with the applicable financial reporting framework when reporting in accordance with a fair presentation framework; or b). The financial statements have been prepared, in all material respects, in accordance with the applicable financial framework when reporting in accordance with a compliance framework. When the modification arises from an inability {o obtain sufficient appropriate audit evidence, the auditor shall use the corresponding phrase “except for the possible effects of the matter(s) ..." for the modified opinion. Ye ‘Seana wth CamS:aner680 Chapter 23 et r 4. When the auditor expresses an adverse op sal the opinion paragraph that, in the auditor's opinion, because ya significance of the matter(s) described in the Basis for Adverse On ty Paragraph: Mg a) The financial statements do nor present fairly in accordance wig applicable financial reporting framework when reporting in a the with a fair presentation framework: or Oran The financial statements have not been prepared, in all respects, in accordance with the applicable financial repo framework when reporting in accordance with a compli ing framework. "ance 5. When the auditor disclaims an opinion due to an inability t9 ob, sufficient appropriate audit evidence, the auditor shall state in the opinsy paragraph that a b) a) Because of the significance of the matter(s) described in the Basis f, Disclaimer of Opinion paragraph, the auditor has not been abe ient appropriate audit evidence to provide a basis fora, obtain suff audit opinion; and, accordingly, bb). The auditor does not express an opinion on the financial statements, Description of Auditor's Responsibility When the Auditor Expresses a Qualified or Adverse Opinion When the auditor expresses a qualified or adverse opinion, the auditor shall amend the description of the auditor’s responsibility to state that the auditor believes that the audit evidence the auditor has obtained is sufficient and appropriate to provide a basis for the auditor's modified audit opinion. When the Auditor Disclaims an Description of Auditor's Respo Opinion When the auditor disclaims an opinion due to an inability to obtain sufficient appropriate audit evidence, the auditor shall amend the introductory paragraph of the auditor's report to state that the auditor was engaged to audit the financial statements. The auditor shall also amend the description of the auditors responsibility and the description of the scope of the audit to state only the “Our responsibility is 10 express an opinion on the fimancial following: International statements based on conducting the audit in accordance with Standards on Auditing. Because of the matter(s) described in the Basis for Disclaimer of Opinion paragraph, however, we were not able to obtain sufficient appropriate atdit evidence to provide a basis for an audit opinion." e ‘Seana wth CamS:anerModifications 10 the Opinion -.- 681 Communication with Those Charged with Governance 's report, the ircumstances f the When the acai expects to modify the opinion in the auditor: ae) au communicate with those charged with governance the ci that 7 e expected ~modificati Sera modification. ification and the proposed ILLUSTRATIVE AUDIT REPORTS WITH MODIFIED OPINION Illustration 23-1: Auditor’s report containing a qualified opinion due to 4 material misstatement of the financial statements. istration 23-2: Auditors Report containing a qualified opinion due 10 the auditor's inability to obtain sufficient appropriate audit evidence, u Illustration 23-3: Auditor's report containing an adverse opinion due to 4 material misstatement of the consolidated financial ‘Statements. Illustration 23-4: Auditor's report containing a disclaimer_of opinion due to audit the auditor's inability to obtain sufficient appropriate evidence about a single element of the consolidated financial statements. Illustration 23-5: Auditor's report containing a disclaimer of opinion due to the auditor's inability to obtain sufficient appropriate audit evidence about multiple elements of the financial statements. ‘Seana wth CamS:aner682 Chapter ing Qualified Ong, p> Me cial Statements a INDEPENDENT AUDITOR'S REPORT To the Shareholders of XYZ Company (or Other Appropriate Addressee) | Report on the Audit of the Financial Statements | Mlustration 23. Material Mi Qualified Opinion We have audited the financial statements of the Company, which comprise the stat of financial positon as at December 31, 20X5, and the slatement of compen income, statement of changes in equity and statement of cash flows forthe yea S'® ended, and notes to the financial statements, including a summary of Pd = accounting policies. “x ey In our opinion, except for the effects of the matter described in the Basis for Qu Opinion section of our report, the accompanying financial statements present fairly, material respects, (or give a true and fair view of) the financial position of xyz Com, (the Company) as at December 31, 20XS, and (of) its financial performance and its flows for the year then ended in accordance with Philippine Financial Reporting Standards (PFRSs). | ing) pan, Basis for Qualified Opinion The Company's inventories are carried in the statement of financial position at Py Management has not stated the inventories at the lower of cost and net realizable Value but has stated them solely at cost, which constitutes a departure from PFRSs. The Company's records indicate that, had management stated the inventories at the lower of cost and net realizable value, an amount of xxx would have been required to write the inventories down to their net realizable value. Accordingly, cost of sales would have been increased by xxx, and income tax, net income and shareholders’ equity would have been reduced by xxx, xxx and xxx, respectively. We conducted our audit in accordance with Philippine Standards on Auditing (PSAs). On| responsibilities under those standards are further described in the Auditors) Responsibilities for the Audit of the Financial Statements section of our report. We ae] independent of the Company within the meaning of [indicate relevant ethical requiremens or applicable Jaw or regulation] and have fulfilled our other responsibilities under those | relevant ethical requirements. We believe that the audit evidence we have oblained is sufficient and appropriate to provide a basis for our qualified opinion. ‘he balance of the report would be in accordance with PSA 700 (Revised)] _’ | oe ‘Seana wth CamS:anerModifications to the Opinion .._ 683 jilustration 23-2. Auditor's Report Containing a Qualified Opinion Due to the Auditor's Inability to Obtain Sufficient Appropriate Audit Evidence [INDEPENDENT AUDITOR'S REPORT To the Shareholders of XYZ Company for Other Appropriate Addressee] Report on the Audit of the Consolidated Financial Statements Qualified Opinion . We have audited the consolidated financial statements of the Group, which comprise ra consolidated statement of financial position as at December 31, 20Xx5, and th consolidated statement of comprehensive income, consolidated statement of ate equity and consolidated statement of cash flows for the year then ended, and notes to the consolidated financial statements, including a summary of significant accounting policies. In our opinion, except forthe possible effects of the mater described in the Basis for consolidated financial Qualified Opinion section of our report, the accompanying ated statements present fairy, in all material respects, (or give a true and fair view of) the financial position of XYZ Company and its subsidiaries (the Group) as at December 31, 20X5, and (of) their consolidated financial performance and their consolidated cash flows for the year then ended in accordance with Philippine Financial Reporting Standards (PERSs). Basis for Qualified Opinion The Group's investment in MNO Company, a foreign associate acquired during the year and accounted for by the equity method, is carried at xxx on the consolidated statement of financial position as at December 31, 20X5, and XYZ's share of MNO's net income of xxx is included in XYZ’s income for the year then ended. We were unable to obtain sufficient appropriate audit evidence about the carrying amount of XYZ's investment in MNO as at December 31, 20X5 and XYZ's share of MNO’s net income for the year because we were denied access to the financial information, management, and the auditors of MNO. Consequently, we were unable to determine whether any adjustments to these amounts were necessary, We conducted our audit in accordance with Intemational Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the Auditor's Responsibilities for the Audit of the consolidated Financial Statements section of our report. We are independent of the Group within the meaning of [indicate relevant ethical requirements or applicable law or regulation] and have fulfilled our other responsibilities under those ethical requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified opinion. | [The balance of the report would be in accordance with PSA 700 (Revised)] ‘Seana wth CamS:aner“ osu taining an Adverse Q; inion ~~ al Statements 228 Aue g INDEPENDENT AUDITOR'S REPORT ——S To the Shareholders XYZ Company [or Other Appropriate Addressee} | Mlustration 23-3: Auditor's Repo Material Misstatement Of The Fi Report on the Audit of the Consolidated Financial Statements | Adverse Opinion | We have audited the consolidated financial statements of the Group, which Compr Consclifated statement of financial poston as at December 31. 20%¢ ae Consolidated statement of comprehensive Income, consolidated statement of chan | equity and consolidated statement of cash flows forthe year then endo Res in| i d, aNd notes fo. | Consolidated financial statements, including a summary of significant accounting Policies | In our opinion, because of the signicance of the matter discussed in the Basis fy | Adverse Opinion section of our report, the accompanying Consolidated financig) Statements do not present fairly (or do not give a true and fair view of the Consolidate financial position of XYZ Company and its subsidiaries (the Group) as at December 31 20X5, and (of) their consolidated financial performance and their Consolidated cash fous for the year then ended in accordance with Philippine Financial Reporting Standards (PFRSs) Basis for Adverse Opinion | As explained in Note X, the Group has not consolidated subsidiary MNO Company i | acquired during 20X5 because it has not yet been able to determine the fair Values of certain of the subsidiary’s material assels and lbillies at the acquisition date Te {hvesimentis therefore accounted for on a cost basis. Under PFRSs, the Company stuf | have consolidated this subsidiary and accounted for the acquisition based (On provisional | amounts. Had MNO Company been consolidated, many elements in the ‘accompanying | Consolidated financial statements would have been materially affected. The effects on the Consolidated financial statements ofthe failure to consolidate have not been determined. | \We conducted our aut in accordance with Philippine Standards on Auditing (PSAs). Our responsibilities under those standards are further described in the Auditors Responsibilities for the Audit of the Consolidated Financial Statements section of our feport. We are independent of the Group within the meaning of indicate relevant ethical requirements or applicable law or regulation] and have fulfilled our other responsibilities | under those ethical requirements. We believe that the audit evidence we have obtained is ' | sufficient and appropriate to provide a basis for our adverse opinion. 1 {The balance of the report would be in accordance with PSA 700 (Revised)) —__ ‘Seanad wth CamSsaner685 — Modifications to she Opinion claimer_of O) je Aud tiustration 23-4: An Auditor's Report Containing a D pue 10 the Auditor's Inability to Obiain Sufficient Appropri Evidence about a Single Element of the Financial Statements. iNOEPENDENT AUDITOR'S REPORT To the Shareholders of ABC Company for Other Appropiste Addressee] Roport on the Audit of tho Consolidated Financial Statements"* pisclaimor of Opinion We were engaged 10 audit the consolidated financial statements of the Group. wihich comprise he Consolidated statement of financial postion as at December 31, 2045, and the consolidated Statement of comprehensive income, consolidated statement of changes equty and consolidated statement of cash flows for the year then ended, ‘and notes to the consolidal financial statements, including a summary of significant accounting policies We do nol express an opinion on the accompanying consolidated financial statements of XYZ Company and its subsidiaries (the Group). Because of the significance of the matter descnbed in the Basis for Disclaimer of Opinion section of our report, we have not been able to obtain suffices! appropriate audit evidence to provide a basis for an audit opinion on tnese consolidated financial statements, Basis for Disclaimer of Opinion The Group's investment in its joint venture MNO Company is carried at x on the Group's consolidated statement of financial position, which represents over 90% of the Group's net assets ‘as al December 31, 20X5. We were not allowed access to the management and the auditors of MNO Company, including MNO Company's auditors’ audit documentation. AS a resull, we were unable to determine whether any adjustments were necessary in respect of the Group's proportional share of MNO Company’s assets that controls yoy ts proportional share of MNO Companys labilties for which iis jointly responsible, «ts proportional share of MNO's income and expenses for the year, and the elements making up the consolidated statement of changes In equity and the consolidated cash flow statement Responsibilities of [Managoment and Those Charged with Governance or other appropriate terms} for the Consolidated Financial Statements {Reporting in accordance with proposed PSA 700 (Revised)] Auditor’s Responsibilities for tho Audit of the Consolidated Financial Statements Our responsibility 15 10 conduct an audit of the Group's consolidated financial statements in accordance with Internabonal Standards on Auditing and to issue an auditor's report. However, because of the matter describad in the Basis for Disclamer Opinron section of our report, we were | not able to obtain sufficient appropnate audit evidence to provide a basis for an audit opinion on | these consolidated financial statements, \ We ave independent of the Group within the meaning o! {indicate relevant ethical requirements or \ sopicable law or regulation) and have fulfilled our other responsibiies under those ethical | ents: \ \ _ [The balance of the report would be in accordance with PSA ‘Seana wth CamS:aner686 Chapter 23 — Mlstration 23-5: Auditor's Report Containing # islaimer of Opigg to the Auditor's Inability To Obtain Sufficient Appropriate Audit u ” Dae About Multiple Elements Of The Financial Statements Piideag INDEPENDENT AUDITOR'S REPORT To the Shareholders of XYZ Company for Other Appropriate Addressee] Report on the Audit of the Financial Statements Disclaimer of Opinion | We were engaged to audit the financial statements of the Company, which comprise the of financial postion 2s at December 31, 20X5, and the statement of comprehengys | statement of changes in equity and statement of cash flows for the year then ended, ang m2" the financial statements, including a summary of significant accounting policies, | “8! We do not express an opinion on the accompanying financial statements of XYZ Com, | Company). Because of the significance of the matters described in the Basis for Dig Opinion section of our report, we have not been able to obtain sufficient appropriate audit to provide @ basis for an audit opinion on these financial statements. Basis for Disclaimer of Opinion We were not appointed as aucitors of the Company until after December 31, 20X5 and thus gg observe the counting of physical inventories at the beginning and end of the year. We were tae | | Y (be lime | nl to satisfy ourselves by alternative means concerning the inventory quanties held at December 20X4 and 20X5, which are stated in the statement of financial position at xxx and xxx, sae In addition, the inttoducton of @ new computerized accounts receivable system in September 204 resulted in numerous errors in accounts receivable. As of the date of our audit report, managemen, was Sill in the process of rectifying the system deficiencies and correcting the errs. We wer unable to confirm or verify by altemiatve means accounts receivable included in the ston | financial positon at a total amount of xxx as at December 31, 20X5. AS a result of these mates, we were unable to determine whether any adjustments might have been found necessay in respect of recorded or unrecorded inventories and accounts receivable, and the elements mang | up the statement of comprehensive income, statement of changes in equity and statement of cash | flows. Responsibilities of [Management and Those Charged with Governance or other appropriate | terms] for the Financial Statements | | i | [Reporting in accordance with PSA 700 (Revised)} Auditor's Responsibilities for the Audit of the Financial Statements Cur responsibilty is to conduct an audit of the Company's financial statements in accordance wt | International Standards on Auditing and to issue an auditors report. However, because of te matters desorbed in the Basis for Disclaimer Opinion section of our report, we were notable © obtain sufficient appropriate audit evidence to provide a basis for an aualt opinion on bes financial statements \ We are independent of the Company within the meaning of [indicate relevant ethical requiem or applicable law or regulation} and have fullled our other responsibiliies under those efit requirements [The balance of the report would be in accordance with PSA 700 (Ré - | a ‘Seanad wth CamS:anerModifications to the Opinion .._ 687 REVIEW QUESTIONS AND EXERCISES Questions 2. What are the major reasons for changing the standard unmodified report? What is the most important distinction between the auditor's opinion on financial statements and an auditor's disclaimer of opinion? Define material scope restriction, Must a material scope restrition always lead to a modification of the audit opinion? Is the reference in an audit report to work performed by another auditor & scope qualification? Explain. If an auditor is not independent with respect to a client, what type of opinion must be issued? Why? Why might an auditor decide to disclaim an opinion? Does the audit opinion extend to the "other information"? What steps should the auditor follow upon learning of a change in accounting principle? Multiple Choice Questions ACPA developed a system for clients to enter transaction data by remote terminal into the CPA's computer. The CPA's system processes the data and prints monthly financial statements. When delivered to clients, these financial statements should include: a. a standard unmodified audit report. b. an adverse audit report. a report containing a description of the character of the auditor's examination and the degree of responsibility he or she is taking. 4. a description of the remote terminal system and the controls for ensuring accurate data processing. ‘Seana wth CamS:aner™ 688 Chapter 23 Under which of the following conditions can a never be given? : 3. Going-concem problems are overwhelming the company, b. The client does not let the auditor have access to evidence a important accounts. boy ¢. The auditor owns stock in the client corporation. 4. The auditor has Found thatthe lint has used the NIFO (next in out) inventory costing method. °F OF oping An auditor may reasonably issue an "except for" qualified opinion fog 3. a(an) Scope Unjustified accounting limitation change a Yes No b. No Yes c. Yes Yes 4 No No 4. Asa result of management's refusal to permit the auditor to Physically examine inventory, the auditor has not accumulated sufficient erideng, to conclude whether financial statements are stated in accordance with PERS. The auditor must depart from the unmodified audit report because a. the financial statements have not been prepared in accordance with PFRS. b. the scope of the audit has been restricted by circumstances beyond either the client's or auditor's control. c._ the auditor has lost independence. d._ the scope of the audit has been restricted. Three of the following conditions would, by themselves, require the auditor to issue a report other than an unmodified report. Which one would not require such a departure? a. Client company's financial statements show a significant net loss for each of the last three years, including the current fiscal period. b. The financial statements have not been prepared in accordance with financial reporting standards. c. The auditor is not independent during the fiscal period under audit. d. The scope of the auditor's examination has been restricted, although the cause of the restriction was not the client's fault. ‘Seanad wthCamS:aner9. Modifications to the Opinion - =. {A report other than an unmodified report must be issued whenever any of the three conditions requiring a icp from an unmodified report a. exists. b. exists and is material. ¢. exists, is material, and is within management's control. d. exists, is material, and is within either management's OF control. the auditor's The necessity to issue a disclaimer of opinion may arise because of a. a severe limitation on the scope of the audit examination. b. anon-independent relationship between auditor and client. c. eithera orb above. 4d. none of the above. ‘An adverse opinion is issued when the auditor believes a. some parts of the financial statements are materi misleading. b. the financial statements will be found to be mislead if an adequate investigation is performed. . c. the overall financial statements are so materially misstated « misleading as a whole that they do not present fairly the financial position or results of operations and cash flows in conformity with PERS. d. the audit firm is not independent. ally misstated or jing or misstated, dor The adverse opinion report will be issued by the independent auditor when he/she a. suspects that client has not followed financial reporting standards (PFRS). . b. suspects that client's financial statements are not in conformity with financial reporting standards (PFRS). c. has knowledge that the financial statements are not in conformity with financial reporting standards (PFRS). d. has knowledge that Philippine Standards on Auditing (ISAs) were not followed. 10. A disclaimer is issued whenever the auditor a. has been unable to satisfy him/herself that the overall financial statements are presented fairly. b. believes that the overall financial statements are not presented fairly. ‘Seana wth CamS:aner690 Chapter 23 c. believes that some material part(s) of the financial statements re presented fairly 4. has determined thatthe financial statements are presented faily 11. Which of the following statements is true? a. The auditor is required to issue a disclaimer of opinion in the ey of a material uncertainty. en b. The auditor is required to issue a disclaimer of opinion in the eye of a going concer problem. oll c. The auditor is required to issue a disclaimer of opinion for a mate; uncertainty and for a going concem problem oral d. The auditor has the option, but it is not required, to issue a disclaim, of opinion for a material uncertainty or fora going concem problem, 12. Whenever an auditor issues a modified report, he or she a. must use the term "subject to" in the opinion paragraph, b. may use either the terms "subject to” or "except for" paragraph, depending on the nature of the qualification. ¢. must use the term “except for" in the opinion paragraph, d. must not use the terms "subject to” or "except for" in the opinion paragraph. n the opinion 13. Both disclaimer and adverse opinions are used a. only when the condition is highly material. whether the condition is material or not. b c. regardless of the auditor's independence. d._ regardless of client's choice of a non-PFRS accounting method. 14, A qualified opinion report can be used only when the auditor believes that the overall financial statements are a. fairly stated. b. not fairly stated. c. materially misstated. d. materially misleading. 15. The Jeast severe type of report for disclosing departures from an unmodified report is the adverse opinion. disclaimer of opinion. qualified opinion. report on unaudited financial statements. eese at ‘Seanad wth Comsatcation the Op! ot 16. A modified report can not a a a. the opinion alone. take the form of a qualification of b. bath the scope and opini c. thescope sions. d._ all of the above. only when the auditor quired by 17, A scope and opinion qualification can be issued a. isnot independent. b, has not been able to accumulate al Philippine Standards on Auditing. ¢. has accumulated all the evidi ired by Phi aa wvidence required by d. has been restricted by client from gathering the needed in! to form an opinion. II the evidence Fe itippine Standards o” formation 18, In which of the following situations would an auditor ordinarily express an opinion without an explanatory paragraph? The auditor wishes to emphasize that the entity had significant related-party transactions. b. The auditor decides to refer to the report of another al basis, in part, for the auditor's opinion. . c. The entity issues financial statements that present financial position and results of operations, but it omits the statement of cash flows. 4, The auditor has substantial doubt about the entity's ability to continue as a going concern, but the circumstances are fully disclosed in the financial statements. uditor as 4 19. Although expressing an unmodified opinion, an auditor includes a separate paragraph jin the report to emphasize that the auditee had significant transactions with related parties. This inclusion a. violates PSAs if this information is already disclosed in the footnotes: b. necessitates 2 revision of the opinion paragraph to include the phrase with foregoing explanation." c. is appropriate and would not negate the unmodified opinion. d. is considered a qualification of the opinion. ‘Seanad wth CamS:aner692 Chapter 23 20. In which of the following circumstances would an auditor Most fi add an explanatory paragraph to the standard report while exprgys unmodified opinion? " a. The auditor is asked to report on the statement of finangial but not on the other basic financial statements, b. There is substantial doubt about the entity's ability to continue going concern ©. Management's estimates of the effects of future events 4, unreasonable vs d. Certain transactions cannot be tested because of managemeny, records retention policy POSitiog By 21. The management of a client company believes that the statement of gy, flows is not a useful document and refuses to include one in the anna) report to stockholders. As a result of this circumstance, the Auditors opinion should be a. adverse. b. unmodified. c. qualified due to inadequate disclosure. d. qualified due to a scope limitation. ie 8 . An auditor may not issue a qualified opinion a. scope limitation prevents the auditor from completing an importan audit procedure. . the auditor's report refers to the work of a specialist. ¢. an accounting principle at variance with financial reporting standards is used. d._ the auditor lacks independence with respect to the audited entity. wv 8 . An auditor was unable to obtain sufficient competent evidential matter concerning certain transactions due to an inadequacy in the entiy’s accounting records. The auditor would choose between issuing a(n) a. qualified opinion and an unmodified opinion with an explanatoy paragraph. b. unmodified opinion with an explanatory paragra opinion. c. adverse opinion and a disclaimer of opinion. d. disclaimer of opinion and a qualified opinion ph and an adverse ‘Seana wth CamS:aner26. AMeadglationts ty tb Opinion ons uutitor bo lenet 1 astinieany’ 0 In whieh of the following situations would « principal i Likely to nuke reference to another andor whe mudited v the entity? h 1 Tho other auditor wan vetnined by: thy peinoipal auditor an im War performed under the priavedpal auditor's gullanee aa) out thr The principal auditor Hinde i tnyrvetioabte te raviow the rh auditor's work or otherwlne be aatinthed ws fo the attiet anulitan ay WOE The finanetal statononts auclited by’ the atten aulltan are jyater tal ql the consolidated Mimi) sicnoula-coveratl by the elute auditor's opinion, . ‘The prineipal auditor by unable to be wathefied ax to the Indep and professional reputation al the other auditor, wndenee fl faded In the aplalon Whieh of the following phrmex should be Ine paragraph when an auditor exprowsen a qualified oplaton't When read in conjunetion With the foregolny with Note explanation a You No b No You A You You a. No No When an anditor expresies an adverse opinion, the opinion paragraph should include fh, the principal effets of the departure from financial reporting standards, b. wdireet reference to a separnte parayraph dixclowing the basis for the opinion, cc. the substantive reasons for the financial statements being mintendiing, d. description of the unvertuinty or scope limitation that provents av unmodified opinion, ‘Scand wthCamS:anerProblem 1 Aya de Jesus, CPA, is the continuin current year-end is January 31, explan: auditor for Various Fabrics, tp. ONS Last year’s audit report eo, he Fy paragraph because of uncertainty regarding the ability of yee Fabries to continue as a going concer. The company had defauteg 8 major loan agreements. and appeared to be losing the race to develop"? . op "sp fabrics. Since the date of last year's audit report, however, eg te com management has changed. Significant new products, which already thy Proven successful in the markets served by Various Fabrics, have pit developed. Creditors have agreed to major debt restructuring ag reement the company appears to be “out of the woods.” Sand Required: Assuming the company presents comparative financial statements for 20X5 and 20X4, present the audit report, Remember, you are updating not reproducing — last year’s audit report Problem 2 Items (1) through (7) present various independent factual situations an auditor might encounter in conducting an audit. List A represents the types of opinions the auditor ordinarily would issue, while List B represents the repo modification (if any) that would be necessary. For each situation, select one response form List A and one from List B. Select as the best answer for each item the action the auditor would normally take. The types of opinions in List A and the report modifications in List B may be selected once, or not at all Assume these conditions. © The auditor is independent. * The auditor previously expressed an unmodified opinion on the prior year's financial statements. * Only single-year (not comparative) statements are presented for the current year. ¢ The conditions for an unmodified opinion exist, unless this contradicted in the factual situations. ¢ The conditions stated in the factual situations are material. ¢ No report modifications are to be made except in response to the factual situations. aaa ‘Seana wth CamS:anet, 5 a Modifications to the Opinion ._ 6 Example: The following is an example of the manner in which the item answered, 5 should be in all material respects. the Item: The financial statements present fairly. cash flows 17 financial position, results of operitions, and conformity with financial reporting standards. Items to be Answered: 1. In auditing the long-term investments account, an auditor is unable (0 a foreign brain audited financial statements for an investee located in @ [Ore country, The auditor concludes that sufficient competent evidential matter regarding this investment cannot be obtained. capital deficiencies, an ability to continue as a vever, the financial 2. Due to recurring operating losses and working auditor has substantial doubt about an entity's going concern for a reasonable period of time. However, statement disclosures concerning these matters are adequate. A\ principal auditor decides to take responsibility for the work of another ind issued an CPA who audited a wholly owned subsidiary of the entity a 1ed unmodified opinion. The total assets and revenues of the subsidiary represent 1796 and 18%, respectively, ofthe total assets and revenues of the entity being audited 4. An entity issues financial statements that present financial position and results of operations but omits the related statement of cash flows. Management discloses in the notes to the financial statements that it does not believe the statement of cash flows to be a useful financial statement. ‘An entity changes its depreciation method for production equipment from the straight-line method to a units-of-production method based on hours of utilization, The auditor concurs with the change, although it has a material effect on the comparability of the entity's financial statenvents. 6. An entity is a defendant in a lawsuit alleging infringement of certain patent rights. However, the ultimate outcome of the litigation cannot reasonably be estimated by management. The auditor believes there is a reasonable possibility of a significantly material loss, but the lawsuit is adequately disclosed in the notes to the financial statements. ‘Seanad wth CamS:aner696 7. Chapter 23 | An entity discloses in the notes to the financial statements cena obligations. The auditor believes that the failure to capitalize hess) is a departure from financial reporting standards, eae a b, USTA Types of Opinions I Report Modifications — -——~__ An “except for’ qualified opinion ‘An unmodified opinion | hi h. Describe the circumstances in an explanatory paragraph preceding the opinion paragraph, without Modifying the three standard raphs. | i. Descnibe the circumstances in an explanatory paragraph following the opi paragraph, without modifying the three standard paragraphs, | c e ‘An adverse opinion Either an “except for qualified opinion or an adverse opinion j. Describe the circumstances in an explanatory paragraph preceding the opinion paragraph, and modify the opinion, paragraph Describe the circumstances in an explanatory paragraph following the opinion paragraph, and modify the opinion | aragraph j Describe the circumstances in an | explanatory paragraph, and modify the scope and opinion paragraphs. ft g. Either a disclaimer of ‘opinion or an “except for’ qualified opinion Either an adverse opinion or a disclaimer of opinion m. Describe the circumstances in an explanatory paragraph following the opinion | paragraph, and modify the scope and | opinion paragraphs. n. Describe the circumstances within the scope paragraph without adding an explanatory paragraph o. Describe the circumstances within the opinion paragraph without adding an | explanatory paragraph. p. Describe the circumstances within the | scope and opinion paragraphs without adding an explanatory paragraph. q. Issue the standard auditors report without modifications. a ‘Seanad wth CamS:anerModifi to the Opinion Problem 3 Because the audit report reflects the degree of responsibility assumed, the independest auditor must exercise caution in choosing the appropriate wording. The following report alternatives are available: Unmodified opinion; Opinion qualified because of departure from PFRS; Opinion qualified for lack of evidence (scope restriction); Disclaimer of opinion — scope restriction; Disclaimer of opinion — uncertainty; Adverse opinion; Explanatory paragraph following opinion paragraph: Uncentainty; Doubt as to ability to continue as a going concern; Emphasis of a matter, ‘Agreed-upon departure from accounting principle; Change in accounting principle. reo soooe Required: For each of the situations described below, indicate by number and letter the appropriate form of audit report. More than one choice may apply to a given situation. For example, an unmodified opinion followed by an explanatory paragraph for emphasis of matter would be answered as | 7c. ‘A. The auditors were able to gather all of the evidence necessary to support an audit opinion; the financial statements contain no material departures from PFRS; but oil and gas reserve information required by ASC as supplemental information has been omitted. B. The client refused to capitalize certain leases meeting one or more of the criteria that define financing leases. The auditors are also in doubt as to the recoverability of purchased patents, the costs of which are material in relation to the company's net assets. C. The client refuscd the auditors’ request to confirm trade. accounts receivable. The unaudited balance in this account is significant in relation to total assets, and the auditors were unable to satisfy themselves by other means. D. Certain subsidiary companies were audited by other independent CPAs. The principal auditors decided to divide responsibility. ‘Seana wth CamS:aner698 Chapter 23 EA land development company deenled to 80H Up all oF sau Gost to current market value and recognized the appreciation gay current income. Management believed that the increase. inns P& would facilitate a public offering of the company’s stock. Np, F Although Company A is virtually insolvent, its Financial state rf based on the going concer assumption. Given the gray tt 8 ituation, the tors do not believe that adding an erplan the Paragraph is adequate in the circumstances mary G. During the year, Company B changed its method of inventory, from FIFO to Average Costing. Although proper accounting pest was accorded the change, management refuses to include me af describing the change coe) H. Although Company ¢ receivable. er ited the auitors 19 confirm aegy sts of the confimation process were disappomt Only 20% of customers responded, and more than half of these n un efi their outstanding balances. The auditors were yy auisty themselves by ether means. In addition, Company C complery to several significant transactions with related parties. Although the tly ang uiditors determined that these transactions were recorded corre ved in the financial statements, they wish to bring he adequately discl ention of the stockholders, ble to o existence of the transactions to the a 1. Company D debited significant amounts of leasehold improvements i repairs expense, The auditors determined that these expenditure shoul have been debited to asset aecounts and amortized over the remaining term of the lease. Management refuses to accept the auditors’ proposed adjustments. In addition, the company's liquidity position is so precarious that the auditors are not certain as to whether it will be able to meet is obligations in the short run J. For many years, Company G followed the practice of recognizing revenue at the point of sale, Given increasing uncertaimy regarding collectibility, the company, with the auditors’ approval, decided 10 change to the installment method of accounting for sales. Rather than recognizing the cumulative effect of the change as a component of current income, however, the company decided to debit the amount 10 beginning retained earnings and restate prior earnings to reflect the new method. The auditors agreed with this departure on the basis that, given the magnitude of accounts receivable at the date of change, the designated treatment would cause the financial statements to be materially misleading ‘Seanad wth ComsatModifications to the Opinion -» 699 the auditors were unable to Also, in conducting the current examination, conableness of the obtain sufficient evidence to evaluate the reast company's provision for the inventory obsolescence. K. Company H changed its method of depreciation from straight-line to the appraisal method for all its property, plant, and equipment. Footnote No. 8 fully described the change and the effect on current earings. Property, plant, and equipment comprise 60% of the company's total assets. L. Company X changes its method of determining inves specific identity to moving average. Footnote No. 6 full change and its impact on current earnings. M. Company X changed its method of accounting for postretirement benefits to conform to the PAS. In addition, the company has sustained significant losses over the past three years, raising “oubts concerning short-term debt-paying ability. ntory cost from ly described the Problem 4 This caselette is designed to test your competence in the preparation of audit report. ‘You are the audit partner of five clients and will have to make a decision as to the appropriate type of audit opinion that should be issued relative to their financial statements. The pertinent data for these clients follow: Client No. 1: DEF Co. DEF holds a note receivable consisting of principal and accrued interest payable in 20X7. The note’s maker recently filed a voluntary bankruptcy petition but DEF failed to reduce the recorded value of the note to its net Fecoverable amount, which is approximately 20% of the recorded amount. Client No. 2: QRS Company You found an immaterial adjustment relating to inventory of QRS. It has refused to adjust the financial statements to reflect this immaterial item. Client No. 3: HIJ Co. HIJ’s financial statements do not disclose certain long-term lease obligations. You determined that the omitted disclosures were required by Philippine Financial Reporting Standards (PFRS). ‘Seana wth CamS:aner100 Chapter 23 Client No. 4: WXY Company WXY Company changed its method of accounting forthe cost of inven from FIFO to weighted-average method. You concur with the chs although it has a material effect on the comparability of the fing ‘statements. ~ Client No. 5: RST Corporation Due to losses and adverse key financial ratios, you have substantial douby about RST’s ability to continue as a going concern for a reasonable Period time. The client has adequately disclosed its financial difficulties in a totem financial statements which do not include any adjustments that might regu} from the outcome of this uncertainty. You have also ruled out the use of disclaimer of opinion Questions. 1. The appropriate audit report on the financial statements of Client No, | is a. Either an ‘expect for" qualified opinion or an adverse opinion. b. Either an adverse opinion or a disclaimer of opinion. c. An unqualified opinion. d. A disclaimer of opinion. wv The appropriate audit report on the financial statements of Client No. 2is a. Either an ‘except for’ qualified opinion or an adverse opinion, b. An unqualified opinion. ¢. Anadverse opinion d. A disclaimer of opinion, 3. The appropriate audit report on the financial statements of Client No. 3is a. Either an ‘except for’ qualified opinion or an adverse opinion. b. An qualified opinion. c. An adverse opinion. d. A disclaimer of opinion. 4. The appropriate audit report on the financial statements of Client No. 4is a. Either an ‘except for’ qualified opinion or an adverse opinion. b. An qualified opinion. c. Anadverse opinion. d. A disclaimer of opinion. aa ‘Seana wth CamS:anerification tO 701 1. Modifications to the Opins 5. The appropriate audit report on the financial statements of Client No. 5 is a. Either an ‘except for’ qualified opinion or an adverse opinion. b. An qualified opinion. c. Anadverse opinion. d. A disclaimer of opinion. Problem 5 Items A to E are situations that Lucas Reyes, CPA has encountered Sere his audit of Nordic Corporation. Select as the best answer for each item auditor would normally take. A. Reyes decided not to take responsibility for the work for another cra who audited a wholly owned subsidiary of Nordic. The total assets revenues of the subsidiary represent 27% and 28%, respectively, 0} related consolidated totals. B. Due to losses and adverse key financial ratios, Reyes has substantial doubt about Nordic’s ability to continue as a going concern for a reasonable period of time. The client has adequately disclosed its financial difficulties in a note to its financial statements, which to not include any adjustments that might result from the outcome of this uncertainty. Also, Reyes has ruled out the use of a disclaimer of opinion. C. Nordic changed this method of accounting for the cost of inventories from FIFO to Weighted Average. Reyes concurs with the change although it has a material effect on the comparability of the financial statements. D. Reyes concludes there is substantial doubt about Nordic’s ability to continue as a going concern for a reasonable period of time. E. Reyes had substantial doubt about Nordic Co."s ability to continue as a going concern when reporting on Nordic’s audited financial statements for the year ended June 30, 20X1. That doubt has been removed in 20X2. Questions: 1. In Situation A, the type of report modification (if any) would be a. Describe the circumstances within the introductory, scope, and opinion paragraphs without adding an explanatory paragraph. b. Describe the circumstances within the scope and opinion paragraphs without adding an explanatory paragraph. ‘Seana wth CamS:anerSS 702 Chapter 23 ¢. Deseribe the circumstances within the oj adding an explanatory paragraph. Witho d. Issue the standard auditor's report without modification, 2. The type of report modification (if any) in Situation B is a. Describe the circumstances in an explanatory Paragraph yi, modifying the three standard paragraphs. thoy b. Describe the circumstances in an explanatory Paragraph and Mod; the opinion paragraph ify ¢. Describe the circumstances in an ex; the scope and opinion paragraphs. d. Issue the standard auditor's report without modification, Planatory paragraph ang esi 3. In Situation C, the type of opinion that the auditor would Ordinary ise is a. An unqualified opinion. b. An “except for” opinion ©. An adverse opinion 4. Enther an “except for” qualified opinion or an adverse opinion 4. In Situation D, the auditor's responsibility is to a. Issue a qualified or adverse opinion, depending upon materiality, die to the possible effects on the financial statements. b. Consider the adequacy of disclosure about the client's Possible inability to continue as a going concern. ©. Report to the client’s audit committee that man, estimates may need to be adjusted 4. Reissue the prior year's auditor's report and add an explanatory Paragraph that specially refers to “substantial doubt” and “scine concern”. jagement’s accounting 5. In Situation E, what is Reyes’ reporting responsibility if Nordic is Presenting its financial statements for the year ended June 30, 20X2 ons comparative basis with that of 20X29 a The explanatory paragraph included in the 20X1 auditor's repon should not be repeated. b. The explanatory paragraph included in the 20X2 auditor's report should be repeated in its entirety. & A different explanatory paragraph describing Reyes’ reasons forthe removal of doubt should be included, 4. A different explanatory paragraph describing Nordic’s plans for financial recovery should be included. ‘Seana wth CamS:aner