Chapter 3 Instructors Guide.docx

Chapter 3 Instructors Guide.docx

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Chapter3InstructorsGuide

Chapter3

AuditReports

Auditreportscanbecoveredatanytimeduringthecourse.Someprofessorspreferitearly,whereasothersteachitneartheend.Itwillcausenoproblemifyouprefertoteachreportslaterortosplititintotwosegmentsasshownintheone-quartersyllabus.Wefindthatstudentsareabletocomprehendtheprimaryreportingissuesearlyintheterm.Wethereforecoveritearlysothatwecanrefertoreportingconceptsthroughoutthetermasweaddressvariousothertopics.

Thewayweteachauditreportingislessconceptualandmorerule-orientedthananyotherpartofthecourse.Thefollowingarethetopicswecover:

⏹Chapteropeningvignette

⏹Overview

⏹Partsoftheauditreport

⏹Categoriesofauditreports

⏹Combinedreportsonfinancialstatementsandinternalcontrol

⏹Unqualifiedauditreportwithexplanatoryparagraphormodifiedwording

⏹Conditionsrequiringadeparture

⏹Auditreportsotherthanunqualified

⏹Otherissues

ChapterOpeningVignette-“TheAuditReportWasTimely,ButatWhatCost?

”

Thisvignettehighlightsseveralimportantissues.Thefirst,andoverridingissue,istheimportanceofknowingthattheaudithasbeencompletelyandproperlyperformedbeforetheauditreportisissued.Thecaseshowstheseverepenaltythatcanresultfromonepoorjudgmentonthepartoftheauditor.

Thesecondissueistheeffectofconflictingresponsibilitiesthatcanoccurinpublicaccounting.Here,thepartner’sparticipationintheengagementisessential,yethewasunabletogivethisauditsufficientattentionuntilthelastdayoffieldwork.

Third,istheproblemoftimepressuretocompleteanauditbyadeadline.Thisisespeciallycommonwhenfilingaregistrationstatement.Theproblemisthatthisisalsoasituationwhereriskisgreat.Sotheauditoris“caughtbetweenarockandahardplace.”

Fourth,isthenotionofrisk.Thecompanyisgoingpublic,whichwillprovidemanagementwithgreatfinancialrewards.Auditriskishighbecausemanagement,whohasextensivecontrol,isstronglymotivatedtooverstateearnings.Businessriskisalsohighbecauseofthemarketaspects.

Fifth,thereareevidenceissuesinvolvingmanagement’srepresentations,representationsbytheCompany’sattorney,andtheweaknessofafaxconfirmation.

Finally,thereisthematteroftheclient’sbehaviorandhowtheauditorreactstoit.Adifficultaspectofauditingoranyotherbusinessishowtodealwithnegativeorthreateningbehavior.

Overview

Fortheclassperioddealingwithauditreporting,wetakeenoughannualreportsfromdifferentcompaniesintoclasssothateachstudenthasatleastone.Wemakesurethereareafewexplanatoryparagraphs,andifpossible,afewqualificationsandmodifiedwordingopinionsincludedintheannualreports.（Studentsdonotkeepthereports.）Afterwehandouttheannualreportsatthestartofclass,eachstudentisaskedtofindtheauditor'sreport.Withtheannualreportasaframeofreference,wecoverthefollowinggeneralconcepts:

⏹Purposeofauditors'reports

⏹Distinctionbetweentheauditor'sandmanagement'sresponsibility

⏹Whichfinancialstatementsandotherinformationarecoveredbytheauditor'sreport

⏹Auditor'sresponsibilityfor"otherinformation"intheannualreport,includingspecificexamplesfromstudents'annualreports

Ifyouprepareacoursepackofmaterials,orifyouprovidestudentswithlecturenotesonawebpage,youcanalsoincludereportexampleswiththesematerials.StudentscanalsofindauditreportexamplesfromcompanywebsitesorSECfilingsonEDGAR.

PartsoftheAuditReport（page46）

Westartbyshowingatransparencyofthepartsoftheauditreport,includingthetitle.

（SeeT-3-1）

ReportTitle-Askstudentstostatetitlesincludedintheirreportsotherthan"IndependentAuditor'sReport."

Address-Askstudentstostateanyreportaddressotherthan"TheStockholdersoftheCompany."

IntroductoryParagraph-Thepurposeoftheintroductoryparagraphisdiscussedalongwiththestandardwording.Askeachstudenttocomparetitlesonthefinancialstatementswiththoseontheauditor'sreport.Then,putthestandardwordingoftheintroductoryparagraphontheoverhead（Figure3-1,onpage47）.Studentsarethenaskedtoidentifyanyreportswithwordingotherthanstandardwording.Discussanymodifiedwording,suchasforasharedauditreport.

（SeeFigure3-1）

ScopeParagraph-Asfortheintroductoryparagraph,thepurposeofthescopeparagraphisdiscussedalongwiththestandardwording.Again,putthestandardwordingofthescopeparagraphontheoverhead（Figure3-1,onpage47）.Studentsarethenaskedtoidentifyanyreportswithwordingotherthanstandardwording.

OpinionParagraph-Gothroughthesameroutinewiththeopinionparagraphasfortheintroductoryandscopeparagraphs.Discussanyreportsotherthanstandardwording.

ExplanatoryParagraph-Anyexplanatoryparagraphsinthereportareidentifiedandbrieflydescribedbythestudents.

NameofCPAFirm-Askwhythenameisincluded,whetherallnamesareinscriptandwhetheranyauditshavebeendonebyfirmsotherthanthe"BigFour."

AuditReportDate-Thepurposeofthedateisexplained.Askstudentstocalculatethenumberofdaysbetweenthebalancesheetdateandthedateoftheauditor'sreport.Theleastandmostnumberofdaysareidentifiedandpossiblereasonsforthedifferencesarebrieflydiscussed.

Alsoaskstudentshowmanyofthereportshavea"StatementofManagement'sResponsibilities."Thatisagoodbasisfordiscussingmanagement'sversusauditor'sresponsibilities.

CategoriesofAuditReports（page49）

Thenexttopicwecoveristhefourcategoriesofauditreports,includingFigure3-2onpage49.Weemphasizetheincreasingseverityofthedeparturesfromastandardunqualifiedreport,asdepictedinFigure3-2.

（SeeFigure3-2）

CombinedReportsonFinancialStatementsandInternalControlOverFinancialReportingRequiredUnderSection404oftheSarbanes–OxleyAct（page49）

Wedisplaythewordingofacombinedreportonfinancialstatementsandinternalcontroloverfinancialreporting（Figure3-3,onpage50）.WediscusswhyreportingoninternalcontrolisrequiredundertheSarbanes–OxleyAct,andtheeffectthishasontheamountofaudittestingandauditfees.Wediscusstheadditionalparagraphsforthedefinitionofinternalcontrolandinherentlimitationsofinternalcontrol.Finally,wehighlightthechangestotheintroductory,scopeandopinionparagraphs,includingtheframeworkusedforinternalcontrol,andthatinternalcontrolisevaluatedasoftheendofthemostrecentfiscalyear.Wealsonotethatbecausetheauditreportisforapubliccompany,itreferstopracticestandardsestablishedbythePCAOB.

（SeeFigure3-3）

UnqualifiedAuditReportwithExplanatoryParagraphorModifiedWording（page51）

Nextwecoverthefivecausesofanunqualifiedreportwithanexplanatoryparagraphormodifiedwording.Weputmostoftheemphasisonreportsinvolvingtheuseofotherauditorsandconsistencyexceptions,becausetheyarethemostcommononesinpractice.Weshowillustrationsfrompractice.Forasummaryofunqualifiedauditreportswithanexplanatoryparagraphormodifiedwording,weuseT-3-2.

（SeeT-3-2）

Whenweplantodiscusstheuseofotherauditorsmoreextensively,wealsouseT-3-5.

ConditionsRequiringaDeparture（page55）

Atthispointgoover,insomedetail,eachofthethreeconditions,thetypeofopinionthatisappropriateforeachcondition,andexamples.WethenreferstudentstoTable3-2（page63）andtrytomakesurestudentsunderstandeverythingonthatpage.T-3-3isalsousefulincoveringtheconditionsandtypeofreport.

（SeeT-3-3）

（SeeTable3-2）

Itisimportantthatstudentsbegivenpracticeatthispoint.Thefollowingproblemsareusefulforthat.（KeepTable3-2projectedontheoverheadthroughoutalloftheproblemsyouhavetimetocover.）

3-25-Multiplechoicequestions.

3-28-Typeofopinion.Afterstudentsanswerthequestionforeachsituation,weoftenchangethesituationslightly.

3-29-Typeofopinion.

3-30-Typeofopinion.

Atthispointitisusefultogooverseveralillustrativeauditreportsincludedinthetexttomakesurestudentsunderstandwhichconditionsexist,thetypeofreportissued,andthenatureofthewording.

AuditReportsOtherThanUnqualified（page55）

Next,wegooverthetypesofqualifiedauditors'reports（qualified,adverse,anddisclaimer）,withemphasisonmateriality.Youmaywishtobringuptheuseoftheauditor'sreportasa"signal"here,i.e.,threeparagraphsgenerallysignalthatthingsareokay,whereasmorethanthreeparagraphssignalsomethingisunusualorabnormalanddemandsthereader'sspecialattention.Weremindstudentsthatthesereportsareonthefinancialstatementsonlytodistinguishthemfromthecombinedreportonfinancialstatementsandinternalcontroloverfinancialreporting.

ThenumberofparagraphsforeachtypeofreportissummarizedinTable3-3（page64）.YoumayalsofindthematrixinT-3-4useful:

（SeeT-3-4）

（SeeTable3-3）

ImpactofE-CommerceonAuditReporting（page65）

ReviewQuestion3-22canbeusedtodiscusstheauditor’sresponsibilityforotherinformationinthecompany’sannualreportandWebsiteinformationlinkedtothefinancialstatements.Weexplaintheauditor’sresponsibilityfortheotherinformationintheannualreport.Wethenaskstudentsiftheresponsibilityshouldbeanydifferentforinformationlinkedtothefinancialstatementsonthecompany’sWebsite.ThisisagoodopportunitytoreinforcewhythereisaneedforassuranceonWebsiteinformation,andthedif