Solution Manual for Auditing and Assurance Services, 16th Edition

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1-1Chapter 1The Demand for Audit and Other Assurance ServicesConcept ChecksP.81.To do an audit, there must be information in averifiable formand somestandards(criteria)bywhichtheauditorcanevaluatetheinformation.Determiningthedegreeofcorrespondencebetweeninformationandestablished criteria is determining whether a given set of information is inaccordancewiththeestablishedcriteria.Foranauditofacompany’sfinancial statements the criteriaareU.S.generally accepted accountingprinciplesorInternational Financial Reporting Standards.2.The four primary causes of information risk are remoteness of information,biases and motives of the provider, voluminous data, and the existence ofcomplexexchange transactions.The three main ways to reduce information risk are:1.User verifies the information.2.User shares the information risk with management.3.Audited financial statements are provided.P.171.The three main types of audits are operational audits, compliance audits, andfinancial statement audits. The table below summarizes the purposes andnature of each type of audit.OPERATIONALAUDITSCOMPLIANCEAUDITSAUDITS OFFINANCIALSTATEMENTSPURPOSETo evaluatewhetheroperatingprocedures areefficient andeffectiveTo determinewhether the client isfollowing specificprocedures set byahigher authorityTo determinewhether theoverall financialstatements arepresented inaccordance withspecified criteria(usually GAAP)

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1-2Concept Checks (continued)OPERATIONALAUDITSCOMPLIANCEAUDITSAUDITS OFFINANCIALSTATEMENTSUSERS OFAUDITREPORTManagement oforganizationAuthority settingdown procedures,internal or externalDifferent groupsfor differentpurposes—manyoutside entitiesNATUREHighlynonstandard;often subjectiveNot standardized,but specific andusually objectiveHighlystandardizedPERFORMEDBY:CPAsFrequentlyOccasionallyAlmostuniversallyGAOAUDITORSFrequentlyFrequentlyOccasionallyIRSAUDITORSNeverUniversallyNeverINTERNALAUDITORSFrequentlyFrequentlyFrequently** Internal auditors may assist CPAs in the audit of financial statements. Internalauditors may also audit internal financial statements for use by management.2.The major differences in the scope of audit responsibilitiesfor CPAs, GAOauditors, IRS agents, and internal auditorsare:•CPAs perform auditsof financial statementspreparedusingU.S.GAAP or IFRSin accordance with auditing standards.•GAO auditors perform compliance or operational audits in order toassure the Congress of the expenditure of public funds in accordancewith its directives and the law.•IRS agents perform compliance audits to enforce the federal taxlawsas defined by Congress, interpreted by the courts, and regulated by theIRS.•Internal auditors perform compliance or operational audits in order toassure management or the board of directors that controls andpoliciesare properly and consistently developed, applied,andevaluated.

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1-3Review Questions1-1To do an audit, there must be information in averifiable formand somestandards (criteria) by which the auditor can evaluate the information. Theinformation for Jones Company's tax return is the federal tax returns filed by thecompany. Theestablished criteria are found in the Internal Revenue Codeandallinterpretations.FortheauditofJonesCompany'sfinancialstatements theinformation is the financial statements being audited and theestablished criteria areU.S. GAAP or IFRS.1-2This apparent paradox arises from the distinction between the function ofauditing and the function of accounting. The accounting function is the recording,classifying,and summarizing of economic events to provide relevant informationto decision makers. The rules of accounting are the criteria used by the auditorfor evaluating the presentation of economic events for financial statements andhe or she must therefore have an understanding of accounting standards, as wellasauditingstandards.Theaccountantneednot,andfrequentlydoesnot,understand what auditors do, unless he or she is involved in doing audits, or hasbeen trained as an auditor.1-3An independent audit is a means of satisfyingthe need for reliableinformationon the part of decision makers.Recent changesin accounting and business operations include:1.Increased global activities of many businessesa.Multiple product linesand transaction locationsb.Foreign exchange affects transactions2.Complexaccounting andexchange transactionsa.Increasing use of derivatives and hedging activitiesb.Increasingly complex accounting standards in areas such asrevenue recognition3.More complex information systemsa.Possibly millions of transactions processed daily through on-line and traditional sales channelsb.Voluminous data requires interpretation1-41.Risk-free interest rateThis is approximately the rate the bank couldearn by investing in U.S. treasury notes for the same length of timeas the business loan.2.Business risk for the customerThis risk reflects the possibility thatthe business will not be able to repay its loan because of economicor business conditions such as a recession, poor managementdecisions, or unexpected competition in the industry.3.Information riskThis risk reflects the possibility that the informationupon which the business risk decision was made was inaccurate. Alikely cause of the information risk is the possibility of inaccuratefinancial statements.Auditing has no effect on either the risk-free interest rate or business risk.However, auditing can significantly reduce information risk.

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1-41-5The three main ways to reduce information risk are:1.User verifies the information.2.User shares the information risk with management.3.Audited financial statements areprovided.The advantages and disadvantages of each are as follows:ADVANTAGESDISADVANTAGESUSER VERIFIESINFORMATION1.User obtains informationdesired.2.User can be more confidentof the qualificationsandactivities of the persongetting the information.1.High cost of obtaininginformation.2.Inconvenience to theperson providing theinformation becauselarge number of userswould be on premises.USER SHARESINFORMATIONRISK WITHMANAGEMENT1.No auditcosts incurred.1.User may not be ableto collect on losses.AUDITEDFINANCIALSTATEMENTSARE PROVIDED1.Multiple users obtain theinformation.2.Information risk can usuallybe reduced sufficiently tosatisfy users at reasonablecost.3.Minimalinconvenience tomanagement by havingonly one auditor.1.May not meet needsof certain users.2.Cost may be higherthan the benefits insome situations, suchas for a smallcompany.1-6Information risk is the risk that information upon which a business decision ismade is inaccurate. Fair value accounting is often based on estimates and requiresjudgment. Fair value can be estimated using multiple methods with some estimatesbeing more subjective than others. Fair value estimates are made at a point in time,but can also change rapidly, depending on market conditions. All of these factorsincrease information risk.1-7An assurance service is an independent professional service to improve thequalityof information for decision makers. An attestation service is a form ofassurance service in which the CPA firm issues a report about the reliability of anassertion that is the responsibility of another party. Audit services are a form ofattestation service inwhich the auditor expresses a written conclusion aboutthe degree ofcorrespondence between information and established criteria.

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1-51-7 (continued)The most common form of audit service is an audit of historical financialstatements, in which the auditor expresses a conclusion as to whether thefinancial statements are presented in accordance with an applicable financialreporting framework such as U.S. GAAP or IFRS. An example of an attestationservice is a report on the effectiveness of an entity’s internal control over financialreporting. There are many possible forms of assurance services, including servicesrelated to business performance measurement, health care performance, andinformation system reliability.1-8The primary evidence the internal revenue agent will use in the audit ofthe Jones Company's tax return include all available documentation and otherinformation available in Jones’office or from other sources. For example, whenthe internal revenue agent audits taxable income, a major source of informationwill be bank statements, the cash receipts journal and deposit slips. The internalrevenue agent is likely to emphasize unrecorded receipts and revenues. Forexpenses, major sources of evidence are likely to be cancelled checksandelectronicfundstransfers,vendors'invoices,andothersupportingdocumentation.1-9Five examples of specific operational audits that could be conducted by aninternal auditor in a manufacturing company are:1.Examine employee timerecordsand personnel records to determineif sufficient information is available to maximize the effective use ofpersonnel.2.Review the processing of sales invoices to determine if it could bedone more efficiently.3.Review the acquisitions of goods, including costs, to determine ifthey are being purchased at thelowest possible cost consideringthe quality needed.4.Review and evaluate the efficiency of the manufacturing process.5.Review the processing of cash receipts to determine if they aredeposited as quickly as possible.1-10When auditing historical financial statements, an auditor must have athorough understanding of the client and its environment. This knowledge shouldinclude the client’s regulatory and operating environment, business strategiesand processes, and measurement indicators. Thisstrategicunderstandingis alsouseful in other assurance or consulting engagements. For example, an auditorwho is performing an assurance service on information technology would need tounderstand the client’s business strategies and processes related to informationtechnology, including such things as purchases and sales via the Internet.Similarly, a practitioner performing a consulting engagement to evaluate theefficiency and effectiveness of a client’s manufacturing process would likely startwith an analysis of various measurement indicators, including ratio analysis andbenchmarking against key competitors.

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1-61-11The four parts of the Uniform CPA Examination are: Auditing and Attestation,Financial Accounting and Reporting, Regulation, and Business Environment andConcepts.Multiple Choice Questions From CPA Examinations1-12a.(3)b.(2)c.(1)1-13a.(2)b.(4)c.(2)Multiple Choice Questions From Becker CPAExamReview1-14a.(4)b.(1)c.(3)Discussion Questions And Problems1-15a.Audit services are a form of attestation service, and attestationservices are a form of assurance service. In a diagram, auditservices are located within the attestation service area, andattestation services are located within the assurance service area.b.1.(2)An attestation service other than an audit service2.(1)Anaudit of historical financial statements3.(3)Anassurance or nonassurance service that is not anattestation service4.(2)An attestation service other than an audit service5.(2)An attestation service other than an audit service6.(2)An attestation service other than an audit service7.(2)An attestation service other than an audit service8.(2)An attestation service other than an audit service9.(2)An attestation serviceother thanan audit service(Review services are a form of attestation, but areperformed according to Statements on Standards forAccounting and Review Services.)10.(2)An attestationserviceotherthananauditservice11.(3)An assuranceor nonassuranceservicethat is not anattestation service1-16a.The interest rate for the loan that requires a review report is lowerthantheloanthatdidnotrequireareviewbecauseoflowerinformation risk. A review report provides moderate assurance tofinancial statement users, which lowers information risk. An auditreport provides further assurance and lower information risk. As aresult of reduced information risk, the interest rate is lowest for theloan with the audit report.

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1-71-16 (continued)b.Given these circumstances,Buschshould select the loan fromFirstCityBankthatrequiresanannualaudit.Inthissituation,theadditional cost of the audit is less than the reduction in interest dueto lower information risk. The following is the calculation of totalcosts for each loan:LENDERCPASERVICECOST OF CPASERVICESANNUALINTERESTANNUALLOAN COSTExisting loanNone0$360,000$360,000UnitedNational BankReview$35,000$300,000$335,000FirstCityBankAudit$60,000$240,000$300,000c.Buschshould select the loan fromUnitedNational Bank due to thehigher cost of the audit and the reduced interest rate for the loanfromUnitedNational Bank. The following is the calculation of totalcosts for each loan:LENDERCPASERVICECOST OFCPASERVICESANNUALINTERESTANNUALLOAN COSTExisting loanNone0$360,000$360,000UnitedNational BankReview$35,000$270,000$305,000FirstCityBankAudit$80,000$240,000$320,000d.Buschmay desire to have an audit because of the many otherbenefits that an audit provides. The audit will provideBusch’smanagement with assurance about annual financial informationusedfor decision-making purposes. The audit may detect errors or fraud,andprovidemanagementwithinformationabouttheeffectivenessofcontrols. In addition, the audit may result in recommendations tomanagement that will improve efficiency or effectiveness.e.The auditor must have a thorough understanding of the client and itsenvironment, including the client’s e-commerce technologies, industry,regulatory and operating environment, suppliers, customers, creditors,and business strategies and processes. This thoroughanalysis helpsthe auditor identify risks associated with the client’s strategies thatmay affect whether the financial statements are fairly stated.Thisstrategic knowledge of the client’s business often helpsthe auditoridentifyways to help the client improve business operations, therebyproviding added value to the audit function.

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1-81-17a.The services provided by Consumers Union are very similar toassurance services provided by CPA firms. The services providedby Consumers Union and assurance services provided by CPAfirms are designed to improve the quality of information for decisionmakers. CPAs are valued for their independence, and the reportsprovided by Consumers Union are valued because ConsumersUnion is independent of the products tested.b.The concepts of information risk for the buyer of an automobile andfor the user of financial statements are essentially the same. Theyare both concerned with the problem of unreliable information beingprovided. In the case of the auditor, the user is concerned aboutunreliable information being provided in the financial statements.The buyer of an automobile is likely to be concerned about themanufacturer or dealer providing unreliable information.c.The four causes of information risk are essentially the same for abuyer of an automobile and a user of financial statements:(1)Remoteness of informationIt is difficult for a user to obtainmuch information about either an automobile manufactureror the automobile itself without incurring considerable cost.The automobile buyer does have the advantage of possiblyknowing other users who are satisfied or dissatisfied with asimilar automobile, and the ability to perform online researchof new vehicles.(2)Biases and motives of providerThere is a conflict betweenthe automobile buyer and the manufacturer. The buyerwantsto buy a high quality product at minimum cost whereastheseller wants to maximize the selling price and quantity sold.(3)Voluminous dataThereis a large amount of availableinformation about automobiles that users might like to havein order to evaluate an automobile. Either that information isnot available or too costly to obtain.(4)Complex exchange transactionsThe acquisition of anautomobile is expensive and certainly a complex decisionbecause of all the components that go into making a goodautomobileandchoosingbetweenalargenumberofalternatives.

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1-91-17 (continued)d.The three ways users of financial statements and buyers ofautomobilesreduce information risk are also similar:(1)User verifies information him or herselfThat can be obtainedby driving different automobiles, examining the specificationsofthe automobiles, talking to other users and doing research invarious magazines.(2)UsersharesinformationriskwithmanagementThemanufacturer of a product has a responsibility to meet itswarranties and to provide a reasonable product. The buyerof an automobile can return the automobile for correction ofdefects. Insome cases a refund may be obtained.(3)Examinetheinformationprepared by Consumer ReportsThis is similar to an audit in the sense that independentinformationisprovidedbyanindependentparty.Theinformationprovided byConsumer Reportsis comparable tothat provided by a CPA firmin anauditoffinancial statements.1-18a.The following parts of the definition of auditing are related to thenarrative:(1)Altmanis being asked to issue a report about qualitative andquantitative information for trucks. The trucks are thereforetheinformationwith which the auditor is concerned.(2)There are fourestablished criteriawhich must be evaluatedand reported byAltman: existence of the trucks on the nightofJune 30, 2016, ownershipofeach truck by RegionalDelivery Service, physical condition of each truck and fairmarket value of each truck.(3)Samantha Altmanwillaccumulateandevaluatefour types ofevidence:(a)Count the trucks to determine their existence.(b)UseregistrationdocumentsheldbyBurrowforcomparison to the serial number on each truck todetermine ownership.(c)Examine the trucks to determine each truck's physicalcondition.(d)Examine the blue book todetermine the fair marketvalue of each truck.(4)Samantha Altman, CPA, appears qualified, as acompetent,independent person. She is a CPA, and shespends most ofher time auditing used automobile and truck dealerships andhasextensivespecializedknowledgeaboutusedtrucksthat is consistent with the nature of theengagement.

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1-101-18 (continued)(5)Thereport resultsare to include:(a)whichofthe25trucksareparkedinRegional'sparking lot the night of June 30.(b)whether all of the trucks are owned by RegionalDelivery Service.(c)theconditionofeachtruck,usingestablishedguidelines.(d)fair market value of each truck using the current bluebook for trucks.b.The only parts of the audit that will be difficult forAltmanare:(1)Evaluating the condition, using the guidelines of poor, good,and excellent. It is highly subjective to do so. If she uses adifferent criterion than the "blue book," the fair marketvaluewill not be meaningful. Her experience will be essential inusing this guideline.(2)Determining the fair market value, unless it is clearly definedin the blue book for each condition.1-19a.The major advantages and disadvantages of a career as an IRSagent, CPA, GAO auditor, or an internal auditor are:EMPLOYMENTADVANTAGESDISADVANTAGESINTERNALREVENUEAGENT1.Extensive training inindividual, corporate, gift,trust and other taxes isavailable with concentrationin area chosen.2.Hands-onexperience withsophisticated selectiontechniques.1.Experience limited totaxes.2.No experience withoperational or financialstatement auditing.3.Training is not extensivewith any businessenterprise.CPA1.Extensive training in audit offinancialstatements,compliance auditing andoperational auditing.2.Opportunity for experience inauditing, tax consulting, andmanagement consultingpractices.3.Experience in a diversity ofenterprises and industrieswith the opportunity tospecialize in a specificindustry.1.Exposure to taxes and tothe business enterprisemay not be as in-depth asthe internal revenue agentor the internal auditor.2.Likely to be less exposedto operational auditingthan is likely for internalauditors.

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1-111-19 (continued)EMPLOYMENTADVANTAGESDISADVANTAGESINTERNALAUDITOR1.Extensive exposure to allsegments of the enterprisewith which employed.2.Constant exposure to oneindustry presentingopportunity for expertise inthat industry.3.Likely to have exposure tocompliance, financial,andoperational auditing.1.Little exposure to taxationand the audit of taxes.2.Experience is limited toone enterprise, usuallywithin one or a limitednumber of industries.GAO AUDITOR1.Increasing opportunity forexperience in operationalauditing.2.Exposure to highlysophisticated statisticalsampling and computerauditing techniques.1.Little exposure to diversityof enterprises andindustries.2.Bureaucracy of federalgovernment.b.Thetwobestchoicesfortheseniorinterestedinbecomingacertified fraud examiner would be starting out as either a CPA or aninternal auditor. A CPA gains experience with internal controls andhas an understanding of incentives and opportunities to commitfraud. An internal auditor gains experience with internal controlsand has an in-depth understanding of operations and the manyfacets of a business. IRS agents and GAO auditors would be indemand for fraud examinations relating specifically to tax fraud orgovernmental entities.c.Other auditing careers that are available are:Auditors within many of the branches of the federal government(e.g.,Department of Homeland Security)Auditors for many state and local government units (e.g.,state insurance or bank auditors)

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1-121-20The most likely type of auditor and the type of audit for each of the examplesare:EXAMPLEa.TYPE OF AUDITORb.TYPE OF AUDIT1.2.3.4.5.6.7.8.9.10.11.12.IRSIRSInternal auditor or CPACPAInternal auditor or CPAInternal auditoror CPAInternal auditor or CPACPAor internal auditorGAOCPAGAOGAOComplianceComplianceFinancial statements or operationalFinancial statementsComplianceComplianceOperationalFinancial statementsOperationalFinancial statementsFinancial statementsCompliance1-21a.Financialstatement audits reduce information risk, which lowersborrowing costs. An audit also provides assurances to managementabout information used for decision-making purposes, and may alsoprovide recommendations to improve efficiency or effectivenessofoperations.b.CzarneckiandHoganlikelyprovidetaxservices,accountingservices, and management advisory services. They may also provideadditional assurance and attestation services other than audits offinancial statements.c.Student answers will vary. They may identify new types of informationthatrequireassurance,suchasenvironmentalorcorporateresponsibility reporting. Students may also identifyopportunitiesfor consulting or management advisory services, such as assistancewith the adoption ofInternationalFinancialReportingStandards.1-22a.Assurance related to financial statements are the most likely formsof assurance that are likely to be provided only by public accountingfirms. Examples include audits of historical financial statements,reviews of historical financial statements, audits of internal controloverfinancialreporting,andcomplianceauditingsuchasthatrequired by the Single Audit Act and OMB Circular A-133 (althoughthese audits may also be provided by government auditors).

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1-131-22 (continued)b.There are many types of information thatareassured by providersother than public accounting firms. Some of these assurancesareprovided by government entities, such as food inspections, elevatorinspections, and pumps at gasoline stations. Other assurances areprovided by nonprofit and for-profit assurance providers, such asISO 9000 certifications.c.Table 1-1 on p.11includes some examples of assurance that maybeprovidedbypublicaccountingfirmsorotherassuranceproviders. For example, assurance on corporate responsibility andsustainability may be provided by public accounting firms or otherassurance providers.Other examples included assurance on Website controls, and information such as Web site traffic or newspapercirculation.1-23a.The vision of the Global Reporting Initiative (GRI) is asustainableglobaleconomywhereorganizationsmanagetheireconomic,environmental, social and governance performance and impactsresponsibly,andreporttransparently.Itsmissionistomakesustainability reporting standardpractice by providing guidance andsupport to organizations.b.According to the GRI“Asustainability report is a report publishedby a company or organization about the economic, environmental,andsocialimpactscausedbyitseverydayactivities.Asustainability report also presents the organization's values andgovernance model, and demonstrates the link between its strategyand its commitment to a sustainable global economy.”In an integrated report, sustainability information is includedalong with financial information. These reports emphasize the linksbetweenfinancial andnon-financialperformance.Anintegratedreport also presents the risks and opportunities the company faces,integrated with disclosure of environmental, social, and governanceissues.c.GRIofferstwo“inaccordance”reportingoptions,CoreandComprehensive. The Core report provides the essential elementsofasustainabilityreport.TheComprehensivereportincludesadditionaldisclosures of the organization’s strategy and analysis,governance,andethicsandintegrity.TheGRIrecommendsexternal assurance, but it is not required for either type of “inaccordance” report.

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1-141-24a.Answers will vary by state. Most states require 150 hours ofeducation, with specific requirements for number of accounting hoursand credit hours in other subject areas.b.Answers will vary by state.Many states require one or two years ofwork experience gained in public practice, or possibly government,academiaorindustry,dependingonthestate.Inmanystates,experience in industry or internal audit is sufficient, depending on thetype of work performed.c.Most states have frequently addressed questions. Many of theseaddress education requirements, as well as information on how toprepare for the exam, as well as information on applying for licensure.d.The Elijah Watt Sells award program was established in 1923bytheAmericanInstituteofCertifiedPublicAccountants(AICPA) to recognize outstanding performance on the UniformCPAExamination.The award ispresented to candidates whoobtained a cumulative average score above 95.50 across all foursections of the Uniform CPA Examination, completed testing duringthe previous calendar year, and passed all four sections of theExamination on their first attempt.e.Passing information is available on the CPA Examination portion oftheAICPAwebsite.Recentpassingrateshaverangedfromapproximately 44% to 59%across the four sections.

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2-1Chapter 2The CPA ProfessionConcept ChecksP. 281.The four major services that CPAs provide are:a.Audit and assurance servicesAssurance services are independentprofessional services that improve the quality ofinformation fordecisionmakers.Assuranceservicesincludeattestationservices,which are any services in which the CPA firm issues a report thatexpresses a conclusion about the reliability of an assertion that istheresponsibilityofanotherparty.Thefourcategoriesofattestationservices are audits of historical financial statements, attestation on theeffectiveness of internal control over financial reporting, reviews ofhistorical financial statements, and other attestation services.b.Accounting and bookkeeping servicesAccounting services involvepreparing the client’s financial statements from the client’s records.Bookkeeping services include the preparation of the client’s journalsandledgers as well as financial statements.c.Tax servicesTaxservices include preparation of corporate, individual,and estate returns as well as tax-planning assistance.d.ManagementconsultingandriskadvisoryservicesTheseservices range fromsuggestions to improve the client’s accountingsystem toadvice on risk management or oncomputer installations.2.The six organizational structures available to CPA firms are proprietorship,generalpartnership,generalcorporation,professionalcorporation,limitedliability company,and limited liability partnership. CPAfirmsaretypicallynotorganized as a general partnership because a general partnership offers lessprotection from legal liability relative to other structures such as a limitedliability partnership.P. 381.ThePublicCompany AccountingOversightBoardprovidesoversightforauditors of public companies, including establishing auditing and qualitycontrolstandards for public company audits, and performing inspections ofthe quality controls at audit firms performing those audits.

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2-2Concept Checks (continued)2.The AICPA is the organization that sets professional requirements forCPAs. The AICPA also conducts research and publishes materials onmanydifferentsubjectsrelatedtoaccounting,auditing,managementconsulting and advisory services,and taxes. The organization also preparesandgradestheCPAexaminations,providescontinuingeducationtoitsmembers, and develops specialty designationsto help market and assure thequality of services in specialized practice areas.3.International Standards on Auditing (ISAs) are issued by the InternationalAuditingandAssuranceStandardsBoard(IAASB)oftheInternationalFederationofAccountants(IFAC)andaredesignedtoimprovetheuniformityofauditingpracticesandrelatedservicesthroughouttheworld.AICPA Statements on Auditing Standards (SASs) are established bythe Auditing Standards Board of the AICPA, and are applicable to privateentitieswithintheUnitedStates.Asaresultofeffortsbythe AuditingStandards Boardof the AICPAto converge U.S.standardswith internationalstandards, AICPA auditing standards and International Standards on Auditingare similar in most respects.PCAOB Auditing Standards apply only to U.S.publiclytradedcompaniesandotherSECregistrants,includingbroker-dealers.However, given that the PCAOB initially adopted existing standardsestablished by the Auditing Standards Board as interim auditing standards,standards for audits of U.S. public and private companies are mostly similar.Review Questions2-1The major characteristics of CPA firms that permit them to fulfill their socialfunction competently and independently are:1.Organizational formACPA firm exists as a separate entity to avoidan employer-employee relationship with its clients. The CPA firmemploys a professional staff of sufficient size to prevent one clientfrom constituting a significant portion of total income and therebyendangering the firm’s independence.2.ConductA CPA firm employs a professional staff of sufficient sizeto provide a broad range of expertise, continuing education, andpromotion of a professional independent attitude and competence.3.Peer reviewThis practice evaluates the performance of CPA firmsin an attempt to keep competence high.2-2ThePublicCompanyAccountingOversightBoard(PCAOB)wasestablishedbytheSarbanes-OxleyActof2002inthewakeofmultipleaccounting scandals and alleged audit failures, including those of Enron andWorldCom. The PCAOBprovides oversight forauditors of public companies,including establishing auditing and quality controlstandards for public companyaudits,andperforminginspectionsofthequalitycontrolsatauditfirmsperforming those audits.

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2-32-3The purpose of the Securities and Exchange Commission is to assist inproviding investors with reliable information upon which to make investmentdecisions. Since most reasonably large CPA firms have clients that must filereports with the SEC each year (all companies filing registration statementsunder the securities acts of 1933 and 1934 must file audited financial statementsand other reports with the SEC at least once each year), the profession is highlyinvolved with the SEC requirements.The SEC has considerable influence in setting generally acceptedaccounting principles and disclosure requirements for financial statementsbecause of its authority for specifying reporting requirements considerednecessary for fair disclosure to investors. In addition, the SEC has power toestablish rules for any CPA associated with audited financial statements submittedto the Commission.2-4Statements on Standards for Attestation Engagementsprovide a frameworkfor attest engagements, including detailed standards for specific types ofattestation engagements.2-5The PCAOB has responsibility for establishing auditing standards forU.S.public companies, while the Auditing Standards Board (ASB) of the AICPAestablishes auditing standards forU.S.private companies.Prior to the creation ofthe PCAOB, the ASB had responsibility for establishing auditing standards forboth public and private companies.Because existing auditingstandards wereadopted by the PCAOB as interim auditing standards for public company audits,there is considerable overlap in the two sets of auditing standards.2-6International Standards on Auditing (ISAs) are issued by the InternationalAuditing and Assurance Standards Board (IAASB) of the International Federationof Accountants (IFAC) and are designed to improve the uniformity of auditingpractices and related services throughout the world. The IAASB issuespronouncements on a variety of audit and attest functions and promotes theiracceptance worldwide. As a result of efforts by the Auditing Standards Board toconverge U.S. GAAS with international standards, AICPA auditing standards andInternational Standards on Auditing are similar in most respects.2-7Auditing standardsrepresent the combination of the four principles and allthe Statements on Auditing Standards (SASs) that are codified in the AU-Csections.TheprinciplesoutlinedinFigure2-2provideaframeworkfortheauditingstandards.Examples ofauditing standardsinclude any of the SASs (e.g., SAS No.125), covering topics such as audit planning or assessing the risk of materialmisstatement.Generally accepted accounting principlesare specific rules for accountingfor transactions occurring in a business enterprise. Examples may be any of theopinions of the FASB, such as accounting for leases, pensions, or fair valueassets.

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2-42-8Auditorsdevelop their competency and capabilities for performing an auditthrough formal education in auditing and accounting, adequate practicalexperience, and continuing professional education. Auditors can demonstratetheir proficiency by becoming licensed to practice as CPAs, which requiressuccessful completion of the Uniform CPA Examination. The specific requirementsfor licensure vary from state to state.2-9For the most part,auditing standards, including SASs,are general ratherthan specific. Many practitioners along with critics of the profession believe thestandardsshouldprovidemoreclearlydefinedguidelinesasanaidindetermining the extent of evidence to be accumulated. This would eliminatesome of the difficult audit decisions and provide a source of defense if the CPA ischarged with conducting an inadequate audit. On the other hand, highly specificrequirements could turn auditing into mechanical evidence gathering, void ofprofessional judgment. From the point of view of both the profession and theusers of auditing services, there is probably a greater harm from definingauthoritative guidelines too specifically than too broadly.2-10Quality controls are the procedures used by a CPA firm that help it meet itsprofessional responsibilities to clients. Quality controls are therefore establishedfor the entire CPA firm as opposed to individual engagements.2-11The element of quality control is personnel management. The purpose ofthe requirement is to help assure CPA firms that all new personnelarequalifiedto perform their work competently. A CPA firm must have competent employeesconducting the audits if quality audits are to occur.2-12A peer review is a review, by CPAs, of a CPA firm’s compliance with itsquality control system. A mandatory peer review means that such a review isrequired periodically. AICPA member firms are required to have a peer reviewevery three years. Registered firms with the PCAOB are subject to qualityinspections. These are different than peer reviewsbecause they are performedby independent inspection teams rather than another CPA firm.Peer reviews can be beneficial to the profession and to individual firms. Byhelping firms meet quality controlstandards, the profession gains if reviews resultin practitioners doing higher quality audits. A firm having a peer review can alsogain if it improves the firm’s practices and thereby enhances its reputation andeffectiveness, and reduces the likelihood of lawsuits. Of course,peer reviews arecostly. There is always a trade-off between cost and benefits.Multiple Choice Questions From CPA Examinations2-13a.(2)b.(3)c.(3)2-14a.(1)b.(2)c.(1)Multiple Choice Questions From Becker CPAExam Review2-15a.(1)b.(4)c.(3)

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2-5Discussion Questions And Problems2-16a.The main objective of an audit of financial statements is to obtainreasonable assurance about whether the financial statements as awhole are free from material misstatement, whether due to fraud orerror, thereby enabling the auditor to express an opinion in a writtenreport on whether the financial statements are presented fairly, inall material respects, in accordance with an applicable financialreporting framework.b.No. In an audit of the financial statements,the auditor performsaudit procedures to obtain reasonable assurance about whether thefinancial statements contain material misstatements. While a highlevel of assurance, reasonable assurance is less than a guarantee―whichimplies absolute (100%) assurance. In an audit, the auditorissues an opinion on whether the financial statements are presentedfairly, but the auditor is not guaranteeing thatthe financial statementsare accuratewith certainty.c.No.Fraud is a broad legal concept that describes any intentionaldeceit meant to deprive another person or party of their property orrights. The auditor does not take responsibility for detecting alltypes of fraud, given many types of fraud do not impact the financialstatements. Instead, the auditor performs auditing procedures toobtain reasonable assurance that the financial statements do notcontain material misstatements, whether due to fraud or error.Thus, the auditor is concerned with detecting fraud that leads to amaterial misstatement. The auditor is not responsible for detectingfraud that does not lead to a material misstatement.d.Each entity faces a number of risks unique to the nature of itsbusiness and industry. The types of operations, the extent ofregulation,how the organization obtains capital to fund its businessmodel,andthenature of accounts in the financial statements,among other factors,eachtrigger different types of risks that couldlead to material misstatements.In addition, there areuniqueaccounting standards for certain industries that impact howtransactions, accounts, and disclosures are reported in financialstatements. Thus, a thorough understanding of the client’s businesse.is critical to assessing the risk of material misstatements in thefinancialstatementswhenplanningtheaudit.Theauditorisresponsibleforobtainingsufficientappropriateauditevidenceaboutwhetherthefinancialstatementsarefreeofmaterialmisstatements. In addition to understanding whether theamountsreported in the financial statements are mathematicallyaccurate,the auditor obtains other types of information to determinethat theamounts reported represent valid transactions and accountsand thatallvalidtransactionsandaccountsareincludedinthosestatements. Evidence is also gathered to determine that the entityhas the rights to assets and has the obligation to repay liabilities

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2-62-16(continued)reflectedin those financial statements and whether the correctdisclosures are included in the financial statements as required byaccounting standards.2-17a.Engagement performanceb.Leadership responsibilitiesc.Monitoringd.Engagement performancee.Engagement performancef.Relevant ethical requirementg.Human resourcesh.Human resourcesi.Acceptance and continuation of clients and engagementsj.Engagement performance2-18a.The AICPA Auditing Standards Board (ASB) isresponsible forissuing standards in the U.S. to be used by auditors when auditingthe financial statements of all entities other than U.S. publiclytraded companies. The PublicCompanyAccounting Oversight Board(PCAOB) is responsible for issuing standards to be used by auditorswhen auditing a U.S. public companyor other entities registeredwith the SEC (e.g.,broker-dealers).b.The International Auditing and Assurance Standards Board (IAASB)of the International Federation of Accountants (IFAC) isresponsiblefor issuing International Standards on Auditing (ISAs). The ISAs donot override a specific country’s regulations governing the audit offinancial statements.c.The ASB has revised most of its standards to converge them withthe international standards. As a result, U.S. standards are mostlyconsistent with international standards, except for certain requirementsthat reflect unique characteristics of the U.S. environment.d.When developing a new SAS, the ASB uses the ISAs as thebase standard and then modifies that base standard only whenappropriate for the U.S. environment.e.The PCAOB develops and issues its standards. While the PCAOBconsiders existing international standards, it does not start withtheISA standard as the base.f.When conducting an audit of a client that is listed on both a foreignstock exchange and a U.S. stock exchange, the auditor would haveto satisfy both the relevant international auditing standards as wellas the PCAOB auditing standards. This does not mean the auditorconducts two separate audits, but rather their procedures mustsatisfy both sets of standards,which will be similar in many waysbut may also require the auditor to perform additional proceduresrequired by one, but not the other, set of standards.

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2-72-19a.AICPAauditing standards.b.International auditing standards.c.PCAOB auditing standards.d.PCAOB auditing standards (reporting in the U.K. will be underinternational auditing standards).e.AICPAauditing standards.f.AICPAauditing standards.g.PCAOBauditing standards.h.International auditing standards.2-20BRIEF DESCRIPTIONOFPRINCIPLEHOLMES’ACTIONS RESULTING INFAILURE TO COMPLY WITHPRINCIPLERESPONSIBILITIESPRINCIPLESThe auditormustpossess thecompetency and capabilitiesto perform theaudit.It was inappropriate for Holmes to hire the twostudents to conduct the audit. The audit mustbe conducted by persons with propereducation and experience in the field ofauditing. Although a junior assistant has notcompleted his formal education, he may help inthe conduct of the audit as long as there isproper supervision and review.The auditor mustcomplywith ethical requirements,whichinclude maintainingindependence in mental attitudein all matters relating to theaudit.To satisfythis principle, Holmes must be withoutbias with respect to the client under audit.Holmes has an obligation for fairness to theowners, management, and creditors who mayrely on the report. Because of the financialinterest in whether the bank loan is granted toRay, Holmes is independent in neither fact norappearance with respect to the assignmentundertaken.The auditor must maintainprofessional skepticism andexercise professional judgmentin the performance of the auditand the preparation of thereport.This principle requires Holmes to perform theaudit with due care, which imposes on Holmesand everyone in Holmes’ organization aresponsibility to observe the principles ofperformance and reporting. Maintainingprofessional skepticism and exercisingprofessional judgment require critical review atevery level of supervision of the work done andthe judgments exercised by those assisting inthe audit. Holmes did not review the work orthe judgments of the assistants and clearlyfailed to adhere to this standard.

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2-82-20(continued)BRIEF DESCRIPTIONOF PRINCIPLEHOLMES’ ACTIONS RESULTING INFAILURE TO COMPLY WITH PRINCIPLEPERFORMANCEPRINCIPLESTheauditor must adequately planthe work and must properlysupervise any assistants.This principle recognizes that early appointmentof the auditor has advantages for the auditorand the client. Holmes accepted theengagement without considering theavailability of competent staff. In addition,Holmes failed to supervise the assistants. Thework performed was not adequately planned.The auditor must identify andassess the risks of materialmisstatement based on asufficient understanding of theentity and its environment,including its internal control, todesign the nature, timing, andextent of further auditprocedures.Holmes did not obtain an understanding of theentity or its internal control, nor did theassistants obtain such anunderstanding.There appears to have been no audit at all.The work performed was more an accountingservice than it was an auditing service.The auditor must obtain sufficientappropriate audit evidence byperforming audit procedures toafford a reasonable basis for anopinion regarding the financialstatements under audit.Holmes acquired no evidence that wouldsupport the financial statements. Holmesmerely checked the mathematical accuracy ofthe records and summarized the accounts.Standard audit procedures and techniqueswere not performed.

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2-92-20(continued)BRIEF DESCRIPTIONOF PRINCIPLEHOLMES’ACTIONS RESULTING INFAILURE TO COMPLY WITH PRINCIPLEREPORTINGPRINCIPLESTheauditormust express anopinion in a written report aboutwhether the financial statementsare presented in accordancewiththe applicable financialreporting framework.The auditor must either expressan opinion regarding thefinancial statements, taken as awhole, or state thatan opinioncannot be expressedin theauditor’s report. When theauditor cannot express anoverall opinion, the auditorshould state the reasonstherefor in the auditor’s report.In all cases where an auditor’sname is associated withfinancial statements, the auditorshould clearly indicate thecharacter of the auditor’s work,if any, and the degree ofresponsibility the auditor istaking, in theauditor’s report.Holmes’report made no reference to generallyaccepted accounting principles. BecauseHolmes did not conduct a proper audit, thereport should state that no opinion can beexpressed as to the fair presentation of thefinancial statements in accordance withgenerally accepted accounting principles.Although Holmes’report contains an expressionof opinion, such opinion is not based on theresults of a proper audit. Holmes shoulddisclaim an opinion because he failed toconduct an audit in accordance with auditingstandards.The auditor must assess whetherthe financial statements arepresented in accordance withthe financial reportingframework.Holmes’improper audit would not enable him todetermine whether generally acceptedaccounting principles were consistentlyapplied. Holmes’report should make noreference to the consistent application ofaccounting principles.Management is primarily responsible foradequate disclosures in the financialstatements, but when the statements donot contain adequate disclosures the auditorshould make such disclosures inthe auditor’s report. In this case both thestatements and the auditor’s report lackadequate disclosures.

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2-102-21a.The objective of the IAASB is to serve the public interest by settinghigh-quality auditing and assurance standards and by facilitatingthe convergence ofinternational and national standards, therebyenhancing the quality and uniformity of practice throughout theworld and strengthening public confidence in the global auditingand assurance profession. International Standards on Auditing(ISA) are used by auditors in countries that have adopted ISAs astheir auditing standardsb.The IAASB follows a dueprocess in setting standards.The standards-setting Public Interest Activity Committees (PIAC)identify new projects based on review of international developmentsand consultation with the Public Interest Oversight Board.PIACmeetings are open to thepublicand written materials are preparedin English.The PIAC is responsible for consulting with the PIAC ConsultativeAdvisory Group (CAG) on the identification and prioritizationofprojects to be undertaken by the PIAC.The project may be assigned to a task force, which considerswhether to hold a public forum or roundtable.When the Project Task Force is satisfied that it has a proposeddraftpronouncementthat is ready for exposure, it presents thedraft to the PIACfor approval.The PIAC votes on the approvalof the exposure draft.Draft pronouncements are exposed for a minimum of 90 days.The task force considers all comments and whether re-exposureis needed.When the Project Task Force is satisfied that it has a proposedfinal pronouncement ready for approval, it presents the revisedcontent of the exposed standard to the PIAC for approval.ThePIACvotesontheapprovalorwithdrawalofthepronouncement.c.The IAASB is committed to transparency. Where practicable, meetingsare broadcast over the Internet or recorded. Meeting agendas andminutes are published on the International Federation of Accountants(IFAC) Website. All exposure drafts are subject to public exposurefor a minimum of 90 days.Meetings of the PIAC are open to thepublic.

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3-1Chapter 3Audit ReportsConcept ChecksP.571.The standard unmodified opinion audit report for a nonpublic entity containsthe following eight parts:1.Report title:Auditing standards require that the report be titled andthat the title includes the wordindependent.2.Audit report address:The report is usually addressed to the company,its stockholders, or the board of directors.3.Introductory paragraph:The introductory paragraph of the reportmakes the simple statement that the CPA firm has done anaudit.Second, it lists the financial statements that were audited, includingthe balance sheet dates and the accounting periods for the incomestatement and statement of cash flows.4.Management’sresponsibility:Thisparagraphindicatesthatthefinancial statements are the responsibility of management, includingselecting appropriate accounting principles and maintaining internalcontrol over financial reporting.The paragraph must be precededbytheheading“Management’sResponsibilityfortheFinancialStatements”.5.Auditor’s responsibility:The auditor’s responsibility section of thereport includes three paragraphsand it must include the heading“Auditor’s Responsibility”. The first paragraph indicates thattheauditor’s responsibility is to express an opinion on the statementsbased on an audit conducted in accordance with auditingstandards,and that the audit provides reasonable assurance that the financialstatementsare free of material misstatement.The second paragraph is thescope paragraphand is a factualstatement about what the auditor did in the audit. The paragraphbriefly describes important aspects of an audit, including that theprocedures depend on the auditor’s judgment and assessment ofthe risks of material misstatements. The scope paragraph alsoindicates that the auditor considers the entity’s internal control, butnot for the purposes of expressing an opinion on the effectivenessof internal control over financial reporting.The last sentence of theparagraphindicatesthattheauditincludesevaluatingtheappropriateness of accounting policies selected, the reasonable-ness of accounting estimates, and the overall financial statementpresentation.

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3-2Concept Check, P. 57 (continued)The third paragraph indicates that the auditor believes theaudit evidence is sufficient and appropriate to provide a basis forthe audit opinion.6.Opinion paragraph:The final paragraph in the standard report statesthe auditor’s conclusions based on the results of the audit.Theparagraph must include the title “Opinion”.7.Signatureand Address of CPA firm:The name identifies the CPAfirmor practitioner who performed the audit, and the city andstatewhere the auditor is located.8.Audit report date:The appropriate date for the report is theone onwhich the auditor completed the auditing procedures needed toobtainsufficient appropriateevidence to support the opinion.2.Theauditorshouldincludeanexplanatoryparagraphinanunmodifiedopinion audit report when the audit is completed with satisfactory results andthe financial statements are fairly presented, but the auditor believes it isimportant to draw the reader’s attention to certain matters or the auditor isrequiredtoprovideadditionalinformation.Thefollowingarethemostimportantcausesoftheadditionofanemphasisofmatterexplanatoryparagraph or a modification in the wording of the standard unmodified opinionaudit report:•Lackofconsistentapplicationofgenerallyacceptedaccountingprinciples•Substantial doubt about going concern•Auditoragreeswithadeparturefrompromulgatedaccountingprinciples•Emphasis of other matters•Reports involving other auditorsP.691.The three conditions requiring a departure from an unmodifiedopinion are:1.The scope of the audit has been restricted.One example is when theclient will not permit the auditor to confirm material receivables. Anotherexample is when the engagement is not agreed upon until after the client’syear-end when it may be impossible to physically observe inventories.2.The financial statements have not been prepared in accordancewithgenerally accepted accounting principles.An example is when the clientinsists upon using replacement costs for fixed assets.3.The auditor is not independent.An example is when the auditorownsstock in the client’s business.

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3-3Concept Check, P. 69 (continued)2.The three alternative opinions that may be appropriate when the client’sfinancial statements are not in accordance with GAAP are an unmodifiedopinion,qualified as to opinion only, and adverse opinion. Determining which isappropriatedependsentirelyuponmateriality.Anunmodifiedopinionisappropriate if theGAAP departure is immaterial (standard unmodified) orif the auditor agreeswith the client’s departure from GAAP (unmodifiedwith explanatory paragraph). A qualified opinion is appropriate when thedeviation from GAAP is material butnot highly material; the adverse opinionis appropriate when the deviation ishighly material.Review Questions3-1Auditors’reports are important to users of financial statements becausethey inform users of the auditor’s opinion as to whether or not thefinancialstatements are fairly stated or whether no conclusion can be made with regard tothe fairness of their presentation. Users especially look for any deviation from thewording of the standard unmodifiedreport and the reasons and implications ofsuch deviations. Having standard wording improves communications for thebenefit of users of the auditor’s report. When there are departures from thestandard wording, users are more likely to recognize and consider situationsrequiring a modification or qualification to the auditor’s report or opinion.3-2The purpose of the scope paragraphunder the auditor’s responsibility istoinform the financial statement usersof the nature of the audit proceduresperformed.The information in the scope paragraph includes:1.An audit involves performing procedures to obtain audit evidenceabout the amounts and disclosures in the financial statements.2.The auditprocedures selected depend on the auditor’s judgment,and consider the auditor’s assessment ofthe risks of materialmisstatement, whether due to fraud or error.3.As part of this risk assessment, the auditor considers internalcontrol over financial reportingin the design of the audit procedures.The assessment is not for the purpose of expressing an opinion oninternal control over financial reporting, and the auditor does notexpress such an opinion.4.An audit includes evaluating the appropriateness of the accountingpolicies used, the reasonableness of significant estimates, and theoverall presentation of the financial statements.3-3The purpose of the opinion paragraph is to state the auditor’sconclusionsbased upon the results of the audit evidence. The most important information inthe opinion paragraph includes:

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3-43-3 (continued)1.The words“in our opinion,”which indicate that the conclusions arebased on professional judgment.2.A statement about whether the financial statements were presentedfairly and in accordance with generally accepted accountingprinciplesalong with indication of the fiscal year(s) associated withthose statements.3-4The auditor’s report should be dated February 17,2017, the date on whichthe auditorconcluded that he or she had sufficient appropriate evidence to supportthe auditor’s opinion.3-5Astandardunmodifiedopinion auditreport may be issued under thefollowing circumstances:1.All statements—balance sheet, income statement, statement ofretained earnings, and statement of cash flows—are included inthefinancial statements.2.Sufficientappropriateevidence has been accumulated and theauditor has conducted the engagement in a manner that enableshim or her to conclude that theaudit was performed in accordancewith auditing standards.3.Thefinancialstatementsarepresentedinaccordancewithappropriate accounting standards such asU.S.generally acceptedaccounting principlesor IFRS. This also means that adequatedisclosures have been included in the footnotes and other parts ofthe financial statements.4.There are no circumstances requiring the addition of an explanatoryparagraph or modification of the wording of the report.3-6The introductory, scope,and opinion paragraphs are modified to includereference to management’s report on internal control over financial reporting, andthe scope of the auditor’s work and opinion on internal control over financialreporting. The introductory and opinion paragraphs also refer to the frameworkused to evaluate internal control. Two additional paragraphs are added betweenthe scope and opinion paragraphs that define internal control and describe theinherent limitations of internal control.3-7The standard unmodified opinion auditreport fora non-public entity underAICPA auditingstandards and the standard unqualified report for a public companyunder PCAOBauditing standards are very similar in substance. The introductoryparagraphsaresimilar,althoughthepubliccompanyreportincludestheresponsibilitiesof management and the auditor. In contrast, the report for thenon-public entity inFigure 3-1 has separate paragraphs for management’sandtheauditor’sresponsibility.Theseparagraphsprovideadditionalinformation on the nature ofthese responsibilities.

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3-53-7(continued)The scope paragraphs in each report are similar. However, there aredifferences in the description of the nature of the auditor’s testing. The report forthe non-public company indicates that the procedures are based on the auditor’sjudgment and consider the risks of material misstatement. The report for the non-public company also indicatesthat theauditor considers internal control indesigning the audit procedures, and not for the purpose of expressing an opinionon internal control.3-8Anunmodifiedopinionauditreport with anexplanatory paragraph ormodified wording is the same as a standard unmodified opinionreportexceptthat the auditor believes it isnecessarytoprovideadditionalinformationabout the audit or the financialstatements. For a qualified report, either thereis a scope limitation (condition 1)or a failure to follow generally acceptedaccountingprinciples(condition2).Undereithercondition,theauditorconcludes that the overall financial statements are fairly presented.Two examples of an unmodified opinion auditreport with an explanatoryparagraph or modified wording are:1.The entity changed from one generally accepted accounting principleto another generally accepted accounting principle.2.A shared report involving the use of other auditors.3-9When another CPA has performed part of the audit, the primary auditorissues one of the following types of reports based on the circumstances.1.No reference is made to the other auditor. This will occur if the otherauditor audited an immaterial portion of thefinancialstatements,the other auditor is known or closely supervised, or if the principalauditor has thoroughly reviewed the other auditor’s work.2.Issue a shared opinion in which reference is made to the otherauditor. This type of report is issued when it is impractical to reviewthe work of the other auditor or when a portion of the financialstatements audited by the other CPA is material in relation to thetotal.3.The report may be qualified if the principal auditor is not willing toassume any responsibility for the work of the other auditor. Adisclaimer may be issued if the segment audited by the other CPAis highly material.3-10Even though this change has been reflected in the financial statements, aseparate explanatory paragraph is required to explain the change in generallyaccepted accounting principles in the first year in which the changetook place.3-11Changes that affect the consistency of the financial statements mayinvolve any of the following:

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3-63-11(continued)a.Change in accounting principleb.Change in reporting entityc.Corrections of errors involving accounting principles.An example of achange that affects consistency would be a change in themethod of computing depreciation from straight line to an accelerated method. Aseparate explanatory paragraph is required if the amounts are material.Comparability refers to items such as changes in estimates, presentation,and events rather than changes in accounting principles. For example, a changein the estimated life of a depreciable asset will affect the comparability of thestatements. In that case, no explanatory paragraph for lack of consistency isneededbecause the same method of depreciation is used in both years, but theinformation may require disclosure in the statements.3-12When the audit report contains a qualified opinion, the eight elementsofthe standard audit reportare as follows:1.Report title:Same as standard unmodified opinion report.2.Audit report address:Same as standard unmodified opinion report.3.Introductory paragraph:Same as standard unmodified opinion report.4.Management’s responsibility:Same as standardunmodified opinionreport.5.Auditor’s responsibility:The first two auditor responsibility paragraphsare the same as the standard unmodified opinion report.The thirdparagraphismodifiedtostatethattheauditevidenceobtainedprovidesasufficientandappropriatebasisforthequalifiedauditopinion.That paragraph is following by a new paragraph that describes thebasis for the qualified opinion.6.Opinion paragraph:The opinion paragraph is modified to include theterm except for in the opinion paragraph.7.Signatureand Address of CPA firm:Same as standard unmodifiedopinion report.8.Audit report date:Same as standard unmodified opinion report.3-13Aqualified opinionstates that there has been either a limitation on thescope of the auditof material accounts, transactions, or disclosuresor amaterialdeparture from GAAP in the financial statements, but that the auditor believesthat the overall financial statements are fairly presented. This type of opinion maynot be used if the auditor believes the exceptions being reported upon areextremely material, in which case a disclaimer or adverse opinion would be used.Anadverse opinionstates that the auditor believes the overall financialstatements are so materially misstated or misleading that they do not presentfairly in accordance with GAAP the financial position, results of operations, orcash flows.

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