Audit Practice II: Week 2 Quiz

Audit Practice and Procedures II: Week Two

• Topic: Audit Reports and Ethics
• Course: Audit Practice and Procedures II
• Week: Two
• Course Provider: Commonwealth Caribbean (UCC)

First Class Recap

• Topics Covered:
  • Brief History of Auditing
  • What is an Audit
  • Functions of Audit
  • Internal vs. External Auditing
  • Dynamics of Auditing

What is an Audit Report?

• Definition: A public document expressing an auditor's opinion on a company's financial status.
• Results: An audit report can yield four different types of results dependent on the company's financial status and practices.
• Summary: The report summarizes a company's financial status, assets, and liabilities, plus the auditor's opinion on its finances.
• Purpose: To inform consumers and investors.
  • Companies may require audits for improvement or for attracting investors

Audit Report Cont'd

• Accompanying Documents: Often accompanied by the company's annual report.
• Requirements: Required by banks, financial institutions, investors, creditors, and regulators.
• Clean Report: Indicates the company's financial statements are compliant with accounting standards.
• Unqualified Report: Indicates potential errors in the financial statements.
• Importance: Essential for investors to assess a company's financial health and for regulatory bodies to evaluate the accuracy of financial statements.
• Significance: An Adverse report can seriously damage a company’s status and reputation.

Types of Audit Reports

• Standard Unqualified Audit Report: Also known as a "Clean Report".
  • Contains no adverse comments or disclaimers about the auditing process.
  • Shows the auditors are satisfied with the company's reporting.
  • Indicates compliance with relevant governance principles and laws.
  • Perceived by all parties as free from any misstatements.
• Unqualified Report with Explanatory Paragraph or Modified Wording:
  • A complete and satisfactory audit has taken place, with a fairly presented financial statement, but further explanation is needed.
• Qualified Audit Report: Audit is materially restricted or applicable accounting standards weren't followed.
• Adverse or Disclaimer Audit Report: Financial statements are not fairly presented.

Four Categories of Audit Reports

• Standard Unqualified: All conditions are met.
• Unqualified with Emphasis-of-matter: Satisfactory audit but additional information is needed.
• Qualified: Material restrictions or failure to follow standards.
• Adverse or Disclaimer: Overall financial statements are misstated.

The Standard Unqualified Audit Report

• Clean Report: The standard report that most companies receive.
• Content: No adverse comments or disclaimers.
• Satisfaction: The auditors are satisfied with the company's provided financial reporting.
• Compliance: Shows the company's compliance with governing laws and principles.
• Materiality: The company's report doesn't contain any material misstatements.

The Auditor's Standard Unqualified Audit Report

• Report Title: Contains the word "independent". Examples mentioned: independent auditor's report, report of independent auditor, or independent accountant's opinion.
• Report Address: Usually addressed to the company, its shareholders, or the board of directors; Indicates the auditor's independence from the company.
• Introductory Paragraph: Notes the financial statements audited; Includes details of the balance sheet dates and accounting periods for income statements.
• Management's Responsibility: Management is responsible for the financial statements.
• Auditor's Responsibility: This details the audit conducted, the search for material misstatements, and that the audit provides high assurance.
• Scope Paragraph: Describes the auditor's assessment of risks in the financial statements and the evidence accumulated.
• Opinion Paragraph: Summarizes any findings or conclusions.
• Name and Address of the CPA Firm
• Audit Report Date Includes the date of the last day of the auditor’s responsibility.

Auditor's Responsibility Cont'd

• Scope of the Audit: Details the evidence and procedures used.
• Internal Control: Assessment of internal control, but not for evaluation its effectiveness.
• Accounting Policies and Estimates: Evaluating accounting policies.

Opinion Paragraph

• Conclusion: States the auditor's conclusions based on the audit.
• Professional Judgement: Conclusions are based on professional judgment.
• Potential Risk: Acknowledges that there's a possibility for information risk in the report.
• Fair Presentation: Discussion on the meaning of "present fairly", addressing that it can mean following GAAP, or whether it needs to account for user misleadings.

Name and Address of CPA Firm

• Identifies the CPA firm conducting the audit
• Includes the city and state of the firm

Audit Report Date

• Indicates the date that the audit procedures were completed
• Addresses events that took place after the financial statements date.

When is a Standard Unqualified Audit Report Issued?

• Criteria: Specified conditions must be met.
• Statements: Balance sheet, Income statement, Statement of changes in equity, and Cash flow statement.
• Evidence: Sufficient and appropriate evidence is obtained.
• GAAP Compliance: Financial statements presented according to GAAP.
• Circumstances: No circumstances require additional explanatory paragraphs.

The Standard Unqualified Audit Report (continued)

• Non-Public Entities (Comparison): Structure of paragraphs is similar to the standard report for non-public entities.

The Standard Unqualified Audit Report (continued)

• Scope Paragraph: Details the scope of the audit, the evidence, and the procedures required.
• Opinion Paragraph: The third paragraph has a focus on stating the opinion of the auditor.
• Separate Report: If applicable, a separate report on internal control would follow.

Disclaimer of Opinion-Disclaimer Report

• Definition: Distance or avoidance of opinion from auditors
• Reasons: Limited circumstances to conduct a thorough audit or lack of satisfactory explanations.
• Consequence: Creates a negative image of the company

Adverse Opinion-Adverse Audit Report

• Definition: Final audit opinion, showing dissatisfaction with the financial statements; Indicates the presence of material misstatements or potential fraud.
• Impact: Creates mistrust among investors and stakeholders, resulting in a negative image and business rejection.

A Qualified Opinion

• Definition: A less severe departure from an unqualified report; arises from scope limitations or GAAP failures.
• Basis: Can result from restricted scope or non-compliance with generally accepted accounting principles (GAAP).
• Scope Restrictions: Limitations on accumulating all necessary evidence.
• Materiality: The use of a qualification for a non-material issue isn't permitted.
• Term "except for": Required when issuing a qualified report, highlighting aspects where the auditor found satisfaction.

An Adverse Opinion

• Definition: Used when the overall financial statements are extremely misstated or misleading.
• Knowledge: Based on auditor having established knowledge about lack of conformity.
• Material Misstatements: Financial statements contain severe material misstatements.

A Disclaimer of Opinion

• Definition: The auditor isn't capable or not able to provide sufficient evidence to support their opinion.
• Reasons for Disclaimer: The relationship between the auditor and client or restrictions in the scope of work.
• Scope Impact: Limitations on the scope restrict the auditor's ability to provide an opinion.

The Difference between Disclaimer and Adverse Opinion

• Disclaimer Origin: Arises from a lack of knowledge from the auditor concerning the statements.
• Adverse Opinion Origin: Required when auditors have knowledge that the statements aren't fairly stated.
• Materiality: Both are used when the condition is highly material.

Relationship of Materiality to Type of Opinion

• Immaterial: Users' decisions aren't affected.
• Material: User decisions might be affected, but not significantly.
• Highly Material: Significant impact on user decisions.
• Implication Lack of independence often requires a disclaimer regardless of materiality.

What are Ethics?

• Definition: A set of moral principles or values, defined by philosophers, religious organizations, and various groups.
• Influence: Includes laws, regulations, codes for professionals, and other organizational codes of conduct.
• Diversity: Recognizing that ethical principles and values vary among individuals based on experiences, upbringing, and other factors.

What are Ethics (continued)

• Importance to Society: Acting ethically is critical for social harmony and clear communication.
• Practical Application: Examples such as professional codes (like those for CPAs) and laws.

Illustrative Prescribed Ethical Principles

• Trustworthiness: Honesty, integrity, reliability, and loyalty.
• Respect: Civility, courtesy, decency, and acceptance for individual beliefs.
• Responsibility: Accountability and restraint in actions.
• Fairness: Equality, impartiality, and due process.
• Caring: Genuine concern for the well-being of others.
• Citizenship: Following pertinent laws, and participating in society.

Why People Act Unethically

• Different Standards: Ethical standards differ from society.
• Self-Interest: People choose to act selfishly.

What is an Ethical Dilemma?

• Definition: A situation requiring an ethical decision, such as choosing between the appropriate conduct to take.
• Example: Finding valuables and selecting the action to take.

Class Discussion

• Case of Rare Disease and Drug: A discussion on whether a wife should steal the drug to save her husband or not, to explore ethical dilemmas.

Auditors, Accountants, and Other Businesspeople Facing Ethical Dilemmas

• Threats to Auditors: Dealings with clients who pose threatening behavior or issues, for example, demanding an unqualified opinion when it's inappropriate.
• Supervisory Overstatement: Decisions of whether to report a supervisor who has overstated departmental revenue and the consequences of such reporting.
• Mishandling Customers: Continual support for a company that mistreats employees or customers.

Resolving Ethical Dilemmas

• Framework: Six steps to help decide appropriate actions.
  • Gathering Facts
  • Identifying Ethical Issues
  • Determining Affected Parties
  • Identifying Potential Actions
  • Evaluating Consequences of Each Action
  • Deciding with the most appropriate Action.

Difference Between CPA Firms and Other Professionals

• Relationship with Clients: CPA firms' relationship with users of financial statements is distinct, often paid by management or the audit committee rather than the client directly.
• Confidentiality/Independence: Professionals need to maintain unbiased judgments.
• Services Value: Reducing information risks through audits increases the value of CPAs' services

Code of Professional Conduct

• AICPA Code of Professional Conduct: The code contains general & specific rules of conduct, parts are listed in increasing specificity, meaning principles are ideal standards while ethical rulings are highly specific.

Ethical Principles

• Responsibilities: Professionals must use sound judgment.
• Public Interest: Acting in the public's best interest.
• Integrity: Maintain honesty in professional duties.
• Objectivity and Independence: Free from biases/conflicts of interest.
• Due Care: A member must maintain high levels of competence and strives for improvement
• Scope and Nature of Services: Conform to the professional conduct code

Rules of Conduct

• Enforceability: They are enforceable.

Interpretations of the rules of conduct

• Needed for Clarity: Interpretations clarifies rules in the areas where there are questions about certain rules.
• Created By: They are created by the Professional Ethics Executive Committee of the AICPA.
• Unenforceable nature: Not enforceable but needed justification should departure occur.

Ethical Rulings

• Specific Instances: Deals with specific situations or facts about issues that the ethics code and rules don't solve.
• Published Explanations: Provides a record of interpretations.
• Part of AICPA Code: Ethical rulings are a part of the AICPA Code of Professional Conduct's guidelines

Test your knowledge on audit reports and ethics in Week Two of the Audit Practice and Procedures II course. This quiz covers the definition, purpose, and types of audit reports, along with the essentials of auditing. Assess your understanding of the internal and external auditing dynamics.