What standards does the auditor follow to carry out the examination of a company's financial statements?
The auditor carries out this examination by following the 10 Generally Accepted Auditing Standards (GAAS) and all of the official pronouncements that explain and interpret GAAS.
Generally Accepted Auditing Standards
TIP PIE ACDO
Generally Accepted Auditing Standards: The General Standards ((T)IP PIE ACDO)
Training - The auditor must have adequate technical training and proficiency to perform the audit.
Generally Accepted Auditing Standards: The General Standards (T(I)P PIE ACDO)
Independence - The auditor must maintain independence in mental attitude in all matters relating to the audit. This standards is often called the cornerstone of the profession since it is necessary to add credibility to what we do. It is defined as independence in fact and appearance.
Generally Accepted Auditing Standards: The General Standards (TI(P) PIE ACDO)
Professional Care - The auditor must exercise due professional care in the planning and performance of the audit and the preparation of the report. Often called the "average auditor" concept.
Generally Accepted Auditing Standards: Standards of Fieldwork (TIP (P)IE ACDO)
Planning and Supervision - The auditor must adequately plan the work and must property supervise any assistants. Audit programs are designed to enumerate appropriate action, and all work of staff auditors should be reviewed by a qualified auditor.
Maintenance of an objective attitude throughout the audit, including a questioning mind and critical assessment of audit evidence.
Due Professional Care
Critical management reviews of work performed at every level of supervision
Generally Accepted Auditing Standards: Standards of Fieldwork (TIP P(I)E ACDO)
Internal Control, Entity, and Environment - The auditor must obtain a sufficient understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement of the financial statements whether due to error or fraud, and to design the nature, extent, and timing of further audit procedures.
Generally Accepted Auditing Standards: Standards of Fieldwork (TIP PI(E) ACDO)
Evidence - The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit. All specific audit work is performed in order to gather evidence.
Generally Accepted Auditing Standards: Standards of Fieldwork (TIP PIE (A)CDO)
Accounting = GAAP - The auditor must state in the auditor's report whether the financial statements are presented in accordance with general accepted accounting principles (GAAP). Explicit statement in auditor's report.
Generally Accepted Auditing Standards: Standards of Fieldwork (TIP PIE A(C)DO)
Consistency - The auditor must identify in the auditor's report those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period. Implicit in auditor's report.
Generally Accepted Auditing Standards: Standards of Fieldwork (TIP PIE AC(D)O)
Disclosure - When the auditor determines that informative disclosures are not reasonably adequate, the auditor must so state in the auditor's report. Implicit in auditor's report.
Generally Accepted Auditing Standards: Standards of Fieldwork (TIP PIE ACD(O))
Express Opinion - The auditor must either express an opinion regarding the financial statements, taken as a whole, or state that an opinion cannot be expressed, in the auditor's report. When the auditor cannot express an overall opinion, the auditor should state the reasons therefor in the auditor's report. In all cases where an auditor's name is associated with financial statements, the auditor should clearly indicate the character of the auditor's work, if any, and the degree of responsibility the auditor is taking, in the auditor's report. Explicit statement in auditor's report.
Contains the following: 1. At statement that the financial statements as identified in the report were audited, and 2. A statement that the financial statements are the responsibility of management and that the auditor's responsibility is to express an opinion.
Contains the following: 1. A statement that the audit was conducted in accordance with US GAAS. (Issuers - reference made to PCAOB standards instead of GAAS) 2. A statement that the financial statements that the audit was planned and performed to obtain reasonable assurance that the financial statements are free from material misstatement. 3. Statements that the audit included examining evidence on a test basis; assessing the accounting principles used and significant estimates made by management; and evaluating the overall presentation. 4. A statement that the audit provides a reasonable basis for an opinion.
Contains the following: 1. A statement referring to the financial statements specifically identified in the introductory paragraph. 2. An opinion as to the fair presentation of the financial statements 3. A statement regarding conformity with the United States generally accepted accounting principle. (GAAP)
Unqualified (Clean) Opinion
States that the financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of the entity in conformity with US GAAP.
Modified Unqualified Opinion
Explanatory language may be added to the auditor's standard (unqualified) report.
Qualified Opinion (Except for)
States that, "except for" the effects of the matter(s) to which the qualification relates, the financial statements present fairly, in all material respects, the financial position, results of operations, or cash flows of the entity in conformity with US GAAP.
States that the financial statements do not present fairly the financial position, results of operations, or cash flows of the entity in conformity with US GAAP
Disclaimer of Opinion
States that the auditor does not express an opinion on the financial statements because he or she was not able to perform an audit sufficient in scope to render an opinion.
Modified unqualified reports (adding explanatory language)
1. Division of responsibility (modified wording only) 2. Necessary and justified departure from GAAP 3. Going concern 4. Emphasis of a matter (auditor's sole decision) 5. Justified lack of consistency
Materiality Level - None or immaterial (GAAP and GAAS)
Materiality Level - Material (GAAP)
Qualified Opinion (modify opinion paragraph)
Materiality Level - Material (GAAS)
Qualified Opinion (modify scope and opinion paragraphs)
Materiality Level - Highly Material (GAAP)
Material Level - Highly Material (GAAS)
Disclaimer of Opinion
Qualified "Except For" GAAP
1. Non-GAAP Change 2. Inadequate Disclosure 3. Unjustified Departure from GAAP 4. Unreasonable Accounting Estimate
Qualified "Except For" GAAS
1. Uncertainty 2. Scope Limitation
1. Non-GAAP Change 2. Inadequate Disclosure 3. Unjustified Departure from GAAP 4. Unreasonable Accounting Estimate
1. Uncertainty 2. Scope Limitation 3. Lack of Independence 4. Unaudited
Withdraw from Audit Engagement
False, Fraudulent, Deceptive, or Misleading
Modified Unqualified Opinion: Division of Responsibility
The auditor's opinion is based in part on the report of another auditor.
Modified Unqualified Opinion: Necessary and justified departure from GAAP
Due to unusual circumstances, a GAAP departure prevents the financial statements from being misleading.
Modified Unqualified Opinion: Going Concern
There is substantial doubt about the entity's ability to continue as a going concern.
Modified Unqualified Opinion: Emphasis a Matter
The auditor may add an explanatory paragraph.
Modified Unqualified Opinion: Justified lack of consistency
Material change in GAAP between periods or a change in the method of the application of accounting principles.
Explanatory Paragraph: General Rule
1. Unqualified opinion: The explanatory paragraph generally would follow the opinion paragraph. 2. Qualified, adverse, and disclaimer of opinion: The explanatory paragraph generally would precede the opinion paragraph. 3. Exception: The explanatory paragraph may be placed either before or after the opinion paragraph: a. Justified GAAP departure b. Emphasis of a matter
Modified Unqualified: Division of Responsibility (reference in report)
When the principal auditor decides to mention the work done by other auditors, the report will express a division of responsibility. The principal auditor will mention this division in all three paragraph.
Modified Unqualified: Division of Responsibility (no reference to other CPA)
When the principal auditor accepts responsibility for the work performed by another auditor, the principal auditor does not refer to the other auditor in the auditor's report. They must assure themselves of the independence, professional competency, and reputation of the other auditor.
Modified Unqualified: Going concern period
The "reasonable period of time," should not exceed one year from the date of the financial statements being audited.
Going Concern Period - Procedures (ADMITS)
1. Analytical procedures 2. Debt compliance: the auditor should review the terms of debt and loan agreements. 3. Minutes: the auditor should review minutes from stockholder and board of director meetings. 4. Inquiry of client's legal counsel 5. Third parties: the auditor should confirm the details of financial support arrangements. 6. Subsequent event review
Conditions and events that may be indicative of substantial doubt - (F)INE
Financial difficulties: loan defaults, dividend arrearages, denial of usual trade credit, debt restructuring, noncompliance with capital requirements, new financial sources or methods, disposal of substantial assets.
Conditions and events that may be indicative of substantial doubt - F(I)NE
Internal matters: work stoppages, labor difficulties, substantial dependence on a particular project, uneconomic long-term commitments, significant revision of operations.
Conditions and events that may be indicative of substantial doubt - FI(N)E
Negative trends: recurrent losses, working capital deficiencies, negative cash flows, adverse financial ratios.
Conditions and events that may be indicative of substantial doubt - FIN(E)
External matters: legal proceedings, new legislation, loss of key franchise, license, or patent, loss of a principal customer or supplier, natural disaster.
Going concern: Mitigating Factors
Auditor looks for mitigating factors: 1. Plans to borrow money or restructure debt 2. Plans to sell assets 3. Plans to delay or reduce expenditures 4. Plans to increase ownership equity
Going Concern: Adequate GAAP Disclosure
Modified Unqualified (Disclaimer not prohibited)
Going Concern: Inadequate GAAP Disclosure
Qualified (GAAP) or Adverse
Modified Unqualified: Emphasis of a Matter
1. A related-party transaction 2. A significant subsequent event 3. The entity is a component of a larger business enterprise. 4. Accounting matters (other than changes in accounting principles) that affect the comparability of the financial statements.
Modified Unqualified: Lack of Consistency (Justified Changes in Accounting Principle)
Consistency deals with the comparability of the F/S from year to year. 1. The change is to an acceptable principle 2. The method of accounting for the change is acceptable 3. Management is justified in the change
Modified Unqualified: Necessary/Justified Departure from GAAP
Under unusual circumstances, when adherence to GAAP would make the financial statements more misleading than they would be under another accounting treatment. The explanatory paragraph should contain the description of the departure, its approximate effects, and reasons why adherence to the GAAP would make the F/S misleading.
Lack of consistency: GAAP = Acceptable/Justified
Lack of consistency: Non GAAP = Unacceptable/Unjustified
Qualified or Adverse
Scope Limitation (GAAS Issue: Qualified or Disclaimer): Inability to obtain sufficient appropriate audit evidence
1. Inability to observe inventory 2. Inability to confirm receivables 3. Inability to obtain audited financial statements of a consolidated investee. 4. Restrictions on the use of auditing procedures 5. Inadequacy of accounting records
Scope Limitation (GAAS Issue: Qualified or Disclaimer):
Scope Limitation (GAAS Issue: Qualified or Disclaimer): Refusal of management
Refusal of management to provide written representation and/or acknowledge its responsibility for the fair presentation of the financial statements in conformity with GAAP
Scope Limitation (GAAS Issue: Qualified or Disclaimer): Refusal of attorney
Refusal of client's attorney to respond to inquiry
Disclaimer of Opinion
1. Uncertainty 2. Scope Limitation 3. Lack of independence 4. Unaudited financial statements
Unaudited Financial Statements
When the prior year's financial statements were not audited and that the current year's financial statements are being audited, the auditor is in essence facing a scope limitation, therefore expresses a disclaimer of opinion.
Updating (Changing) Prior Opinions
If, during the current examination, the auditor becomes aware of evidence that affects the prior statements and the opinion that was expressed, the auditor should update the opinion in the current year's report.
Updating (Changing) Prior Opinions: Format - DORCS
1. Date of the auditor's previous report 2. Opinion type previously issued 3. Reason for the prior opinion 4. Changes that have occurred 5. Statement that the "Opinion....is different"
Report of a Predecessor Auditor - Presented
In deciding whether to reissue their report, the predecessor auditor should: 1. Read the statements for the current period 2. Compare the statements audited with the current period statement 3. Obtain a letter of representation from the successor auditor. 4. Obtain a letter of representation from management
Report of a Predecessor Auditor - Presented: Date of Report
1. Unrevised - use the original date 2. Revised - dual date
Report of a Predecessor Auditor - Not Presented
Successor auditor should indicate in the introductory paragraph: 1. That the statements were examined by other auditors in prior period. 2. The date of the predecessor auditor's report 3. The type of opinion expressed by the predecessor auditor 4. The substantive reason(s) for other than an unqualified report
Events or transaction that occur after the balance sheet date, but before the financial statements are issued. A subsequent event may require adjustment to the financial statements or may require disclosure of an event without adjustment to the financial statements.
Subsequent Events : Type I
Conditions existing on or before the balance sheet date. An adjustment to the F/S is usually required if the condition existed at the date of the financial statements.
Subsequent Events : Type II
Conditions existing after the balance sheet date. Significant business events, such as the purchase of a business or the sale of debenture bonds, occurring subsequent to the date of financial statements, require no adjustments to the statements, but may require significant additional disclosure by note to the F/S. May require footnote disclosure.
Auditor's Responsibility for Subsequent Events
The period between the date of the F/S and the date of the auditor's report is called subsequent period. During this period, the auditor has an active responsibility to investigate certain subsequent events.
Auditor's Responsibility for Subsequent Events - (P)RIME
Post balance sheet transactions: Review for proper cutoff and to better evaluate year-end balances.
Auditor's Responsibility for Subsequent Events - P(R)IME
Representation letter should be obtained from management (usually CEO and CFO) regarding whether any events occurred during the subsequent period that require adjustments to or disclosure in the F/S.
Auditor's Responsibility for Subsequent Events - PR(I)ME
Inquiry of and discuss with management whether: 1. Any material contingent liabilities or commitments existed at the date of the balance sheet or current exists 2. Any significant change in capital stock, long-term debt, or working capital has occurred since the balance sheet date 3. Any material unusual adjustments have been made during the subsequent period 4. There have been any changes in items that had been accounted for on an indefinite basis Inquire of client's legal counsel concerning litigation, claims, and assessments
Auditor's Responsibility for Subsequent Events - PRI(M)E
Minutes of stockholders, directors, and other committee meetings should be read during the subsequent period.
Auditor's Responsibility for Subsequent Events - PRIM(E)
Examine latest available interim financial statements; compare them with the financial statements under audit
Auditor's Responsibility after the Original Date of the Auditor's Report
The auditor has no active responsibility to make any inquires or to perform any further auditing procedures to discover subsequent events after the original date of the auditors report. However, if the auditor becomes aware of any information relating to subsequent events, the auditor should consider whether it is necessary to adjust the F/S or the related disclosure.
Subsequent Discovery of Facts Existing at the Date of the Auditors Report (Discovered After Report is Issued)
If an auditor becomes aware of material information that would have affected the report, and that persons are currently relying or are likely to rely on the F/S covered by the report, the auditor should take appropriate action. If materiality affects the report, and other persons' reliance on it, the auditor should advise the client to immediately disclose the new information and its impact on the F/S to person currently relying or likely to rely on the F/S. Accomplished by 1. Advising the client to issue revised F/S along with new audit report describing the reasons for revision, or 2. Advising the client to make necessary disclosures or revisions to any imminent F/S 3. If the effect on the F/S cannot be determined on a timely basis, providing notification that the F/S and report should not be relied upon.
Required Supplementary Information
Limited Procedures 1. Inquire of management how the supplementary information was prepared, including changes from prior years and significant assumptions 2. Determine if the supplementary information is consistent with management's responses, audited financial statements, and other knowledge 3. Consider whether the client representation letter should refer to the supplementary information