audit reports

1. Transactions are illegal or fraudulent.
2. An item may materially affect some future period, even though it is immaterial
when only the current period is considered.
3. An item has a “psychic” effect (for example, the item changes a small loss to a
small profit, maintains a trend of increasing earnings, or allows earnings to
exceed analysts’ expectations).
4. An item may be important in terms of possible consequences arising from
contractual obligations (for example, the effect of failure to comply with a debt
restriction may result in a material loan being called).
Materiality Decisions—Scope Limitations Condition When there is a scope limitation in
an audit, the audit report will be unqualified, qualified scope and opinion, or disclaimer,
depending on the materiality of the scope limitation. The auditor will consider
the same three factors included in the previous discussion about materiality decisions
for failure to follow GAAP, but they will be considered differently. The size of potential
misstatements, rather than known misstatements, is important in determining
whether an unqualified report, a qualified report, or a disclaimer of opinion is appropriate
for a scope limitation. For example, if recorded accounts payable of $400,000
was not audited, the auditor must evaluate the potential misstatement in accounts
payable and decide how materially the financial statements could be affected. The pervasiveness
of these potential misstatements must also be considered.
It is typically more difficult to evaluate the materiality of potential misstatements
resulting from a scope limitation than for failure to follow GAAP. Misstatements
resulting from failure to follow GAAP are known. Those resulting from scope limita -
tions must usually be subjectively measured in terms of potential or likely misstate -
ments. For example, a recorded accounts payable of $400,000 might be understated by
more than $1 million, which may affect several totals, including gross margin, net
earnings, and total assets.
DISCUSSION OF CONDITIONS REQUIRING A DEPARTURE
You should now understand the relationships among the conditions requiring a departure
from an unqualified report, the major types of reports other than unqualified, and
the three levels of materiality. This part of the chapter examines the conditions requiring
a departure from an unqualified report in greater detail and shows examples of
reports.
OBJECTIVE 3-7
Draft appropriately modified
audit reports under a variety of
circumstances.
Two major categories of scope restrictions exist: those caused by a client and those
caused by conditions beyond the control of either the client or the auditor. The effect
on the auditor’s report is the same for either, but the interpretation of materiality is
likely to be different. When there is a scope restriction, the appropriate response is to
issue an unqualified report, a qualification of scope and opinion, or a disclaimer of
opinion, depending on materiality.
For client-imposed restrictions, the auditor should be concerned about the possibility
that management is trying to prevent discovery of misstated information. In such
cases, auditing standards encourage a disclaimer of opinion when materiality is in
question. When restrictions result from conditions beyond the client’s control, a qualification
of scope and opinion is more likely.
Two restrictions occasionally imposed by clients on the auditor’s scope relate to the
observation of physical inventory and the confirmation of accounts receivable, but
other restrictions may also occur. Reasons for client-imposed scope restrictions may be
a desire to save audit fees and, in the case of confirming receivables, to prevent possible
conflicts between the client and customer when amounts differ.
Auditor’s Scope Has
Been Restricted
CHAPTER 3 / AUDIT REPORTS 59