PART TWO: Understanding Audit Reports and Auditor’s Opinion
Material Misstatements in Financial Statements
Because materiality will vary from company to company and even from year to year for a specific company, it is not defined in terms of dollars or percentages throughout the professional auditing standards. Once again, like reasonable assurance, materiality is a decision left to the auditors’ judgment. Also, like reasonable assurance, the word material is required by professional auditing standards to be in the auditors’ report.
Modifications to the Standard Audit Report
In a few circumstances, auditors may give an unqualified opinion but add an extra paragraph to the report. For example, auditors are required to add an extra paragraph after the opinion paragraph if the company did not apply the same generally accepted accounting principles consistently from last year to this year. Also, auditors must add an extra paragraph after the opinion paragraph if they have serious doubt about the company’s ability to continue as a going concern for a period of up to one year past the balance sheet date. Auditors also are allowed to add an extra paragraph to emphasize any matter they wish, but that choice is always at the discretion of the auditor.
Further, when the accounting profession issues a new standard that changes the way certain types of transactions previously were accounted for and requires that all companies follow the new standard, consistency comes into play and the auditors must include the additional paragraph again.
Because the accounting profession frequently issues new accounting pronouncements, auditors often include consistency paragraphs in their reports.
Auditors cannot predict the future any better than the average person can, but they are required under auditing standards, to add a “going concern” paragraph to an audit opinion if they uncovered evidence during the audit that gives them “substantial doubt” about the company’s ability to continue as a going concern for a period of up to one year beyond the balance sheet date. The content of the paragraph is up to the auditor’s judgment, but the two terms substantial doubt and going concern must be included.
The opinion on the historical financial statements still can be unqualified (the best opinion) because the financial statements relate to the past and the opinion states whether they are presented in conformity with GAAP. The auditor will refer the financial statement readers to the financial statement footnote (prepared by management) that discusses the circumstances that have given rise to the going concern issue as well as its plans to mitigate those circumstances. However, the absence of a going concern paragraph is never a guarantee from the auditors that the company will be in existence for a year beyond the balance sheet date.
Management’s Responsibilities vs. Auditor’s Responsibilities
The audit report makes it clear that the financial statements, including the footnotes, are management’s responsibility. The auditors are not responsible for preparing the financial statements or for any aspect of capturing the accounting data throughout the year that eventually generate the account balances reported on the financial statements. Instead, the auditors’ responsibility is to express an opinion that is based on the audit work.
Auditing standards require the addition of a consistency paragraph to indicate to the readers that if the financial statements are different this year (for example, either a higher or lower net income than last year), it could be because the use of accounting principles differed between the two years. In other words, the financial statements may not be directly comparable. However, this does not imply that the company is engaged in anything improper. Companies are allowed to switch from one generally accepted accounting principle (GAAP) to another as long as the change, its effects, and management’s justification for the change are disclosed.
This information has been excerpted from Accounting Financial Tax. Copyright ©2012. All rights reserved.
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