understanding the auditor s report

8/11/2019 Understanding the Auditor s Report

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Understanding the Auditor's Report

If all the facts concerning financial transactions were properly and accurately recorded

and if the owners and managers of business enterprises were entirely honest andsufficiently skilled in matters of accounting and recording, there would be little need for

independent auditing. However, human nature being as it is, there probably will alwaysbe a need for the auditor. Many businesses, depending on size and nature, employ internalauditors. Their responsibilities and functions, while similar to those of an independent

auditor, are vitally different in a major respect having to do with impartiality and

independence. or the purpose of this discussion the terms accountant, auditor andcertified public accountant !"#$% are used interchangeably and only refer to the &outside&

independent auditor.

The Role of the Auditor'ependable financial information is essential to the very e(istence of our society. The

credit professional making a decision to grant trade credit, the investor making a decision

to buy or sell securities, the banker deciding whether to approve a loan, the governmentin obtaining revenue based on income ta( returns, all are relying upon information

provided by others. In many of these situations, the goals of the providers of information

run directly counter to those of the users of the information. Implicit in this line ofreasoning is recognition of the social need for independent auditors ) individuals with a

professional competence and integrity who can tell us whether the information on which

we rely constitutes a fair picture of what is really going on.

*ood accounting and financial reporting aid society in allocating its resources in the mostefficient manner. The goal is to allocate our limited capital resources to the production of

those goods and services for which demand is greatest. +conomic resources are attracted

to the industries and organizational entities that are shown by accounting measurementsto be capable of using the resources to the best advantage. Inadeuate accounting and

inaccurate reporting, on the other hand, conceal waste and inefficiency and thereby

prevent our economic resources from being allocated in a rational manner.

$ decision by a credit professional to grant credit is usually based on careful study of thecompany-s financial statements along with other information. The credit manager-s

purpose in granting credit is to facilitate the sale of product and collect payment when it

is due. ut what if the financial statements submitted by the company along with its

credit application are not dependable/ $ssume, for e(ample, that the financial statementsoverstate current assets and annual earnings, and omit major liabilities. $ssume also that

the credit manager, acting on the basis of such misleading information, grants tradecredit. The end result is likely to be that the credit manager does not receive payment andmay have to write the transaction off as a loss.

The contribution of the independent auditor is to give credibility to financial statements.

"redibility, in this usage, means that the financial statements can be believed0 that is, they

can be relied upon by outsiders, such as trade creditors, bankers, stockholders,government and other interested third parties.


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$udited financial statements are now the accepted means by which business corporations

report their operating results and financial position. The word audit when applied to

financial statements means that the balance sheet, statements of income and retainedearnings, and statement of cash flows are accompanied by an audit report prepared by

independent public accounts, e(pressing their professional opinion as to the fairness of

the company-s financial statements.

The goal is to determine whether these statements have been prepared in conformity withgenerally accepted accounting principles !*$$#%. inancial statement audits are

normally performed by firms of certified public accountants0 users of auditors- reports

include trade creditors, management, investors, bankers, financial analysts andgovernment agencies.

The Public Accounting Profession

American Institute of Certified Public Accountants - AICPA

$t the very heart of the public accounting profession is the $I"#$, a voluntary nationalorganization of more that 122,222 "#$s. The $I"#$ establishes standards and rules to

guide "#$s in their conduct of professional services, carries on a continuous program ofresearch and publications, promotes continuing professional education and contributes to

the profession-s system of self)regulation.

Financial Accounting Standards Board - FASB

$uditors must determine whether financial statements are prepared in conformity withgenerally accepted accounting principles. The $I"#$ has designated the inancial

$ccounting 3tandards oard as the body with power to set forth these principles for

entities other than state and local governments. Thus $3 3tatements, e(posure drafts,

public hearings, and research projects are all of major concern to the public accountingprofession.

Securities and Exchange Commission - SEC

The 3+" is an agency of the 4.3. *overnment. It administers the 3ecurities $ct of 5611,the 3ecurities +(change $ct of 5617, and other legislation concerning securities and

financial matters. The function of the 3+" is to protect investors and the public by

reuiring full disclosure of financial information by companies offering securities for saleto the public. $ second objective is to prevent misrepresentation, deceit or other fraud in

the sale of securities.

The term registration statement is an important one in any discussion of the impact of the3+" on accounting practice. To register securities means to ualify them for sale to thepublic by filing with the 3+" financial statements and other data in a form acceptable to

the "ommission. $ registration statement contains audited financial statements, including

balance sheets for a two)year period and income statements and statements of cash flowfor a three year period. The legislation creating the 3+" made the "ommission

responsible for determining whether the financial statements presented to it reflect proper

application of accounting principles.


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The Auditor Renders a Report on the Financial Statements, not on the

Accounting Records"ontrary to some beliefs, a certified public accountant-s letter of opinion is not acertification and actually is nothing more than an opinion. It is not a guarantee.It is the

accountant who is certified, not the financial statements.$s a professional, the

accountant e(presses a detached judgement. He says, in effect, that proper accountingprinciples appear to have been applied consistently by management and that standard

auditing procedures deemed applicable under particular circumstances have revealed

nothing which would cause him to uestion the fairness of the resultant statements.

8aturally, some of the items on a financial statement cannot be subjected to e(actmeasurement. 4nfortunately, many of these are important in that they may materially

affect either or both the condition of the company at a given point in time, or the results

of operations over a period of time. y their very nature, certain of these items mustrepresent estimates and appro(imations. However, we are justified in looking to the

certified public accountant for a value based on informed judgement. It is important to

recognize that the financial statements and all supplemental data that may accompany the

statements are the responsibility of the client. The accountant assumes responsibility onlyfor the opinion that accompanies the report.

The primary purpose of an audit is to provide assurance to the users of the financial

statements that these statements are reliable. $uditors do not e(press an opinion on theclient-s accounting records. The auditors- investigation of financial statement items

includes reference to the client-s accounting records, but is not limited to these records.

The auditors- e(amination includes observation of tangible assets, inspection of suchdocuments as purchase orders and contracts, and the gathering of evidence from outsiders

including banks, customers, and suppliers, as well as analysis of the client-s accounting

records.

$ principal means of establishing the validity of a balance sheet and income statement isto trace the statement figures to the accounting records and back through the records to

the original evidence of transactions. However, the auditors- use of the accounting records

is only a means to an end 9 and merely a part of the audit. It is, therefore, appropriate forthe auditors to state in their report that they have made an audit of the financial

statements rather than to say that they have made an audit of the accounting records.

+(pressing an independent and e(pert opinion on the fairness of financial statements is

the most important and valuable service rendered by the public accounting profession.The auditors- standard report states that the e(amination was performed in conformity

with generally accepted auditing standards and by e(pressing an opinion that the client-sfinancial statements are presented fairly in conformity with generally accepted

accounting principles. However, if there are deficiencies in the client-s financialstatements or limitations in the auditors- e(amination, or if there are other unusual

conditions about which the readers of the financial statements should be informed,

auditors- cannot issue the standard report. Instead, they must carefully modify their reportto make these problems or conditions known to users of the audited financial statements.


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The Company is Responsible for the Financial StatementsThe management of a company has the responsibility for maintaining adeuate

accounting records and of preparing proper financial statements for the use of

stockholders and creditors. +ven though the financial statements are sometimesconstructed and produced in the auditors- office, primary responsibility for the statements

remains with management.

The auditors- product is their report. It is a separate document from the client-s financial

statements, although the two are closely related and transmitted together to stockholdersand to creditors.

Reporting Phase of the Audit

The reporting phase of an audit begins when the independent auditors have completed

their field work and their proposed adjustments have been accepted and recorded by theclient. efore writing their report, the auditors must review the client)prepared financial

statements for form and content, or draft the financial statements on behalf of the client.

The financial statements on which the independent auditors customarily report are the

balance sheet, the income statement, the statement of retained earnings, and the statementof cash flows. :ften, the statement of retained earnings is combined with the income

statement. In some cases, the retained earnings statement may be e(panded to a statement

of stockholders- euity. inancial statements generally are presented in comparative formfor the current year and the preceding year and are accompanied by e(planatory notes.

The financial statements for a parent corporation usually are consolidated with those of

the subsidiaries.

Financial Statement Disclosure

The purpose of notes to financial statements is to achieve adeuate disclosure wheninformation in the financial statements is insufficient to attain this objective. $lthough the

notes, like the financial statements themselves, are representations of the client, theindependent auditors generally assist in drafting the notes.

$deuate disclosure in the notes to financial statements is necessary for the auditors to

issue an unualified opinion on the financial statements. 'isclosure reuirements that

have become a part of the basic financial statements include the disclosure of significantaccounting policies, accounting changes, loss contingencies, and lease and pension

information.

Detecting isstatements*enerally accepted accounting principles reuire that the financial statements be freefrom material misstatements. The auditors have a responsibility to detect various types of

material misstatements, including errors, irregularities and those caused by illegal acts.

The auditors are reuired to assess the risk that errors and irregularities have occurred

affecting the client-s financial records. The audit is designed to provide reasonable


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assurance of detecting errors and irregularities that are material to the financial

statements.

The Auditors' Unqualified ReportThe standard unualified report is regarded as a clean bill of health, the auditor made no

e(ceptions and inserts no ualifications in the report. $n unualified opinion can only bee(pressed when the independent auditor has formed the opinion on the basis of an

e(amination made in accordance with generally accepted accounting principles, applied

in a consistent basis and includes all informative disclosures necessary to make thestatements not misleading. The standard unualified report consist of three paragraphs.

The first paragraph clarifies the responsibilities of management and the auditors, and is

referred to as the introductory paragraph. The second paragraph describes the nature of

the audit and is called the scope paragraph. The final paragraph is the opinion paragraph,which is a concise statement of the auditor-s opinion based on the audit. The auditors-

report is addressed to the persons who retained the auditors.

!he Introductor" ParagraphThe introductory paragraph emphasizes that the client company is primarily responsible

for the financial statements and that the auditors render a report on the financial

statements, not on the accounting records.

!he Scope Paragraph

The scope paragraph describes the nature of the audit, that it was conducted in

accordance with generally accepted auditing standards and provides reasonable assurance

that the financial statements are free of material misstatement.

!he #pinion Paragraph

In the opinion paragraph, the auditors are e(pressing nothing more than an informedopinion. They do not guarantee or certify that the statements are accurate.

Independent $uditors- ;eport225, and the related statements of income, retained earnings, and

cash flow for the year then ended. These financial statements are the

responsibility of the "ompany-s management. :ur responsibility is to e(press an

opinion on these financial statements based on our audit.

=e conducted our audit in accordance with generally accepted auditing standards.

Those standards reuire that we plan and perform the audit to obtain reasonable

assurance about whether the financial statements are free of materialmisstatement. $n audit includes e(amining, on a test basis, evidence supporting

the amounts and disclosures in the financial statements. $n audit also includes

assessing the accounting principles used and significant estimates made by


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management, as well as evaluating the overall financial statement presentation.

=e believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in allmaterial respects, the financial position of $" "ompany as of 'ecember 15,

>225, and the results of its operations and its cash flows for the year then ended inconformity with generally accepted accounting principles.

"allahan, 'urant, 3imms ? "o."olumbia, Maryland

"ertified #ublic $ccountants

March 5, >22>

ther Types of Auditors' Reports$lternatives to an unualified report include unualified opinion with e(planatory

language, a ualified opinion, an adverse opinion, or a disclaimer of opinion.

Explanator" $anguage Added to the %n&ualified #pinion

"ertain circumstances reuire auditors to add e(planatory language to the standard report.

$dding the additional language is not regarded as a qualification because it does not

lessen the auditors' reporting responsibilityfor the financial statements.

$uditors add e(planatory language to an unualified opinion to indicate

understanding the auditor s report

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