Chapter 03

Audit Reports

Lecture 06
Dr/Mostafa I. EL-Feky
 Conditions for Standard Unmodified report
The standard unmodified opinion audit report is issued when the following conditions have
been met:
(1) All statements—balance sheet, income statement, statement of changes in stockholders’ equity, and statement
of cash flows—are included in the financial statements.
(2)Sufficient appropriate evidence has been accumulated, and the auditor has conducted the
engagement in a manner that enables him/her to conclude that the audit was performed in
accordance with auditing standards.
(3) The financial statements are presented fairly in all material respects in accordance with generally
accepted accounting principles or other appropriate accounting framework. This also means that
adequate disclosures have been included in the footnotes and other parts of the financial statements.
(4)There are no circumstances requiring the addition of an emphasis-of-matter paragraph or
modification of wording or auditor’s opinion in the report.
If any of the requirements for the standard unmodified opinion audit report are not met,
the standard unmodified opinion audit report cannot be issued.

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 Four Categories of Audit Reports
Standard Unmodified Opinion Audit Report

First paragraph is introductory paragraph and indicates that an

audit was performed and the financial statements that were
audited. Information is similar to the first three paragraphs in
standard unmodified opinion audit report for nonpublic entities.

The scope paragraph is similar to the second paragraph under

the auditor’s responsibilities and indicates that an audit is
designed to provide reasonable assurance that the financial
statements are free of material misstatement. The scope
paragraph notes that auditing is done on a test basis.

The third paragraph is opinion paragraph. If auditor also issues

a separate report on internal control over financial reporting, a
fourth paragraph would follow opinion paragraph and reference
the audit report on internal control.

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 Reports on Internal Control Over Financial Reporting
The auditor may choose to issue separate reports, such as the separate report on internal control over financial
reporting, or in a combined report. It addresses both the financial statements and management’s report on
internal control over financial reporting. While the combined report is permitted, the separate report on internal
control over financial reporting is more common and includes these elements:
▪ A title that includes the word "independent."
▪ The introductory, scope, and opinion paragraphs describe that the scope of the auditor’s work and opinion is
on internal control over financial reporting, and the introductory paragraph highlights management’s
responsibility for and its separate report that contains management’s assessment of internal control over
financial reporting.
▪ The introductory and opinion paragraphs also refer to the framework used to evaluate internal control and that
the audit was conducted in accordance with PCAOB standards.
▪ Report includes a paragraph after the scope paragraph defining internal control over financial reporting.
▪ Report also includes an additional paragraph before the opinion that addresses the inherent limitations of
internal control.
▪ Although the audit opinion on the financial statements addresses multiple reporting periods, the auditor’s
opinion about the effectiveness of internal control is as of the end of the most recent fiscal year.
▪ The last paragraph of the report includes a cross-reference to the auditor’s separate report on the financial
statements.
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 Unmodified Opinion Audit Report with emphasis-of-
matter paragraph or nonstandard report wording
It meets the criteria of a complete audit with satisfactory results and financial statements that are fairly presented,
but the auditor believes it is important to draw the reader’s attention to certain matters or the auditor is required to
provide additional information. In a qualified, adverse, or disclaimer report, the auditor either has not been able to
perform a satisfactory audit, is not satisfied that the financial statements are fairly presented or is not independent.
The following are the most important causes of the addition of an emphasis-of-matter paragraph or a modification
in the wording of the standard unmodified opinion audit report under both AICPA and PCAOB audit standards:
➢ Lack of consistent application of generally accepted accounting principles.
➢ Substantial doubt about going concern.
➢ Auditor agrees with a departure from promulgated accounting principles.
➢ Emphasis of other matters.
➢ Reports involving other auditors.
The first four reports all require the addition of an explanatory paragraph. The term "explanatory paragraph" was
replaced in the AICPA auditing standards with "emphasis-of-matter" or "other-matter "paragraphs.

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 Unmodified Opinion Audit Report with emphasis-of-
matter paragraph or nonstandard report wording
 "Emphasis-of-matter" paragraphs are used to draw the reader’s attention to information presented
or disclosed in the financial statements, such as a footnote disclosure.
 "Other matter" paragraphs refer to a matter that is not presented or disclosed in the financial
statements, such as an explanation by the auditor of responsibilities related to a law or regulation.
Lack of Consistent application of GAAP
❖ Auditing standards require the auditor to call attention to circumstances in which accounting principles have not been
consistently observed in the current period in relation to the preceding period.

❖ GAAP require that changes in accounting principles or their method of application be to a preferable principle and the
nature and impact of the change be adequately disclosed. When a material change occurs, the auditor should add an
explanatory paragraph after the opinion paragraph that discusses the nature of the change and points the reader to the
footnote that discusses the change.

❖ The materiality of a change is evaluated based on the current year effect of the change. An explanatory paragraph is
required for both voluntary changes and required changes due to a new accounting pronouncement.

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 Consistency Versus Comparability
The auditor must be able to distinguish between changes that affect consistency and those that may
affect comparability but do not affect consistency. The following are examples of changes that affect
consistency and therefore require an explanatory paragraph if they are material:
(1) Changes in accounting principles, such as a change from FIFO to LIFO inventory valuation.
(2) Changes in reporting entities, such as the inclusion of an additional company in combined
financial statements.
(3) Corrections of errors involving principles, by changing from an accounting principle that is
not generally acceptable to one that is acceptable, including correction of the resulting error.
Changes that affect comparability but not consistency and therefore need not be included in the audit
report include the following:
(1) Changes in an estimate, such as a decrease in the life of an asset for depreciation purposes
(2) Error corrections not involving principles, such as a previous year’s mathematical error.
(3) Variations in format and presentation of financial information.
(4) Changes because of substantially different transactions or events, such as new endeavors in
research and development or the sale of a subsidiary
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 End of
Lecture 06
Dr/Mostafa I. EL-Feky