AUD: Audit Reports: Modified Opinions Due to Financial Statement Issues - Issuer

Summary

The script discusses the auditing process and reporting under GAAP, focusing on material issues leading to different audit opinions. It explains 'except for' or qualified opinions for material GAAP problems and 'adverse' opinions for very material issues. The script outlines the structure of audit reports, including opinion paragraphs, additional paragraphs detailing issues, and critical audit matters. It emphasizes the importance of professional judgment in deciding the impact of GAAP issues on audit opinions.

Takeaways

• ⚖️ GAAP problems lead to different audit opinions based on materiality: material issues result in 'except for' opinions, while very material issues lead to 'adverse opinions'.
• 📄 The 'except for' opinion, also known as a qualified opinion, is used when there's a GAAP issue that is material but not extremely so.
• 🔍 In a qualified opinion, the auditor still expresses that the financials are fairly presented except for the noted issue.
• 📝 The auditor must include an additional paragraph detailing the issue that led to the 'except for' qualification.
• 💡 The basis for an 'except for' opinion could also involve critical audit matters, depending on professional judgment.
• 🏢 The adverse opinion is used when a GAAP issue is very material, significantly affecting the financial statements' fairness.
• 🚫 In an adverse opinion, the auditor states that the financials do not present fairly in conformity with GAAP due to the discussed matters.
• 🔑 The opinion paragraph in both 'except for' and adverse opinions is modified to highlight the issue and its impact on the financial statements.
• 📊 The impact of the GAAP issue on the financials, such as changes in property, debt, and retained earnings, must be clearly stated.
• 📋 The standard audit report elements like RAP MEE (Risk Assessment, Performance, and Evaluation of Errors) are still included in the report despite the modified opinion.
• ✍️ Auditors must communicate critical audit matters separately, noting that these do not alter the overall opinion on the financials.

Q & A

What is a GAAP problem in the context of auditing?

A GAAP problem refers to an issue where the financial statements do not conform to Generally Accepted Accounting Principles in the United States. This can lead to different levels of audit opinions depending on the materiality of the issue.

What is the difference between a 'qualified opinion' and an 'adverse opinion' in auditing?

A 'qualified opinion', also known as an 'except for' opinion, is issued when there is a material GAAP problem. An 'adverse opinion' is issued when the GAAP issue is very material, indicating that the financial statements do not present fairly in conformity with GAAP.

How does a qualified opinion paragraph differ from a standard unmodified opinion paragraph?

In a qualified opinion paragraph, the phrase 'except for' is used to indicate that the financial statements are fairly presented except for the effects of the issue discussed in the additional paragraph detailing the GAAP problem.

What additional information is included in an audit report when a qualified or adverse opinion is issued?

When a qualified or adverse opinion is issued, the audit report includes an additional paragraph explaining the GAAP problem, its effects on the financial statements, and the basis for the auditor's opinion.

Why are critical audit matters mentioned in the audit report?

Critical audit matters are mentioned to highlight specific areas that were particularly challenging, subjective, or complex in the audit process, and that involved significant judgment by the auditors.

How does the PCAOB (Public Company Accounting Oversight Board) impact the audit report?

The PCAOB sets the standards that auditors must follow, which are reflected in the audit report's language regarding the planning and performance of the audit.

What is the significance of the phrase 'RAP MEE' in the context of the audit report?

The acronym 'RAP MEE' stands for 'Risk Assessment Procedures - Materiality - Evidence - Evaluation', which is a simplified way to remember the key components of the audit process as required by PCAOB standards.

What is the role of management in the context of an audit?

Management is responsible for the preparation and fair presentation of the financial statements in accordance with GAAP. Auditors express an opinion on these statements based on their audit.

How does the auditor address the issue of materiality in the audit report?

The auditor addresses materiality by discussing the impact of GAAP issues on the financial statements and determining whether the issues lead to a qualified or adverse opinion based on their materiality.

What is the purpose of including the tenure of the auditors in the audit report?

Including the tenure of the auditors provides transparency about the length of time the auditing firm has been associated with the company, which can be relevant for users of the financial statements.

Outlines

00:00

📊 GAAP Issues and Opinions in Auditing

This paragraph discusses how to handle GAAP (Generally Accepted Accounting Principles) issues during an audit. It outlines the process for addressing material GAAP problems, distinguishing between a 'qualified opinion' (also known as 'except for') and an 'adverse opinion'. The paragraph explains that a qualified opinion is issued when there's a material GAAP issue, while an adverse opinion is reserved for very material GAAP issues. The paragraph also describes the structure of an auditor's report, including the opinion paragraph, additional paragraphs detailing the issue, the basis for the opinion, and critical audit matters if applicable. An example is provided where the company has not capitalized certain lease obligations, resulting in a qualified opinion. The paragraph concludes with a mention of the PCAOB standards and the auditor's responsibility to plan and perform the audit accordingly.

05:03

🚫 Adverse Opinion Due to Material GAAP Violations

The second paragraph delves into the issuance of an adverse opinion, which occurs when there is a very material GAAP issue that significantly impacts the financial statements' fairness. The paragraph explains that an adverse opinion directly states that the financials do not present fairly in conformity with GAAP. An example is given where the company carries property, plant, and equipment (PP&E) at appraised value instead of net book value, leading to a departure from GAAP and resulting in an adverse opinion. The paragraph also covers the structure of the auditor's report in such cases, including the modified opinion paragraph, a new paragraph detailing the GAAP violation and its impact on the financials, the basis for the opinion, and critical audit matters. The paragraph emphasizes that the communication of critical audit matters does not alter the overall opinion on the financials and that the auditor's tenure is stated at the end of the report.

Keywords

💡GAAP

GAAP stands for Generally Accepted Accounting Principles, which are a set of accounting standards and procedures that guide the preparation of financial statements in the United States. In the script, GAAP is central to the discussion of financial reporting issues and the different types of audit opinions that can be issued based on compliance with these principles. The mention of 'GAAP problems' and 'material GAAP issues' illustrates the significance of adhering to these standards in auditing and financial reporting.

💡Material

In the context of financial reporting, 'material' refers to the significance of an item or event in relation to the financial statements as a whole. An item is considered material if its omission or misstatement could influence the decisions of users of the financial statements. The script discusses how the materiality of a GAAP problem can lead to different audit opinions, such as 'except for' or 'adverse' opinions.

💡Qualified Opinion

A qualified opinion in auditing is an opinion other than an unqualified or 'clean' opinion, which indicates that the financial statements are fairly presented in accordance with GAAP. The script refers to a 'qualified opinion' as an 'except for' opinion, which means that the financial statements are generally fair except for certain issues, such as the failure to capitalize lease obligations as discussed in the script.

💡Adverse Opinion

An adverse opinion is the most severe type of audit opinion and indicates that the financial statements are not presented fairly in accordance with GAAP due to one or more significant issues. The script contrasts this with a qualified opinion, explaining that an adverse opinion is issued when there is a 'very material GAAP issue,' such as carrying property, plant, and equipment at appraised value instead of net book value.

💡Critical Audit Matters

Critical audit matters are significant issues that involve especially challenging, subjective, or complex judgments by the auditors. The script mentions that these matters are communicated to the audit committee and may be included in the auditor's report if they relate to material accounts or disclosures. The example given in the script about not capitalizing leases could potentially be a critical audit matter, depending on the professional judgment of the auditors.

💡Audit Opinion

An audit opinion is the auditor's formal conclusion about the fairness with which the financial statements are presented, in accordance with GAAP. The script outlines different types of audit opinions, including unqualified, qualified (except for), and adverse opinions, and how they are determined based on the materiality and nature of the issues identified during the audit.

💡PCAOB

The PCAOB stands for the Public Company Accounting Oversight Board, which is responsible for overseeing the audits of public companies in the United States. The script refers to the PCAOB standards, which auditors must follow when conducting their audits. These standards include the planning and performing of the audit to ensure its quality and integrity.

💡RAP MEE

RAP MEE is an acronym used in the script to remember the key components of the PCAOB standards: Risk Assessment, including Internal Control; Planning and Supervision; Materiality; Evidence Obtained; and Evaluation of Findings. This acronym is used to ensure that auditors cover all necessary aspects of an audit as per the PCAOB standards.

💡Basis for Opinion

The basis for opinion is the rationale behind the auditor's conclusion on the financial statements. In the script, it is mentioned that while the financial statements are the responsibility of the company's management, the auditor's responsibility is to express an opinion based on their audit. This includes following the PCAOB standards and evaluating the evidence obtained during the audit process.

💡Except for

In the context of audit opinions, 'except for' is used to qualify an opinion, indicating that the financial statements are generally fairly presented except for specific issues. The script uses the term 'except for' in relation to a qualified opinion, where the financial statements would be considered fair if not for the effects of not capitalizing certain lease obligations.

Highlights

Moving down the decision tree for GAAP problems leads to different audit opinions depending on materiality.

Material GAAP problems result in a 'qualified opinion' or 'except for' opinion.

Very material GAAP problems lead to an 'adverse opinion'.

Qualified opinion includes an 'except for' paragraph detailing the GAAP issue.

The basis for an 'except for' opinion may involve critical audit matters.

An example of a qualified opinion is provided, highlighting the modification in the opinion paragraph.

The impact of not capitalizing lease obligations is explained in the 'except for' paragraph.

The standard audit opinion paragraph remains unchanged in a qualified opinion.

PCAOB standards are followed in the audit process, as mentioned in the transcript.

Critical audit matters are discussed and may or may not be related to the GAAP issue.

An adverse opinion is issued for very material GAAP issues, significantly impacting the financial statements.

The adverse opinion clearly states that the financials do not present fairly due to the GAAP issue.

An example of an adverse opinion is provided, with a focus on the material violation of GAAP.

The impact of carrying PP&E at appraised value instead of net book value is detailed in the adverse opinion.

The opinion paragraph in an adverse opinion is modified to reflect the significant departure from GAAP.

The communication of critical audit matters does not alter the overall audit opinion.

The tenure of the auditors is stated at the end of the audit report.

Transcripts

All right scholars, we're now going to move down the side of the decision tree

where you have problems and these are your GAAP problems. If you have a GAAP

problem and its material, where do you go? You go to the except for opinion.

How about if it's very material? Then you go down to the adverse opinion. So

we're going to take a look at both the qualified opinion of an issuer and then

the, ultimately, the adverse opinion of an issuer. Now, qualified is also known

as except for, so we're going to be dealing with GAAP issues. Note, you

start with your opinion paragraph, you add any additional paragraph talking

about the problem, you give your basis for your opinion paragraph, and then you

have your critical audit matters, if they also apply. Now, the basis for the

except for could also be a critical audit matters or it may not be. That's

something that professional judgment will make a decision on. So let's take a look

at how the qualified, known as the except for opinion, of an issuer looks like.

Note the title, the Report of the Independent Registered Public Accounting

Firm. We addressed it to the shareholders or board of directors, never

management, and notice how it's modified. We have audited the accompanying balance

sheet, blah, blah, blah, blah, right? But go down to the second sentence. In

our opinion, here is the important area and it's in bold, except for. That's why

the qualified is known as the except for opinion. Except for and, in this case,

the example is the effects of not capitalizing certain lease obligations as

discussed in the following paragraph but except for that, the financials referred

to above present fairly. So it's important to understand we're still

saying they're fair, except for that one item. Now we have a new paragraph. The

company has excluded from property and debt. In other words, they didn't debit

the asset and credit the liability. In the accompanying balance sheet, certain

lease obligations that in our opinion should be capitalized in order to conform

with generally accepted accounting principles in the United States. If

these lease obligations had been capitalized, property would have

increased by X and X. Long-term debt by X and X. By the way, two Xs because it's

each of the two years. And then, of course, it would have had an impact on

retained earnings as of a certain period in time. So you're highlighting what the

impact would be. Next, we have our standard paragraph, nothing different

here. Notice right here and this one your basis for your opinion, this is a

standard one. These financials are the responsibility of companies' management,

our responsibility is to express an opinion based on our audit. And then it

goes on; nothing different there. Note the next portion of it, we conducted our

audit in accordance with standards of the PCAOB, those standards required that we

plan and perform. You have RAP MEE, RAP MEE, right? The double R, double A,

double P, double M, double E, double E, right? It's all going to be there,

nothing changed. Then we have our critical audit matters. Notice here, the

critical audit matters communicated below are matters arising from the current

period that were communicated or required to be communicated to the audit

committee, that, one, relate to accounting or disclosures that are

material, and involved our especially challenging, subjective, and complex

judgments. So to give you an idea, the fact that they didn't capitalize those

leases, that is a technical GAAP problem but it may not have been a hard problem

to figure out, so it may not rise to the level of a critical audit matter. And

yet, it created an except for opinion. Notice after we've done all of this, we

would list the critical audit matter and then we would sign, state how long we've

been the auditors in the number of years. The second part of this is adverse. When

do you issue an adverse? When you have a very material GAAP issue. So we have a

very material GAAP issue. So we've gone down from except for qualified, down to

the adverse opinion. So notice, we're going to start with the opinion, we'll

add the additional paragraph, then we'll have the basis for opinion, and then

we'll talk about critical audit matters. First of all, in the adverse opinion

you're still going to highlight it and address it as Report of the Independent

Registered Public Accounting Firm. Once again, we're addressing it to the

shareholders or board of directors. Note also the opinion, a paragraph, which is

the first one, is modified. And this is what it states: We have audited the

accompanying balance sheet of X Company at December 31st, X2 and X1, and the

related statements of income, comprehensive income, stockholders'

equity, and cash flows for the period then ended, and the related notes and

schedules collectively referred to as the financial statements. Here's where you

have the difference and we're bolding it, in our opinion, because of. That's the

important words, because of the effects of matters discussed in the following

paragraph, the financials, and here's the kiss of death: They do not present

fairly. That's the big item. In conformity with accounting principles

generally accepted in the United States of America, the financial position of the

company or the results of operations or cash flows for the year then ended. So

because of the problem, these are not fair. Then we would have the new

paragraph, as discussed in Note X, the company carries PP&E at appraised value

rather than net book value, depreciated value. So we're going to tell them, this

is what's wrong and this is significant enough. It's such a material violation

of GAAP that we're going down to the adverse opinion. We would have the

modified, the new paragraph, because of this departure from GAAP, accepted in the

United States of America, as of X2 and X1, inventories have been increased by

dot and dot. By inclusion in manufacturing overhead of depreciation in

excess of the basis, etcetera, etcetera. So we're going to mention what the

problem is, how it impacted, say, the income statement, how it impacts the

balance sheet. Then you go to your opinion. All right, in this case, the

basis for your opinion, these financials are the responsibility of the company's

management. Our responsibility is to express an opinion. By the way, does

this look like RAP MEE, RAP MEE? You bet. And on the next part, we conducted

our audit in accordance with standards of the PCAOB, those standards required that

we plan and perform. So there's part of the RAP MEE, RAP MEE. You have the

double R, double A, double P, then the double M, the double E, and then again,

another double E. Very, very simple to remember that. Then you have your

critical audit matters. The critical audit matters communicated below are

matters arising from the current audit of the financials that were communicated or

required to be communicated to the audit committee and that relate to accounts or

disclosures that are material to the financials and involved our especially

challenging, subjective, or complex judgments. The communication of critical

audit matters does not alter in any way our opinion on the financials, taken as a

whole, and we do not, by communicating the critical audit matters below, provide

separate opinions on the critical audit matters or on the accounts or disclosures

they're related. Note, we sign it and we state the tenure that we have been the

auditors. So that's a nice example of both the adverse, which is the biggest

problem, or the qualified except for opinion.