04_CH03_045-074.QXD:AEB12 1/5/07 12:13 PM Page 70 • Allison was unable to perform normal accounts receivable confirmation procedures, but alternative procedures were used to satisfy Allison as to the existence of the receivables. • Optima Corporation is the defendant in a litigation, the outcome of which is highly uncertain. If the case is settled in favor of the plaintiff, Optima will be required to pay a substantial amount of cash, which might require the sale of certain fixed assets. The litigation and the possible effects have been properly disclosed in footnote 11. • Optima issued debentures on January 31, 2006, in the amount of $10 million. The funds obtained from the issuance were used to finance the expansion of plant facilities. The debenture agreement restricts the payment of future cash dividends to earnings after December 31, 2011. Optima declined to disclose this essential data in the footnotes to the financial statements. Required a. Identify and explain any items included in “Other Information” that need not be part of the auditor’s report. b. Explain the deficiencies in Allison’s report as drafted.* 3-28 (Objectives 3-4, 3-5, 3-6, 3-7, 3-8) For the following independent situations, assume that you are the audit partner on the engagement: 1. During your audit of Debold.com, Inc., you conclude that there is a possibility that inventory is materially overstated. The client refuses to allow you to expand the scope of your audit sufficiently to verify whether the balance is actually misstated. 2. Four weeks after the year-end date, a major customer of Prince Construction Co. declared bankruptcy. Because the customer had confirmed the balance due to Prince at the balance sheet date, management refuses to charge off the account or otherwise disclose the information. The receivable represents approximately 10% of accounts receivable and 20% of net earnings before taxes. 3. You complete the audit of Johnson Department Store, and in your opinion, the financial statements are fairly presented. On the last day of the field work, you discover that one of your supervisors assigned to the audit has a material investment in Johnson. 4. Auto Delivery Company has a fleet of several delivery trucks. In the past, Auto Delivery had followed the policy of purchasing all equipment. In the current year, they decided to lease the trucks. The method of accounting for the trucks is therefore changed to lease capitalization. This change in policy is fully disclosed in footnotes. 5. You are auditing Woodcolt Linen Services for the first time. Woodcolt has been in business for several years but has never had an audit before. After the audit is completed, you conclude that the current year balance sheet is stated correctly in accordance with GAAP. The client did not authorize you to do test work for any of the previous years. 6. You were engaged to audit the Cutter Steel Company’s financial statements after the close of the corporation’s fiscal year. Because you were not engaged until after the balance sheet date, you were not able to physically observe inventory, which is highly material. On the completion of your audit, you are satisfied that Cutter’s financial statements are presented fairly, including inventory about which you were able to satisfy yourself by the use of alternative audit procedures. Required For each situation, do the following: a. Identify which of the conditions requiring a modification of or a deviation from an unqualified standard report is applicable. b. State the level of materiality as immaterial, material, or highly material. If you cannot decide the level of materiality, state the additional information needed to make a decision. c. Given your answers in parts a and b, state the type of audit report that should be issued. If you have not decided on one level of materiality in part b, state the appropriate report for each alternative materiality level. *AICPA adapted. 70 PART ONE / THE AUDITING PROFESSION
04_CH03_045-074.QXD:AEB12 1/5/07 12:13 PM Page 70 • Allison was unable to perform normal accounts receivable confirmation procedures, but alternative procedures were used to satisfy Allison as to the existence of the receivables. • Optima Corporation is the defendant in a litigation, the outcome of which is highly uncertain. If the case is settled in favor of the plaintiff, Optima will be required to pay a substantial amount of cash, which might require the sale of certain fixed assets. The litigation and the possible effects have been properly disclosed in footnote 11. • Optima issued debentures on January 31, 2006, in the amount of $10 million. The funds obtained from the issuance were used to finance the expansion of plant facilities. The debenture agreement restricts the payment of future cash dividends to earnings after December 31, 2011. Optima declined to disclose this essential data in the footnotes to the financial statements. Required a. Identify and explain any items included in “Other Information” that need not be part of the auditor’s report. b. Explain the deficiencies in Allison’s report as drafted.* 3-28 (Objectives 3-4, 3-5, 3-6, 3-7, 3-8) For the following independent situations, assume that you are the audit partner on the engagement: 1. During your audit of Debold.com, Inc., you conclude that there is a possibility that inventory is materially overstated. The client refuses to allow you to expand the scope of your audit sufficiently to verify whether the balance is actually misstated. 2. Four weeks after the year-end date, a major customer of Prince Construction Co. declared bankruptcy. Because the customer had confirmed the balance due to Prince at the balance sheet date, management refuses to charge off the account or otherwise disclose the information. The receivable represents approximately 10% of accounts receivable and 20% of net earnings before taxes. 3. You complete the audit of Johnson Department Store, and in your opinion, the financial statements are fairly presented. On the last day of the field work, you discover that one of your supervisors assigned to the audit has a material investment in Johnson. 4. Auto Delivery Company has a fleet of several delivery trucks. In the past, Auto Delivery had followed the policy of purchasing all equipment. In the current year, they decided to lease the trucks. The method of accounting for the trucks is therefore changed to lease capitalization. This change in policy is fully disclosed in footnotes. 5. You are auditing Woodcolt Linen Services for the first time. Woodcolt has been in business for several years but has never had an audit before. After the audit is completed, you conclude that the current year balance sheet is stated correctly in accordance with GAAP. The client did not authorize you to do test work for any of the previous years. 6. You were engaged to audit the Cutter Steel Company’s financial statements after the close of the corporation’s fiscal year. Because you were not engaged until after the balance sheet date, you were not able to physically observe inventory, which is highly material. On the completion of your audit, you are satisfied that Cutter’s financial statements are presented fairly, including inventory about which you were able to satisfy yourself by the use of alternative audit procedures. Required For each situation, do the following: a. Identify which of the conditions requiring a modification of or a deviation from an unqualified standard report is applicable. b. State the level of materiality as immaterial, material, or highly material. If you cannot decide the level of materiality, state the additional information needed to make a decision. c. Given your answers in parts a and b, state the type of audit report that should be issued. If you have not decided on one level of materiality in part b, state the appropriate report for each alternative materiality level. *AICPA adapted. 70 PART ONE / THE AUDITING PROFESSION
04_CH03_045-074.QXD:AEB12 1/5/07 12:13 PM Page 71 3-29 (Objectives 3-4, 3-5, 3-6, 3-7, 3-8) For the following independent situations, assume that you are the audit partner on the engagement: 1. The controller of Fair City Hotels Co. will not allow you to confirm the receivable balance from two of its major customers. The amounts of the receivables are material in relation to Fair City’s financial statements. You are unable to satisfy yourself as to the receivable balances by alternative procedures. 2. In the last 3 months of the current year, Oil Refining Company decided to change direction and go significantly into the oil drilling business. Management recognizes that this business is exceptionally risky and could jeopardize the success of its existing refining business, but there are significant potential rewards. During the short period of operation in drilling, the company has had three dry wells and no successes. The facts are adequately disclosed in footnotes. 3. Your client, Auto Rental Company, has changed from straight-line to sum-of-the- years’ digits depreciation. The effect on this year’s income is immaterial, but the effect in future years is likely to be material. The facts are adequately disclosed in footnotes. 4. Kieko Technology Corporation has prepared financial statements but has decided to exclude the statement of cash flows. Management explains to you that the users of their financial statements find this statement confusing and prefer not to have it included. 5. HardwareFromHome.com is an Internet-based start-up company created to sell home hardware supplies online. Although the company had a promising start, a down turn in e-commerce retailing has negatively affected the company. The com - pany’s sales and cash position have deteriorated significantly, and you have reser - vations about the ability of the company to continue in operation for the next year. 6. Approximately 20% of the audit of Fur Farms, Inc. was performed by a different CPA firm, selected by you. You have reviewed their working papers and believe they did an excellent job on their portion of the audit. Nevertheless, you are unwilling to take complete responsibility for their work. For each situation, do the following: a. Identify which of the conditions requiring a modification of or a deviation from an Required unqualified standard report is applicable. b. State the level of materiality as immaterial, material, or highly material. If you cannot decide the level of materiality, state the additional information needed to make a decision. c. Given your answers in parts a and b, state the appropriate audit report from the following alternatives (if you have not decided on one level of materiality in part b, state the appropriate report for each alternative materiality level): (1) Unqualified—standard wording (2) Unqualified—explanatory paragraph (3) Unqualified—modified wording (4) Qualified opinion only (5) Qualified scope and opinion (6) Disclaimer (7) Adverse d. Based on your answer to part c, indicate which paragraphs, if any, should be modified in the standard audit report. Also indicate whether an additional paragraph is necessary and its location in the report. 3-30 (Objectives 3-4, 3-5, 3-6, 3-7, 3-8) The following are independent situations for which you will recommend an appropriate audit report: 1. Subsequent to the date of the financial statements as part of his post-balance sheet date audit procedures, a CPA learned that a recent fire caused heavy damage to one of a client’s two plants; the loss will not be reimbursed by insurance. The newspapers described the event in detail. The financial statements and appended notes as prepared by the client did not disclose the loss caused by the fire. CHAPTER 3 / AUDIT REPORTS 71
04_CH03_045-074.QXD:AEB12 1/5/07 12:13 PM Page 71 3-29 (Objectives 3-4, 3-5, 3-6, 3-7, 3-8) For the following independent situations, assume that you are the audit partner on the engagement: 1. The controller of Fair City Hotels Co. will not allow you to confirm the receivable balance from two of its major customers. The amounts of the receivables are material in relation to Fair City’s financial statements. You are unable to satisfy yourself as to the receivable balances by alternative procedures. 2. In the last 3 months of the current year, Oil Refining Company decided to change direction and go significantly into the oil drilling business. Management recognizes that this business is exceptionally risky and could jeopardize the success of its existing refining business, but there are significant potential rewards. During the short period of operation in drilling, the company has had three dry wells and no successes. The facts are adequately disclosed in footnotes. 3. Your client, Auto Rental Company, has changed from straight-line to sum-of-the- years’ digits depreciation. The effect on this year’s income is immaterial, but the effect in future years is likely to be material. The facts are adequately disclosed in footnotes. 4. Kieko Technology Corporation has prepared financial statements but has decided to exclude the statement of cash flows. Management explains to you that the users of their financial statements find this statement confusing and prefer not to have it included. 5. HardwareFromHome.com is an Internet-based start-up company created to sell home hardware supplies online. Although the company had a promising start, a down turn in e-commerce retailing has negatively affected the company. The com - pany’s sales and cash position have deteriorated significantly, and you have reser - vations about the ability of the company to continue in operation for the next year. 6. Approximately 20% of the audit of Fur Farms, Inc. was performed by a different CPA firm, selected by you. You have reviewed their working papers and believe they did an excellent job on their portion of the audit. Nevertheless, you are unwilling to take complete responsibility for their work. For each situation, do the following: a. Identify which of the conditions requiring a modification of or a deviation from an Required unqualified standard report is applicable. b. State the level of materiality as immaterial, material, or highly material. If you cannot decide the level of materiality, state the additional information needed to make a decision. c. Given your answers in parts a and b, state the appropriate audit report from the following alternatives (if you have not decided on one level of materiality in part b, state the appropriate report for each alternative materiality level): (1) Unqualified—standard wording (2) Unqualified—explanatory paragraph (3) Unqualified—modified wording (4) Qualified opinion only (5) Qualified scope and opinion (6) Disclaimer (7) Adverse d. Based on your answer to part c, indicate which paragraphs, if any, should be modified in the standard audit report. Also indicate whether an additional paragraph is necessary and its location in the report. 3-30 (Objectives 3-4, 3-5, 3-6, 3-7, 3-8) The following are independent situations for which you will recommend an appropriate audit report: 1. Subsequent to the date of the financial statements as part of his post-balance sheet date audit procedures, a CPA learned that a recent fire caused heavy damage to one of a client’s two plants; the loss will not be reimbursed by insurance. The newspapers described the event in detail. The financial statements and appended notes as prepared by the client did not disclose the loss caused by the fire. CHAPTER 3 / AUDIT REPORTS 71
04_CH03_045-074.QXD:AEB12 1/5/07 12:13 PM Page 72 2. E-Lotions.com, Inc. is an online retailer of body lotions and other bath and body supplies. The company records revenues at the time customer orders are placed on the Web site, rather than when the goods are shipped, which is usually 2 days after the order is placed. The auditor determined that the amount of orders placed but not shipped as of the balance sheet date is not material. 3. For the past 5 years a CPA has audited the financial statements of a manufacturing company. During this period, the audit scope was limited by the client as to the observation of the annual physical inventory. Because the CPA considered the inventories to be material and he was not able to satisfy himself by other auditing procedures, he was unable to express an unqualified opinion on the financial statements in each of the 5 years. The CPA was allowed to observe physical inventories for the current year ended December 31, 2007, because the client’s banker would no longer accept the audit reports. In the interest of economy, the client requested the CPA to not extend his audit procedures to the inventory as of January 1, 2007. 4. During the course of his audit of the financial statements of a corporation for the purpose of expressing an opinion on the statements, a CPA is refused permission to inspect the minute books containing the significant decisions from the board of directors meetings. The corporation secretary instead offers to give the CPA a certified copy of all resolutions and actions involving accounting matters. 5. A CPA is engaged in the audit of the financial statements of a large manufacturing company with branch offices in many widely separated cities. The CPA was not able to count the substantial undeposited cash receipts at the close of business on the last day of the fiscal year at all branch offices. As an alternative to this auditing procedure used to verify the accurate cutoff of cash receipts, the CPA observed that deposits in transit as shown on the year-end bank reconciliation appeared as credits on the bank statement on the first business day of the new year. He was satisfied as to the cutoff of cash receipts by the use of the alternative procedure. 6. On January 2, 2008, the Retail Auto Parts Company received a notice from its primary supplier that effective immediately, all wholesale prices will be increased 10%. On the basis of the notice, Retail Auto Parts revalued its December 31, 2007, inventory to reflect the higher costs. The inventory constituted a material proportion of total assets; however, the effect of the revaluation was material to current assets but not to total assets or net income. The increase in valuation is adequately disclosed in the footnotes. 7. A CPA has completed her audit of the financial statements of a bus company for the year ended December 31, 2007. Prior to 2007, the company depreciated its buses over a 10-year period. During 2007, the company determined that a more realistic estimated life for its buses was 12 years and computed the 2007 depreciation on the basis of the revised estimate. The CPA has satisfied herself that the 12-year life is reasonable. The company has adequately disclosed the change in estimated useful lives of its buses and the effect of the change on 2007 income in a note to the financial statements. Required For each situation, do the following: a. Identify which of the conditions requiring a deviation from or modification of an unqualified standard report is applicable. b. State the level of materiality as immaterial, material, or highly material. If you cannot decide the level of materiality, state the additional information needed to make a decision. c. Given your answers in parts a and b, state the appropriate audit report from the following alternatives (if you have not decided on one level of materiality in part b, state the appropriate report for each alternative materiality level): 72 PART ONE / THE AUDITING PROFESSION
04_CH03_045-074.QXD:AEB12 1/5/07 12:13 PM Page 72 2. E-Lotions.com, Inc. is an online retailer of body lotions and other bath and body supplies. The company records revenues at the time customer orders are placed on the Web site, rather than when the goods are shipped, which is usually 2 days after the order is placed. The auditor determined that the amount of orders placed but not shipped as of the balance sheet date is not material. 3. For the past 5 years a CPA has audited the financial statements of a manufacturing company. During this period, the audit scope was limited by the client as to the observation of the annual physical inventory. Because the CPA considered the inventories to be material and he was not able to satisfy himself by other auditing procedures, he was unable to express an unqualified opinion on the financial statements in each of the 5 years. The CPA was allowed to observe physical inventories for the current year ended December 31, 2007, because the client’s banker would no longer accept the audit reports. In the interest of economy, the client requested the CPA to not extend his audit procedures to the inventory as of January 1, 2007. 4. During the course of his audit of the financial statements of a corporation for the purpose of expressing an opinion on the statements, a CPA is refused permission to inspect the minute books containing the significant decisions from the board of directors meetings. The corporation secretary instead offers to give the CPA a certified copy of all resolutions and actions involving accounting matters. 5. A CPA is engaged in the audit of the financial statements of a large manufacturing company with branch offices in many widely separated cities. The CPA was not able to count the substantial undeposited cash receipts at the close of business on the last day of the fiscal year at all branch offices. As an alternative to this auditing procedure used to verify the accurate cutoff of cash receipts, the CPA observed that deposits in transit as shown on the year-end bank reconciliation appeared as credits on the bank statement on the first business day of the new year. He was satisfied as to the cutoff of cash receipts by the use of the alternative procedure. 6. On January 2, 2008, the Retail Auto Parts Company received a notice from its primary supplier that effective immediately, all wholesale prices will be increased 10%. On the basis of the notice, Retail Auto Parts revalued its December 31, 2007, inventory to reflect the higher costs. The inventory constituted a material proportion of total assets; however, the effect of the revaluation was material to current assets but not to total assets or net income. The increase in valuation is adequately disclosed in the footnotes. 7. A CPA has completed her audit of the financial statements of a bus company for the year ended December 31, 2007. Prior to 2007, the company depreciated its buses over a 10-year period. During 2007, the company determined that a more realistic estimated life for its buses was 12 years and computed the 2007 depreciation on the basis of the revised estimate. The CPA has satisfied herself that the 12-year life is reasonable. The company has adequately disclosed the change in estimated useful lives of its buses and the effect of the change on 2007 income in a note to the financial statements. Required For each situation, do the following: a. Identify which of the conditions requiring a deviation from or modification of an unqualified standard report is applicable. b. State the level of materiality as immaterial, material, or highly material. If you cannot decide the level of materiality, state the additional information needed to make a decision. c. Given your answers in parts a and b, state the appropriate audit report from the following alternatives (if you have not decided on one level of materiality in part b, state the appropriate report for each alternative materiality level): 72 PART ONE / THE AUDITING PROFESSION
04_CH03_045-074.QXD:AEB12 1/5/07 12:13 PM Page 73 (1) Unqualified—standard wording (2) Unqualified—explanatory paragraph (3) Unqualified—modified wording (4) Qualified opinion only (5) Qualified scope and opinion (6) Disclaimer (7) Adverse* 3-31 (Objective 3-4) Various types of “accounting changes” can affect the second reporting standard of the generally accepted auditing standards. This standard reads, “The report shall identify those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period.’’ Assume that the following list describes changes that have a material effect on a client’s financial statements for the current year: 1. Correction of a mathematical error in inventory pricing made in a prior period. 2. A change from prime costing to full absorption costing for inventory valuation. 3. A change from presentation of statements of individual companies to presentation of consolidated statements. 4. A change from deferring and amortizing preproduction costs to recording such costs as an expense when incurred because future benefits of the costs have become doubtful. The new accounting method was adopted in recognition of the change in estimated future benefits. 5. A change from the completed-contract method to the percentage-of-completion method of accounting for long-term construction contracts. 6. A change in the estimated useful life of previously recorded fixed assets based on newly acquired information 7. A change to including the employer share of Social Security (FICA) taxes as “retirement benefits” on the income statement from including it with “other taxes.’’ 8. A change from the FIFO method of inventory pricing to the LIFO method of inventory pricing. Identify the type of change described in each item above, and state whether any modi - Required fication is required in the auditor’s report as it relates to the second standard of reporting. Organize your answer sheet as shown. For example, a change from the LIFO method of inventory pricing to the FIFO method of inventory pricing would appear as shown. Assume that each item is material.* Should Auditor’s Item No. Type of Change Report Be Modified? Example An accounting change from one generally accepted Yes accounting principle to another generally accepted accounting principle 3-32 (Objective 3-7) The following is an audit report, except for the opinion paragraph, of Tri-Nation Coin Investments. INDEPENDENT AUDITOR’S REPORT To the Board of Directors and Stockholders, Tri-Nation Coin Investments, Phila - delphia, Pennsylvania We have audited the accompanying consolidated balance sheet of Tri-Nation Coin Investments and subsidiaries as of July 31, 2007, and the related statements of income, stockholders’ equity, and cash flows for the year then ended and the related schedules listed in the accompanying index. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. *AICPA adapted. CHAPTER 3 / AUDIT REPORTS 73
04_CH03_045-074.QXD:AEB12 1/5/07 12:13 PM Page 73 (1) Unqualified—standard wording (2) Unqualified—explanatory paragraph (3) Unqualified—modified wording (4) Qualified opinion only (5) Qualified scope and opinion (6) Disclaimer (7) Adverse* 3-31 (Objective 3-4) Various types of “accounting changes” can affect the second reporting standard of the generally accepted auditing standards. This standard reads, “The report shall identify those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period.’’ Assume that the following list describes changes that have a material effect on a client’s financial statements for the current year: 1. Correction of a mathematical error in inventory pricing made in a prior period. 2. A change from prime costing to full absorption costing for inventory valuation. 3. A change from presentation of statements of individual companies to presentation of consolidated statements. 4. A change from deferring and amortizing preproduction costs to recording such costs as an expense when incurred because future benefits of the costs have become doubtful. The new accounting method was adopted in recognition of the change in estimated future benefits. 5. A change from the completed-contract method to the percentage-of-completion method of accounting for long-term construction contracts. 6. A change in the estimated useful life of previously recorded fixed assets based on newly acquired information 7. A change to including the employer share of Social Security (FICA) taxes as “retirement benefits” on the income statement from including it with “other taxes.’’ 8. A change from the FIFO method of inventory pricing to the LIFO method of inventory pricing. Identify the type of change described in each item above, and state whether any modi - Required fication is required in the auditor’s report as it relates to the second standard of reporting. Organize your answer sheet as shown. For example, a change from the LIFO method of inventory pricing to the FIFO method of inventory pricing would appear as shown. Assume that each item is material.* Should Auditor’s Item No. Type of Change Report Be Modified? Example An accounting change from one generally accepted Yes accounting principle to another generally accepted accounting principle 3-32 (Objective 3-7) The following is an audit report, except for the opinion paragraph, of Tri-Nation Coin Investments. INDEPENDENT AUDITOR’S REPORT To the Board of Directors and Stockholders, Tri-Nation Coin Investments, Phila - delphia, Pennsylvania We have audited the accompanying consolidated balance sheet of Tri-Nation Coin Investments and subsidiaries as of July 31, 2007, and the related statements of income, stockholders’ equity, and cash flows for the year then ended and the related schedules listed in the accompanying index. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. *AICPA adapted. CHAPTER 3 / AUDIT REPORTS 73
04_CH03_045-074.QXD:AEB12 1/5/07 12:13 PM Page 74 The company had significant deficiencies in internal control, including the lack of detailed records and certain supporting data, which were not available for our audit. Therefore, we were not able to obtain sufficient evidence in order to form an opinion on the accompanying financial statements including whether the inventory at July 31, 2007 ($670,490), was stated at lower of cost or market, or whether the deferred subscription revenue ($90,260) is an adequate estimate for the applicable liability, as discussed in Notes 5 and 12, respectively. Required Write the auditor’s opinion to accompany this portion of the audit report. Where is the opinion located in this audit report? 3-33 (Objectives 3-1, 3-2, 3-4) The following tentative auditor’s report was drafted by a staff accountant and submitted to a partner in the accounting firm of Better & Best, CPAs: AUDIT REPORT To the Audit Committee of American Broadband, Inc. We have examined the consolidated balance sheets of American Broadband, Inc. and subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of income, retained earnings, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our respon - sibility is to express an opinion on these financial statements based on our audits. Our audits were made in accordance with auditing standards generally accepted in the United States of America as we considered necessary in the circumstances. Other auditors audited the financial statements of certain subsidiaries and have furnished us with reports thereon containing no exceptions. Our opinion expressed herein, insofar as it relates to the amounts included for those subsidiaries, is based solely upon the reports of the other auditors. As fully discussed in Note 7 to the financial statements, in 2007, the company extended the use of the last-in, first-out (LIFO) method of accounting to include all inventories. In examining inventories, we engaged Dr. Irwin Same (Nobel Prize winner 2005) to test check the technical requirements and specifications of certain items of equipment manufactured by the company. In our opinion, the financial statements referred to above present fairly the financial position of American Broadband, Inc. as of December 31, 2007, and the results of operations for the years then ended, in conformity with accounting principles generally accepted in the United States of America. To be signed by Better & Best, CPAs March 1, 2008 Required Identify deficiencies in the staff accountant’s tentative report that constitute departures from the generally accepted standards of reporting.* INTERNET PROBLEM 3-1: RESEARCH ANNUAL REPORTS Reference the CW site. The U.S. Securities and Exchange Commission (SEC) is an inde - pend ent, nonpartisan, quasi-judicial regulatory agency with responsibility for adminis - tering the federal securities laws. Publicly traded companies must electronically file a variety of forms or reports with the SEC (for example, annual financial statements). The SEC makes most of these electronic documents available on the Internet via EDGAR. EDGAR stands for Electronic Data Gathering, Analysis, and Retrieval system. The primary purpose for EDGAR is to increase the efficiency and fairness of the securities market for the benefit of investors, corporations, and the economy by accelerating the receipt, acceptance, dissemination, and analysis of time-sensitive corporate information filed with the agency. This problem requires students to use the EDGAR site (1) to research the definitions of SEC filings (for example, 10-K, 8-K) and (2) to use several companies’ 10-K reports to classify types of audit opinions issued. *AICPA adapted. 74 PART ONE / THE AUDITING PROFESSION
04_CH03_045-074.QXD:AEB12 1/5/07 12:13 PM Page 74 The company had significant deficiencies in internal control, including the lack of detailed records and certain supporting data, which were not available for our audit. Therefore, we were not able to obtain sufficient evidence in order to form an opinion on the accompanying financial statements including whether the inventory at July 31, 2007 ($670,490), was stated at lower of cost or market, or whether the deferred subscription revenue ($90,260) is an adequate estimate for the applicable liability, as discussed in Notes 5 and 12, respectively. Required Write the auditor’s opinion to accompany this portion of the audit report. Where is the opinion located in this audit report? 3-33 (Objectives 3-1, 3-2, 3-4) The following tentative auditor’s report was drafted by a staff accountant and submitted to a partner in the accounting firm of Better & Best, CPAs: AUDIT REPORT To the Audit Committee of American Broadband, Inc. We have examined the consolidated balance sheets of American Broadband, Inc. and subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of income, retained earnings, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our respon - sibility is to express an opinion on these financial statements based on our audits. Our audits were made in accordance with auditing standards generally accepted in the United States of America as we considered necessary in the circumstances. Other auditors audited the financial statements of certain subsidiaries and have furnished us with reports thereon containing no exceptions. Our opinion expressed herein, insofar as it relates to the amounts included for those subsidiaries, is based solely upon the reports of the other auditors. As fully discussed in Note 7 to the financial statements, in 2007, the company extended the use of the last-in, first-out (LIFO) method of accounting to include all inventories. In examining inventories, we engaged Dr. Irwin Same (Nobel Prize winner 2005) to test check the technical requirements and specifications of certain items of equipment manufactured by the company. In our opinion, the financial statements referred to above present fairly the financial position of American Broadband, Inc. as of December 31, 2007, and the results of operations for the years then ended, in conformity with accounting principles generally accepted in the United States of America. To be signed by Better & Best, CPAs March 1, 2008 Required Identify deficiencies in the staff accountant’s tentative report that constitute departures from the generally accepted standards of reporting.* INTERNET PROBLEM 3-1: RESEARCH ANNUAL REPORTS Reference the CW site. The U.S. Securities and Exchange Commission (SEC) is an inde - pend ent, nonpartisan, quasi-judicial regulatory agency with responsibility for adminis - tering the federal securities laws. Publicly traded companies must electronically file a variety of forms or reports with the SEC (for example, annual financial statements). The SEC makes most of these electronic documents available on the Internet via EDGAR. EDGAR stands for Electronic Data Gathering, Analysis, and Retrieval system. The primary purpose for EDGAR is to increase the efficiency and fairness of the securities market for the benefit of investors, corporations, and the economy by accelerating the receipt, acceptance, dissemination, and analysis of time-sensitive corporate information filed with the agency. This problem requires students to use the EDGAR site (1) to research the definitions of SEC filings (for example, 10-K, 8-K) and (2) to use several companies’ 10-K reports to classify types of audit opinions issued. *AICPA adapted. 74 PART ONE / THE AUDITING PROFESSION
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