4A1 - Modified Opinions

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University of Illinois, Chicago *

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435

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Accounting

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Nov 24, 2024

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4A1 – Modified Opinions Modification of Opinion - The auditor SHOULD modify the opinion in the auditor’s report, if the auditor: o Concludes, based on the audit evidence obtained, the F/S as a whole are materially misstated o Is unable to obtain sufficient appropriate audit evidence to conclude that the F/S as a whole are free from material misstatement Departures from Unmodified Opinion - Qualified Opinion o “Except for” o Material GAAP vs. GAAS - Adverse Opinion o Pervasive Material GAAP o “because of” - Disclaimer of Opinion o Material GAAS o Scope Limitation - Withdrawal o Fraud o Deceptive or Misleading Financial Statements Qualified or Adverse Opinion - Material misstatement of the F/S MAY arise in relation to the following: o Inappropriate accounting policies selected and/or applied o Inappropriate F/S presentation and/or inadequacy of disclosures in the F/S - Determining what opinion to issue: o If the material item is PERVASIVE  Adverse o If the material item is NOT PERVASIVE  Qualified Qualified or Disclaimer of Opinion - The auditor’s inability to obtain sufficient appropriate audit evidence MAY arise from the following: o Circumstances beyond the control of the entity o The entity’s accounting records have been destroyed o The accounting records of a significant competent have been seized indefinitely by governmental authorities o Circumstances relating to the nature or timing of the auditor’s work o Limitations imposed by management - Also referred to as “limitation on the scope” of the audit

Examples of Limitations Imposed by Management - Management prevents the auditor from observing the counting of physical inventory - Management prevents the auditor from requesting external confirmation of specific account balances - Note : Inability to perform a specific procedure does NOT constitute a limitation on the scope of the audit: o If the auditor is able to obtain sufficient audit evidence by performing alternative procedures Modified Opinion Report Requirements - MUST include a “Basis for Opinion” paragraph that describes the circumstances causing the modification. - The paragraph is placed AFTER the Opinion paragraph and MUST have an appropriate heading: o Basis for Qualified Opinion o Basis for Adverse Opinion o Basis for Disclaimer of Opinion - The title of the Opinion paragraph also MUST be modified to reflect the type of opinion expressed: o Qualified Opinion o Adverse Opinion o Disclaimer of Opinion Qualified Opinion Due to a Material Misstatement of the F/S Qualified Opinion [Standard opinion into] In our opinion, EXCEPT FOR the effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements referred to above present fairly, in all material respects, the financial position of XYZ Company as of December 31, 20X5 and 20X4, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Basis for Qualified Opinion The Company has stated inventories at cost in the accompanying balance sheets. Accounting principles generally accepted in the United States of America require inventories to be stated at the lower of cost or market. If the Company stated inventories at the lower of cost or market, a write-down of $XX and $XX would have been required as of December 31, 20X5 and 20X4, respectively. Accordingly, cost of sales would have been increased by $XX and $XX, and net income, income taxes, and stockholders’ equity would have been reduced by $XX, $XX, and $XX, and $XX, $XX, and $XX, as of and for the years ended December 31, 20X5 and 20X4, respectively.

Adverse Opinion Due to a Material Misstatement Adverse Opinion [Standard opinion intro] In our opinion, BECAUSE OF the significance of the matter discussed in the Basis for Adverse Opinion paragraph, the consolidated financial statements referred to above do NOT present fairly the financial position of XYZ Company and its subsidiaries as of December 31, 20X4, or the results of their operations or their cash flows for the year ended in accordance with accounting principles generally accepted in the United States of America. Basis for Adverse Opinion As described in Note T, the Company has NOT consolidated the financial statements of subsidiary X Company that it acquired during 20X4 because it has NOT yet been able to ascertain the fair value of certain of the subsidiary’s material assets and liabilities at the acquisition date. This investment is therefore accounted for on a cost basis by the Company. Under accounting principles generally accepted in the United States of America, the subsidiary SHOULD have been consolidated because it is controlled by the Company. Had X Company been consolidated, many elements in the accompanying consolidated financial statements would have been materially affected. The effects on the consolidated financial statements of the failure to consolidate have NOT been determined. Qualified Opinion – Inability to Obtain Sufficient Appropriate Audit Evidence Qualified Opinion In our opinion, EXCEPT FOR the possible effects of the matter described in the Basis for Qualified Opinion paragraph, the financial statements referred to above present fairly, in all material respects, the financial position of XYX Company as of December 31, 20X4, and the results of its operations and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America. Basis for Qualified Opinion [Describe nature of scope limitation] We conducted our audit in accordance with auditing standards generally accepted in the United Stats of America (GAAS). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are REQUIRED to be independent of XYZ Company and to meet our other ethical responsibilities, in accordance with the relevant ethical requirements relating to our audit. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified audit opinion .

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Disclaimer of Opinion – Inability to Obtain Sufficient Appropriate Audit Evidence Disclaimer of Opinion We were engaged to audit the accompanying financial statements of XYZ Company, which comprise the balance sheet as of December 31, 20X5, and the related statements of income, changes in stockholders’ equity, and the cash flows for the year then ended, and the related notes to the financial statements. We do NOT express an opinion on the accompanying financial statements of ABC Company. Because of the significance of the matter described in the Basis for Disclaimer of Opinion section of our report, we have NOT been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion on the financial statements. Basis for Disclaimer of Opinion The Company’s investment in X Company, is carried at $XX on the Company’s balance sheet, which represents over 95% of the Company’s net assets as of December 31, 20X5. We were NOT allowed access to the management and the auditors of X Company. As a result, we were unable to determine whether any adjustments were necessary relating to the Company’s proportional share of X Company’s assets that it controls jointly, its proportional share of X Company’s liabilities for which it is jointly responsible, its proportional share of X Company’s income and expenses for the year, and the elements making up the statements of changes in stockholders’ equity and cash flows. Auditor’s Responsibility Our responsibility is to express an opinion on these financial statements based on conducing the audit in accordance with auditing standards generally accepted in the United States of America. Because of the matter described in the Basis for Disclaimer of Opinion paragraph, however, we were NOT able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion. Summary of Modified Audit Opinions Type of Modified Opinion Paragraphs to Change Qualified Opinion; basis for opinion Adverse Opinion; basis for opinion Disclaimer of Opinion Opinion; basis for opinion; auditor’s responsibility

Question #1 In which of the following circumstances would an auditor NOT express an unmodified opinion? a) There has been a material change between periods in accounting principles b) Quarterly financial data REQUIRED by the SEC has been omitted c) The auditor wishes to emphasize an unusually important subsequent event d) The auditor is unable to obtain unaudited financial statements of a consolidated investee Question #2 Assume financial statements are materially misstated but the effect on the financial statements is NOT pervasive. The auditor SHOULD most likely issue what type of audit opinion? a) Unmodified opinion b) Qualified opinion c) Adverse opinion d) Disclaimer of opinion Question #3 An auditor who qualifies an opinion because of an insufficiency of audit evidence SHOULD describe the limitations in a basis for modification paragraph. The auditor SHOULD also refer to the limitation in the: Auditor’s Responsibility Section Opinion Paragraph Notes to the financial statements A Yes No Yes B No Yes No C Yes Yes No D Yes Yes Yes Question #4 An auditor concludes that a client’s illegal act, which has a material effect on the financial statements, has NOT been properly accounted for or disclosed. Depending on the materiality of the effect on the financial statements, the auditor SHOULD express either a(n): a) Adverse opinion or a disclaimer opinion b) Qualified opinion or an adverse opinion c) Disclaimer of opinion or an unmodified opinion with a separate emphasis-of-matter paragraph d) Unmodified opinion with a separate emphasis-of-matter paragraph or a qualified opinion Question #5 When disclaiming an opinion due to a client-imposed scope limitation on a nonpublic company’s financial statements, an auditor SHOULD indicate in a separate paragraph why the audit did NOT comply with generally accepted auditing standards. The auditor SHOULD also omit which of the two sections (paragraphs) below? Auditor Responsibility Opinion A No Yes B Yes Yes C Yes No D No No