Supplementary Information Audit Opinion

You can report on supplementary information in an audit opinion or as a separate report

Are you looking for a supplementary information audit opinion example? Well, here it is.

supplementary information audit opinion

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Two Options for Reporting

You can opine on supplementary information in two ways:

  1. In the financial statement opinion or
  2. In a separate opinion that addresses just the supplementary information

Below you will see sample wording for both options.

The Clarity Project – Modified Opinions

Options include qualified, disclaimer and adverse

You are performing an audit that has a material misstatement, and the client is unwilling to  post the proposed adjustment. So you are wondering, “how do I modify the opinion under the new Clarity audit standards?”

First let’s take a look at a summary of opinion modification options, and then we will review sample opinion language.

OPINION

Opinion Modification Options

Opinion TypeCircumstance
QualifiedMaterial misstatement is not pervasive
AdverseMaterial misstatements are pervasive
DisclaimerSufficient audit evidence not available; potential material misstatements are pervasive
QualifiedSufficient audit evidence not available; potential material misstatement is not pervasive

Definitions

Before we explore potential opinions, let’s look relevant definitions included in AU-C 705:

Modified opinion. A qualified opinion, an adverse opinion, or a disclaimer of opinion

Pervasive. A term used in the context of misstatements to describe the effects on the financial statements of misstatements or the possible effects on the financial statements of misstatements, if any, that are undetected due to an inability to obtain sufficient appropriate audit evidence [my italics]. Pervasive effects on the financial statements are those that, in the auditor’s professional judgment

  •    are not confined to specific elements, accounts, or items of the financial statements;
  •    if so confined, represent or could represent a substantial proportion of the financial statements; or
  •    with regard to disclosures, are fundamental to users’ understanding of the financial statements.

Sample Opinion Language

1. Qualified Opinion

Let’s suppose your audit reveals inventories are materially misstated, the client will not record your proposed audit adjustment, and there are no other material misstatements. If this is your situation (a material misstatement exists that is not pervasive), then audit standards require the issuance of a qualified opinion.

The sample opinion language provided by AU-C 705 is as follows:

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 $XXX and $XXX would have been required as of December 31, 20X1 and 20X0, respectively. Accordingly, cost of sales would have been increased by $XXX and $XXX, and net income, income taxes, and stockholders’ equity would have been reduced by $XXX, $XXX, and $XXX, and $XXX, $XXX, and $XXX, as of and for the years ended December 31, 20X1 and 20X0, respectively.

Qualified Opinion

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 ABC Company …

2. Adverse Opinion

Now let’s suppose that you are auditing a consolidated entity for which your client does not wish to include a material subsidiary and which, if it were included, would have a pervasive impact on the statements.

The sample opinion language provided by AU-C 705 is as follows:

Basis for Adverse Opinion

As described in Note X, the Company has not consolidated the financial statements of subsidiary XYZ Company that it acquired during 20X1 because it has not yet been able to ascertain the fair values 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 XYZ 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.

Adverse Opinion

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 ABC Company and its subsidiaries as of …

3. Disclaimer of Opinion

Finally let’s suppose you are performing an audit in which insufficient audit information is provided with regard to receivables and inventories (both of which are material) and that the misstatements have a pervasive impact on the financial statements as a whole.

The sample opinion language provided by AU-C 705 is as follows:

Basis for Disclaimer of Opinion

We were not engaged as auditors of the Company until after December 31, 20X1, and, therefore, did not observe the counting of physical inventories at the beginning or end of the year. We were unable to satisfy ourselves by other auditing procedures concerning the inventory held at December 31, 20X1, which is stated in the balance sheet at $XXX. In addition, the introduction of a new computerized accounts receivable system in September 20X1 resulted in numerous misstatements in accounts receivable. As of the date of our audit report, management was still in the process of rectifying the system deficiencies and correcting the misstatements. We were unable to confirm or verify by alternative means accounts receivable included in the balance sheet at a total amount of $XXX at December 31, 20X1. As a result of these matters, we were unable to determine whether any adjustments might have been found necessary in respect of recorded or unrecorded inventories and accounts receivable, and the elements making up the statements of income, changes in stockholders’ equity, and cash flows.

Disclaimer of Opinion

Because of the significance of the matters described in the Basis for Disclaimer of Opinion paragraph, we have not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion. Accordingly, we do not express an opinion on these financial statements.

Group Audits – Referencing Component Auditors

Does your firm audit consolidated financial statements that contain a subsidiary audited by another firm? How about a governmental audit that contains a component unit audited by another firm? Or maybe an audit of an entity that has an equity-method investment audited by another firm?

Decision – Assume Responsibility or Not

If you audit an entity (e.g., Father Company, Inc.) that contains a component (Son Company, Inc.) audited by another firm, you will, under the new Clarity standards, make a decision to reference or not reference the component auditor.

assume

If you reference the component auditors, you are not taking responsibility for the component.

If you don’t reference the component auditors, you are, in effect, taking responsibility for the audit of all entities comprising the entity. (There will be additional work for the group auditor as he directs audit activities related to the entity as a whole, including procedures of the component auditor.)

1. When to Reference Component Auditors

photo-1First Question – Are there any significant components of the consolidated financial statements that are audited by an external audit firm?

If yes, go to the second question below.

If no, then there is no need to reference the component auditor (and you – the group auditor – will probably just perform analytical procedures for the component).

Second Question – Do you (the group auditor) want to assume responsibility for the work of the component auditor?

Sometimes the answer will be “no,” and you will reference the other firm.

When referencing occurs, the group auditor’s report will normally state “we did not audit the financial statements of X Company” and that “those statements were audited by other auditors.”

The component auditor is usually not named, but you may, if you wish, provided that you:

  • Obtain permission from the component auditor
  • Include the component auditor’s report with the group auditor’s report

Communication with Component Auditor

Whether you name the component auditor or not, AU-C 600 requires the group auditor to check (orally or in writing) on the component auditor’s:

  • Compliance with independence and ethical requirements
  • Competence

Referencing should not occur unless the following are true:

  • The financial statements were prepared using the same accounting framework as the group financial statements.
  • The component auditor follows GAAS (or, when required by law, PCAOB audit standards).
  • The component auditor’s report is not restricted as to use.

2. How to Reference Component Auditors

photo-4

Changes will be made to two auditor’s report paragraphs:

Auditor’s Responsibility Paragraph

You will add a paragraph like the following:

We did not audit the financial statements of ABC Company, Inc., a wholly owned subsidiary, which statements reflect total assets of $3,020,000 as of March 31, 2013, and total revenues of $7,050,200 for the year then ended. Those statements were audited by other auditors, whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for ABC Company, Inc., is based solely on the report of the other auditors.

Notice you will disclose the magnitude of the financial statements not audited in:

  • Dollar amounts or
  • Percentages

Those magnitudes may be expressed using one or more of the following:

  • Total assets
  • Total revenues
  • Other appropriate criteria (whichever appropriately describes the portion not audited)

Opinion Paragraph

The opinion paragraph will state “In our opinion, based on our audits and the report of the other auditors…”

To see a full sample auditor’s report (with these changes), click here.

Your Thoughts

I’m curious. Do you think your firm will normally reference or not reference outside component auditors?

Illustrative Group Auditor’s Report – Component Audited by Component Auditor

Below is an illustration of a group auditor’s report when a component is audited by a component auditor (AU-C Section 600 – Exhibit A – Illustration 2 of Auditor’s Reports on Group Financial Statement).

If you audit a consolidated entity that has a component (e.g., subsidiary) audited by another CPA firm, then consider this sample report. If the group auditor does not reference the component audit, then he is assuming responsibility for the audit of the component.

Independent Auditor’s Report

[Appropriate Addressee]

Report on the Consolidated Financial Statements

We have audited the accompanying consolidated financial statements of ABC Company and its subsidiaries, which comprise the consolidated balance sheets as of December 31, 20X1 and 20X0, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for the years then ended, and the related notes to the financial statements.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

Auditor’s Responsibility

Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We did not audit the financial statements of B Company, a wholly-owned subsidiary, which statements reflect total assets constituting 20 percent and 22 percent, respectively, of consolidated total assets at December 31, 20X1 and 20X0, and total revenues constituting 18 percent and 20 percent, respectively, of consolidated total revenues for the years then ended. Those statements were audited by other auditors, whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for B Company, is based solely on the report of the other auditors. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, based on our audit and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ABC Company and its subsidiaries as of December 31, 20X1 and 20X0, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.

[Auditor’s signature]

[Auditor’s city and state]

[Date of the auditor’s report]

The Clarity Project – Multiple Year Engagement Letters

If you have an existing multiple year audit engagement letter (e.g., letter covering 2011, 2012 and 2013), should you get a new letter to cover the requirements of the Clarity Project?

Yes (or at least create an addendum to your original letter).

Personally I prefer to create a new engagement letter. That way I know I’ve covered all the requisite elements of the new Clarity standards.

It’s cumbersome to create an addendum to the original engagement letter. In order to do so, you will need to compare your old letter with the new engagement letter from your audit materials provider (e.g. PPC, McGladrey, CCH) or the suggested language in the audit standards themselves; then you’ll need to craft an addendum sufficient for that particular client. It’s cleaner to create a new engagement letter. (I previously provided one example of a new engagement letter change.)

Either way, you will need to provide a full letter or addendum to the client.

New Requirement for Multiple Year Engagement Letters

And while we are talking about multiple year engagement letters, remember that under the Clarity standards certain communications are required for recurring audits. The auditor must assess whether circumstances require the terms of the audit engagement to be revised. If the auditor concludes that the terms of the engagement need not be revised, the auditor should remind the entity of the terms of the engagement by (1) providing a new engagement letter or (2)  providing a reminder, either written or oral, that the responsibilities outlined in the previous letter still apply. AU-C section 210 requires that the reminder, whether written or oral, be documented. Standards prior to the Clarity Project did not require the reminder.

Updated Governmental Audit Quality Center Reports

The AICPA Governmental Audit Quality Center has recently updated its example reports (including updated Clarity opinions and Yellow Book reports).

Click here to see the sample reports.

New reports include:

Government Auditing Standards Report Illustrations (Including a Financial Statement Report Illustration for a Government and a Not-for-Profit Entity)

Example No.

Title

4-1

Unmodified Opinions on Basic Financial Statements Accompanied by Required Supplementary Information and Other Information—State or Local Governmental Entity

4-2

Unmodified Opinion on Consolidated Financial Statements Accompanied by Other Information —Not-for-Profit Entity

4-3

Report on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance With Government Auditing Standards (for a Governmental Entity)

(No Material Weaknesses No Significant Deficiencies Identified, No Reportable Instances of Noncompliance or Other Matters)

4-4

Report on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance With Government Auditing Standards (for a Governmental Entity and With Reference to Audits by Other Auditors Using the Reference Option)

(No Material Weaknesses Identified, No Significant Deficiencies Identified, No Reportable Instances of Noncompliance or Other Matters Identified)

4-5

Report on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance With Government Auditing Standards (for a Governmental Entity)

(No Material Weaknesses Identified; Significant Deficiencies Identified; and Reportable Instances of Noncompliance and Other Matters Identified)

4-6

Report on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance With Government Auditing Standards (for a Governmental Entity and With Reference to Audits by Other Auditors Using the Inclusion Option)

(No Material Weaknesses Identified; Significant Deficiencies Identified; and Reportable Instances of Noncompliance and Other Matters Identified)

4-7

Report on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance With Government Auditing Standards (for a Governmental Entity)

(Material Weaknesses and Significant Deficiencies Identified; and Reportable Instances of Noncompliance and Other Matters Identified)

OMB Circular A-133 Report Illustrations

Example No.

Title

13-1

Report on Compliance for Each Major Federal Program; Report on Internal Control Over Compliance; and Report on Schedule of Expenditures of Federal Awards Required by OMB Circular A-133 (Unmodified Opinion on Compliance; No Material Weaknesses or Significant Deficiencies in Internal Control Over Compliance Identified)

13-2

Report on Compliance for Each Major Federal Program; Report on Internal Control Over Compliance; and Report on Schedule of Expenditures of Federal Awards Required by OMB Circular A-133  (Unmodified Opinion on Compliance for Each Major Federal Program; Significant Deficiencies in Internal Control Over Compliance Identified)

13-3

Report on Compliance for Each Major Federal Program; Report on Internal Control Over Compliance; and Report on Schedule of Expenditures of Federal Awards Required by OMB Circular A-133  (Qualified Opinion on Compliance for One Major Federal Program; Unmodified Opinion on Compliance on Each of the Other Major Federal Programs; Material Weaknesses and Significant Deficiencies in Internal Control Over Compliance Identified)

State and Local Government Financial Statement Report Illustrations

Example No.

Title

        A-1Unmodified Opinions on Basic Financial Statements Accompanied by Required Supplementary Information and Other Information

A-2

Unmodified Opinion on the Basic Financial Statements of a Special-Purpose Government That Has a Single Opinion Unit

A-5

Report on Basic Financial Statements That Includes Qualified Opinions on Major Governmental Funds Because of a GAAP Departure

A-9

Unmodified Opinions on Basic Financial Statements Accompanied by Required Supplementary Information and Other Information With Reference to an Audit by Another Auditor  

A-10

Report on Basic Financial Statements That Includes Multiple Opinion Modifications, Including an Adverse Opinion Because A Major Fund Is Omitted  

HUD Report Illustrations 

Report on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance With Government Auditing Standards

 

The Clarity Project – Compliance with Laws and Regulations

This is just a reminder that the Clarity Auditing Standards introduced new procedures with regard to your client’s compliance with laws and regulations. Specifically, the standards require the following:

  1. The  auditor must inspect correspondence, if any, with relevant licensing or regulatory authorities.
  2. While implied in prior audit standards, the new standards require the following:
    1. Obtain an understanding of the legal and regulatory framework.
    2. Obtain an understanding of how the entity is complying with that framework.
    3. Determine whether the auditor has a responsibility to report suspected noncompliance to outside parties.
    4. Document identified or suspected noncompliance.

As you perform your fraud inquiries, also ask about compliance with laws and regulations. See if the client has received any adverse correspondence from regulators or licensing bodies, and consider adding the response to your management representation letter.

Also document your understanding of the regulatory framework in your understanding of the entity and its environment.

Finally, consider that regulated entities (e.g., telecommunications) should have internal controls in place to ensure that legal and regulatory compliance is monitored and communicated.

The Clarity Project – Sending an Attorney Letter

When are auditors required to send an attorney letter (request to client’s attorney requesting information about litigation, claims, or assessments – actual or potential)?

AU-C 501 requires the auditor to send an attorney letter only if he or she believes actual or potential litigation, claims, or assessments may give rise to a risk of material misstatement.

How is AU-C 501 different from prior audit requirements?

Prior to the Clarity standards, if the client paid an attorney or consulted with an attorney on any potential litigation (even if no losses were expected), the auditor generally sent an attorney letter.

Now the auditor is required to send the attorney letter only if he or she believes there is a risk of material misstatement.

What are the documentation requirements?

The auditor must document the basis for any decision not to seek direct communication with legal counsel. If the auditor does not send an attorney letter, then the auditor should document the reasons for not doing so.

What if management has not consulted with counsel regarding litigation, claims, or assessments?

The auditor would document his or her reasons for not sending the attorney letter – e.g., The client had no contact with an attorney, and the client represents there is no existing litigation or other potential losses from legal issues.

Consider including such verbal client assertions in the client representation letter.

What procedures should the auditor perform to identify litigation, claims, or assessments?

  • inquire of entity management (including in-house counsel, if any),
  • obtain a description of litigation, claims, and assessments through the year-end to the date the description is furnished,
  • review relevant minutes, documents, and correspondence, and
  • review legal expenses

What if the auditor identifies potential litigation, claims or assessments?

The auditor must obtain evidence regarding:

  • the period in which the event occurred,
  • the probability of an unfavorable outcome, and
  • the potential loss

What if procedures indicate a risk of material misstatement (related to litigation, claims, or assessments)?

Then, an attorney letter should be sent (this is a presumptively mandatory requirement); if the auditor decides to not send the attorney letter – though required – he or she should document the following:

  • the justification for not sending the letter, and
  • how the intent of the requirement was met by other means

Form

Here’s a form I’ve created to assist with the decision to send or to not send the attorney’s letter.

The Clarity Project – Key Changes

The Clarity Project audit standards are effective for audits of entities with fiscal year-ends after December 15, 2012.

Here are a few posts that will help you make the transition to these new auditing standards.

The New Auditor’s Report

The New Engagement Letter

The New Representation Letter

The New Guidance on Audits of Group Financial Statements

Planning for Implementation of the Clarity Project Standards

These posts, while not comprehensive, represent some areas that I have found of interest.

Click here to see my Clarity-Project-presentation slide deck.

Are there other parts of the Clarity Standards that are of interest to you?