Audit Scope Limitations | AUD CPA Review #6

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Welcome back to this CPA Review class, we're going to continue our discussion on reporting issues, and you'll remember that in our last class we talked about what we do in terms of the audit report. If there is a problem with the financial statements, if there's a gap or disclosure problem, we know if there's a material gap or disclosure problem.

The auditor has to issue an except for qualified opinion. If there's a very material, a pervasive gap or disclosure problem, the auditor has to issue an adverse opinion. Well, in this glass, what I want to talk about is what we do in terms of the audit report. If there's a problem with the audit, okay, let's start with a scope problem.

What if. The auditor is unable to obtain evidence. That's what a scope problem is. It's the unavailability of data. The auditor is not able to obtain evidence in, there are inadequate records. The auditor's not able to obtain minutes of meetings. The auditor's not able to observe the inventory count at the end of the year, something like that.

Well. If there's a material scope problem, the auditor issues an except for qualified opinion. If there's a very material pervasive scope problem, the auditor has to disclaim an opinion. So remember that there's a material scope problem. An except-for qualified opinion. Very material disclaim. Now, what if there's a client imposed scope limitation?

The client will not let you. Confirm their accounts receivable. It's client imposed. Well, of course, you ask management to remove the limitation of course, if they won't. You communicate this problem with those in charge of governance. You do that, of course. But what if you're stuck with the fact that management will not let you confirm accounts receivable?

Well, if it's. Material and pervasive. The auditor disclaims an opinion. It's that simple. There's a client imposed scope limitation and you've communicated this with those in charge of governance and nothing is done about it. Well, then you have to decide if it's material and pervasive. It's all-encompassing.

The auditor would disclaim an opinion now in international standards in that situation, in international standards. The auditor would be required to withdraw. Now, if you look in your viewer's guide, you'll see an example of an except-for qualified opinion. When there's a scope limitation, remember, if there's a material scope limitation that's an except for qualified opinion.

And here's the example in the viewer's guide, and you'll notice right away, introductory paragraph, exactly the same management responsibility paragraph, exactly the same. But now, of course, the auditor's responsibility paragraph has to conclude, we believe that the audit evidence we have obtained is sufficient, inappropriate to provide a basis for our qualified opinion.

And now we're going to add an explanatory paragraph before the opinion paragraph because it does modify the opinion and it'll have a heading basis for a qualified opinion. In this example. We were not engaged as auditors of the company until after December 31 year one and therefore we're unable to observe the counting of the physical inventory at the beginning or end of the year.

As a result, we were unable to determine whether any adjustment might've been necessary with respect to recorded inventories and the elements making up the statements of income changes in stockholders' equity and cash flows. And now the opinion paragraph, it's an except for qualified opinion. So the opinion paragraph is going to say in our, 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.

So you can see if it's a material scope problem. You wish you an except for a qualified opinion. Now, if there's a very material pervasive scope problem, the auditor is going to have to disclaim an opinion, and in your viewer's guide, you'll see an example of a disclaimer of opinion when there's a very material scope limitation.

Notice the introductory paragraph has changed. Now the introductory paragraph says we were engaged to audit.

The accompanying financial statements of XYZ company management responsibility paragraph is unchanged. Now, the auditor's responsibility paragraph is changed our responsibilities to express an opinion on these financial statements based on conducting the audit in accordance with auditing standards generally accepted in the United States of America.

Because of the matters 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. And now of course, we're going to add an explanatory paragraph before the opinion paragraph because we've modified the opinion and it'll have a heading basis for disclaimer.

It says. Due to the introduction of a new computerized accounts receivable system. There were a number of misstatements in accounts receivable. We were unable to confirm by alternative means, accounts receivable, which total X in the balance sheet at December 31 year one, and of course now the opinion paragraph has a different heading.

It's now called a disclaimer of opinion as a heading. Because of the significant of the, 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. So that's how you handle scope problems. You have a material scope problem, and except for a qualified opinion, very material. Disclaim. How about an uncertainty? How do we handle an uncertainty? Well, let me say, first of all, if there's an uncertainty, like a lawsuit, and assuming that the auditor was able to obtain sufficient, appropriate evidence about the lawsuit, about the uncertainty, and assuming it's fully disclosed in the financial statements, then the auditor would issue a standard unmodified opinion and may add.

It's not required but may add based on the auditor's judgment, an emphasis of matter paragraph. That's your typical uncertainty. The auditor has been able to obtain sufficient appropriate audit evidence about that lawsuit, about that uncertainty. It's fully disclosed in the financial statements. No problem.

Standard unmodified opinion and the auditor, depending on their judgment, may add an emphasis of matter. Paragraph. Let me address this possibility. Let's say there's an uncertainty. That's causing a material misstatement in the financial statements. Now you know how to handle that, right? If there's an uncertainty that's causing a material misstatement in the financial statements, well, it's a gap problem.

So if it's material and except for a qualified opinion, very material adverse, you know that like, you know your name, that's no problem. Here's the one that's a little tricky. What if there's an uncertainty caused by the fact that the auditor is not able. To obtain sufficient appropriate audit evidence.

That's what's causing the uncertainty. You have an uncertainty caused by the fact that the auditor is not able to obtain sufficient inappropriate audit evidence about the situation. Well, then it's looking at it as a type of scope limitation. That's really what it amounts to. If there's an uncertainty that's being caused by the fact that the auditor's not able, not able.

To obtain sufficient appropriate audit evidence. Well, that's a skull problem, so you know how to handle it. If it's a material uncertainty caused by the auditor's inability to obtain evidence an except-for for qualified opinion, if it's very material, if it's pervasive, you disclaim. Now, I want to mention that international standards are a little different.

International standards of auditing say that there could be an interaction of several uncertainties. And the interaction of several uncertainties could mean that the auditor is not able to form an opinion even though they were able to obtain sufficient appropriate audit evidence. Let me say that again.

In international standards, they concede that it's possible there could be an interaction of several uncertainties and the result is the audit. The auditor's not able to form an opinion, even though they, the auditor was able to obtain sufficient appropriate audit evidence. While in that case. The auditor would disclaim, even though they were able to obtain sufficient appropriate audit evidence.

But it's important to remember that in U S generally accepted auditing standards with an uncertainty, the auditor only disclaims if they're not able to obtain sufficient appropriate audit evidence. So remember that in U S generally accepted auditing standards, the auditor would only disclaim with an uncertainty if they are not able to obtain sufficient.

Appropriate audit evidence.

How about a going concern problem? How do we handle that? Remember on every audit, the auditor is responsible to evaluate the audit evidence that they gathered during the audit to determine whether the company, whether the entity

will or will not, you know, continue as a going concern. The auditor has that responsibility. They have the responsibility of any audit to evaluate the audit evidence, to determine is there a substantial doubt about the company's ability to continue as a going concern for a reasonable period of time?

What's a reasonable period of time not to exceed one year? In other words, the auditor's not required to look 10 years out, 20 years out, no, not to exceed one year. Now, what kind of evidence would. The auditor considers trying to determine if there's a going concern problem. Well, they would read minutes of meetings, legal letters, very important.

And in your viewer's guide, you'll see a list of negative trends. You know, that might indicate a going concern, problem, recurring losses, negative cash flows, adverse financial ratios. They're defaulting on a row on loans. They're unable to get usual trade credit terms. Okay? There are arrearages of dividends.

There are pending legal proceedings. They've lost the legal right to a patent. There's a whole list of negative trends, and then in your viewer's guide, you'll see some mitigating factors, a disposal of assets that would actually might be a good sign. Where they're trying to dispose of unproductive assets and concentrate on their more profitable parts of the business.

They're restructuring debt. They're reducing or delaying expenditures. They've increased stockholders' equity, they've acquired more capital. They've somehow reduce their dividend requirements. Those would be mitigating factors, but on every audit, the auditor has to look at all the evidence to determine is there.

A substantial doubt about the company's ability to continue as a going concern. All right, so let's get to it. How do we handle a going concern problem? It's a problem with the audit. Well, if there is a material going concern, problem material, not pervasive. If there's a material going concern problem, the auditor issues a standard.

Unmodified opinion, just a standard unmodified opinion with a required emphasis of matter paragraph. Right. We know that's a required emphasis of matter paragraph. If there is a very material going concern problem, the auditor disclaims an opinion and of course, I should add that the auditor always communicates this concern to those who are in charge of governance as well.

But that's the bottom line with going concern problems. If there's a material going concern, problem, standard unmodified opinion, but the auditor would be required to add an emphasis of matter paragraph, you know, using that language, raising substantial doubt about the entity's ability to continue as a going concern using that very particular language.

But if it's a very material going concern problem, it's pervasive. Disclaim. All right, so let me summarize. Here's the way I want you to think in the audit is the way I want you to think of the exam. When you're in the CPA Exam and you can tell from a question, it's not going to be a clean opinion. You break it up in your mind this way.

Is it a problem with the financial statements or is it a problem with the audit? If it's a problem with the financial statements, a gap or disclosure problem, you know what to do if it's a material gap problem, an except-for qualified opinion, if it's very material. Adverse. That's how you handle prob all problems with the financial statements.

But what if it's a problem with the audit? What if there's a scope limitation? If there's a material scope limitation on material, not pervasive, an except-for qualified opinion if it's very material disclaim. How about an uncertainty? Well, the one y'all were, the only, the only uncertainty you're worried about is an uncertainty caused by the auditor's inability.

To obtain sufficient appropriate audit evidence. So it's really a scope limitation. So if it's a very, if it's a material uncertainty caused by the fact that the auditor is not able to obtain sufficient appropriate audit evidence, you wish you an except for qualified opinion. But if it's very material, it's pervasive, it's all-encompassing.

Disclaim. And then finally going concern. If there's a material going concern problem, what do you do? Material not pervasive. You issue a standard unmodified opinion, but you are required to add an emphasis of matter paragraph. But if there's a very material going concern problem, disclaims an opinion. Now you will notice that before you start the next class, I want you to do 14 questions.

There are 14 questions I want you to answer, and as always, it's important that you do those questions first, get all of your 14 answers before you start the next class, and I look to see you then.

 
 
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