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ExpandAS No. 1: References in Auditors’ Reports to the Standards of the Public Company Accounting Oversight Board
ExpandAS No. 3: Audit Documentation
ExpandAS No. 4: Reporting on Whether a Previously Reported Material Weakness Continues to Exist
ExpandAS No. 5: An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements
ExpandAS No. 6: Evaluating Consistency of Financial Statements
ExpandAS No. 7: Engagement Quality Review
ExpandAS No. 8: Audit Risk
ExpandAS No. 9: Audit Planning
ExpandAS No. 10: Supervision of the Audit Engagement
ExpandAS No. 11: Consideration of Materiality in Planning and Performing an Audit
ExpandAS No. 12: Identifying and Assessing Risks of Material Misstatement
ExpandAS No. 13: The Auditor's Responses to the Risks of Material Misstatement
ExpandAS No. 14: Evaluating Audit Results
ExpandAS No. 15: Audit Evidence
ExpandAS No. 16: Communications with Audit Committees
ExpandAS No. 17: Auditing Supplemental Information Accompanying Audited Financial Statements
ExpandAU Section 100 - Statements on Auditing Standards -- Introduction
ExpandAU Section 200 - The General Standards
ExpandAU Section 300 - The Standards of Field Work
ExpandAU Section 400 - The First, Second, and Third Standards of Reporting
CollapseAU Section 500 - The Fourth Standard of Reporting
AU Section 504 - Association With Financial Statements
AU Section 9504 - Association With Financial Statements: Auditing Interpretations of Section 504
AU Section 508 - Reports on Audited Financial Statements
AU Section 9508 - Reports on Audited Financial Statements: Auditing Interpretations of Section 508
AU Section 530 - Dating of the Independent Auditor's Report
AU Section 532 - Restricting the Use of an Auditor's Report
AU Section 534 - Reporting on Financial Statements Prepared for Use in Other Countries
AU Section 9534 - Reporting on Financial Statements Prepared for Use in Other Countries: Auditing Interpretations of Section 534
AU Section 543 - Part of Audit Performed by Other Independent Auditors
AU Section 9543 - Part of Audit Performed by Other Independent Auditors: Auditing Interpretations of Section 543
AU Section 544 - Lack of Conformity With Generally Accepted Accounting Principles
AU Section 550 - Other Information in Documents Containing Audited Financial Statements
AU Section 9550 - Other Information in Documents Containing Audited Financial Statements: Auditing Interpretations of Section 550
AU Section 551 - Reporting on Information Accompanying the Basic Financial Statements in Auditor-Submitted Documents
AU Section 552 - Reporting on Condensed Financial Statements and Selected Financial Data
AU Section 558 - Required Supplementary Information
AU Section 9558 - Required Supplementary Information: Auditing Interpretations of Section 558
AU Section 560 - Subsequent Events
AU Section 561 - Subsequent Discovery of Facts Existing at the Date of the Auditor's Report
AU Section 9561 - Subsequent Discovery of Facts Existing at the Date of the Auditor's Report: Auditing Interpretations of Section 561
ExpandAU Section 600 - Other Types of Reports
ExpandAU Section 700 - Special Topics
ExpandAU Section 800 - Compliance Auditing
ExpandAU Section 900 - Special Reports of the Committee on Auditing Procedures

AU Section 9508

Reports on Audited Financial Statements: Auditing Interpretations of Section 508

1.    Report of an Outside Inventory-Taking Firm as an Alternative Procedure for Observing Inventories

.01

Question—Section 508, Reports on Audited Financial Statements, paragraph .24 states that "Common restrictions on the scope of the audit include those applying to the observation of physical inventories and the confirmation of accounts receivable by direct communication with debtors. . . ." A footnote to that paragraph states: "Circumstances such as the timing of the work may make it impossible for the auditor to accomplish these procedures. In this case, if the auditor is able to satisfy himself or herself as to inventories or accounts receivable by applying alternative procedures, there is no significant limitation on the scope of the work, and the report need not include reference to the omission of the procedures or to the use of alternative procedures." Outside firms of nonaccountants specializing in the taking of physical inventories are used at times by some companies, such as retail stores, hospitals, and automobile dealers, to count, list, price and subsequently compute the total dollar amount of inventory on hand at the date of the physical count. Would obtaining the report of an outside inventory-taking firm be an acceptable alternative procedure to the independent auditor's own observation of physical inventories?

.02

[The following paragraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004. For audits of fiscal years beginning before December 15, 2010, click here.]

Interpretation—Sufficient appropriate evidential matter for inventories is discussed in section 331, Inventories, paragraphs .09-.12. Section 331.09 states that ". . . it is ordinarily necessary for the independent auditor to be present at the time of count and, by suitable observation, tests, and inquiries, satisfy himself respecting the effectiveness of the methods of inventory-taking and the measure of reliance which may be placed upon the client's representations about the quantities and physical condition of the inventories."

.03

Section 331.10 and .11 discusses two variations of that procedure when the client has well-kept perpetual records that are checked periodically by comparisons with physical counts or when the client uses statistical sampling to determine inventories. In such instances, the auditor may vary the timing and extent of his observation of physical counts, but he "must be present to observe such counts as he deems necessary and must satisfy himself as to the effectiveness of the counting procedures used."

.04

Section 331.12 deals with circumstances in which the auditor has not satisfied himself or herself as to inventories in the possession of the client through procedures described in section 331.09-.11. In those circumstances, the general requirement for satisfactory alternative procedures is that ". . . tests of the accounting records alone will not be sufficient for him to become satisfied as to quantities; it will always be necessary for the auditor to make, or observe, some physical counts of the inventory and apply appropriate tests of intervening transactions."

.05

The fact that the inventory is counted by an outside inventory firm of nonaccountants is not, by itself, a satisfactory substitute for the auditor's own observation or taking of some physical counts. The auditor's concern, in this respect, is to satisfy himself as to the effectiveness of the counting procedures used. If the client engages an outside inventory firm to take the physical inventory, the auditor's primary concern would be to evaluate the effectiveness of the procedures used by the outside firm and his auditing procedures would be applied accordingly.

.06

Thus, the auditor would examine the outside firm's program, observe its procedures and controls, make or observe some physical counts of the inventory, recompute calculations of the submitted inventory on a test basis and apply appropriate tests to the intervening transactions. The independent auditor ordinarily may reduce the extent of the work on the physical count of inventory because of the work of an outside inventory firm, but any restriction on the auditor's judgment concerning the extent of his or her contact with the inventory would be a scope restriction.

[Issue Date: July, 1975; Revised: October, 2000.]

[2.]    Reporting on Comparative Financial Statements of Nonprofit Organizations

[.07–.10]

[Superseded by Statement on Auditing Standards No. 15, effective for periods ending after June 30, 1977.]

[3.]     Reporting on Loss Contingencies

[.11–.14]

[Superseded by Statement on Auditing Standards No. 58, effective for reports issued or reissued on or after January 1, 1989.] (See section 508.)

[4.]    Reports on Consolidated Financial Statements That Include Supplementary Consolidating Information

[.15–.20]

[Superseded December 31, 1980, by SAS No. 29.] (See section 551.)

[5.]    Disclosures of Subsequent Events

[.21–.24]

[Superseded by Statement on Auditing Standards No. 58, effective for reports issued or reissued on or after January 1, 1989.] (See section 508.)

[6.]    The Materiality of Uncertainties

[.25–.28]

[Superseded by Statement on Auditing Standards No. 58, effective for reports issued or reissued on or after January 1, 1989.] (See section 508.)

[7.]    Reporting on an Uncertainty

[.29–.32]

[Withdrawn August, 1982 by Statement on Auditing Standards No. 43.]

8.    Reporting on Financial Statements Prepared on a Liquidation Basis of Accounting

.33

Question—Footnote 6 of Statement of Position 93-3, Rescission of Accounting Principles Board Statements, states that an enterprise is not viewed as a going concern if liquidation appears imminent. How should the auditor report on financial statements that are prepared on a liquidation basis of accounting for an entity in liquidation or for which liquidation appears imminent?

.34

Answer—A liquidation basis of accounting may be considered generally accepted accounting principles for entities in liquidation or for which liquidation appears imminent. Therefore, the auditor should issue an unqualified opinion on such financial statements, provided that the liquidation basis of accounting has been properly applied, and that adequate disclosures are made in the financial statements.

.35

Typically, the financial statements of entities that adopt a liquidation basis of accounting are presented along with financial statements of a period prior to adoption of a liquidation basis that were prepared on the basis of generally accepted accounting principles for going concerns. In such circumstances, the auditor's report ordinarily should include an explanatory paragraph that states that the entity has changed the basis of accounting used to determine the amounts at which assets and liabilities are carried from the going concern basis to a liquidation basis.

.36

Examples of auditor's reports with such an explanatory paragraph follow.

Report on Single Year Financial Statements in Year of Adoption of Liquidation Basis

"We have audited the statement of net assets in liquidation of XYZ Company as of December 31, 20X2, and the related statement of changes in net assets in liquidation for the period from April 26, 20X2 to December 31, 20X2. In addition, we have audited the statements of income, retained earnings, and cash flows for the period from January 1, 20X2 to April 25, 20X2. 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 audit.

"We conducted our audit 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

"As described in Note X to the financial statements, the stockholders of XYZ Company approved a plan of liquidation on April 25, 20X2, and the company commenced liquidation shortly thereafter. As a result, the company has changed its basis of accounting for periods subsequent to April 25, 20X2 from the going-concern basis to a liquidation basis.

"In our opinion, the financial statements referred to above present fairly, in all material respects, the net assets in liquidation of XYZ Company as of December 31, 20X2, the changes in its net assets in liquidation for the period from April 26, 20X2 to December 31, 20X2, and the results of its operations and its cash flows for the period from January 1, 20X2 to April 25, 20X2, in conformity with accounting principles generally accepted in the United States of America applied on the bases described in the preceding paragraph."

Report on Comparative Financial Statements in Year of Adoption of Liquidation Basis

"We have audited the balance sheet of XYZ Company as of December 31, 20X1, the related statements of income, retained earnings, and cash flows for the year then ended, and the statements of income, retained earnings, and cash flows for the period from January 1, 20X2 to April 25, 20X2. In addition, we have audited the statement of net assets in liquidation as of December 31, 20X2, and the related statement of changes in net assets in liquidation for the period from April 26, 20X2 to December 31, 20X2. 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.

"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 financial statements are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

"As described in Note X to the financial statements, the stockholders of XYZ Company approved a plan of liquidation on April 25, 20X2, and the company commenced liquidation shortly thereafter. As a result, the company has changed its basis of accounting for periods subsequent to April 25, 20X2 from the going-concern basis to a liquidation basis.

"In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of XYZ Company as of December 31, 20X1, the results of its operations and its cash flows for the year then ended and for the period from January 1, 20X2 to April 25, 20X2, its net assets in liquidation as of December 31, 20X2, and the changes in its net assets in liquidation for the period from April 26, 20X2 to December 31, 20X2, in conformity with accounting principles generally accepted in the United States of America applied on the bases described in the preceding paragraph."

.37

The auditor may, in subsequent years, continue to include an explanatory paragraph in his report to emphasize that the financial statements are presented on a liquidation basis of accounting.

[.38]

[.38]    [Paragraph deleted to reflect conforming changes necessary due to the issuance of Statement on Auditing Standards No. 79.]

[Issue Date: December, 1984; Revised: June, 1993; Revised: February, 1997; Revised: October, 2000.]

[9.]    Quantifying Departures From Generally Accepted Accounting Principles

[.39–.43]

[Superseded by Statement on Auditing Standards No. 58, effective for reports issued or reissued on or after January 1, 1989.] (See section 508.)

[10.]    Updated Reports Resulting From the Retroactive Suspension of Earnings per Share and Segment Information Disclosure Requirements

[.44–.48]

[Withdrawn March, 1989 by the Auditing Standards Board.]

[11.]    Restating Financial Statements Reported on by a Predecessor Auditor

[.49–.50]

[Superseded by Statement on Auditing Standards No. 84, effective with respect to acceptance of an engagement after March 31, 1998.] (See section 315.)

12.    Reference in Auditor's Standard Report to Management's Report

.51

Question—One of the basic elements of the auditor's standard report is a statement that the financial statements are the responsibility of the Company's management. That statement is required in the auditor's report even when a document containing the auditor's report includes a statement by management regarding its responsibility for the presentation of the financial statements. When an annual shareholders' report (or other client-prepared document that includes audited financial statements) contains a management report that states the financial statements are the responsibility of management, is it permissible for the auditor's report to include a reference to the management report?

.52

Interpretation—No. The statement about management's responsibilities for the financial statements required by section 508, Reports on Audited Financial Statements, should not be further elaborated upon in the auditor's standard report or referenced to management's report. Such modifications to the standard auditor's report may lead users to erroneously believe that the auditor is providing assurances about representations made by management about their responsibility for financial reporting, internal controls and other matters that might be discussed in the management report.

[Issue Date: January, 1989.]

[13.]    Reference to Country of Origin in the Auditor's Standard Report

[.53–.55]

[.53–.55]    [Withdrawn October, 2000 by SAS No. 93.]

14.    Reporting on Audits Conducted in Accordance With Auditing Standards Generally Accepted in the United States of America and in Accordance With International Standards on Auditing

.56

Question— Section 508, Reports on Audited Financial Statements, states that a basic element of the auditor’s report is a statement that the audit was conducted in accordance with generally accepted auditing standards and an identification of the United States of America as the country of origin of those standards. If the auditor conducts the audit in accordance with standards generally accepted in the United States of America and in accordance with the International Standards on Auditing promulgated by the International Auditing Practices Committee of the International Federation of Accountants, may the auditor so indicate in the auditor’s report?

.57

Interpretation—Yes. Section 508 requires that the auditor indicate in the auditor’s report that the audit was conducted in accordance with generally accepted auditing standards and an identification of the United States of America as the country of origin of those standards; however, section 508 does not prohibit the auditor from indicating that the audit also was conducted in accordance with another set of auditing standards. If the audit also was conducted in accordance with the International Standards on Auditing, in their entirety, the auditor may so indicate in the auditor’s report. To determine whether an audit was conducted in accordance with the International Standards on Auditing, it is necessary to consider the text of the International Standards on Auditing in their entirety, including the basic principles and essential procedures together with the related guidance included in the International Standards on Auditing. fn 1

.58

When reporting on an audit performed in accordance with auditing standards generally accepted in the United States of America and International Standards on Auditing, the auditor should comply with reporting standards generally accepted in the United States of America.

.59

An example of reporting on an audit conducted in accordance with auditing standards generally accepted in the United States and in accordance with International Standards on Auditing follows:

We conducted our audit in accordance with auditing standards generally accepted in the United States of America and in accordance with International Standards on Auditing. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

[Issue Date: March, 2002.]

15.    Reporting as Successor Auditor When Prior-Period Audited Financial Statements Were Audited by a Predecessor Auditor Who Has Ceased Operations fn 2

.60

Question—If the prior-period financial statements audited by a predecessor auditor who has ceased operations are presented for comparative purposes with current-period audited financial statements, how is the successor auditor's report affected?

.61

Interpretation—If the prior-period audited financial statements are unchanged, pursuant to section 508, Reports on Audited Financial Statements, paragraph .74, the successor auditor should indicate in the introductory paragraph of his or her report (a) that the financial statements of the prior period were audited by another auditor, (b) the date of the predecessor auditor's report, (c) the type of report issued by the predecessor auditor, and (d) if the report was other than a standard report, the substantive reasons therefor. The successor auditor ordinarily also should indicate that the other auditor has ceased operations. Footnote 29 of section 508 indicates that the successor auditor should not name the predecessor auditor in the report. An example of the reference that would be added to the introductory paragraph of the successor auditor's report is presented as follows:

The financial statements of ABC Company as of December 31, 20X1, and for the year then ended were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those financial statements in their report dated March 31, 20X2.

A reference to the predecessor auditor's report should be included even if the predecessor auditor's report on the prior-period financial statements is reprinted and accompanies the successor auditor's report, because reprinting does not constitute reissuance of the predecessor auditor’s report.

.62

If the prior-period financial statements have been restated, and the entity does not file annual financial statements with the Securities and Exchange Commission (SEC), the successor auditor should follow the guidance in paragraph .61 above, indicating that the predecessor auditor reported on such financial statements before restatement.

.63

When the prior-period financial statements have been restated, the successor auditor may be engaged either to reaudit the prior-period financial statements or to audit only the restatement adjustments. If the successor auditor is engaged to audit only the restatement adjustments and applies sufficient procedures to satisfy himself or herself as to the appropriateness of the restatement adjustments, the successor auditor may report on the restatement adjustments using the guidance in section 508.74. (The auditor also may use the guidance on alternative language contained in paragraph .71, below.) In determining the nature, timing and extent of procedures, the successor auditor should consider that a predecessor auditor who has ceased operations cannot perform the procedures to evaluate the appropriateness of the restatement adjustments as described in section 561, Subsequent Discovery of Facts Existing at the Date of the Auditor's Report.

.64

If the successor auditor neither performs a reaudit of the prior-period financial statements nor audits only the restatement adjustments, the note to the financial statements describing the restatement adjustments should be marked “Unaudited.” Depending on the nature and extent of the restatement adjustments, it may be appropriate for the prior-period financial statements to be marked “Unaudited.”

.65

If the entity files annual financial statements with the SEC, the SEC staff has indicated (specifically with respect to Arthur Andersen LLP) that, in annual reports (on Form 10-K and to shareholders), the predecessor auditor's latest signed and dated report on the prior-period financial statements should be reprinted with a legend indicating (a) that the report is a copy of the previously issued report and (b) that the predecessor auditor has not reissued the report. fn 3

.66

The successor auditor should refer to the predecessor auditor's report in his or her report, as described in paragraph .61 above, and, if the prior-period financial statements have been restated, indicate that the predecessor auditor reported on such financial statements before restatement.

.67

SEC rules require that annual and, in some instances, other financial statements be audited. To satisfy the SEC audit requirement when the prior-period financial statements have been restated, the successor auditor may be engaged either to reaudit the prior-period financial statements or to audit only the restatement adjustments. A successor auditor who is engaged to audit only the restatement adjustments is not required to perform procedures to identify all adjustments to the financial statements that may be appropriate. fn 4

.68

In some cases, prior-period financial statement disclosures may be revised in a manner that does not involve restating amounts in the prior-period financial statements, but rather involves the addition of disclosures. In such cases, the successor auditor may be engaged to perform audit procedures to satisfy himself or herself as to the appropriateness of the additional disclosures. Financial statements that have been revised are considered to be restated for the purposes of this Interpretation.

.69

Some revisions may be sufficiently inconsequential such that audit procedures by the successor auditor would be unnecessary and the reference to the predecessor auditor's report on the prior-period financial statements would not indicate that the predecessor auditor reported on such financial statements before restatement. For example, inconsequential revisions might include conforming editorial modifications to footnote disclosures or reclassifications made for comparative purposes in the financial statements. fn 5

.70

When the successor auditor is engaged to audit only the restatement adjustments, the procedures performed will vary significantly depending on the nature of adjustment. In some instances, the successor auditor may determine that conducting a reaudit of the prior-period financial statements is necessary based on the nature of the restatement adjustments. Examples of restatement adjustments whose nature indicates that a reaudit ordinarily is necessary (particularly with respect to entities that file financial statements with the SEC) include, but are not limited to:

  • Corrections of an error.
  • Reflection of a change in reporting entity.
  • Retroactive accounting changes (a) with significant impact on previously reported amounts or (b) that affect previously reported net income or net assets.
  • Reporting discontinued operations.
  • Changes affecting previously reported net income or net assets.

.71

If the successor auditor is engaged to audit only the restatement adjustments and applies sufficient procedures to satisfy himself or herself as to the appropriateness of the restatement adjustments, the successor auditor may report on the restatement adjustments using the guidance in section 508.74. Alternatively, the successor auditor may wish to make it clear that he or she did not audit, review, or apply other procedures to the prior-period financial statements beyond the procedures applied to the restatement adjustments. Accordingly, he or she may include the following paragraph in his or her report:

As discussed above, the financial statements of ABC Company as of December 31, 20X1, and for the year then ended were audited by other auditors who have ceased operations. As described in Note X, these financial statements have been restated [revised]. We audited the adjustments described in Note X that were applied to restate [revise] the 20X1 financial statements. In our opinion, such adjustments are appropriate and have been properly applied. However, we were not engaged to audit, review, or apply any procedures to the 20X1 financial statements of the Company other than with respect to such adjustments and, accordingly, we do not express an opinion or any other form of assurance on the 20X1 financial statements taken as a whole.

.72

If the auditor wishes to identify the procedures performed in his or her report, he or she may include in his or her report a paragraph similar to the following example:

Restatement Adjustments for Changes in Segment Composition

As discussed above, the financial statements of ABC Company as of December 31, 20X1, and for the year then ended were audited by other auditors who have ceased operations. As described in Note X, the Company changed the composition of its reportable segments in 20X2, and the amounts in the 20X1 financial statements relating to reportable segments have been restated to conform to the 20X2 composition of reportable segments. We audited the adjustments that were applied to restate the disclosures for reportable segments reflected in the 20X1 financial statements. Our procedures included (a) agreeing the adjusted amounts of segment revenues, operating income and assets to the Company’s underlying records obtained from management, and (b) testing the mathematical accuracy of the reconciliations of segment amounts to the consolidated financial statements. In our opinion, such adjustments are appropriate and have been properly applied. However, we were not engaged to audit, review, or apply any procedures to the 20X1 financial statements of the Company other than with respect to such adjustments and, accordingly, we do not express an opinion or any other form of assurance on the 20X1 financial statements taken as a whole.

.73

When the revision of the prior-period financial statements is limited to expansion of footnote disclosure, the phrase “restatement adjustments” may not be applicable. In such circumstances, the auditor may include in his or her report a paragraph similar to the following example:

Addition of FAS 142, paragraph 61, Disclosure

As discussed above, the financial statements of ABC Company as of December 31, 20X1, and for the year then ended were audited by other auditors who have ceased operations. As described in Note X, these financial statements have been revised to include the transitional disclosures required by Statement of Financial Accounting Standards (Statement) No. 142, Goodwill and Other Intangible Assets, which was adopted by the Company as of January 1, 20X2. Our audit procedures with respect to the disclosures in Note X with respect to 20X1 included (a) agreeing the previously reported net income to the previously issued financial statements and the adjustments to reported net income representing amortization expense (including any related tax effects) recognized in those periods related to goodwill, intangible assets that are no longer being amortized, deferred credits related to an excess over cost, equity method goodwill, and changes in amortization periods for intangible assets that will continue to be amortized as a result of initially applying Statement No. 142 (including any related tax effects) to the Company’s underlying records obtained from management, and (b) testing the mathematical accuracy of the reconciliation of adjusted net income to reported net income, and the related earnings-per-share amounts. In our opinion, the disclosures for 20X1 in Note X are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 20X1 financial statements of the Company other than with respect to such disclosures and, accordingly, we do not express an opinion or any other form of assurance on the 20X1 financial statements taken as a whole.

.74

Question—If the prior-period financial statements audited by a predecessor auditor who has ceased operations have been subsequently restated, but the successor auditor has not yet completed an audit of current-period financial statements, can the successor auditor report on the restatement adjustments pursuant to section 508.74?

.75

Interpretation—No. Section 508.74 is only applicable when the prior-period financial statements are presented for comparative purposes with current-period audited financial statements. If the prior-period financial statements have been restated, and the successor auditor is requested to report on those financial statements without also reporting on current-period audited financial statements, the successor auditor would need to reaudit the prior-period financial statements in order to report on them.

[Issue Date: November, 2002.]

16.    Effect on Auditor's Report of Omission of Schedule of Investments by Investment Partnerships That Are Exempt From Securities and Exchange Commission Registration Under the Investment Company Act of 1940

.76

Question—The Audit and Accounting Guide Audits of Investment Companies (the Guide) addresses financial statement presentation and disclosure requirements for investment partnerships that are exempt from Securities and Exchange Commission (SEC) registration under the Investment Company Act of 1940 (the 1940 Act). Paragraphs 7.10 through 7.14 of the Guide specifically describe information that should be disclosed in a Schedule of Investments. Paragraph 7.12 of the Guide states that the financial statements of an investment partnership that is exempt from SEC registration under the Investment Company Act of 1940, when prepared in conformity with generally accepted accounting principles, should:

  1. Categorize investments by the following:
    (i) Type (such as common stocks, preferred stocks, convertible securities, fixed-income securities, government securities, options purchased, options written, warrants, futures, loan participations, short sales, other investment companies, and so forth)
    (ii) Country or geographic region
    (iii)  Industry

Report (1) the percent of net assets that each such category represents and (2) the total value and cost for each category in (a)(i) and (a)(ii).

  1. Disclose the name, shares or principal amount, value, and type of the following:
    (i) Each investment (including short sales), constituting more than 5 percent of net assets
    (ii) All investments in any one issuer aggregating more than 5 percent of net assets

In applying the 5 percent test, total long and total short positions in any one issuer should be considered separately.

  1. Aggregate other investments (each of which is 5 percent or less of net assets) without specifically identifying the issuers of such investments and categorize them as required by (a) above.

.77

Section 508.41 addresses the effect of inadequate disclosure of information essential for fair presentation of the financial statements on the auditor's report. It states:

If the financial statements, including accompanying notes, fail to disclose information that is required by generally accepted accounting principles, the auditor should express a qualified or adverse opinion because of the departure from those principles and should provide the information in the report, if practicable, unless its omission from the auditor's report is recognized as appropriate by a specific Statement on Auditing Standards.

.78

Section 508.42 provides an example of a report qualified for inadequate disclosure (assuming the effects are such that the auditor has concluded an adverse opinion is not appropriate) as follows:

Independent Auditor's Report

[Same first and second paragraphs as the standard report]

The Company's financial statements do not disclose [describe the nature of the omitted disclosures]. In our opinion, disclosure of this information is required by accounting principles generally accepted in the United States of America.

In our opinion, except for the omission of the information discussed in the preceding paragraph, . . .

.79

The Guide does not make it clear how the guidance in section 508.41 and .42 should be applied to reports on financial statements of investment partnerships that are exempt from SEC registration and that do not include all the investment information required in the Schedule of Investments as required by the Guide. For example, if the financial statements did not disclose each of the required items for each investment, the guidance in section 508.41 indicates the auditor should, if practicable, include the missing information (for example, the Schedule of Investments or information about individual investments) in the auditor's report. However, the example in section 508.42 provides that the auditor would disclose the nature of the missing information, rather than the actual information, in the auditor's report.

.80

In applying section 508.41 and .42 to an auditor's report on financial statements of an investment partnership that is exempt from SEC registration and that does not include the required Schedule of Investments information required by paragraph 7.12 of the Guide, is it sufficient for the auditor to describe "the nature of the omitted disclosures" in his or her report expressing a qualified (or adverse) opinion?

.81

Interpretation—No. The example in section 508.42 does not change the requirement in section 508.41 for the auditor to issue a qualified or adverse opinion and also to provide the missing information, if practicable. If the investment disclosures required by the Guide are not included in the financial statements and it is practicable for the auditor to determine them or any portion thereof, the auditor should include the information in his or her report expressing the qualified or adverse opinion.

.82

Footnote 15 of section 508 indicates that it is practicable to provide the missing information if "the information is reasonably obtainable from management's accounts and records and … providing the information in the report does not require the auditor to assume the position of a preparer of financial information." Ordinarily, it would be practicable for the auditor to obtain and present the information about investments constituting more than 5 percent of net assets called for by section (b) of the disclosure requirement described in paragraph .76 above. However, due to the need to categorize the investments for the purpose of preparing the schedule called for by section (a) of the disclosure requirement described in paragraph .76 above, the auditor might be in the position of preparer of financial information and, therefore, would not include the schedule in his or her report. In rare cases, the Schedule of Investments information may be so limited that the auditor may conclude that disclosure of the entire Schedule is practicable.

.83

Following is an illustration of a report that expresses a qualified opinion because the Schedule of Investments fails to disclose investments constituting more than 5 percent of net assets, but in all other respects conforms to the requirements of the Guide:

Independent Auditor's Report

[Same first and second paragraphs as the standard report]

The Schedule of Investments included in the Partnership's financial statements does not disclose required information about the following investments, each constituting more than 5 percent of the Partnership's total net assets, at December 31, 20X2:

  • Amalgamated Buggy Whips, Inc., 10,000 shares of common stock—fair value $3,280,000 (Consumer nondurable goods)
  • Paper Airplane Corp., 6.25% Cv. Deb. due 20XX, $4.5 million par value—fair value $4,875,000 (Aviation)

In our opinion, disclosure of this information is required by accounting principles generally accepted in the United States of America.

In our opinion, except for the omission of the information discussed in the preceding paragraph, the financial statements and financial highlights referred to above present fairly, …

.84

An illustration of an adverse opinion relating to failure to present the entire Schedule of Investments and all of the related required information follows. fn 6 This illustration assumes that the auditor has concluded that it is not practicable to present all of the required information. In such circumstances, the auditor presents in his or her report the missing information, where it is practicable to do so, and describes the nature of the missing information where it is not practicable to present the information in the report:

Independent Auditor's Report

[Same first and second paragraphs as the standard report]

The Partnership has declined to prepare and present a Schedule of Investments and the related information as of December 31, 20X2. Accounting principles generally accepted in the United States of America require presentation of this Schedule and the related information. Presentation of this Schedule would have disclosed required information about the following investments, each constituting more than 5 percent of the Partnership's total net assets, at December 31, 20X2:

  • Amalgamated Buggy Whips, Inc., 10,000 shares of common stock—fair value $3,280,000 (Consumer nondurable goods) fn 7
  • Paper Airplane Corp., 6.25% Cv. Deb. due 20XX, $4.5 million par value—fair value $4,875,000 (Aviation)

In addition, presentation of the Schedule of Investments would have disclosed [describe the nature of the information that it is not practicable to present in the auditor's report].

In our opinion, because the omission of a Schedule of Investments results in an incomplete presentation as explained in the preceding paragraph, the financial statements and financial highlights referred to above do not present fairly, …

[Issue Date: April 9, 2003.]

Footnotes (AU Section 9508 — Reports on Audited Financial Statements: Auditing Interpretations of Section 508):

fn 1 Appendix B, Analysis of International Standards on Auditing, identifies sections and paragraphs, if applicable, within the International Standards on Auditing that may require procedures and documentation in addition to those required by U.S. auditing standards.

fn 2 A firm is considered to have ceased operations when it no longer issues audit opinions either in its own name or in the name of a successor firm. A firm may cease operations with respect to public entities and still issue audit opinions with respect to non-public entities.

fn 3 See Securities and Exchange Commission Release No. 33-8070, Requirements for Arthur Andersen LLP Auditing Clients.

fn 4 However, a successor auditor who identifies other adjustments that may be appropriate to the prior-period financial statements, either in the course of auditing the restatement adjustments or in the audit of current-period financial statements, should consider their effect on the prior-period financial statements. See section 315. Section 561 provides further guidance that may be useful to a successor auditor who either reaudits the prior-period financial statements or audits only the restatement adjustments.

fn 5 If reclassifications result in material changes to prior-period financial statements, they should be disclosed and the successor auditor would, at a minimum, need to perform audit procedures on the related restatement adjustments.

fn 6 Section 508.36 discusses the factors the auditor considers in deciding whether to issue a qualified opinion or an adverse opinion.

fn 7 In the absence of a Schedule of Investments containing categorizations by type, country or geographic region, and industry, such categorizations should be provided only if readily ascertainable from management's accounts and records. The auditor should not assign such categorizations if management has not done so.

Copyright © 2001, 2003, 2004, American Institute of Certified Public Accountants, Inc.