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Upon completion of this lesson, candidates should be able to:

Understand when and how to express a qualified audit opinion for a misstatement (including
inadequate disclosure) affecting the fair presentation of an entity's financial statements.

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Study Guide

1. Relevant AICPA Guidance—The relevant AICPA guidance is provided by AU 705, Modifications to the
Opinion in the Independent Auditor's Report. The standard states that the auditor's objective is to
express clearly an appropriately modified opinion when (1) the auditor concludes that the financial
statements as a whole are misstated; or (2) the auditor is unable to obtain sufficient appropriate
audit evidence to conclude that the financial statements as a whole are free from material
misstatement. (This lesson focuses on the first matter, since the scope limitation is discussed in a
separate lesson.)

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

Pervasive: (a) Effects that are not confined to specific elements, accounts, or items of the financial
statements; (b) effects that, if so confined, represent or could represent a substantial proportion of
the financial statements; or (c) regarding disclosures, are fundamental to users’ understanding of
the financial statements.

2. Opinion Choice for a Misstatement (Including Inadequate Disclosure) Involves Judgment

1. Qualified Opinion—The auditor should express a qualified opinion when the auditor concludes
that misstatements are material, but not pervasive to the financial statements.
2. Adverse Opinion—The auditor should express an adverse opinion when the auditor concludes
that misstatements are material, and pervasive to the financial statements. (A separate lesson
focuses on the adverse opinion.)
3. Effect of a Qualification for a Misstatement on the Auditor's Report
1. No effect on the introductory paragraph or management's responsibility section
2. Auditor's Responsibility Section—Modify the last sentence to state, “We believe that the audit
evidence we have obtained is sufficient and appropriate to provide a basis for our qualified
audit opinion.”
3. Add a “Basis for Qualified Opinion” paragraph (with such a label) before the opinion paragraph.
The auditor should include a description and quantification of the financial effects of the
misstatement (when practicable); likewise, the auditor should include the omitted information
(when practicable).
4. Qualify the opinion using appropriate language such as: “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 . . .” and label the opinion paragraph “Qualified Opinion.”
4. Sample Audit Report Qualified for a Misstatement

Independent Auditor's Report

(Appropriate Addressee)

We have audited the accompanying financial statements of ABC Company, which comprise the
balance sheet as of December 31, 20X1, and the related statements of income, changes in

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stockholders’ equity and cash flows for the year 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 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 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 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 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 financial statements.

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

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 then ended in accordance with accounting
principles generally accepted in the United States of America.

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
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financial position of ABC Company as of December 31, 20X1 and 20X0, 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.

(Auditor's signature)

(Auditor's city and state)

(Date of the auditor's report)

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Notes

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Flashcards

1
The auditor is expressing one or more
reservations (specifically about the
financial statement presentation; for
What is the meaning of a
example, a "GAAP departure") while still
qualified opinion for a concluding that, except for the specific
misstatement relative to GAAP matter referenced, the financial
statements, taken as a whole, are fairly
or other applicable financial
stated and the auditor has obtained
reporting framework? sufficient, appropriate audit evidence as
a reasonable basis for the auditor's
conclusions.

2
What type of report should the Adverse opinion
auditor express when a
misstatement is viewed as
material and pervasive?

3
What type of report should the Qualified opinion
auditor express when a
misstatement is viewed as
material but not pervasive?

4
"In our opinion, except for the
Give an example of the effects of the matter described in
language used in an auditor's the Basis for Qualified Opinion
paragraph, the financial
report for a "qualified statements referred to above
opinion" for inadequate present fairly???"
disclosure. The qualification (i.e., reservation)
is the phrase "except for???."

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Knowledge Checks

Question 1 (PQ1137)

When expressing a qualified opinion for a material misstatement, the auditor is required, in all cases, to
specify the effects of the misstatement or to include the omitted disclosures in the body of the auditor's
report.
True
False

Question 2 (PQ8323)

When a misstatement is both material and pervasive, the auditor should choose between a qualified or
adverse opinion.
True
False

Question 3 (PQ6949)

When management has omitted an entity's statement of cash flows, the auditor is required to present the
omitted statement of cash flows in the auditor's report.
True
False

Question 4 (PQ6951)

When management has omitted the disclosure of information from the entity's financial statements that is
required by generally accepted accounting principles (or other applicable financial reporting framework),
the auditor should present the omitted information in the auditor's report "if practicable" and express
either a qualified or adverse opinion.
True
False

Question 5 (PQ7280)

When the auditor expresses a qualified opinion, the "basis for qualified opinion" paragraph should follow
the opinion paragraph.
True
False

Question 6 (PQ7281)

When an auditor wishes to express a qualified opinion due to a deficiency in financial statement disclosure,
the opinion paragraph should include the phrase ". . .except for the effects of the matter described in the
Basis for Qualified Opinion paragraph . . ."
True
False
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Slides

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Supplementary Questions

Question 1 (REPT-0044B)
Which of the following phrases would an auditor most likely include in the auditor's report when expressing
a qualified opinion because of inadequate disclosure?
Subject to the departure from U.S. generally accepted accounting principles, as described above.
With the foregoing explanation of these omitted disclosures.
Except for the omission of the information discussed in the preceding paragraph.
Does not present fairly in all material respects.

Question 2 (REPT-0048B)
In which of the following situations would an auditor ordinarily choose between expressing an "except for"
qualified opinion or an adverse opinion?
The auditor did not observe the entity's physical inventory and is unable to become satisfied as to
its balance by other auditing procedures.
The financial statements fail to disclose information that is required by generally accepted
accounting principles.
The auditor is asked to report only on the entity's balance sheet and not on the other basic financial
statements.
Events disclosed in the financial statements cause the auditor to have substantial doubt about the
entity's ability to continue as a going concern.

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