Adverse opinion

¨This is cause by highly material (severe) departure from GAAP, usually stemming from multiple departures from GAAP.

¨Modification when there are highly material (severe) GAAP problems:

INTRO and SCOPE will remain the same.

TWO EXTRA paragraphs:

1) Qualitative: explaining just in words what the client did wrong

Classic example: “The client has written up his equipment to fair market value, based on his own appraisal.” (Well, you’re
not supposed to write things up, and you’re not supposed to use your own appraisal.) “Accordingly, assets are overstated,
depreciation is overstated, net income is understated, retained earnings is understated, and earnings per share is
understated.”

2) Quantitative: giving exact dollar amounts of the errors going uncorrected.

“Accordingly, assets are overstated by $---, depreciation is overstated by $---, net income is understated by $---, retained
earnings is understated by $---, and earnings per share is understated by $---.”

OPINION: In our opinion, based on the matters discussed in the preceding paragraphs, the financial statements
referred to above do not present fairly, in all material respects, the financial position of X Company as of (at) December 31,
20XX, and the results of its operations and its cash flows for the year then ended in conformity with United States generally
accepted accounting principles.

¨No more “except for” language; this isn’t “except for”; this is bad! Also, don’t use the word “adverse” because the reader
doesn’t understand what that word is about, but the reader does understand the words “do not …”

5) Disclaimer of an Opinion

¨The following two situations will cause the auditor to give a disclaimer:

1) There is a highly material scope limitation – there’s not enough evidence to gather, and the auditor doesn’t feel
comfortable giving an opinion, based on APJ.

It may have been destroyed (by fire, flood, etc.)

Or client may have stood in auditor’s way.

[In real life, for almost any client-imposed scope limitation (e.g., client doesn’t allow auditor to see cash, inventory, etc.), the
CPA firm would go out of its way to give a disclaimer, and the materiality level shrinks.]

2) There’s a significant uncertainty about a particular thing; even the best evidence available, is just not enough to clear up
this uncertainty, and the auditor feels uncomfortable giving an opinion.

Example: There is a major lawsuit against the client, but there’s nothing to say about it at this point. But it’s known that if the
client loses, he could be gone. And the auditor is uncertain about how to handle it.

¨There are two modifications in the introductory paragraph:

(1) “We have audited” is changed to “We were engaged to audit” because the client was not fully audited.

(2) The last sentence “Our responsibility is to express an opinion…” is omitted because the auditor is not expressing an
opinion.
INTRO: We were engaged to audit the accompanying balance sheet of XYZ Company as of December 31, 20XX, and the
related statements of income, retained earnings, and cash flows for the year then ended. These financial statements are the
responsibility of the company’s management.

SCOPE paragraph is entirely omitted.

EXTRA paragraph – preceding the last paragraph – describes the problem that led to a disclaimer and the effect – both in
words and in dollar amounts – it had on the financial statements.

DISCLAIMER paragraph will look somewhat like this:

“Based on the matters discussed in the preceding paragraph, we were unable to satisfy ourselves regarding [whatever
could not be audited], and are, therefore, unable to express an opinion, and do not express an opinion on the financial
statements taken as a whole.”

Changing the Opinion on Last Year

¨Example: Last year, the auditor gave a qualified opinion. There was a lease that was material, and the auditor said that it
should be capitalized because it matched one of the criteria, but the client refused to capitalize it, and it caused a highly
material misstatement of assets, depreciation, and interest expense (and it effects the times-interest-earned ratio). The next
year, the client shows comparative financial statements, and he informs the auditor that he fixed up last year’s lease, as the
auditor wanted last year. Now, since the auditor is reporting on two years’ financial statements, he has to give an opinion on
last year’s and on this year’s financial statements.

¨In this year’s audit report the auditor will add an EXTRA paragraph – preceding the opinion paragraph – will include the
following:

DORCS (Day Opinion Reason-Change Statement):

D – Date of last year’s report

O – Opinion type given last year on last year’s financial statements

RC – Reason for Change of opinion on last year’s financial statements

S – Statement that says that the opinion given now on last year’s is different from the opinion given last year on last year’s.

Dual Dating the Report

¨Central rule: The report is dated the last day of fieldwork. That is when significant work is done on the client
(not necessarily at the client).

¨Suppose the last day of work was April 18th, 2009, and the date of mailing the financials of 2008 with the report to the public
was May 1st, 2009; then on April 21st, 2009, suddenly, there was a big flood that wiped out the ending inventory that was not
insured.

Does it impact the financials of 2008?

If yes, the client must include a footnote disclosure, (not an accrual, because it happened suddenly).

(If client refuses to disclose it, it would possibly result in a qualified or adverse opinion due to lack of adequate disclosure.)

If the client makes the disclosure, the auditor should dual date the report as follows:

April 18th (except for note XZ for which the date is April 21st).
¨Dual dating spares the auditor from the responsibility for anything else that may have happened after April 18 th without his
knowledge. If he would not dual date the report, he would assume responsibility for anything else that may have happened
after April 18th.