AU 623: Special Reports

AU-C 806: Reporting on Compliance with Aspects of Contractual Agreements or Regulatory Requirements in Connection with Audited Financial Statements

AU-C 800: Special Considerations—Audits of Financial Statements Prepared in Accordance with Special-Purpose Frameworks

AU-C 805: Special Considerations—Audits of Single Financial Statements and Specific Elements, Accounts, or Items of a Financial Statement

AU EFFECTIVE DATE AND APPLICABILITY

Original Pronouncements Statements on Auditing Standards (SASs) 62 and 77, as revised to reflect the conforming changes necessary due to the issuance of SAS 87.
Effective Date These statements currently are effective.
Applicability Auditor’s reports issued in connection with the following:
1. Other comprehensive basis of accounting (OCBOA). Audited financial statements prepared in accordance with a comprehensive basis of accounting other than generally accepted accounting principles (see the section “Definitions of Terms”).
2. Elements, accounts, or items. Audited specified elements, accounts, or items of a financial statement.
3. Compliance. Compliance with aspects of contractual agreements or regulatory requirements related to audited financial statements.
4. Special-purpose financial presentations. Financial presentations prepared to comply with contractual agreements or regulatory provisions.
5. Prescribed forms. Financial information presented in prescribed forms or schedules that require a prescribed form of auditor’s report.
Auditor’s reports issued in connection with any of the above are special reports.
Not Applicable to Reports issued in connection with the following:
1. Reviews of interim financial statements
2. Financial forecasts, projections, or feasibility studies
3. Compliance with aspects of contractual agreements or regulatory requirements unrelated to financial statements
NOTE: When the auditor is engaged to perform an audit in accordance with Governmental Auditing Standards (the “Yellow Book”) issued by the Comptroller General of the United States or the Single Audit Act, he or she should follow guidance contained in Section 801, Compliance Auditing Considerations in Audits of Governmental Entities and Recipients of Governmental Financial Assistance.
A review of specified elements, accounts, or items in accordance with Statements on Standards for Accounting and Review Services (SSARS) is not appropriate. However, the auditor may be engaged to make a review in accordance with attestation standards (see Section AT 101).

AU-C EFFECTIVE DATE AND SUMMARY OF CHANGES

SAS No. 122, Codification of Auditing Standards and Procedures, is effective for audits compliance issued in connection with audits of financial statements with periods ending on or after December 15, 2012.

The clarified SAS does not change the requirements of extant AU Section 623 in any significant respect.

AU DEFINITIONS OF TERMS

Historical Financial Statements

Generally accepted auditing standards (GAAS) are applicable whenever an auditor is engaged to audit and report on any historical financial statement.

Characteristics. A financial statement has the following characteristics:

1. It is a presentation of financial data, including accompanying notes.
2. It is derived from accounting records.
3. It is intended to communicate an entity’s economic resources or obligations at a point in time or the changes in the economic resources or obligations for a period of time in accordance with generally accepted accounting principles (GAAP) or a comprehensive basis of accounting.

Examples of financial statements. For reporting purposes, the following types of financial presentations are financial statements:

1. Balance sheet
2. Statement of income or statement of operations
3. Statement of retained earnings
4. Statement of cash flows
5. Statement of changes in owners’ equity
6. Statement of assets and liabilities that does not include owners’ equity accounts
7. Statement of revenue and expenses
8. Summary of operations
9. Statement of operations by product lines
10. Statement of cash receipts and disbursements

Entities. A financial statement may be presented for any of the following:

1. A corporation
2. A consolidated group of corporations
3. A combined group of affiliated entities
4. A not-for-profit organization
5. A governmental unit
6. An estate or trust
7. A partnership
8. A proprietorship
9. A segment of any of the preceding
10. An individual

Comprehensive Basis of Accounting other than GAAP

For purposes of this section, a comprehensive basis of accounting other than GAAP is a basis to which at least one of the following descriptions applies:

Regulatory. A basis of accounting used by the reporting entity in compliance with requirements or financial reporting provisions of a governmental regulatory agency with jurisdiction over the entity. Examples are the following:

1. Interstate Commerce Commission
2. Department of Housing and Urban Development
3. State insurance commissions
NOTE: A special report cannot be used unless the statements are filed solely with the agency.

Tax. A basis of accounting that the reporting entity uses or expects to use in filing its income tax return for the period covered by the financial statements.

Cash. The cash receipts and disbursements basis of accounting and modifications of the basis that have substantial support. Modifications having substantial support include, for example:

1. Recording depreciation on long-lived assets
2. Accruing income taxes

Other. A definite set of criteria having substantial support that is applied to all material items appearing in the financial statements. An example of this type is financial statements prepared on the price-level basis of accounting.

NOTE: Current-value financial statements that supplement historical-cost financial statements in a general-use presentation of real estate entities are not considered to be OCBOA financial statements. See the “Techniques for Application” section and AU Illustration 16 for additional information.

For this section to apply, the financial statements should conform to one of the four descriptions. Reporting on other kinds of financial statements is not necessarily prohibited; however, the guidance in this section is not applicable.

AU-C DEFINITIONS OF TERMS

AU-C 806 does not contain any definitions.

OBJECTIVES OF AU SECTION 623

Engagements That May Be Accepted

An independent auditor expresses an opinion about whether the audited financial statements are presented fairly, in all material respects, in conformity with GAAP. GAAP requires financial statements to be prepared on the accrual basis. There are, however, organizations that believe that neither they nor the users of their financial statements need accrual-basis financial statements. Examples of these organizations are the following: (1) some not-for-profit entities, (2) certain nonpublic entities (e.g., service enterprises and small, closely held businesses), (3) regulated companies that must file financial statements based on accounting principles prescribed by a governmental regulatory agency, and (4) entities formed for special purposes, such as certain partnerships and joint ventures.

Sometimes an auditor is asked to express an opinion on parts (elements, accounts, or items) of a financial statement. Situations in which this may occur include audits of sales for purposes of computing royalties or additional rent. Unions sometimes require a special audit of the allocation of their expenses between those chargeable and those not chargeable to nonunion workers whom they represent in collective bargaining arrangements.

The objectives of this section are (1) to identify those engagements that the auditor may accept to audit and report on financial statements that are not prepared in conformity with GAAP without expressing a qualified or adverse opinion and (2) to identify those engagements that the auditor may accept to audit and report on parts of financial statements.

GAAS

The section establishes that whenever the auditor is engaged to audit and report on financial statements prepared in accordance with a comprehensive basis of accounting other than GAAP, the audit should be performed in accordance with GAAS.

For other audits described, the section indicates which of the standards apply.

Auditor’s Report

The section provides examples of reports that an auditor should issue under each type of engagement. It also provides guidance when the auditor’s report contains wording prescribed by the regulatory body to whom the client’s financial statements are submitted.

OBJECTIVES OF AU-C 623

AU-C 623 states that “the objective of the auditor is to report appropriately on an entity’s compliance with aspects of contractual agreements or regulatory requirements, in connection with the audit of financial statements, when the auditor is requested to report on such matters.”

FUNDAMENTAL REQUIREMENTS: FINANCIAL STATEMENTS PREPARED IN CONFORMITY WITH AN OCBOA

Components of Auditor’s Standard Report

When reporting on financial statements prepared in conformity with an OCBOA, the independent auditor’s report should include the following:

1. A title that includes the word independent
2. A standard introductory paragraph
3. A standard scope paragraph, including an identification of the United States of America as the country of origin of the auditing standards used
4. A paragraph that
a. Identifies the basis of presentation and refers to the note to the financial statements that describes that basis
b. Indicates that the basis of presentation is a comprehensive basis of accounting other than GAAP
5. An opinion paragraph that presents the auditor’s opinion as to whether the financial statements are presented fairly, in all material respects, in conformity with the basis of accounting described
6. The manual or printed signature of the auditing firm
7. The date
NOTE: If the financial statements are prepared in conformity with the requirements or financial reporting provisions of a governmental regulatory agency, see the section on “Governmental Regulatory Agencies.”

(See Illustrations 1 and 2.)

Departures from Unqualified Opinions

The auditor may conclude that he or she cannot express an unqualified opinion on the financial statements in the following circumstances:

1. The financial statements are not presented fairly on the basis of accounting described.
2. There is a limitation on the scope of the audit.

In these circumstances, the auditor should do the following:

1. Include an explanatory paragraph before the opinion paragraph that discloses all substantive reasons for the modified opinion.
2. Include in the opinion paragraph appropriate modifying language and a reference to the explanatory paragraph.

Governmental Regulatory Agencies

Sometimes the auditor reports on financial statements prepared in conformity with the requirements on financial reporting of a governmental regulatory agency. (See Illustration 3.) In these circumstances, the auditor’s report should include a paragraph after the opinion paragraph that restricts the use of the report solely to those within the entity and for filing with the regulatory agency. This paragraph is appropriate even though the auditor’s report may be made a matter of public record by law or regulation.

Financial Statements Not in Conformity with OCBOA

If the financial statements do not meet the conditions for presentation in conformity with a comprehensive basis of accounting other than GAAP (see “AU Definitions of Terms”), the auditor should issue the standard auditor’s report modified because of a GAAP departure (see Section 508, Reports on Audited Financial Statements).

Title of Financial Statements

Titles used for financial statements prepared in conformity with GAAP are not appropriate for financial statements prepared in conformity with a comprehensive basis of accounting other than GAAP. For example, cash-basis financial statements would be titled “Statement of Assets and Liabilities Arising from Cash Transactions” and “Statement of Revenue Collected and Expenses Paid.”

If the auditor believes the financial statements are not titled appropriately, he or she should ask the client to change the titles and, failing that, disclose his or her reservations in an explanatory paragraph of the auditor’s reports and issue a qualified opinion.

Financial Statement Disclosures

The notes to the financial statements prepared on an OCBOA should include a summary of significant accounting policies that describes the basis of presentation and indicates how that basis differs from GAAP. The effects of the differences do not have to be quantified.

Items that are similar to those in GAAP financial statements (for example, depreciation in modified cash-basis financial statements) require the same informative disclosures.

FUNDAMENTAL REQUIREMENTS: SPECIFIED ELEMENTS, ACCOUNTS, OR ITEMS OF A FINANCIAL STATEMENT

Examples and Other Services

An auditor may accept an engagement to express an opinion on one or more specified elements, accounts, or items of a financial statement, either as a separate engagement or in conjunction with the audit of the financial statements. The specified elements, accounts, or items may be presented in the auditor’s report or in a document accompanying the report.

Examples of specified elements, accounts, or items of a financial statement on which an auditor may report include accounts receivable, investments, rentals, royalties, provision for income taxes, and total expenses. For specified elements, accounts, or items, the accountant may review the specified elements, accounts, or items in accordance with attestation standards (see Section AT 201).

GAAS

Nine of the ten GAAS are applicable to any engagement to express an opinion on one or more elements, accounts, or items of a financial statement. The first standard of reporting (GAAP conformity) is not applicable unless the specified elements, accounts, or items are intended to be presented in conformity with GAAP.

Scope of Audit and Level of Materiality

In these types of engagements, the auditor expresses an opinion on each of the specified elements, accounts, or items encompassed by the auditor’s report. The measurement of materiality, therefore, should be related to each individual element, account, or item reported on, and not to the aggregate of them or to the financial statements taken as a whole.

Because the amount considered material is usually smaller in an audit of this nature, the audit of the specified element, account, or item usually is more extensive than it is when the same information is being considered in conjunction with an audit of the financial statements taken as a whole.

Many financial statement elements, such as sales and receivables, inventory and payables, long-lived assets and depreciation, are interrelated. The auditor may therefore also apply audit procedures to elements, accounts, or items that are interrelated with those on which he or she has been engaged to express an opinion.

Adverse Opinion or Disclaimer on the Basic Financial Statements

An auditor may have expressed an adverse opinion or disclaimed an opinion on the basic financial statements. In these circumstances, the auditor still may report on one or more specified elements, accounts, or items of the basic financial statements if the following conditions exist:

1. The matters to be reported on and the scope of the audit were not intended to and did not include so many elements, accounts, or items that they compose a major portion of the basic financial statements.
2. The report on the elements, accounts, or items should be presented separately from the report on the financial statements of the entity.

Specified Element, Account, or Item Related to Net Income or Stockholders’ Equity

The auditor should have audited the complete financial statements when expressing an opinion on a specified element, account, or item when that specified element, account, or item is, or is based upon, an entity’s net income or stockholders’ equity or their equivalent.

The Auditor’s Report

The auditor’s report on one or more specified elements, accounts, or items of a financial statement should include the following:

1. A title that includes the word independent
2. An introductory paragraph with statements that:
a. The specified elements, accounts, or items identified in the report were audited.
(1) If the audit was made in conjunction with the audit of the entity’s financial statements, this should be stated, and the date of auditor’s report on those financial statements should be indicated.
(2) Any departure from the auditor’s standard report on the entity’s financial statements should be noted if considered relevant to the presentation of the specified element, account, or item.
b. The specified elements, accounts, or items are the responsibility of the entity’s management and the auditor’s responsibility is to express an opinion on the specified elements, accounts, or items based on the audit.
3. A scope paragraph with statements that:
a. The audit was conducted in accordance with auditing standards generally accepted in the United States of America.
b. Those standards require that the auditor plan and perform the audit to obtain reasonable assurance about whether the specified elements, accounts, or items are free of material misstatement.
c. An audit includes:
(1) Examining, on a test basis, evidence supporting the amounts and disclosures in the presentation of the specified elements, accounts, or items.
(2) Assessing the accounting principles used and significant estimates made by management.
(3) Evaluating the overall presentation of the specified elements, accounts, or items.
d. The auditor believes that the audit provides a reasonable basis for the opinion.
4. A paragraph with statements that:
a. Describe the basis on which the specified elements, accounts, or items are presented and, if applicable, any agreements specifying the basis if the basis is not in conformity with GAAP. (If the presentation is prepared in conformity with GAAP, the paragraph should include an identification of the United States of America as the country of origin of those accounting principles.)
b. Describe significant interpretations, if any, made by the entity’s management relating to the provisions of a relevant agreement.
5. An opinion paragraph that states whether the specified elements, accounts, or items are fairly presented, in all material respects, in conformity with the basis of accounting described (or disclaims an opinion). If the auditor concludes that the specified elements, accounts, or items are not presented fairly on the basis of accounting described or if there has been a scope limitation, the auditor should:
a. Disclose all the substantive reasons for his or her conclusion in an explanatory paragraph preceding the opinion paragraph of the report
b. Modify the opinion and refer to the explanatory paragraph
6. A paragraph that restricts the use of the auditor’s report to those within the entity and parties to a contract or agreement if the specified element, account, or item is prepared to comply with the requirements of a contract or agreement that results in a presentation not in conformity with GAAP or OCBOA.
7. The manual or printed signature of the auditing firm and the date of the report.

(See AU Illustrations 4 to 8.)

FUNDAMENTAL REQUIREMENTS: COMPLIANCE WITH CONTRACTUAL OR REGULATORY REQUIREMENTS RELATED TO AUDITED FINANCIAL STATEMENT

Agreements Requiring Compliance Reports

Bond indentures, loan and other agreements, or regulatory agencies may require compliance reports by independent auditors. For example, loan agreements may contain covenants for borrowers, such as payments into sinking funds, payments of interest, maintenance of current ratios, restriction of dividend payments, and use of proceeds of sales of property. Also, these agreements may require that the borrower provide annual financial statements that have been audited by an independent auditor.

If the auditor is testing compliance with laws and regulations in an audit in accordance with the Government Auditing Standards (the “Yellow Book”) issued by the Comptroller General of the United States or a single audit act in accordance with an office of management budget circular, he or she should follow the guidance in Section 801, Compliance Auditing Considerations in Audits of Governmental Entities and Recipients of Governmental Financial Assistance.

Request for Assurance

In certain circumstances, lenders request from the independent auditor assurance that the borrower has complied with the covenants of the agreements relating to accounting or auditing matters. (The lender’s request is made to the client, not the auditor.) The independent auditor usually satisfies this request by giving negative assurance concerning the applicable covenants. Such assurance may not be given if the auditor has not audited the financial statements related to the contractual agreements or regulatory requirements, if the auditor has issued an adverse opinion or disclaimer of opinion on those statements, or if the assurance extends to covenants addressing matters not subjected to auditing procedures.

The negative assurance given by the auditor may be provided in a separate report or in one or more paragraphs of the auditor’s report accompanying the financial statements.

Assurance Given in Auditor’s Report on the Financial Statements

The auditor may include his or her report on compliance with contractual agreements or regulatory provisions in the auditor’s report on the financial statements. In this case, the auditor should include a paragraph, after the opinion paragraph, that provides the negative assurance relative to compliance with the applicable covenants of the agreement, insofar as they relate to accounting matters. The paragraph also should state that (1) the negative assurance is being given in connection with the audit of the financial statements and (2) the audit was not directed primarily toward obtaining knowledge regarding compliance.

The auditor’s report should also include a paragraph that describes and states the source of any significant interpretations made by the entity’s management and a paragraph that restricts its use to those within the entity and the parties to the contract or agreement or for filing with the regulatory agency, if appropriate.

Separate Auditor’s Report

If an auditor’s report on compliance with contractual agreements or regulatory provisions is a separate report, it should include the following:

1. A title that includes the word independent.
2. A paragraph stating that the financial statements were audited in accordance with auditing standards generally accepted in the United States of America and the date of the auditor’s report on the financial statements. Any departure from the auditor’s standard report on the financial statements should be disclosed.
3. A paragraph that:
a. Refers to the specific covenants or paragraphs of the agreement
b. Provides negative assurance relative to compliance with the applicable covenants of the agreement insofar as they relate to accounting matters
c. Specifies that the negative assurance is being given in connection with the audit of the financial statements
d. States that the audit was not directed primarily toward obtaining knowledge regarding compliance
4. A paragraph that describes and states the source of any significant interpretations made by the entity’s management relating to provisions of the agreement.
5. A paragraph that restricts the use of the report to those within the entity and the parties to the contract or agreement or for filing with the regulatory agency, if appropriate.
6. The manual or printed signature of the auditing firm and the date of the report.

(See AU Illustrations 9 and 10.)

FUNDAMENTAL REQUIREMENTS: SPECIAL-PURPOSE FINANCIAL PRESENTATIONS TO COMPLY WITH CONTRACTUAL AGREEMENTS OR REGULATORY PROVISIONS

Special-Purpose Financial Presentations

Sometimes an auditor is asked to report on special-purpose financial statements prepared to comply with a contractual agreement or regulatory provisions. Such presentations are generally intended for use of the parties to the agreement, regulatory bodies, or other specified parties. They include the following:

1. A financial presentation prepared in compliance with a contractual agreement or regulatory provision that is not a complete presentation of the entity’s assets, liabilities, revenues, or expenses, but is otherwise prepared in conformity with GAAP or OCBOA (an incomplete presentation).
2. A financial presentation (a complete set of financial statements or a single financial statement) prepared on a basis of accounting prescribed in an agreement that is not a presentation in conformity with GAAP or OCBOA.

Incomplete Presentations

Situations That Would Involve Incomplete Presentations

The following situations involve incomplete presentations:

1. A governmental agency requires a schedule of gross income and certain expenses, exclusive of items such as interest, depreciation, and income taxes, of a entity’s real estate operations.
2. A buy-sell agreement specifies a schedule of assets and liabilities measured in conformity with GAAP, but limited to certain designated assets and liabilities (for example, tangible assets and liabilities, exclusive of loans from stockholders).

These presentations should differ from complete financial statements only to the extent necessary to meet the special purposes for which they were prepared.

Disclosures

If these financial presentations contain items the same as, or similar to, those contained in a complete set of financial statements prepared in conformity with GAAP, similar informative disclosures should be made.

Title

The financial statements should be appropriately titled to avoid any implication that these incomplete presentations are intended to present financial position, results of operations, or cash flows.

Materiality

Although not complete financial statements, these financial presentations are considered to be financial statements for purposes of considering materiality. That is, the measurement of materiality for purposes of issuing an opinion should be related to the financial presentation taken as a whole.

Auditor’s Report

When the auditor reports on financial statements prepared on a basis of accounting prescribed in a contractual agreement or regulatory provision that results in an incomplete presentation, but one that is otherwise in conformity with GAAP or OCBOA, the auditor’s report should include the following:

1. A title that includes the word independent.
2. A standard introductory paragraph.
3. A standard scope paragraph, including an identification of the United States of America as the country of origin of the auditing standards used.
4. A paragraph that:
a. Explains the intention of the presentation and refers to the note to the financial statements that describes the basis of presentation
b. States that the presentation is not intended to be a complete presentation of the entity’s assets, liabilities, revenues, and expenses if the basis of presentation is in conformity with GAAP or OCBOA
5. A paragraph that states the auditor’s opinion related to the fair presentation, in all material respects, of the information the presentation is intended to present in conformity with GAAP or OCBOA. The paragraph should include an identification of the United States of America as the country of origin of those accounting principles if the presentation is prepared in conformity with GAAP. If the auditor decides that the information the presentation is intended to present is not presented fairly on the basis of accounting described or if there has been a scope limitation, the auditor should:
a. Disclose all the substantive reasons for his or her conclusion in an explanatory paragraph preceding the opinion paragraph of the report
b. Modify the opinion and refer to the explanatory paragraph
6. A paragraph that restricts the use of the auditor’s report to the parties to the contract or agreement, to those with whom the entity is negotiating directly, or for filing with a regulatory agency.
NOTE: There should not be a restrictive paragraph when the report and related financial presentation are to be filed with a regulatory agency, such as the Securities and Exchange Commission (SEC), and are to be included in a document that is distributed to the general public, such as a prospectus.
7. The manual or printed signature of the auditing firm and the date of the report.

(See AU Illustrations 11 and 12.)

Non-GAAP or Non-OCBOA Presentations

Situations That Would Involve Non-GAAP or Non-OCBOA Presentations

The following situations involve special-purpose financial statements presented in conformity with a basis of accounting that departs from GAAP or OCBOA:

1. The borrower may be required by a loan agreement to prepare financial statements in which assets, such as inventory, are presented on a basis that does not conform with GAAP.
2. An acquisition agreement may require that the acquired entity’s financial statements be prepared in conformity with GAAP, except for certain assets for which a valuation basis is stated in the agreement.

Another example would be when current-value financial statements supplement historical-cost financial statements in a general-use presentation of real estate entities.

Auditor’s Report

When the auditor reports on financial statements described above, the auditor’s report should include:

1. A title that includes the word independent.
2. A standard introductory paragraph.
3. A standard scope paragraph, including an identification of the United States of America as the country of origin of the auditing standards used.
4. A paragraph that:
a. Explains the intent of the presentation and refers to the note to the financial statements that describes the basis of presentation.
b. States that the presentation is not intended to be a GAAP presentation.
5. A paragraph that describes and provides the source of any significant interpretations made by the entity’s management relating to provisions of a relevant agreement.
6. A paragraph that states the auditor’s opinion related to the fair presentation, in all material respects, of the information the presentation is intended to present on the basis of accounting specified. If the auditor concludes that the information the presentation is intended to present is not presented fairly on the basis of accounting described or if there has been a limitation on the scope of the audit, the auditor should:
a. Disclose all the substantive reasons for his or her conclusion in an explanatory paragraph preceding the opinion paragraph of the report.
b. Modify the opinion and refer to the explanatory paragraph.
7. A paragraph that restricts the use of the report to those in the entity, to parties to the contract or agreement, to those with whom the entity is negotiating directly, or for filing with a regulatory agency.
NOTE: When current-value financial statements of a real estate entity supplement the historical-cost financial statements and are not presented as a stand-alone presentation, it is not necessary to restrict the distribution of the auditor’s report.
8. The manual or printed signature of the auditing firm and the date of the report.

(See AU Illustration 13.)

FUNDAMENTAL REQUIREMENTS: CIRCUMSTANCES REQUIRING EXPLANATORY LANGUAGE IN AN AUDITOR’S SPECIAL REPORT

Circumstances Requiring Explanatory Language

Circumstances that do not affect the auditor’s unqualified opinion may nonetheless require that the auditor add explanatory language to the special report. These circumstances include the following:

1. Lack of consistency in accounting principles
2. Going concern uncertainties
3. Other auditors
4. Comparative financial presentations

Lack of Consistency in Accounting Principles

A change in accounting principles or in the method of their application for the financial statements or specified elements, accounts, or items of financial statements may cause a material lack of comparability. In these circumstances, the auditor should add an explanatory paragraph to the auditor’s report. The explanatory paragraph should:

1. Follow the opinion paragraph
2. Describe the change
3. Refer to the note that discusses the change and the effect (see Section 508, Reports on Audited Financial Statements)

Change from GAAP to OCBOA. The auditor does not have to follow the above requirements if the financial statements or specified elements, accounts, or items were prepared in conformity with GAAP one year and OCBOA the following year. The auditor may, however, add an explanatory paragraph to the auditor’s report to call attention to the difference in the bases of presentation.

GAAP and OCBOA financial statements. Sometimes, two sets of financial statements for the same year may be issued—one prepared in conformity with GAAP, the other in conformity with OCBOA. In these circumstances, the auditor may add an explanatory paragraph to each report stating that another set of financial statements prepared in conformity with another basis have been reported on and issued.

Change in the tax law. A change in the tax law is not considered to be a change in accounting principle for financial statements prepared in conformity with the tax basis of accounting. The auditor would not, therefore, need to add an explanatory paragraph to the auditor’s report. However, disclosure of the tax law change may be necessary.

Going Concern Uncertainties

The auditor may have substantial doubt about the entity’s ability to continue as a going concern for a period of time not to exceed one year beyond the date of the financial statements. In these circumstances, the auditor should add an explanatory paragraph after the opinion paragraph of the auditor’s report if the going concern uncertainty is relevant to what the auditor is reporting on (see Section 341, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern).

Other Auditors

If the auditor decides to refer to the report of another auditor as a basis, in part, for his or her opinion, the auditor should disclose this in the introductory paragraph of the auditor’s report and should refer to the other auditor’s report in the opinion paragraph (see Section 508).

Comparative Financial Presentations

The auditor may issue an opinion on prior period financial statements or specified elements, accounts, or items that is different from the opinion he or she previously expressed on the same information. In these circumstances, the auditor should disclose all substantive reasons for the different opinion in a separate explanatory paragraph that precedes the opinion paragraph of the auditor’s report.

FUNDAMENTAL REQUIREMENTS: FINANCIAL INFORMATION PRESENTED IN PRESCRIBED FORMS OR SCHEDULES

The Auditor’s Report

Printed forms or schedules sometimes are designed or adopted by the agencies with which they are to be filed. These forms or schedules might prescribe wording of the auditor’s report that is not acceptable to the auditor because it does not conform to the standards of reporting. When a printed auditor’s report form contains an assertion that the independent auditor believes he or she is not justified in making, the auditor should either reword the form or attach a separate report.

AU INTERPRETATIONS

Auditors’ Special Reports on Property and Liability Insurance Companies’ Loss Reserves(Issued May 1981; Revised February 1999; Revised October 2000; Revised 2009)

State regulatory agencies may require property and liability insurance companies to file the statement of a qualified loss reserve specialist setting forth his or her opinion on the loss and loss adjustment expense reserves.

An independent auditor who has the competence may be a qualified loss reserve specialist. In these circumstances, the auditor who expresses an opinion on the loss and loss expense reserves should be guided by the provisions of the section pertaining to auditors’ reports expressing an opinion on one or more specified elements, accounts, or items of a financial statement.

A report issued under these circumstances and the schedule of liabilities for losses and loss adjustment expenses that would accompany the report are illustrated in the interpretation. (See AU Illustration 14.)

Reports on the Financial Statements Included in Internal Revenue Form 990, “Return of Organizations Exempt from Income Tax” (Issued December 1991; Revised February 1997; Revised February 1999; Revised October 2000; Revised June 2009)

Form 990 may be used as a uniform annual report by charitable organizations in some states for reporting to both state and federal governments. Many states require an auditor’s opinion on whether the financial statements included in Form 990 are presented fairly in conformity with GAAP. However, financial statements included in a Form 990 used by a charitable organization as a uniform annual report may contain certain material departures from the accounting principles in the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 954 for Health Care Organizations and FASB ASC 958 for Not-for-Profit Organizations.

In most states, the report filed by the charitable organization is used to satisfy statutory requirements, but the regulators make the financial statements and the accompanying auditor’s report a matter of public record. In some situations, there may be public distribution of the charitable organization’s report.

Financial Statements in Conformity with GAAP

If the financial statements are in conformity with GAAP, the auditor can express an unqualified opinion.

Financial Statements Not in Conformity with GAAP

If the financial statements are not in conformity with GAAP, the auditor should consider the distribution of the report to determine whether it is appropriate to issue a special report on financial statements prepared on a basis prescribed by a regulatory agency solely for filing with that agency (see the “AU Illustrations” section). This type of reporting is appropriate if the report is intended solely for filing with regulatory agencies, even though the regulatory agencies might make the auditor’s report a matter of public record by law or regulation. (See AU Illustration 15.)

If there is public distribution of the report of the charitable organization, and the financial statements included in it are not in conformity with GAAP, the auditor’s report described in the preceding paragraph is not appropriate. In these circumstances, the auditor should issue a qualified or adverse opinion. Public distribution occurs when the report is sent unsolicited to contributors or others by the charitable organization.

Reporting on Current-Value Financial Statements That Supplement Historical-Cost Financial Statements in a General-Use Presentation of Real Estate Entities (Issued July 1990; Revised February 1999; Revised October 2000)

The auditor may accept an engagement to report on current-value financial statements that supplement historical-cost financial statements in a general-use presentation of real estate entities only if the following two conditions are met:

1. The measurement and disclosure criteria used in preparing the current-value statements are reasonable.
2. Competent persons using the measurement and disclosure criteria would normally arrive at materially similar measurements or disclosures.

The auditor should consider whether disclosures relating to the current-value statements are adequate, including appropriate disclosure of the basis of presentation, nature of the reporting entity’s properties, status of construction-in-process, valuation bases used for each classification of assets and liabilities, and sources of valuation. These disclosures should be made in the notes in a sufficiently clear and comprehensive manner that enables a knowledgeable reader to understand the current-value financial statements. A restriction on use of the auditor’s report is not necessary because the presentation is only a supplement to historical financial statements rather than being a stand-alone presentation. (See AU Illustration 16.)

Evaluation of the Appropriateness of Informative Disclosures in Insurance Enterprises’ Financial Statements Prepared on a Statutory Basis (Issued December 1991; Revised February 1997. Amended December 2001 by Sop 01-5, Amendments to Specificaicpa Pronouncements for Changes Related to the Naic Codification; Revised January 2005; Revised November 2006)

When financial statements are presented on a statutory basis, the auditor should consider whether the financial statements and notes are informative of matters that may affect their use, understanding, and interpretation.

In the case of an insurance enterprise, most states are expected to adopt the updated Accounting Practices and Procedures Manual, revised by the National Association of Insurance Commissioners (NAIC). Since the revised Manual contains extensive disclosure requirements, the statutory basis of enterprises in states that have adopted the revised Manual will include informative disclosures appropriate for that basis of accounting. However, some states may not adopt the revised Manual or may adopt it with significant departures.

Disclosures in statutory-basis financial statements for items and transactions that are similarly accounted for under a statutory basis and under GAAP should be the same as, or similar to, the required GAAP disclosures unless the revised Manual specifically states the NAIC Codification rejected the GAAP disclosures. Any disclosures required by the revised Manual should also be included. If the state’s required accounting for an item or transaction differs from the accounting in the revised Manual, but is in accordance with GAAP or superseded GAAP, the statutory basis financial statement disclosures for that item or transaction should be the applicable GAAP or superseded GAAP disclosures. Finally, if the accounting required by the state for an item or transaction differs from the accounting in the revised Manual, GAAP, or superseded GAAP, the auditor should be sure that sufficient relevant disclosures are made.

If state requirements have not been revised to reflect new GAAP disclosure requirements, sufficient relevant disclosures should be made.

Reporting on a Special-Purpose Financial Statement That Results in an Incomplete Presentation But Is Otherwise in Conformity with GAAP (Issued May 1995; Revised February 1999)

An offering memorandum providing information as the basis for negotiating an offer to sell certain assets, or an entire business, or to simply raise funds does not constitute a contractual agreement. The auditor should follow the guidance for reporting GAAP departures in a standard audit report (Section 508) rather than the guidance for a special-purpose financial presentation as described in Section 623.

An agreement between a client and one or more third parties other than the auditor to prepare financial statements using a special-purpose presentation is a contractual agreement, and Section 623 applies. The report’s use should be restricted to the entity, parties to the agreement, or parties negotiating the agreement directly with the entity.

Evaluating the Adequacy of Disclosure and Presentation in Financial Statements Prepared in Conformity with an Other Comprehensive Basis of Accounting (Issued January 1998; Revised January 2005; Revised June 2009)

Note disclosures in these types of OCBOA financial statements should contain disclosures similar to GAAP for financial statement items that are the same as, or similar to, those prepared in conformity with GAAP. However, in applying that general guideline, the following modifications may be made:

1. Brief and less detailed is fine.
2. Quantification is not necessary.
3. Communication of substance of the disclosure is enough.
4. Disclosures not relevant to the basis of accounting need not be considered.

Examples of these modifications are as follows:

  • Disclosure of the basis of presentation may be limited to a brief identification of the basis and primary differences from GAAP. Quantification of the differences is not required.
  • Disclosure of repayment terms of significant long-term borrowing communicates the substance of future principal reductions, and a schedule of payments for the next five years is not necessary.
  • If the accounting basis does not adjust cost of securities to fair value, then fair value information is not relevant.
  • Information on accounting changes, discontinued operations, and extraordinary items may be disclosed in a note without following the GAAP requirements for statement presentation and disclosing net-of-tax effects.
  • Disclosure about use of estimates is not relevant in a presentation that has no estimates such as one based on cash receipts and disbursements.

Auditor Reports on Regulatory Accounting or Presentation When the Regulated Entity Distributes the Financial Statements to Parties other than the Regulatory Agency Either Voluntarily or Upon Specific Request (Issued January 2005)

When financial statements prepared for a regulated entity are to be used outside that entity, the auditor should modify the standard form of report because of departures from GAAP and then state in an additional paragraph an opinion on whether the financial statements are presented in conformity with the regulatory basis of accounting.

AU ILLUSTRATIONS

Illustrations 1–16 illustrate auditor’s reports adapted from AU Section 623 and its interpretations.

Illustration 1. Financial Statements Prepared on the Entity’s Income Tax Basis
To the Board of Directors
Main City, USA
Independent Auditor’s Report
We have audited the accompanying statements of assets, liabilities, and capital-income tax basis of Widget Partnership as of December 31, 20X6, and 20X5, and the related statements of revenue and expenses-income tax basis and of changes in partners’ capital accounts-income tax basis for the years then ended. These financial statements are the responsibility of the Partnership’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 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 audits provide a reasonable basis for our opinion.
As described in Note A, these financial statements were prepared on the basis of accounting the Partnership uses for income tax purposes, which is a comprehensive basis of accounting other than generally accepted accounting principles.
In our opinion, the financial statements referred to above present fairly, in all material respects, the assets, liabilities, and capital of Widget Partnership as of December 31, 20X6 and 20X5, and its revenue and expenses and changes in partners’ capital accounts for the years then ended, on the basis of accounting described in Note A.
Smith and Jones
February 15, 20X6
Illustration 2. Financial Statements Prepared on the Cash Basis
To the Board of Directors
Main City, USA
Independent Auditor’s Report
We have audited the accompanying statements of assets and liabilities arising from cash transactions of Widget Company as of December 31, 20X6 and 20X5, and the related statements of revenue collected and expenses paid for the years then ended. 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 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 presentations. We believe that our audits provide a reasonable basis for our opinion.
As described in Note A, these financial statements were prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.
In our opinion, the financial statements referred to above present fairly, in all material respects, the assets and liabilities arising from cash transactions of Widget Company as of December 31, 20X6 and 20X5, and its revenues collected and expenses paid during the years then ended, on the basis of accounting described in Note A.
Smith and Jones
February 15, 20X6
Illustration 3. Financial Statements Prepared on a Basis Prescribed by a Regulatory Agency Solely For Filing with That Agency1
To the Board of Directors
Main City, USA
Independent Auditor’s Report
We have audited the accompanying statutory statements of admitted assets, liabilities, and surplus of Carmichael Insurance Company as of December 31, 20X6 and 20X5, and the related statutory statements of income and changes in surplus and cash flows for the years then ended. 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 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 audits provide a reasonable basis for our opinion.
As described more fully in Note A to the financial statements, these financial statements were prepared in conformity with the accounting practices prescribed or permitted by the Insurance Department of [State], which is a comprehensive basis of accounting other than generally accepted accounting principles.
In our opinion, the financial statements referred to above present fairly, in all material respects, the admitted assets, liabilities, and surplus of Carmichael Insurance Company as of [at] December 31, 20X6 and 20X5, and the results of its operations and its cash flows for the years then ended, on the basis of accounting described in Note A.
This report is intended solely for the information and use of the board of directors and the management of Carmichael Insurance Company and the New York State Insurance Department and is not intended to be, and should not be, used by anyone other than these specified parties.
Smith and Jones
February 15, 20X6
Illustration 4. Report on Specified Elements, Accounts, or Items Relating to Accounts Receivable
To the Board of Directors
Main City, USA
Independent Auditor’s Report
We have audited the accompanying schedule of accounts receivable of Widget Company as of December 31, 20X6. This schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion on this schedule 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 schedule of accounts receivable is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the schedule of accounts receivable. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall schedule presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the schedule of accounts receivable referred to above presents fairly, in all material respects, the accounts receivable of Widget Company as of December 31, 20X6, in conformity with accounting principles generally accepted in the United States of America.
Smith and Jones
February 15, 20X6
Illustration 5. Report on Specified Elements, Accounts, or Items Relating to Amount of Sales for the Purpose of Computing Rental
To the Board of Directors
Main City, USA
Independent Auditor’s Report
We have audited the accompanying schedule of gross sales [as defined in the lease agreement dated March 4, 20X0, between Widget Company, as lessor, and Carmichael Stores Corporation, as lessee] of ABC Stores Corporation at its Main Street Store, [City], [State], for the year ended December 31, 20X6. This schedule is the responsibility of Carmichael Stores Corporation’s management. Our responsibility is to express an opinion on this schedule 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 schedule of gross sales is free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the schedule of gross sales. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall schedule presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the schedule of gross sales referred to above presents fairly, in all material respects, the gross sales of ABC Stores Corporation at its Main Street store, Main City, USA, for the year ended December 31, 20X6, as defined in the lease agreement referred to in the first paragraph.
This report is intended solely for the information and use of the boards of directors and managements of ABC Stores Corporation and Widget Company and is not intended to be, and should not be, used by anyone other than these specified parties.
Smith and Jones
February 15, 20X6
Illustration 6. Report on Specified Elements, Accounts, or Items Relating to Royalties with Disclosure of Management’s Interpretation of Agreement
To the Board of Directors
Main City, USA
Independent Auditor’s Report
We have audited the accompanying schedule of royalties applicable to engine production of the Q Division of Widget Corporation for the year ended December 31, 20X6, under the terms of a license agreement dated May 14, 20X0, between ABC Company and Widget Corporation. This schedule is the responsibility of Widget Corporation’s management. Our responsibility is to express an opinion on this schedule 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 schedule of royalties is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the schedule. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall schedule presentation. We believe that our audit provides a reasonable basis for our opinion.
We have been informed that, under Widget Corporation’s interpretation of the agreement referred to in the first paragraph, royalties were based on the number of engines produced after giving effect to a reduction for production retirements that were scrapped, but without a reduction for field returns that were scrapped, even though the field returns were replaced with new engines without charge to customers.
In our opinion, the schedule of royalties referred to above presents fairly, in all material respects, the number of engines produced by the Q Division of Widget Corporation during the year ended December 31, 20X6, and the amount of royalties applicable thereto, under the license agreement referred to above.
This report is intended solely for the information and use of the boards of directors and managements of Widget Corporation and ABC Company and is not intended to be, and should not be, used by anyone other than these specified parties.
Smith and Jones
February 15, 20X6
Illustration 7. Report on Specified Elements, Accounts, or Items Relating to a Profit Participation with Identification of Relevant Agreements
To the Board of Directors
Main City, USA
Independent Auditor’s Report
We have audited, in accordance with auditing standards generally accepted in the United States of America, the financial statements of Basic Company for the year ended December 31, 20X5, and have issued our report thereon dated March 10, 20X6. We have also audited Basic Company’s schedule of Jane Doe’s profit participation for the year ended December 31, 20X5. This schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion on this schedule based on our audit.
We conducted our audit of the schedule 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 schedule of profit participation is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the schedule. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall schedule presentation. We believe that our audit provides a reasonable basis for our opinion.
We have been informed that the documents that govern the determination of Jane Doe’s profit participation are (1) the employment agreement between Jane Doe and Basic Company dated February 1, 20X0, (2) the production and distribution agreement between Basic Company and Television Network Incorporated dated March 1, 20X0, and (3) the studio facilities agreement between Basic Company and QRZ Studios dated April 1, 20X0, as amended November 1, 20X0.
In our opinion, the schedule of profit participation referred to above presents fairly, in all material respects, Jane Doe’s participation in the profits of Basic Company for the year ended December 31, 20X5, in accordance with the provisions of the agreements referred to above.
This report is intended solely for the information and use of the boards of directors and management of Basic Company and Jane Doe and is not intended to be, and should not be, used by anyone other than these specified parties.
Smith and Jones
February 15, 20X6
Illustration 8. Report on Specified Elements, Accounts, or Items Relating to Federal And State Income Taxes Included in Financial Statements with Reference to Audit Report on Related Financial Statements
To the Board of Directors
Main City, USA
Independent Auditor’s Report
We have audited, in accordance with auditing standards generally accepted in the United States of America, the financial statements of Widget Company, Inc., for the year ended June 30, 20X5, and have issued our report thereon dated August 15, 20X5. We have also audited the current and deferred provision for the Company’s federal and state income taxes for the year ended June 30, 20X5, included in those financial statements, and the related asset and liability tax accounts as of June 30, 20X5. This income tax information is the responsibility of the Company’s management. Our responsibility is to express an opinion on it based on our audit.
We conducted our audit of the income tax information 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 federal and state income tax accounts are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures related to the federal and state income tax accounts. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the federal and state income tax accounts. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the Company has paid or, in all material respects, made adequate provision in the financial statements referred to above for the payment of all federal and state income taxes and for related deferred income taxes that could be reasonably estimated at the time of our audit of the financial statements of Widget Company, Inc., for the year ended June 30, 20X5.
Smith and Jones
February 15, 20X6
Illustration 9. Report on Compliance with Contractual Provisions Given in a Separate Report
To the Board of Directors
Main City, USA
Independent Auditor’s Report
We have audited, in accordance with auditing standards generally accepted in the United States of America, the balance sheet of Widget Company as of December 31, 20X6, and the related statements of income, retained earnings, and cash flows for the year then ended, and have issued our report thereon dated February 16, 20X6.
In connection with our audit, nothing came to our attention that caused us to believe that the Company failed to comply with the terms, covenants, provisions, or conditions of Section XX to XX, inclusive, of the Indenture dated July 21, 20X0, with Basic Bank in so far as they relate to accounting matters. However, our audit was not directed primarily toward obtaining knowledge of such noncompliance.
This report is intended solely for the information and use of the boards of directors and management of Widget Company and Basic Bank and is not intended to be, and should not be, used by anyone other than these specified parties.
Smith and Jones
February 15, 20X6
Illustration 10. Report on Compliance with Regulatory Requirements Given in a Separate Report When the auditor’s Report on the Financial Statements Included an Explanatory Paragraph Because of a Going Concern Uncertainty
To the Board of Directors
Main City, USA
Independent Auditor’s Report
We have audited, in accordance with auditing standards generally accepted in the United States of America, the balance sheet of Widget Company as of December 31, 20X6, and the related statements of income, retained earnings, and cash flows for the year then ended, and have issued our report thereon dated March 5, 20X6, which included an explanatory paragraph that described the substantial doubt about Widget Company’s ability to continue as a going concern discussed in Note A of those statements.
In connection with our audit, nothing came to our attention that caused us to believe that the Company failed to comply with the accounting provisions in sections (1), (2), and (3) of the [name of state regulatory agency]. However, our audit was not directed primarily toward obtaining knowledge of such noncompliance.
This report is intended solely for the information and use of the board of directors and management of Widget Company and the NY Insurance Department and is not intended to be, and should not be, used by anyone other than these specified parties.
Smith and Jones
February 15, 20X6
Illustration 11. Report on a Schedule of Gross Income and Certain Expenses to Meet a Regulatory Requirement and to Be Included in a Document Distributed to the General Public2
To the Audit Committee, Board of Directors, and Shareholders
Main City, USA
Report of Independent Registered Public Accounting Firm
We have audited the accompanying Historical Summaries of Gross Income and Direct Operating Expenses of Basic Apartments, City, State (Historical Summaries), for each of the three years in the period ended December 31, 20X5. These Historical Summaries are the responsibility of the Apartments’ management. Our responsibility is to express an opinion on the Historical Summaries based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (PCAOB; United States). This report is prepared to comply with the requirements of the SEC. Therefore, the authors have assumed that the auditor is preparing the report for an issuer client and has complied with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the Historical Summaries are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the Historical Summaries. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the Historical Summaries. We believe that our audits provide a reasonable basis for our opinion.
The accompanying Historical Summaries were prepared for the purpose of complying with the rules and regulations of the Securities and Exchange Commission (for inclusion in the registration statement on Form S-11 of DEF Corporation) as described in Note A and are not intended to be a complete presentation of the Apartments’ revenues and expenses.
In our opinion, the Historical Summaries referred to above present fairly, in all material respects, the gross income and direct operating expenses described in Note A of Basic Apartments for each of the three years in the period ended December 31, 20X5, in conformity with accounting principles generally accepted in the United States of America.
Smith and Jones
February 15, 20X6
Illustration 12. Report on Statement of Assets and Liabilities Transferred to Comply with a Contractual Agreement
To the Board of Directors
Main City, USA
Independent Auditor’s Report
We have audited the accompanying statement of net assets sold of Widget Company as of June 8, 20X5. This statement of net assets sold is the responsibility of Widget Company’s management. Our responsibility is to express an opinion on the statement of net assets sold 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 statement of net assets sold is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the statement. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the statement of net assets sold. We believe that our audit provides a reasonable basis for our opinion.
The accompanying statement was prepared to present the net assets of Widget Company sold to Basic Corporation pursuant to the purchase agreement described in Note X, and is not intended to be a complete presentation of Widget Company’s assets and liabilities.
In our opinion, the accompanying statement of net assets sold presents fairly, in all material respects, the net assets of Widget Company as of June 8, 20X5, sold pursuant to the purchase agreement referred to in Note X, in conformity with accounting principles generally accepted in the United States of America.
This report is intended solely for the information and use of the boards of directors and managements of Widget Company and Basic Corporation and is not intended to be, and should not be, used by anyone other than these specified parties.
Smith and Jones
February 15, 20X6
Illustration 13. Report on Financial Statements Prepared Pursuant to a Loan Agreement That Results in a Presentation Not in Conformity with Generally Accepted Accounting Principles or an Other Comprehensive Basis of Accounting
To the Board of Directors
Main City, USA
Independent Auditor’s Report
We have audited the special-purpose statement of assets and liabilities of Widget Company as of December 31, 20X6 and 20X5, and the related special-purpose statements of revenues and expenses and of cash flows for the years then ended. 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 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 audits provide a reasonable basis for our opinion.
The accompanying special-purpose financial statements were prepared for the purpose of complying with Section 4 of a loan agreement between Basic Bank and the Company as discussed in Note X, and are not intended to be a presentation in conformity with generally accepted accounting principles.
In our opinion, the special-purpose financial statements referred to above present fairly, in all material respects, the assets and liabilities of Widget Company as of December 31, 20X6 and 20X5, and the revenues, expenses and cash flows for the years then ended, on the basis of accounting described in Note X.
This report is intended solely for the information and use of the boards of directors and managements of Widget Company and Basic Bank and is not intended to be, and should not be, used by anyone other than these specified parties.
Smith and Jones
February 15, 20X6
Illustration 14. Auditor’s Report Expressing an Opinion on an Insurance Company’s Loss and Loss Adjustment Expense Reserves and the Schedule That Would Accompany the Report
Board of Directors
X Insurance Company
We are members of the American Institute of Certified Public Accountants (AICPA) and are the independent public accountants of Basic Insurance Company. We acknowledge our responsibility under the AICPA’s Code of Professional Conduct to undertake only those engagements which we can complete with professional competence.
We have audited the financial statements prepared in conformity with accounting principles generally accepted in the United States of America [or prepared in conformity with accounting practices prescribed or permitted by the Insurance Department of the State of New York] of Basic Insurance Company as of December 31, 20X5, and have issued our report thereon dated March 1, 20X6. In the course of our audit, we have audited the estimated liabilities for unpaid losses and unpaid loss adjustment expenses of Basic Insurance Company as of December 31, 20X5, as set forth in the accompanying schedule including consideration of the assumptions and methods relating to the estimation of such liabilities.
In our opinion, the accompanying schedule presents fairly, in all material respects, the estimated unpaid losses and unpaid loss adjustment expenses of Basic Insurance Company that could be reasonably estimated at December 31, 20X5, in conformity with accounting practices prescribed or permitted by the Insurance Department of the State of New York on a basis consistent with that of the preceding year.
This report is intended solely for the information and use of the board of directors and management of Basic Insurance Company and Insurance Department of the State of New York and is not intended to be, and should not be, used by anyone other than these specified parties.
Smith and Jones
February 15, 20X6

Basic Insurance Company Schedule of Liabilities for Losses and Loss Adjustment Expenses December 31, 20X5

Liability for losses $xx,xxx,xxx
Liability for loss adjustment expenses x,xxx,xxx
  Total $xx,xxx,xxx
Note 1—Basis of presentation
The above schedule has been prepared in conformity with accounting practices prescribed or permitted by the Insurance Department of the State of New York. [Significant differences between statutory practices and generally accepted accounting principles for the calculation of the above amounts should be described, but the monetary effect of any such differences need not be stated.]
Losses and loss adjustment expenses are provided for when incurred in accordance with the applicable requirements of the insurance laws [and/or regulations] of the State of New York. Such provisions include (1) individual case estimates for reported losses, (2) estimates received from other insurers with respect to reinsurance assumed, (3) estimates for unreported losses based on past experience modified for current trends, and (4) estimates of expenses for investigating and settling claims.
Note 2—Reinsurance
The Company reinsures certain portions of its liability insurance coverages to limit the amount of loss on individual claims and purchases catastrophe insurance to protect against aggregate single occurrence losses. Certain portions of property insurance are reinsured on a quota share basis.
The liability for losses and the liability for loss adjustment expense were reduced by $xxx,xxx and $xxx,xxx, respectively, for reinsurance ceded to other companies.
Contingent liability exists with respect to reinsurance which would become an actual liability in the event the reinsuring companies, or any of them, might be unable to meet their obligations to the Company under existing reinsurance agreements.
Illustration 15. Auditor’s Report on the Financial Statements Included in Internal Revenue Service Form 990, “Return of Organizations Exempt from Income Tax”
To the Board of Directors
Main City, USA
Independent Auditor’s Report
We have audited the balance sheet (Part IV) of Basic Charity as of December 31, 20X5, and the related statement of revenue, expenses, and changes in net assets (Part I) and statement of functional expenses (Part II) for the year then ended included in the accompanying Internal Revenue Service Form 990. These financial statements are the responsibility of Basic Charity’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, these financial statements were prepared in conformity with accounting practices prescribed by the Internal Revenue Service and the Office of the State of New York, which is a comprehensive basis of accounting other than generally accepted accounting principles.
In our opinion, the financial statements referred to above present fairly, in all material respects, the assets, liabilities and fund balances of Basic Charity as of December 31, 20X5, and its revenue, expenses, and changes in fund balances for the year then ended on the basis of accounting described in Note X.
Our audit was made for the purpose of forming an opinion on the above financial statements taken as a whole. The accompanying information on pages 12–15 is presented for purposes of additional analysis and is not a required part of the above financial statements. Such information, except for that portion marked “unaudited,” on which we express no opinion, has been subjected to the auditing procedures applied in the audit of the above financial statements; and, in our opinion, the information is fairly stated in all material respects in relation to the financial statements taken as a whole.
This report is intended solely for the information and use of the board of directors and management of Basic Charity, the Internal Revenue Service, and the Office of the State of New York and is not intended to be, and should not be, used by anyone other than these specified parties.
Smith and Jones
February 15, 20X6
Illustration 16. Auditor’s Report on Current-Value Financial Statements That Supplement Historical Cost Financial Statements in a General-Use Presentation of a Real Estate Entity
To the Audit Committee and Board of Directors
Main City, USA
Independent Auditor’s Report
We have audited the accompanying historical-cost balance sheet of Basic Company as of December 31, 20X3 and 20X6, and the related historical-cost statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 20X3. We have also audited the supplemental current-value balance sheets of Basic Company as of December 31, 20X3 and 20X6, and the related supplemental current value statements of income and shareholders’ equity for each of the three years in the period ended December 31, 20X3. 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 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 audits provide a reasonable basis for our opinion.
In our opinion, the historical-cost financial statements referred to above present fairly, in all material respects, the financial position of Basic Company as of December 31, 20X3 and 20X6, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 20X3, in conformity with accounting principles generally accepted in the United States of America.
As described in Note 1, the supplemental current-value financial statements have been prepared by management to present relevant financial information that is not provided by the historical-cost financial statements, and are not intended to be a presentation in conformity with generally accepted accounting principles. In addition, the supplemental current-value financial statements do not purport to present the net realizable, liquidation, or market value of the Company as a whole. Furthermore, amounts ultimately realized by the Company from the disposal of properties may vary significantly from the current values presented.
In our opinion, the supplemental current-value financial statements referred to above present fairly, in all material respects, the information set forth in them on the basis of accounting described in Note 1.
Smith and Jones
February 15, 20X6

AU-C ILLUSTRATIONS

The following reports on compliance with aspects of contractual agreements or regulatory requirements in connection with audited financial statements are illustrated:

1. A Report on Compliance with Aspects of Contractual Agreements Provided in a Separate Report When No Instances of Noncompliance Are Identified
2. A Report on Compliance with Aspects of Contractual Agreements Provided in a Separate Report When Instances of Noncompliance Are Identified
3. A Report on Compliance with Aspects of Contractual Agreements Provided in a Separate Report When Instances of Noncompliance Are Identified and a Waiver Has Been Obtained
4. A Report on Compliance with Aspects of Contractual Agreements Provided in a Separate Report When Instances of Noncompliance Are Identified and the Auditor Has Disclaimed an Opinion on the Financial Statements
5. A Report on Compliance with Aspects of Contractual Agreements Given in a Combined Report, and No Instances of Noncompliance Were Identified
Illustration 1. A Report on Compliance with Aspects of Contractual Agreements Provided in a Separate Report When No Instances of Noncompliance Are Identified
Independent Auditor’s Report
[Appropriate Addressee]
We have audited, in accordance with auditing standards generally accepted in the United States of America, the financial statements of XYZ Company, which comprise the balance sheet as of December 31, 20X2, and the related statements of income, changes in stockholders’ equity, and cash flows for the year then ended, and the related notes to the financial statements, and have issued our report thereon dated February 16, 20X3.
In connection with our audit, nothing came to our attention that caused us to believe that XYZ Company failed to comply with the terms, covenants, provisions, or conditions of sections XX to YY, inclusive, of the Indenture dated July 21, 20X0, with ABC Bank, insofar as they relate to accounting matters. However, our audit was not directed primarily toward obtaining knowledge of such noncompliance. Accordingly, had we performed additional procedures, other matters may have come to our attention regarding the Company’s noncompliance with the above-referenced terms, covenants, provisions, or conditions of the Indenture, insofar as they relate to accounting matters.
This report is intended solely for the information and use of the board of directors and management of XYZ Company and ABC Bank and is not intended to be and should not be used by anyone other than these specified parties.
[Auditor’s signature]
[Auditor’s city and state]
[Date of the auditor’s report]
Illustration 2. A Report on Compliance with Aspects of Contractual Agreements Provided in a Separate Report When Instances of Noncompliance Are Identified
Independent Auditor’s Report
[Appropriate Addressee]
We have audited, in accordance with auditing standards generally accepted in the United States of America, the financial statements of XYZ Company, which comprise the balance sheet as of December 31, 20X2, and the related statements of income, changes in stockholders’ equity, and cash flows for the year then ended, and the related notes to the financial statements, and have issued our report thereon dated March 5, 20X3.
In connection with our audit, we noted that XYZ Company failed to comply with the “Working Capital” provision of section XX of the Loan Agreement dated March 1, 20X2, with ABC Bank. Our audit was not directed primarily toward obtaining knowledge as to whether XYZ Company failed to comply with the terms, covenants, provisions, or conditions of sections XX to YY, inclusive, of the Loan Agreement, insofar as they relate to accounting matters. Accordingly, had we performed additional procedures, other matters may have come to our attention regarding noncompliance with the above-referenced terms, covenants, provisions, or conditions of the Loan Agreement, insofar as they relate to accounting matters.
This report is intended solely for the information and use of the board of directors and management of XYZ Company and ABC Bank and is not intended to be and should not be used by anyone other than these specified parties.
[Auditor’s signature]
[Auditor’s city and state]
[Date of the auditor’s report]
Illustration 3. A Report on Compliance with Aspects of Contractual Agreements Provided in a Separate Report When Instances of Noncompliance Are Identified and a Waiver Has Been Obtained
Independent Auditor’s Report
[Appropriate Addressee]
We have audited, in accordance with auditing standards generally accepted in the United States of America, the financial statements of XYZ Company, which comprise the balance sheet as of December 31, 20X2, and the related statements of income, changes in stockholders’ equity, and cash flows for the year then ended, and the related notes to the financial statements, and have issued our report thereon dated March 5, 20X3.
In connection with our audit, we noted that XYZ Company failed to comply with the “Working Capital” provision of section XX of the Loan Agreement dated March 1, 20X2, with ABC Bank. The Company has received a waiver dated February 5, 20X3, from ABC Bank. Our audit was not directed primarily toward obtaining knowledge as to whether XYZ Company failed to comply with the terms, covenants, provisions, or conditions of sections XX to YY, inclusive, of the Loan Agreement, insofar as they relate to accounting matters. Accordingly, had we performed additional procedures, other matters may have come to our attention regarding noncompliance with the above-referenced terms, covenants, provisions, or conditions of the Loan Agreement, insofar as they relate to accounting matters.
This report is intended solely for the information and use of the board of directors and management of XYZ Company and ABC Bank and is not intended to be and should not be used by anyone other than these specified parties.
[Auditor’s signature]
[Auditor’s city and state]
[Date of the auditor’s report]
Illustration 4. A Report on Compliance with Aspects of Contractual Agreements Provided in a Separate Report When Instances of Noncompliance Are Identified, and the Auditor Has Disclaimed an Opinion on the Financial Statements
Independent Auditor’s Report
[Appropriate Addressee]
We were engaged to audit, in accordance with auditing standards generally accepted in the United States of America, the financial statements of XYZ Company, which comprise the balance sheet as of December 31, 20X2, and the related statements of income, changes in stockholders’ equity, and cash flows for the year then ended, and the related notes to the financial statements, and have issued our report thereon dated March 5, 20X3. Our report disclaims an opinion on such financial statements because of [describe the scope limitation or matter causing the disclaimer].
In connection with our engagement, we noted that XYZ Company failed to comply with the “Working Capital” provision of section XX of the Loan Agreement dated March 1, 20X2, with ABC Bank. Our engagement was not directed primarily toward obtaining knowledge as to whether XYZ Company failed to comply with the terms, covenants, provisions, or conditions of sections XX to YY, inclusive, of the Loan Agreement, insofar as they relate to accounting matters. Accordingly, had we been able to complete the audit, other matters may have come to our attention regarding noncompliance with the above-referenced terms, covenants, provisions, or conditions of the Loan Agreement, insofar as they relate to accounting matters.
This report is intended solely for the information and use of the board of directors and management of XYZ Company and ABC Bank and is not intended to be and should not be used by anyone other than these specified parties.
[Auditor’s signature]
[Auditor’s city and state]
[Date of the auditor’s report]
Illustration 5. A Report on Compliance with Aspects of Contractual Agreements Provided in a Separate Report When No Instances of Noncompliance Are Identified
Independent Auditor’s Report
[Appropriate Addressee]
Report on the Financial Statements
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 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 financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the 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 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.fn 2 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 audit option.
Opinion
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ABC Company as of December 31, 20X1, and the results of its operations and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America.
Other Matter
In connection with our audit, nothing came to our attention that caused us to believe that ABC Company failed to comply with the terms, covenants, provisions, or conditions of sections XX to YY, inclusive, of the Indenture dated July 21, 20X0 with XYZ Bank, insofar as they relate to accounting matters. However, our audit was not directed primarily toward obtaining knowledge of such noncompliance. Accordingly, had we performed additional procedures, other matters may have come to our attention regarding the Company’s noncompliance with the above-referenced terms, covenants, provisions, or conditions of the Indenture, insofar as they relate to accounting matters.
Restricted Use Relating to the Other Matter
The communication related to compliance with the aforementioned Indenture described in the Other Matter paragraph is intended solely for the information and use of the boards of directors and management of ABC Company and XYZ Bank and is not intended to be and should not be used by anyone other than these specified parties.fn 3
Report on Other Legal and Regulatory Requirements
[Form and content of this section of the auditor’s report will vary depending on the nature of the auditor’s other reporting responsibilities.]
[Auditor’s signature]
[Auditor’s city and state]
[Date of the auditor’s report]
[Illustration added, December 2011, to reflect conforming changes necessary due to the issuance of SAS No. 125.]

1 This report is presented in SOP 01-5, Amendments to Specific AICPA Pronouncements for Changes Related to the NAIC Codification. The amendments in SOP 01-5 are effective for audits of statutory financial statements for fiscal years ending on or after December 15, 2001. Retroactive application is not permitted.

1 We assume that, since the historical summaries are prepared for the purpose of complying with the rules and regulations of the SEC, the client is most likely to be an issuer and the auditor would be following the standards of the Public Company Accounting Oversight Board (PCAOB).

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