AU 431: Adequacy of Disclosure in Financial Statements

AU-C 705: Modifications to the Opinion in the Independent Auditor’s Report

AU EFFECTIVE DATE AND APPLICABILITY

Original Pronouncement Statement on Accounting Standards (SAS) 32.
Effective Date This statement currently is effective.
Applicability Audits of financial statements in accordance with generally accepted auditing standards (GAAS).

AU-C EFFECTIVE DATE AND SUMMARY OF CHANGES

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

AU-C Section 705 has no significant changes from the extant standard.

AU DEFINITIONS OF TERMS

Adequate disclosure. Material matters include the (1) form, (2) arrangement, and (3) content of the financial statements and the appended notes, including:

  • Terminology used
  • Amount of detail given
  • Classification of items
  • Bases of amounts

AU-C DEFINITIONS OF TERMS

Source: AU-C 705.06

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

Pervasive. A term used in the context of misstatements to describe the effects on the financial statements of misstatements or the possible effects on the financial statements of misstatements, if any, that are undetected due to an inability to obtain sufficient appropriate audit evidence. Pervasive effects on the financial statements are those that, in the auditor’s professional judgment:

  • Are not confined to specific elements, accounts, or items of the financial statements;
  • If so confined, represent or could represent a substantial proportion of the financial statements; or
  • With regard to disclosures, are fundamental to users’ understanding of the financial statements.

OBJECTIVES OF AU SECTION 431

This section is a carryover from the explanation of the reporting standard on adequate disclosure issued when GAAS were originally proposed in 1947. Thus, it is more philosophical than operational.

OBJECTIVES OF AU-C SECTION 705

AU-C section 705 states that

. . . the objective of the auditor is to express clearly an appropriately modified opinion on the financial statements that is necessary when

a. the auditor concludes, based on the audit evidence obtained, that the financial statements as a whole are materially misstated or
b. the auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement.”

FUNDAMENTAL REQUIREMENTS

Reporting Standard

According to 431.01, the third standard of reporting is “Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report.”

Basic Requirement

If management fails to disclose information required by generally accepted accounting principles (GAAP), the auditor should:

1. Issue a qualified or adverse opinion
2. Provide the information in the report (see below for exceptions to this requirement)

Exceptions to Need to Include Information

The auditor may omit the information from the audit report if:

1. The omission is recognized as appropriate by an AU section.
2. The information is not reasonably obtainable from management’s accounts and records.
3. Providing the information would require the auditor to assume the position of a preparer of financial information. For example, an auditor would not be expected to provide:
a. A basic financial statement, such as a statement of cash flows
b. Segment information

Accounting Services Permissible

An independent auditor may participate in preparing financial statements, including accompanying notes. This participation does not change the character of the statements as management’s representations.

NOTE: This means that providing accounting services in conjunction with an audit is permissible and the fact that the auditor rather than management has prepared disclosure information does not create any reporting requirement. (However, for a Securities and Exchange Commission [SEC] reporting company, the auditor would lose his or her independence by performing accounting services such as bookkeeping.)

INTERPRETATIONS

There are no interpretations for this section.

TECHNIQUES FOR APPLICATION

To aid the auditor in determining that all material matters have been adequately disclosed, a disclosure checklist may be completed at the end of the audit. The auditor may prepare his or her own disclosure checklists; however, checklists may be obtained from many sources, such as the American Institute of Certified Public Accountants (AICPA).

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