Auditor S Responsibilities and Reports

From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton

CHAPTER 2 AUDITOR’S RESPONSIBILITIES AND REPORTS

Learning Objectives

The learning objectives for Chapter 2 have been stated in terms of Auditor Knowledge that the student should understand and two important Audit Decisions that the student should be able to make. They are: Auditor Knowledge 1. Know the relationship between accounting and auditing. 2. Understand how the concept of verifiability relates to the concept of “fair presentation, in all material respects.” 3. Understand the auditor’s relationship with management, the board of directors, the audit committee, and other groups. 4. Know the 10 generally accepted auditing standards. 5. Understand some important auditor’s responsibilities that are implied by completing the audit. 6. Understand the basic elements of the auditor’s standard report on financial statements. 7. Understand the basic elements of the auditor’s standard report on internal controls over financial reporting.

Audit Decisions 1. When should the auditor use a nonstandard report on financial statements? 2. When should the auditor use a nonstandard report on internal controls over financial reporting?

Chapter Outline

1. Chapter-opening Vignette: Auditor’s Responsibility for Going Concern, 42 2. Preview of Chapter 2, 43 3. Focus on Auditor Knowledge, 43 4. Focus on Audit Decisions, 44 5. Fundamentals Underlying Financial Statement Audits, 44 5.1. Relationship Between Accounting and Auditing, 44…….. (Figure 2-1: Relationship Between Accounting and Auditing) 5.2. Verifiability, Professional Judgment, and Fair Presentation, 45 5.3. Independent Auditor Relationships, 47

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-1 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton 5.3.1. Management, 47 5.3.2. Board of Directors and Audit Committee, 48 5.3.3. Internal Auditors, 48 5.3.4. Stockholders, 49 5.3.5. Who is the Client? 49 6. Auditing Standards 6.1. Generally Accepted Auditing Standards …..(Figure 2-2: Generally Accepted Auditing Standards), 50 6.1.1. General Standards, 50 6.1.1.1. Adequate Technical Training and Proficiency, 50 6.1.1.2. Independence in Mental Attitude, 50 6.1.1.3. Due Professional Care, 51 6.1.2. Standards of Fieldwork, 52 6.1.2.1. Adequate Planning and Proper Supervision, 52 6.1.2.2. Understanding the Entity and its Environment, including Internal Control, 52 6.1.2.3. Sufficient, Competent Audit Evidence, 52 6.1.3. Standards of Reporting, 52 6.1.3.1. Financial Statements Presented in Accordance with GAAP, 52 6.1.3.2. Consistency in the Application of GAAP, 53 6.1.3.3. Adequacy of Informative Disclosures, 53 6.1.3.4. Expression of Opinion, 53 6.1.4. Applicability of Generally Accepted Auditing Standards, 54 6.2. Statements on Auditing Standards, 54 6.3. PCAOB Auditing Standards, 54 7. Assurance Provided by An Audit, 55 7.1. Auditor Independence, 56 7.2. Reasonable Assurance, 56 7.3. Detecting and Reporting Fraud, 57 7.3.1. Responsibility to Detect Fraud, 57 7.3.2. Responsibility to Report Fraud, 58 7.4. Detecting and Reporting Illegal Acts, 59 7.4.1. Responsibility to Detect Illegal Acts, 59 7.4.2. Responsibility to Report Illegal Acts, 60 7.5. Evaluation of Internal Control, 61 7.6. Assurance about Going Concern, 61 7.7. A Clean Bill of Health? 62 8. The Auditor’s Report on Financial Statements, 64

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-2 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton 8.1. The Standard Report on Financial Statements, 64 ……….… (Figure 2-3: Auditor’s Standard Report on Financial Statements) 8.1.1. Title and Address, 66 8.1.2. Introductory Paragraph, 66 8.1.3. Scope Paragraph, 66 8.1.4. Opinion Paragraph, 67 8.2. Departures from the Standard Report, 68 …………….....(Figure 2-4: Types of Auditor’s Reports and Circumstances) 8.2.1. Standard Report with Explanatory Language, 68 8.2.2. Other Types of Opinions, 69 9. The Auditor’s Report on Internal Control, 72 9.1. The Standard Report on Internal Control, 72 ………………(Figure 2-5: Auditor’s Standard Report on Internal Control over Financial Reporting) 9.1.1. Title and Address, 72 9.1.2. Introductory Paragraph, 72 9.1.3. Scope Paragraph, 74 9.1.4. Definition Paragraph, 75 9.1.5. Inherent Limitations Paragraph, 76 9.1.6. Opinion Paragraph, 76 9.1.7. Explanatory Paragraph, 77 9.1.8. Signature and Date, 77 9.2. Departures from the Standard Report, 78 … ….(Figure 2-6: Example Criteria for Evaluating a deficiency in Internal Control) ….(Figure 2-7: Departures from the Standard Report on Internal Control over Financial Reporting) 9.2.1. Material Weakness in Internal Control over Financial Reporting, 79 9.2.2. Significant Deficiency in Internal Control over Financial Reporting, 80 9.2.3. Scope Limitations, 80 9.2.4. Are Companies Ready for Audit s of their Internal Controls over Financial Reporting? 81 10. Focus on Auditor Knowledge and Audit Decisions, 82 …. (Figure 2-8: Summary of Auditor Knowledge Discussed in Chapter 2) …. (Figure 2-9: Summary of Audit Decisions Discussed in Chapter 2) 11. Appendix 2a: Example Departures from the Standard Audit Report, 84 11.1. Unqualified Opinion on the Financial Statements with Explanatory Language Regarding Going Concern, 85 11.2. Unqualified Opinion on the Financial Statements with Explanatory Language Regarding a Change in Accounting Principle Accounted for in Conformity with GAAP, 86

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-3 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton 11.3. Unqualified Opinion on the Financial Statements with Opinion based in part of the report of auditor where there is no scope limitation or nonconformity with GAAP, 87 11.4. Unqualified Opinion on the Financial Statements with emphasis of a matter by the auditor, 88 11.5. Qualified Opinion for Departure from GAAP, 89 11.6. Qualified Opinion for Scope Limitation, 90 11.7. Adverse Opinion for Departure fro GAAP, 91 11.8. Disclaimer of Opinion for Scope Limitation, 92 11.9. Unqualified Opinion – Other Comprehensive Basis of Accounting, 93 12. Objective Questions, online at www.wiley.com/college/boynton 13. Comprehensive Questions, 94 14. Professional Simulation, 100

New to the 8th Edition

The 8th edition has several new features: 1. Chapter-opening vignette that discusses the auditor’s responsibility to evaluate going concern in the context of Enron Corporation.. 2. Focus on audit knowledge and audit decisions at the beginning of the chapter, in the margin throughout the chapter and an end of chapter summary that focus on important auditor knowledge and audit decisions covered in the chapter. 3. New material has been added on the PCAOB. 4. Discussion has been added about the auditor’s report on internal control over financial reporting. 5. A extensive appendix provides examples of many auditor’s reports that may be used by auditors. Along with the examples, the discussion explains what the report means for financial statement users and the auditor’s criteria for using the report. 6. A CPA exam style professional simulation has been added at the end of the chapter.

Focus on Audit Decisions

An explicit focus on audit decisions is new to the 8th edition. Chapter Two addresses two decisions associated with choices about nonstandard audit reports.

First, the chapter looks at when an auditor should use a nonstandard report on financial statements. Figure 2-4 (page 71) should assist in the discussion of when the auditor would use an unqualified opinion with additional explanatory wording, a qualified opinion, and adverse opinion, or a disclaimer of opinion. This figure makes it clear that a departure from GAAP results in a qualified or adverse opinion, depending on the materiality of the departure from GAAP. If the auditor is unable to obtain sufficient, competent evidence (a scope limitation), the

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-4 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton auditor should use a qualified opinion or a disclaimer of opinion, depending on the materiality of the scope limitation. The text also makes it clear that material, client imposed scope limitations result in a disclaimer of opinion.

Second, the chapter addresses the conditions that would cause the auditor to use a nonstandard report on internal controls over financial reporting. Figure 2-6 (page 78), explains the criteria for determining if a deficiency in internal controls is an internal control deficiency, a significant deficiency, or a material weakness. Note: Only a material weakness results in reporting to the public through an adverse opinion on the effectiveness of internal control over financial reporting. A significant deficiency is reported to the audit committee or the board of directors, but does not result in a nonstandard auditor’s report on internal controls over financial reporting. Figure 2-7 (page 80) describes the circumstances that result in nonstandard reports on internal controls over financial reporting.

Key Questions for Students

Following is a list of common questions for students that instructors might want to weave into class discussion of Chapter 2 topics. o Develop and example that explains the difference between accounting and auditing. o What is the relationship between accounting and the ability of the auditor to verify financial information? o Explain the independent auditor’s relationship with management? With the board of directors and audit committee? With internal auditors? With shareholders? o Who is the audit client? o Explain each of the three general standards of generally accepted auditing standards. o Explain each of the three field work standards of generally accepted auditing standards. o Explain each of the four reporting standards of generally accepted auditing standards. o Explain the concept of reasonable assurance? Why can the auditor only provide reasonable assurance and not absolute assurance? o Explain the three aspect’s of the auditor’s responsibility to detect fraud. o What is the auditor’s responsibility to report fraud? o How are illegal acts different from fraud? o What is the auditor’s responsibility to detect illegal acts? o What is the auditor’s responsibility to report illegal acts? o In a public company what is the auditor’s responsibility to evaluate internal controls over financial reporting? o How does this responsibility differ in a private company audit? o In a private company audit what assurance does the financial statement user get about internal controls over financial reporting? o What is the auditor’s responsibility to evaluate whether an entity is a going concern? o If a company gets an unqualified opinion from its auditor, does that mean that it is financially healthy?

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-5 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton o What are the key elements communicated in the standard unqualified opinion on financial statements? o When should an auditor use a qualified opinion? o When should an auditor use an adverse opinion? o When should an auditor use a disclaimer of opinion? o What are the key elements communicated in the standard unqualified opinion on internal controls over financial reporting? o Distinguish between a material weakness and a significant deficiency. o In a public company, what is the auditor’s responsibility to report a material weakness? To report a significant deficiency? o Under what circumstances would an auditor withdraw from and engagement to audit internal controls over financial reporting? o When should an auditor use a qualified opinion? o When should an auditor use an adverse opinion? o When should an auditor use a disclaimer of opinion?

Teaching Notes

Chapter 2 focuses on auditor responsibilities and auditor communications with the public. It is broken down into five distinct parts. 1. The Fundamentals Underlying Financial Statement Audits. 2. Auditing Standards 3. The Assurance Provided by an Audit 4. The Auditor’s Report on Financial Statements. 5. The Auditor’s Reports on Internal Controls over Financial Reporting.

The first part of the chapter explains the difference between accounting and auditing. It also focuses on the imprecision that exists in GAAP. Further, an audit cannot add precision to the financial statements. o Figure 2-1 illustrates the relationship between accounting and auditing.

The second part of the chapter focuses on the auditor’s professional responsibilities under Generally Accepted Auditing Standards. It explains the 10 basic auditing standards and explains the role of the PCAOB in setting auditing standards for public companies and the role of the ASB in setting auditing standards for private companies. At the time that this book went to print, the major difference between public company audits and private company audits related to PCAOB Audit Standard No. 2 on Audits of Internal Control over Financial Reporting, which is explained in the last part of the chapter. o Figure 2-2 summarizes the 10 generally accepted auditing standards.

When the student completes, he or she should have a good understanding of the assurance provided by an audit, and be a competent reader of audit reports. The key elements of understanding the assurance provided by an audit that are discussed in this chapter include: o Auditor independence Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-6 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton o Reasonable assurance o Detecting and reporting fraud. o Detecting and reporting illegal acts. o Evaluating internal control. o Evaluating whether an entity is a going concern.

Some common student problems in understanding this material include the following. o While the fraud triangle is discussed in detail in chapter 9, faculty may want to introduce the fraud triangle at this early stage. o Students often have a difficulty distinguishing between fraud and other types of illegal acts. Examples of illegal acts that have a direct and material effect on the financial statements might include a materially misstated tax accrual or a public company making loans to officers and directors. Students also believe that auditors have a higher level of responsibility for indirect effect illegal acts, and students need to be reminded that auditor’s are not qualified to determine if the company has violated environmental or OHSA laws. o It is useful to contrast the responsibility of the auditor of a public company for internal controls (where the auditor issues an opinion on internal controls) and the responsibility of the auditor of a private company for internal controls where the auditor considers internal control in planning the audit (but issues no opinion on internal controls). Readers cannot infer about the quality of internal control by reading an opinion on the financial statements. o When discussing going concern it is important to explain the concept of substantial doubt and what causes the auditor to reach a conclusion about substantial doubt. Students find the discussion of Enron’s financial condition at December 31, 2000 interesting given that it went bankrupt in early December 2001. US Technologies, Inc., (see audit opinion on page 85) provides a helpful contrast of a company that earned a going concern opinion.

The next unit in the chapter focuses on auditor’s reports on financial statements. Figure 2-3 (page 65) provides an example of Intel’s audit report for the year ended December 25, 2004 along with a description of the basic elements of the auditor’s report. Figure 2-4 focuses on departures from the standard audit report. Students often find it helpful to discuss both the type of report and the criteria for using the report. This is the first audit decision that is discussed in Chapter 2. Examples each of these reports are provided in appendix A, and are reproduced at the end of the Chapter 2 instructor’s manual if faculty want to make overheads of the reports.

The final unit of Chapter 2 focuses on auditor’s reports on internal control over financial reporting. Figure 2-5 provides an example of Intel’s audit report on internal controls over financial reporting for the year ended December 25, 2004 along with a description of the basic elements of the auditor’s report. Students should note that the auditor provides two opinions in this report: (1) an opinion on management’s assertion about of internal controls over financial reporting, and (2) an opinion on the effectiveness of the system of internal controls over financial reporting.

Figure 2-6 focuses on the criteria for evaluating a deficiency in internal control. Students often question why a significant deficiency in internal controls over financial reporting does not result in reporting to the public. This is due to the magnitude of the deficiency does not rise to a level

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-7 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton of materiality to require reporting to the public. Only a material weakness is reported to the public in an auditor’s report. A significant deficiency, however, is reported to the board of directors or its audit committee. This discussion is important to understanding the criteria for rendering an adverse opinion on the effectiveness of the system of internal controls over financial reporting.

Figure 2-7 outlines the criteria for issuing the following opinions on internal controls over financial reporting. o Unqualified opinion o Adverse opinion o Qualified opinion o Disclaimer of opinion o Withdraw from the engagement.

17 of the Chapter 2 instructor’s manual provides an example of the adverse opinion on internal controls over financial reporting that was received by the Eastman Kodak Company for the year ended December 31, 2004.

Figure 2-8 provides an end of chapter summary that is tied to the auditor knowledge learning objectives for Chapter 2. Figure 2-9 provides an end of chapter summary that is tied to the audit decision learning objectives for Chapter 2.

Example Audit Reports

The following audit reports are found in appendix A to Chapter 2. They are provided here if instructor’s want to make overheads of these examples.

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-8 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton Unqualified Opinion on the Financial Statements with Explanatory Language regarding Going Concern: The following opinion was issued by Radin, Glass & Co., LLP on April 10, 2002 with respect to the financial statements for U.S. Technologies, Inc. for the years ended December 31, 2001 and 2000. Note: The portions of the auditor’s report that differ from the standard, three-paragraph audit opinion are highlighted in bold.

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

Board of Directors U.S. Technologies Inc. Washington, D.C.

We have audited the accompanying consolidated balance sheets of U.S. Technologies Inc. as of December 31, 2001 and 2000 and the related consolidated statements of operations, stockholders' equity (capital deficit), and cash flows for each of the two years in the period ended December 31, 2001. 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 and schedule are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedule. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of U.S. Technologies Inc. at December 31, 2001 and 2000, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has suffered recurring losses from operations and has a working capital and net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-9 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton /s/ Radin, Glass & Co., LLP Certified Public Accountants New York, NY April 10, 2002

Unqualified Opinion on the Financial Statements with Explanatory Language regarding a change in accounting principles accounted for in conformity with GAAP: The following opinion was issued by Ernst and Young., LLP on January 29, 2003 with respect to the financial statements for Verizon Communications, Inc. for the years ended December 31, 2002, 2001, and 2000. Note: The portions of the auditor’s report that differ from the standard, three- paragraph audit opinion are highlighted in bold.

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Shareowners of Verizon Communications Inc.:

We have audited the consolidated balance sheets of Verizon Communications Inc. and subsidiaries (Verizon) as of December 31, 2002 and 2001, and the related consolidated statements of income, cash flow and changes in shareowners’ investment for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of Verizon’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. 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Verizon at December 31, 20x2 and 20x1 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States.

As discussed in Note 2 to the consolidated financial statements, Verizon changed its method of accounting for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards (SFAS) No.

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-10 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton 142 “Goodwill and Other Intangible Assets” effective January 1, 2002, and as discussed in Note 14 to the consolidated financial statements, Verizon changed its method of accounting for derivative instruments in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and SFAS No. 138, “Accounting for Certain for Derivative Instruments and Certain Hedging Activities” effective January 1, 2001.

/s/ Ernst and Young LLP Certified Public Accountants [New York, NY]

January 29, 2003

Unqualified Opinion on the Financial Statements with Opinion based in part on report of another auditor where there is no scope limitation or nonconformity with GAAP: The following opinion is a fictitious opinion for a private company based on the guidance provided in generally accepted auditing standards, AU 508.13. Note: The portions of the auditor’s report that differ from the standard, three-paragraph audit opinion are highlighted in bold.

INDEPENDENT AUDITOR’S REPORT

To the Board of Directors of MLJ Company

We have audited the accompanying balance sheets of MLJ Company as of December 31, 20x2 and 20x1, and the related statements of income, stockholders’ equity 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 did not audit the financial statements of XYZ Company, a wholly owned subsidiary, which statements reflect total assets of $10 Million and $ 9 Million as of December 31, 20X2 and 20X1, respectively, and total revenues of $12 Million and $ 10 Million for the years then ended. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for XYZ Company, is based solely on the report of the other auditors.

We conducted our audits in accordance with auditing standards generally accepted in the United States. 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

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-11 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton believe that our audits and the report of other auditors provide a reasonable basis for our opinion.

In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of MLJ Company as of December 31, 20x2 and 20x1 and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.

/s/ Reedy and Abel, LLP Certified Public Accountants Portland, Oregon

February 14, 20x3

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-12 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton Unqualified Opinion on the Financial Statements with Emphasis of a matter by the auditor: The following opinion is a fictitious opinion for a private company based on the guidance provided in generally accepted auditing standards, AU 508.19. Note: The portions of the auditor’s report that differ from the standard, three-paragraph audit opinion are highlighted in bold.

To the Board of Directors of MLJ Company:

We have audited the accompanying balance sheets of MLJ Company as of December 31, 20x5 and 20x4, and the related statements of income, stockholders’ equity 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.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of MLJ Company as of December 31, 20x5 and 20x4 and the results of its operations and its cash flows for each of the years then ended in conformity with accounting principles generally accepted in the United States.

As discussed in note 8 to the financial statements, the Company has had numerous dealings with businesses controlled by, and people who are related to, the officers of the Company.

February 14, 20x6

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-13 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton Qualified Opinion for Departure from GAAP: The following opinion is a fictitious opinion for a private company based on the guidance provided in generally accepted auditing standards, AU 508.35-.57. Note: The portions of the auditor’s report that differ from the standard, three-paragraph audit opinion are highlighted in bold.

We have audited the balance sheets of MLJ Company as of December 31, 20x7 and 20x6, and the related statements of income, stockholders’ equity 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.

The Company has excluded, from property and debt in the accompanying balance sheets, certain lease obligations that, in our opinion, should be capitalized in order to conform with generally accepted accounting principles. If these lease obligations were capitalized, property would be increased by $18 Million and $16 Million long-term debt by $19.5 Million and $18.8 Million, and retained earnings would be decreased by $1.5 Million and $2.8 Million as of December 31, 20x7 and 20x6, respectively. Additionally, net income would be decreased by $1.5 Million and $1.3 Million respectively, for the years then ended.

In our opinion, except for the effects of not capitalizing certain lease obligation as discussed in the preceding paragraph, the financial statements referred to above present fairly, in all material respects, the financial position of MLJ Company as of December 31, 20x7 and 20x6 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.

//s/ Reedy and Abel, LLP Certified Public Accountants Portland, Oregon

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-14 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton

February 14, 20x8

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-15 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton Qualified Opinion for Scope Limitation: The following opinion is a fictitious opinion for a private company based on the guidance provided in generally accepted auditing standards, AU 508.22-.34. Note: The portions of the auditor’s report that differ from the standard, three- paragraph audit opinion are highlighted in bold.

We have audited the accompanying balance sheets of MLJ Company as of December 31, 20x8 and 20x7, and the related statements of income, stockholders’ equity 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.

Except as discussed in the following paragraph, we conducted our audits in accordance with auditing standards generally accepted in the United States. 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.

We were unable to obtain audited financial statements supporting the Company's investment in a foreign affiliate stated at $10 Million and $9.5 Million at December 31, 20x8 and 20x7, respectively, or its equity in earnings of that affiliate of $500,000 and $ 350,000, which is included in net income for the two years then ended and described in Note 12 to the financial statements; nor were we able to satisfy ourselves as to the carrying value of the investment in the foreign affiliate or the equity in its earnings by other auditing procedures.

In our opinion, except for the effects of such adjustments, if any, as might have been determined to be necessary had we been able to examine evidence regarding the foreign affiliate investment and earnings, the financial statements referred to above present fairly, in all material respects, the financial position of MLJ Company as of December 31, 20x8 and 20x7 and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.

/s/ Reedy and Abel, LLP Certified Public Accountants

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-16 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton Portland, Oregon

February 14, 20x9

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-17 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton Adverse Opinion for Departure from GAAP: The following opinion is a fictitious opinion for a private company based on the guidance provided in generally accepted auditing standards, AU 508.58-.60. Note: The portions of the auditor’s report that differ from the standard, three- paragraph audit opinion are highlighted in bold.

We have audited the balance sheets of MLJ Company as of December 31, 20x3 and 20x2, and the related statements of income, stockholders’ equity and cash flows for each of 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.

As discussed in Note 6 to the financial statements, the Company carries its property, plant and equipment accounts at appraisal values, and provides depreciation on the basis of such values. Further, the Company does not provide for income taxes with respect to differences between financial income and taxable income arising because of the use, for income tax purposes, of the installment method of reporting gross profit from certain types of sales. Generally accepted accounting principles require that property, plant and equipment be stated at an amount not in excess of cost, reduced by depreciation based on such amount, and that deferred income taxes be provided.

Because of the departures from generally accepted accounting principles identified above, as of December 31, 20x3 and 20x2, inventories have been increased $9 Million and $9 Million by inclusion in manufacturing overhead of depreciation in excess of that based on cost; property, plant and equipment, less accumulated depreciation, is carried at $10 Million and $12 Million in excess of an amount based on the cost to the Company; and deferred income taxes of $3 Million and $4 Million have not been recorded; resulting in an increase of $12 Million and $14 Million in retained earnings and in appraisal surplus of $10 Million and $12 Million, respectively. For the years ended December 31, 20x3 and 20x2, cost of goods sold has been increased 1 Million and $2 Million respectively, because of the effects of the depreciation accounting referred to above and deferred income taxes of $2 Million and $3.5 Million have not been provided, resulting in an increase in net income of $1 Million and $ 1.5 Million, respectively.

In our opinion, because of the effects of the matters discussed in the preceding paragraphs, the financial statements referred to above do not present fairly, in

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-18 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton conformity with accounting principles generally accepted in the United States, the financial position of MLJ Company as of December 31, 20x3 and 20x2, or the results of its operations or its cash flows for the years then ended.

February 14, 20x4 Disclaimer of Opinion for Scope Limitation: The following opinion is a fictitious opinion for a private company based on the guidance provided in generally accepted auditing standards, AU 508.22-.34.and AU 508.61-63. Note: The portions of the auditor’s report that differ from the standard, three-paragraph audit opinion are highlighted in bold.

We were engaged to audit the balance sheets of MLJ Company as of December 31, 20x4 and 20x3, and the related statements of income, stockholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. [Omit last sentence of the introductory paragraph.]

[Omit the scope paragraph.]

The Company did not make a count of its physical inventory in 20x4 or 20x3, stated in the accompanying financial statements at $6.5 Million as of December 31, 20x4, and at $7.1 Million as of December 31, 20x3. Further, evidence supporting the cost of property and equipment acquired prior to December 31, 20x3, is no longer available. The Company's records do not permit the application of other auditing procedures to inventories or property and equipment.

Since the Company did not take physical inventories and we were not able to apply other auditing procedures to satisfy ourselves as to inventory quantities and the cost of property and equipment, the scope of our work was not sufficient to enable us to express, and we do not express, an opinion on these financial statements.

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-19 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton

February 14, 20x5

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-20 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton Unqualified Opinion - Other Comprehensive Basis of Accounting: The following opinion is a fictitious opinion for a private company based on the guidance provided in generally accepted auditing standards, AU 623.02-.10. Note: The portions of the auditor’s report that differ from the standard, three-paragraph audit opinion are highlighted in bold.

We have audited the accompanying statements of assets, liabilities, and capital - income tax basis of MLJ 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.

As described in Note 1, 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 ABC 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 1.

February 14, 20x7

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-21 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton Adverse Opinion on the Internal Controls over Financial Reporting: The following opinion was issued by PricewaterhouseCoopers LLP on April 6, 2005 with respect to management’s assertion about internal controls over financial reporting for the Eastman Kodak Company as of December 31, 2004. This opinion discusses 2 material weaknesses in internal controls over financial reporting and one limitation on the scope of the opinion (explaining that internal controls of an acquired company were not audited). Note: The portions of the auditor’s report that differ from the standard, three-paragraph audit opinion are highlighted in bold.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Eastman Kodak Company:

We have completed an integrated audit of Eastman Kodak Company’s 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits are presented below.

Consolidated financial statements

In our opinion, the consolidated financial statements and financial statement schedule listed in the index appearing under Item 15(a)(1) and (2) on page 165 of this Annual Report on Form 10-K present fairly, in all material respects, the financial position of Eastman Kodak Company and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. 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 of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting [principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As described in Note 1 to the consolidated financial statements, the Company has restated its 2003 consolidated financial statements primarily for certain tax and pension and other postretirement benefit plans matters.

Internal control over financial reporting

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-22 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton Also, we have audited management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that Eastman Kodak Company did not maintain effective internal control over financial reporting as of December 31, 2004, because the Company did not maintain effective controls over the accounting for income taxes including income taxes payable, deferred income tax assets and liabilities and the related income tax provision and the valuation and recording of its pension and other postretirement benefit obligations and expenses, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a control deficiency, or combination of control deficiencies, that results in more that a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses have been identified and included in management’s assessments:

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-23 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton Accounting for Income Taxes:

As of December 31, 2004, the Company did not maintain effective controls over the accounting for income taxes including income taxes payable, deferred income tax assets and liabilities and the related tax provision. Specifically, the Company had a lack of local tax law expertise or failure to engage local tax law expertise resulting in the incorrect assumptions of reduced tax expense associated with restructuring charges in various foreign locations in 2004 and 2003; inadequate knowledge and application of the generally accepted accounting principles by tax personnel resulting in errors in the accounting for income taxes; lack of clarity in roles and responsibilities within the global tax organization related to income tax accounting; insufficient or ineffective review and approval practices within the global tax and finance organizations resulting in the errors not being prevented or detected in a timely manner; and a lack of processes to effectively reconcile the income tax general ledger accounts to supporting detail and adequate verification of data used in computations. This material weakness contributed to the restatement of the Company’s consolidated financial statements for 2003, for each of the quarters in the year ended December 31, 2003 and for the first, second and third quarters for 2004, and in the Company recording audit adjustments to the fourth quarter 2004 financial statements. Additionally, this material weakness could result in a misstatement of income taxes payable, deferred income tax assets and liabilities and the related income tax provision that would result in a material misstatement to annual or interim financial statements that would not be prevented or detected.

Accounting for Pension and Other Postretirement Benefit Plans:

As of December 31, 2004, the Company did not maintain effective controls over the valuation and recording of its pension and other postretirement benefit obligations and expenses. Specifically, the Company has a deficiency in the design of controls to validate actual versus estimated benefit payments in the accounting for other postretirement benefits. The design deficiency was an erroneous belief that actual payment data could not be captured at the required level of detail to enable adjustment of actuarial estimates on a quarterly basis. In addition, the Company had a failure to demonstrate operating effectiveness in controls surrounding reconciliation of participant census data between source systems and the plan actuary models for various domestic and international pension and other postretirement benefit plans. While analytical procedures to validate the reasonableness of census data extracts were employed, they were not sufficiently robust to prevent or detect errors in census data. This material weakness resulted in adjustments that were included in the restatement of the Company’s consolidated financial statements for 2003, for each of the quarters in the year ended December 31, 2003 and for the first, second and third quarters for 2004, and in the Company recording adjustments to the fourth quarter 2004 financial statements. Additionally, this material weakness could result in a misstatement of pension and other postretirement obligations and expenses that would result in a material misstatement to annual or interim financial statements that would not be prevented or detected.

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-24 From https://testbankgo.eu/p/Solution-Manual-for-Modern-Auditing-Assurance-Services-and- the-Integrity-of-Financial-Reporting-8th-Edition-by-Boynton These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2004 consolidated financial statements, and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements.

As described in Management’s Report on Internal Control Over Financial Reporting, management has excluded the NexPress-related entities and Scitex Digital Printing (renamed Kodak Versamark) from its assessment of internal control over financial reporting as of December 31, 2004 because they were acquired by the Company in purchase business combinations during 2004. We have also excluded the NexPress-related entities and Kodak Versamark from our audit of internal control over financial reporting. The NexPress- related entities and Kodak Versamark are wholly owned subsidiaries of the Company that represent 2% and 2%, respectively, of consolidated total assets and 1% and 1%, respectively, of consolidated revenue as of and for the year ended December 31, 2004.

In our opinion, management’s assessment that Eastman Kodak Company did not maintain effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control – Integrated Framework issued by the COSO. Also, in our opinion, because of the effects of the material weaknesses described above on the achievement of the objectives of the control criteria, Eastman Kodak Company has not maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the COSO.

PRICEWATERHOUSECOOPERS LLP Rochester, NY April 6, 2005

Instructor’s Manual to Modern Auditing: Copyright  2005, John Wiley and Sons, Inc. 2-25