Rick Stephan Hayes, Roger Dassen, Arnold Schilder, Philip Wallage

Audit Reports and CommunicationPrinciples of Auditing: An Introduction to International Standards on Auditing - - Ch. 12 Rick Stephan Hayes, Roger Dassen, Arnold Schilder, Philip Wallage

Management Responsibility for Audit Report - SOx Sox Requires that the principal executive officer or officers and the principal financial officer or officers, certify in each report filed with the SEC the following: • the signing officer has reviewed the report; • the report does not contain any untrue statement of a material fact or omit to state a material fact; • the financial statements, and other financial information, fairly present in all material respects the financial condition of the company; • the signing officers • are responsible for establishing and maintaining internal controls; • have evaluated the effectiveness of the company’s internal controls; and • have presented in the report their conclusions about the effectiveness of their internal controls based on their evaluation;

Corporate Responsibility for Audit Report under SOx (cont.) Requires that the principal executive officer or officers and the principal financial officer or officers, certify in each report filed with the SEC the following: • the signing officers have disclosed to the company’s auditors and the audit committee of the board of directors — • all significant deficiencies in the design or operation of internal controls which could adversely affect the company’s ability to record, process, summarize, and report financial data and have identified for the company’s auditors any material weaknesses in internal controls; and • any fraud, whether or not material, that involves management or other employees who have a significant role in the company’s internal controls;

ISA 700 Elements of Auditor’s Report – Not in Text (a) Title; (b) Addressee; (c) Introductory paragraph; (d) Management’s responsibility for the financial statements; (e) Auditor’s responsibility;

ISA 700 Elements of Auditor’s Report (cont.) (f) Auditor’s opinion; (g) Other reporting responsibilities; (h) Auditor’s signature; (i) Date of the auditor’s report; and (j) Auditor’s address.

Contents of the Auditor's Report • title, • addressee, • opening or introductory paragraph • scope paragraph (describing the nature of an audit) • opinion paragraph containing an expression of opinion on the financial statements, • the date of the report • the auditor's address, and • auditor’s signature

Example PCAOB Amgem Saple audit report from Audit Standard No. 4 NEXT SLIDE

Report of Independent Registered Public Accounting Firm on the Financial Statements The Board of Directors and Stockholders of Amgen Inc. We have audited the accompanying Consolidated Balance Sheets of Amgen Inc. (the “Company”) as of December 31, 2005 and 2004, and the related Consolidated Statements of Operations, Stockholders’ Equity, and Cash Flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the Index at Item 15(a)2. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits 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 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Amgen Inc. at December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Amgen Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 2, 2006 expressed an unqualified opinion thereon. Ernst & Young LLP Los Angeles, California March 2, 2006

Example PCAOB sample audit report from Audit Standard No. 5 NEXT SLIDES

Report of Independent Registered Public Accounting Firm [Introductory paragraph] We have audited the accompanying balance sheets of W Company as of December 31, 20X8 and 20X7, and the related statements of income, stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 20X8. We also have audited management's assessment, included in the accompanying [title of management's report], that W Company maintained effective internal control over financial reporting as of December 31, 20X8, based on [Identify control criteria, for example, "criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)." ]. W Company's management is responsible for these financial statements, 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 an opinion on these financial statements and an opinion on the company's internal control over financial reporting based on our audits.

[Scope paragraph] We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included 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. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

[Definition paragraph] 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 (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) 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 (3) 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.

[Inherent limitations paragraph] 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. [Opinion paragraph] In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of W Company as of December 31, 20X8 and 20X7, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 20X8 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, W Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 20X8, based on [Identify control criteria, for example, "criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)." ]. [Signature] [City and State or Country] [Date]

The opinion expressed in the auditor's report may be one of four types: unqualified, qualified, adverse, or disclaimer of opinion Q U A D

Unqualified Audit Opinion • Most common type of audit report • Called “clean opinion” • Used for more than 90 per cent of all audit reports • Other audit reports are referred to as 'other than unqualified reports‘ (adverse opinion, disclaimer of opinion, and qualified opinion).

An Unqualified Opinion should be expressed when the auditor concludes that the financial statements give a true and fair view or are presented fairly, in all material respects, in accordance with the applicable financial reporting framework.

Modifications To The Opinion – ISA 705 (not in text) • ISA 705 uses the term “modifications to the opinion” to describe qualified opinions (“except for” opinions), adverse opinions, and disclaimers of opinion. • ISA 705 establishes standards and provides guidance on (a) circumstances that may result in a modification to the opinion in the auditor’s report, (b) the type of opinion appropriate in the circumstances, and (c) the form and content of the auditor’s report when the auditor’s opinion is modified.

The auditor should modify the opinion in the auditor’s report when: (not in text) (a) The auditor concludes that, based on the audit evidence obtained, the financial statements are not free from material misstatement and accordingly are not prepared, in all material respects, in accordance with an applicable financial reporting framework; or (b) The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements are free from material misstatement.

Auditor’s Report Containing a Qualified Opinion An auditor’s report containing a qualified opinion is issued when the auditor concludes that an unqualified opinion cannot be expressed but that the effect of any disagreement with management, or limitation on scope is not so material as to require an adverse opinion or a disclaimer of opinion.

Auditor’s Report Containing an Adverse Opinion An adverse opinion is issued when the effect of a disagreement is so material and pervasive to the financial statements that the auditor concludes that a qualification of her report is not adequate to disclose the misleading or incomplete nature of the financial statements.

Auditor’s Report Containing a Disclaimer of Opinion An auditor’s report containing a disclaimer of opinion should be expressed when the possible effect of a limitation on scope is so material and pervasive that the auditor has not been able to obtain sufficient appropriate audit evidence and therefore is unable to express an opinion on the financial statements.

In addition to the, specific elements discussed, whenever the auditor expresses a modified opinion on the financial statements, the auditor should include a paragraph that provides: (a) A clear description of all the substantive reasons for the modification; (b) In the event of a disagreement with management about disclosures, a description of the omitted disclosures, unless impracticable or prohibited by law or regulation. (c) In the event of a disagreement with management, a description and quantification of the principal effects on the financial statements of the matter giving rise to the modification (d) In the event of an inability to obtain sufficient appropriate audit evidence, a description of the reason for the inability.

An Emphasis of a Matter Paragraph with an Unqualified Opinion An auditor’s unqualified report is sometimes expanded upon to explain matters that do not affect the auditor’s opinion, but should be emphasized to the financial statement user. In certain circumstances an auditor’s report may be modified by adding a fourth paragraph to highlight a material going concern problem or when there is significant uncertainties in the future which may affect the financial statements.

ISA 706, “Emphasis of Matter Paragraphs and Other Matters Paragraphs in the Independent Auditor’s Report” (Not in text) The auditor’s report should emphasize a matter presented or disclosed in the financial statements or the notes when (a) the matter is both unusual and (b) of fundamental importance to the users’ understanding of the financial statements.

An auditor might write an Emphasis of a Matter paragraph: • If there is a significant uncertainty which may affect the financial statements, the resolution of which is dependent upon future events • Examples of uncertainties that might be emphasized include • the existence of related party transactions, • important accounting matters occurring subsequent to the balance sheet date • matters affecting the comparability of financial statements with those of previous years (e.g. change in accounting methods) • Litigation, long-term contracts, recoverability of asset values, losses on discontinued operations • To highlight a material matter regarding a going concern problem.

Going Concern • The going concern assumption is that the enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. • When a question arises regarding the appropriateness of the going concern assumption, the auditor should gather sufficient appropriate audit evidence to attempt to determine the entity's ability to continue in operation for the foreseeable future.

Going Concern Disclosure • If the going concern questions are not resolved, the auditor must adequately disclose in her report the principal conditions that raise doubt about the entity's ability to continue in operation in the foreseeable future. • The disclosure should: • describe the principal conditions that raise doubt; • state that there are doubts about going concern, therefore the entity may be unable to realize its assets and discharge its liabilities in the normal course of business; • state that the financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or to amounts and classification of libilities.

Circumstances That May Result in Modifications to the Audit Report According to ISA 705. there are at least two circumstances where the auditor may not be able to express an unqualified opinion: • a limitation in scope and • a disagreement with management

Limitation on Scope Scope limitations arise when the auditors are unable for any reason to obtain sufficient appropriate audit evidence to conclude that the financial statements are free from material misstatement

Disagreement with Management The auditor may disagree with management as to: a) The acceptability of the accounting policies selected; b) The method of policy application, including the adequacy of valuations and disclosures in the financial statements; or c) The compliance of the financial statements with relevant regulations and statutory requirements. If any of these disagreements are material, but not pervasive, the auditor should express a qualified opinion. If the effect of the disagreement is so material and pervasive to the financial statements that a qualification would not be adequate , an adverse opinion should be expressed.

In determining the pervasiveness of the effect of a disagreement with management or the inability to obtain sufficient appropriate audit evidence, the auditor considers: (a) The extent to which the disagreement with management or inability to obtain sufficient appropriate audit evidence can be (i) related to specific items in the financial statements and (ii) quantified. (b) Whether the effect of the disagreement with management on the financial statements can be clearly described in the auditor’s report so that the modification can address the incomplete or misleading nature of the financial statements.

Uncertainties Leading to Qualification of Opinions Although ISAs specify qualification of opinions based on either limitation of scope or disagreement with management, certain uncertainties such as material uncertainties, lack of consistency of application of accounting principles, independence of auditor, reports in reference to experts orfraudmay lead to an auditor’s report containing a qualification of opinion in many countries.

Accounting Principles Not Consistently Applied Lack of consistency in the application of accounting principles in the current period in relation to the preceding period may require a modification to an unqualified opinion in many countries based on local standards.

Auditor is Not Independent IFAC's Guideline on Ethics for Professional Accountants stresses the great importance to auditing of independence both in fact and appearance. However, the ISA Auditing standards do not require a qualified opinion or a disclaimer of opinion if the auditor is not independent, although this is the case in most countries.

Reports involving other auditors and experts ISA 620 suggests that when expressing an unqualified opinion the auditor should not refer to the work of an expert in her report as such a reference might be misunderstood to be a qualification of the auditor's opinion or a division of responsibility. If the auditor as a result of the other auditor's or expert's work issues an auditor’s report containing other than an unqualified opinion, she may in some circumstances describe the work of the expert.

Communications With Those Charged With Governance • ISA 260 states: “The auditor should communicate audit matters of governance interest arising from the audit of financial statements with those charged with governance of an entity.” • ‘Governance’ is the term used to describe the role of persons entrusted with the supervision, control and direction of an entity, usually the board of directors or supervisory board or the audit committee.

Governance Structures • The structures of governance vary from country to country reflecting cultural and legal backgrounds. • In some countries, the supervision function, and the management function are legally separated into different bodies, such as a supervisory (wholly or mainly non-executive) board and a management (executive) board. • In other countries, like the U.S., both functions are the legal responsibility of a single, unitary board.

Auditor Communications to Governance Entity Audit matters of governance interest to be communicated by the auditor to the board or audit committee ordinarily include: • Material weaknesses in internal control; • Non-compliance with laws and regulations. • Fraud involving management • Questions regarding management integrity; • The general approach and overall scope of the audit; • The selection of, or changes in, significant accounting policies and practices that have a material effect on the financial statements;

Auditor Communications to Governance Entity (cont) Audit matters of governance interest to be communicated by the auditor to the board or audit committee ordinarily include: • The potential effect on the financial statements of any significant risks and exposures, such as pending litigation, that requires disclosure in the financial statements; • Significant audit adjustments to the accounting records; • Material uncertainties related to the entity’s ability to continue as a going concern; • Disagreements with management about matters that could be significant to the entity’s financial statement. • Expected modifications to the auditor’s report

Fraud and Error • ISA 240 says the auditor should communicate to management any material weaknesses in internal control related to the prevention or detection of fraud and error, which have come to the auditor’s attention. • If the auditor concludes that it is not possible to continue performing the audit as a result of a misstatement resulting from fraud or suspected fraud, withdrawal from the engagement must then be seriously considered.

Reporting of Non-compliance with Laws • If the auditor concludes that the noncompliance has a material effect on the financial statements, and has not been properly reflected in the financial statements, the auditor should express a qualified or an adverse opinion. • The auditor’s duty of confidentiality would ordinarily preclude reporting noncompliance to a third party. However, in certain circumstances, that duty of confidentiality is overridden by statute, law or by courts of law (for example, in some countries the auditor is required to report noncompliance by financial institutions to the supervisory authorities).

Long-Form Audit Report • In many countries it is customary for the auditor to prepare a ‘long-form’ report to the Audit Committee of an entity’s board of directors in addition to the publicly published ‘short-form’ report discussed in this chapter. • A long- form report ordinarily includes: • Overview of the Audit Engagement • Analysis of Financial Statements • Risk Management and Internal Control • Optional Topics • Auditor independence and quality control • Fees

XBRL is a freely licensed, open technology standard that makes it possible to store and/or transfer data along with the complex hierarchies, data-processing rules and descriptions. • Permits the automatic exchange and reliable extraction of financial information across all software formats and technologies, including the Internet • Reduces the need to enter financial information more than one time, reducing the risk of data entry error and eliminating the need to manually key information for various formats

Continuous Reporting and Auditing • Continuous reporting is the real-time disclosure of transaction data. • Embedded audit modules (EAM) are database software routines that are placed at predetermined points to gather information about transactions or events within the system that auditors deem to be material. EAMs allow auditors to proactively monitor auditable conditions.

Thank You for Your Attention Any Questions?

Rick Stephan Hayes, Roger Dassen, Arnold Schilder, Philip Wallage