The auditor's report is a disclaimer thereof, issued by either an internal auditor or an independent external auditor as a result of an internal or external audit, as an assurance service in order for the user to make decisions based on the results of the audit.
An auditor's report is considered an essential tool when reporting financial information to users, particularly in business. Since many third-party users prefer, or even require financial information to be certified by an independent external auditor, many auditees rely on auditor reports to certify their information in order to attract investors, obtain loans, and improve public appearance. Some have even stated that financial information without an auditor's report is "essentially worthless" for investing purposes.
Auditor's report on financial statements
It is important to note that auditor's reports on financial statements are neither evaluations nor any other similar determination used to evaluate entities in order to make a decision. The report is only an opinion on whether the information presented is correct and free from material misstatements, whereas all other determinations are left for the user to decide.
There are four common types of auditor's reports, each one presenting a different situation encountered during the auditor's work. The four reports are as follows:
An opinion is said to be unqualified when the Auditor concludes that the Financial Statements give a true and fair view in accordance with the financial reporting framework used for the preparation and presentation of the Financial Statements. An Auditor gives a Clean opinion or Unqualified Opinion when he or she does not have any significant reservation in respect of matters contained in the Financial Statements. The most frequent type of report is referred to as the "Unqualified Opinion", and is regarded by many as the equivalent of a "clean bill of health" to a patient, which has led many to call it the "Clean Opinion", but in reality it is not a clean bill of health, because the Auditor can only provide reasonable assurance regarding the Financial Statements, not the health of the company itself, or the integrity of company records not part of the foundation of the Financial Statements. This type of report is issued by an auditor when the financial statements are free of material misstatements and are presented fairly in accordance with the Generally Accepted Accounting Principles (GAAP), which in other words means that the company's financial condition, position, and operations are fairly presented in the financial statements. It is the best type of report an auditee may receive from an external auditor.
An Unqualified Opinion indicates the following –
(1) The Financial Statements have been prepared using the Generally Accepted Accounting Principles which have been consistently applied;
(2) The Financial Statements comply with relevant statutory requirements and regulations;
(3) There is adequate disclosure of all material matters relevant to the proper presentation of the financial information subject to statutory requirements, where applicable;
(4) Any changes in the accounting principles or in the method of their application and the effects thereof have been properly determined and disclosed in the Financial Statements.
The report consists of a title and header, a main body, the auditor's signature and address, and the report's issuance date. US auditing standards require that the title includes "independent" to convey to the user that the report was unbiased in all respects. Traditionally, the main body of the unqualified report consists of three main paragraphs, each with distinct standard wording and individual purpose. Nonetheless, certain auditors (including PricewaterhouseCoopers) have since modified the arrangement of the main body (but not the wording) in order to differentiate themselves from other audit firms, even though such modification is contrary to the clarified US AICPA standards on auditing.
The first paragraph (commonly referred to as the introductory paragraph) states the audit work performed and identifies the responsibilities of the auditor and the auditee in relation to the financial statements. The second paragraph (commonly referred to as the scope paragraph) details the scope of audit work, provides a general description of the nature of the work, examples of procedures performed, and any limitations the audit faced based on the nature of the work. This paragraph also states that the audit was performed in accordance with the country's prevailing generally accepted auditing standards and regulations. The third paragraph (commonly referred to as the opinion paragraph) simply states the auditor's opinion on the financial statements and whether they are in accordance with generally accepted accounting principles.
The following is an example of a standard unqualified auditor's report on financial statements as it is used in most countries, using the name ABC Company as an auditee's name. Note that this report is acceptable only for periods ending before December 15, 2012:
Recently modifications have been made by the PCAOB to the opinion in the independent auditors report. These changes can be attributed to the introduction of SAS No. 122 and SAS No. 123. For periods ending after December 15, 2012, the following is an example of a standard unqualified auditor's report on financial statements as it is used in most countries, using the name ABC Company, which was incorporated in California, as an auditee's name:
Qualified Opinion report
Qualified report is given by the auditor in either of these two cases:
- When the financial statements are materially misstated due to misstatement in one particular account balance, class of transaction or disclosure that does not have pervasive effect on the financial statements.
- When the auditor is unable to obtain audit evidence regarding particular account balance, class of transaction or disclosure that does not have pervasive effect on the financial statements.
The report is mostly like a Clear Opinion Report and only includes a paragraph viz. Basis for Qualification after Scope paragraph and before Opinion paragraph. Opinion paragraph in addition to its standard wording includes “except for the matter described in Basis for Qualification paragraph the financial statements give true and fair view.”
A Qualified Opinion report is issued when the auditor encountered one of the two types of situations which do not comply with generally accepted accounting principles, however the rest of the financial statements are fairly presented. This type of opinion is very similar to an unqualified or "clean opinion", but the report states that the financial statements are fairly presented with a certain exception which is otherwise misstated. The two types of situations which would cause an auditor to issue this opinion over the Unqualified opinion are:
- Single deviation from GAAP – this type of qualification occurs when one or more areas of the financial statements do not conform with GAAP (e.g. are misstated), but do not affect the rest of the financial statements from being fairly presented when taken as a whole. Examples of this include a company dedicated to a retail business that did not correctly calculate the depreciation expense of its building. Even if this expense is considered material, since the rest of the financial statements do conform with gaap, then the auditor qualifies the opinion by describing the depreciation misstatement in the report and continues to issue a clean opinion on the rest of the financial statements.
- Limitation of scope – this type of qualification occurs when the auditor could not audit one or more areas of the financial statements, and although they could not be verified, the rest of the financial statements were audited and they conform to GAAP. Examples of this include an auditor not being able to observe and test a company's inventory of goods. If the auditor audited the rest of the financial statements and is reasonably sure that they conform with GAAP, then the auditor simply states that the financial statements are fairly presented, with the exception of the inventory which could not be audited.
The wording of the qualified report is very similar to the Unqualified opinion, but an explanatory paragraph is added to explain the reasons for the qualification after the scope paragraph but before the opinion paragraph. The introductory paragraph is left exactly the same as in the unqualified opinion, while the scope and the opinion paragraphs receive a slight modification in line with the qualification in the explanatory paragraph.
The scope paragraph is edited to include the following phrase in the first sentence, so that the user may be immediately aware of the qualification. This placement also informs the user that, except for the qualification, the rest of the audit was performed without qualifications:
- "Except as discussed in the following paragraph, we conducted our audit..."
The opinion paragraph is also edited to include an additional phrase in the first sentence, so that the user is reminded that the auditor's opinion explicitly excludes the qualification expressed. Depending on the type of qualification, the phrase is edited to either state the qualification and the adjustments needed to correct it, or state the scope limitation and that adjustments could have but not necessarily been required in order to correct it.
For a qualification arising from a deviation from GAAP, the following phrase is added to the opinion paragraph, using the depreciation example mentioned above:
- "In our opinion, except for the effects of the Company's incorrect determination of depreciation expense, the financial statement referred to in the first paragraph presents fairly, in all material respects, the financial position of…"
For a qualification arising from a scope of limitation, the following phrase is added to the opinion paragraph, using the inventory example mentioned above:
- "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 perform proper tests and procedures on the Company's inventory, the financial statement referred to in the first paragraph presents fairly, in all material respects, the financial position of…
Adverse Opinion report
An Adverse Opinion Report is issued on the financial statements of a company when the financial statements are materially misstated and such misstatements have pervasive effect on the financial statements.
In Audit Report after Scope paragraph but before Opinion paragraph, Basis for Adverse Opinion paragraph is added. In Opinion paragraph the wording changes to, "Because of situations mentioned in Basis for Adverse Opinion paragraph, in our opinion the financial statements of XYZ Co. Ltd. as mentioned in first paragraph does not give true and fair view/are not free from material misstatements."
An Adverse Opinion is issued when the auditor determines that the financial statements of an auditee are materially misstated and, when considered as a whole, do not conform with GAAP. It is considered the opposite of an unqualified or clean opinion, essentially stating that the information contained is materially incorrect, unreliable, and inaccurate in order to assess the auditee's financial position and results of operations. Investors, lending institutions, and governments very rarely accept an auditee's financial statements if the auditor issued an adverse opinion, and usually request the auditee to correct the financial statements and obtain another audit report.
Generally, an adverse opinion is only given if the financial statements pervasively differ from GAAP. An example of such a situation would be failure of a company to consolidate a material subsidiary.
The wording of the adverse report is similar to the qualified report. The scope paragraph is modified accordingly and an explanatory paragraph is added to explain the reason for the adverse opinion after the scope paragraph but before the opinion paragraph. However, the most significant change in the adverse report from the qualified report is in the opinion paragraph, where the auditor clearly states that the financial statements are not in accordance with GAAP, which means that they, as a whole, are unreliable, inaccurate, and do not present a fair view of the auditee's position and operations.
- "In our opinion, because of the situations mentioned above (in the explanatory paragraph), the financial statements referred to in the first paragraph do not present fairly, in all material respects, the financial position of…"
Disclaimer of Opinion report
A Disclaimer of Opinion is issued in either of the following cases:
- When the auditor is not independent or when there is conflict of interest.
- When the limitation on scope is imposed by client, as a result the auditor is unable to obtain sufficient appropriate audit evidence.
- When there are significant uncertainties in the business of client.
The audit report changes significantly when there is Disclaimer of opinion. An additional paragraph "Basis for Disclaimer" is added in audit report which is placed after Scope paragraph and before Opinion paragraph. In Scope paragraph the wording changes to "We were engaged to audit the financial statements of XYZ Co. Ltd." from "We have audited the financial statements of XYZ Co. Ltd." In Opinion paragraph wording changes to "We do not express an opinion on the financial statements of XYZ Co. Ltd. due to situations explained in Basis for Disclaimer paragraph"
A Disclaimer of Opinion, commonly referred to simply as a Disclaimer, is issued when the auditor could not form and consequently refuses to present an opinion on the financial statements. This type of report is issued when the auditor tried to audit an entity but could not complete the work due to various reasons and does not issue an opinion. The disclaimer of opinion report can be traced back to 1949, when the Statement on Auditing Procedure No. 23: Recommendation Made To Clarify Accountant's Representations When Opinion Is Not Expressed was published in order to provide guidance to auditors in presenting a disclaimer.
Statements on Auditing Standards (SAS) provide certain situations where a disclaimer of opinion may be appropriate:
- A lack of independence, or material conflict(s) of interest, exist between the auditor and the auditee (SAS No. 26)
- There are significant scope limitations, whether intentional or not, which hinder the auditor's work in obtaining evidence and performing procedures (SAS No. 58);
- There is a substantial doubt about the auditee's ability to continue as a going concern or, in other words, continue operating (SAS No. 59)
- There are significant uncertainties within the auditee (SAS No. 79).
Although this type of opinion is rarely used, the most common examples where disclaimers are issued include audits where the auditee willfully hides or refuses to provide evidence and information to the auditor in significant areas of the financial statements, where the auditee is facing significant legal and litigation issues in which the outcome is uncertain (usually government investigations), and where the auditee has going concern issues (the auditee may not continue operating in the near future). Investors, lending institutions, and governments typically reject an auditee's financial statements if the auditor disclaimed an opinion, and will request the auditee to correct the situations the auditor mentioned and obtain another audit report.
A disclaimer of opinion differs substantially from the rest of the auditor's reports because it provides very little information regarding the audit itself, and includes an explanatory paragraph stating the reasons for the disclaimer. Although the report still contains the letterhead, the auditee's name and address, the auditor's signature and address, and the report's issuance date, every other paragraph is modified extensively, and the scope paragraph is entirely omitted since the auditor is basically stating that an audit could not be realized.
In the introductory paragraph, the first phrase changes from "We have audited" to "We were engaged to audit" in order to let the user know that the auditee commissioned an audit, but does not mention that the auditor necessarily completed the audit. Additionally, since the audit was not completely and/or adequately performed, the auditor refuses to accept any responsibility by omitting the last sentence of the paragraph. The scope paragraph is omitted in its entirety since, effectively, no audit was performed. Similar to the qualified and the adverse opinions, the auditor must briefly discuss the situations for the disclaimer in an explanatory paragraph. Finally, the opinion paragraph changes completely, stating that an opinion could not be formed and is not expressed because of the situations mentioned in the previous paragraphs.
The following is a draft of the three main paragraphs of a disclaimer of opinion because of inadequate accounting records of an auditee, which is considered a significant scope of limitation:
Auditor's report on internal controls of public companies
Following the enactment of the Sarbanes-Oxley Act of 2002, the Public Company Accounting Oversight Board (PCAOB) was established in order to monitor, regulate, inspect, and discipline audit and public accounting firms of public companies. The PCAOB Auditing Standards No. 2 now requires auditors of public companies to include an additional disclosure in the opinion report regarding the auditee's internal controls, and to opine about the company's and auditor's assessment on the company's internal controls over financial reporting. These new requirements are commonly referred to as the COSO Opinion.
The auditor's report is modified to include all necessary disclosures by either presenting the report subsequent to the report on the financial statements, or combining both reports into one auditor's report. The following is an example of the former version of adding a separate report immediately after the auditor's report on financial statements.
Going concern is a term which means that an entity will continue to operate in the near future which is generally more than next 12 months, so long as it generates or obtains enough resources to operate. If the auditee is not a going concern, it means that the entity might not be able to sustain itself within the next twelve months. Auditors are required to consider the going concern of an auditee before issuing a report. If the auditee is a going concern, the auditor does not modify his/her report in any way. However, if the auditor considers that the auditee is not a going concern, or will not be a going concern in the near future, then the auditor is required to include an explanatory paragraph before the opinion paragraph or following the opinion papragraph, in the audit report explaining the situation, which is commonly referred to as the going concern disclosure. Such an opinion is called an "unqualified modified opinion".
Unfortunately, many auditors are increasingly reluctant to include this disclosure in their opinions, since it is considered a "self-fulfilling prophecy" by some. This is because a disclosure for a lack of going concern is viewed negatively by investors, lending institutions, and credit agencies, and therefore reduces the chance that the auditee may obtain the capital or borrowing it needs to survive once the disclosure is made. If this situation occurs, the auditee is more likely to stop being a going concern while the auditor loses potential future audit engagements, and so the auditor may be pressured to avoid including a going concern disclosure. In a study performed on 2001 bankruptcies, nearly half (48%) of selected public companies who faced bankruptcy in 2001 did not have a "going concern disclosure" in the previous auditor's reports. Additionally, 12 of the 20 largest bankruptcies in U.S. history occurred between 2001 and 2002 and none of them had a "going concern disclosure" in their previous auditor's report.
As for the actual wording of the auditor's report, when a lack of going concern is determined by the auditor, the disclosure paragraph should state the situation, state the auditor's determination, and state the auditee's plan to correct the situation. The disclosure paragraph should immediately follow the opinion paragraph.
Other explanatory information and paragraphs
Although the auditor reports mentioned above are the standard reports for financial statement audits, the auditor may add additional information to the report if it is deemed necessary without changing the overall opinion of the report. Usually, this additional information is included after the opinion paragraph, although some situations require that the additional information be included in paragraphs before the opinion paragraph. The most frequent paragraphs include:
- Limiting distribution of the report – In some occasions, the audit report is restricted to a specified user and the auditor includes this restriction in the report, such as a report for financial statements made in cash basis which are prepared for tax purposes only, financial statements for a wholly owned subsidiary whose sole user of its financial statements is its parent company, etc.
- Additional or supplemental information – Certain auditees include additional and/or supplemental information with their financial statements which is not directly related to the financial statements. Examples due to size, time, location, and/or technical constraints. When the main auditor has to rely on another auditor's work, the main auditor may either accept responsibility for the component's information and not modify the audit report, or may chose to disclaim the audit on the specific component, stating that the main auditor did not audit the component, that another auditor audited the component, that the component's audited information is therefore the responsibility of another auditor, and that the main auditor is simply including it in the original auditee's information. If used, this disclaimer is usually included in the introductory paragraph.
Auditor's reports on financial statements in different countries
The auditor's report usually does not vary from country to country, although some countries do require either additional or less wording. In the United States, auditors are required to include in the scope paragraphs a phrase stating that they conducted their audit "in accordance with generally accepted auditing standards in the United States of America", and, in the opinion paragraph, state whether the financial statements are presented "in conformity with generally accepted accounting principles in the United States of America". Some countries, such as the Philippines, use similar reports to those issued in the United States, with the exception that second paragraph would state that the audit was conducted in accordance with Philippine Standards on Auditing, and that the financial statements are in accordance with Philippine Financial Reporting Standards.
Opinion shopping is a term used by external auditors and, after the Enron and Arthur Andersen accounting scandals, the media and general public refer to auditees who contract or reject auditors based on the type of opinion report they will issue on the auditee. The underlying principles of this concept are that auditees determine the compensation to auditors for their work (called "audit fees") as well as awarding future audit engagements; that such fees are the auditor's main source of income; that certain auditees may try to contract auditors that will issue audit opinions based on the auditees' needs; and that certain auditors are willing to comply with such demands so long as they are assured future audit engagements.
The most common example is an auditee that knows that the current auditor is going to issue a qualified, adverse, or disclaimer of opinion report, who then rescinds the audit engagement before the opinion is issued, and subsequently "shops" for another auditor who is willing to issue an "unqualified" opinion, regardless of any qualifying situations mentioned in the previous sections. However, opinion shopping is not limited to auditees contracting auditors based on issuing opinions. It also includes auditors who are over-pleasing to auditees by issuing unqualified reports without properly auditing, or by simply overlooking material issues affecting the audit. These auditors' objective is to appear much more attractive and easy-going than other auditors in order to secure future audit engagements and fees.
Although the great majority of auditors are not willing to jeopardize their profession and reputation for guaranteed audit fees, there are some that will issue opinions solely based on obtaining or maintaining audit engagements. This includes auditors who knowingly emit unmodified unqualified opinions for auditees who are engaged in illegal activities, auditees who have caused a material limitation of scope, auditees that have a lack of going concern, or auditees who present fraudulent financial statements (e.g. Enron and Arthur Andersen). This situation is a clear conflict of interest which should hinder an auditor's independence and the ability to audit (AICPA Code of Ethics), but some auditors willingly ignore this statute.
Recent laws and industry standards have been implemented in order to correct this situation, which include the Sarbanes-Oxley Act and the AICPA's practice-monitoring program and Peer Review Program, which are in some cases voluntary, and in other cases, required.
Other engagements and reports
There are various other audits and evaluations which an external auditor performs in addition to the engagements mentioned in the previous sections, each with their respective standard report(s):
- Certification audit reports (for example, an ISO 9000 audit report)
- Compilations (not an audit, but requires a report)
- Due Diligence
- Environmental audit report
- Financial forecasts
- Filing of a public company's Form 10-Q and Form 10-K
- Agreed Upon Procedures
- Internal audit reports
- Regulatory inspection reports
- Review of financial statements (an overview with very limited auditing procedures)
- Fraud & Materiality Memo
- Second opinion
- XBRL assurance
- Information security audit information technology audit or information technology security audit
Report to the audit committee or board
The auditor's report on the financial statements typically provides very limited details on the procedures and findings of the audit. In contrast, auditors provide much more detail to the board of directors or to the audit committee of the board. Beginning in 2002, many countries have tasked the audit committee with primary responsibility over the audit. For example, in the United States, section 204 of the Sarbanes-Oxley Act passed in 2002 required auditors to communicate certain information to audit committees, which were required to be entirely independent, and also made the audit committee responsible for the auditor's hiring. In August 2012, the U.S. Public Company Accounting Oversight Board finalized Auditing Standard No. 16, which requires additional communications to the audit committee.
- Financial audit
- Internal audit
- Generally Accepted Auditing Standards
- International Standards on Auditing
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- Accounting What The Numbers Mean, (Marshall, McManus, Viele 2008), Mc Graw Hill
- Auditing & Assurance Services: A systematic approach. Messier, W and C. Emby. McGraw-Hill Ryerson Limited, 2005.
- "Using Disclaimers in Audit Reports: Discerning Between Shades of Opinion" by Robert R. Davis, CPA Journal, 2004, retrieved on January 24, 2007
- The Going-Concern Assumption Revisited: Assessing a Company's Future Viability by Elizabeth K. Venuti, CPA, PhD; The CPA Journal; 2004; retrieved January 16, 2007
- Statement on Auditing Standards No. 59: The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern, issued by the Auditing Standards Board
- PPC's Guide to Auditor's Reports, Thomson Publishing Group, Vol. 1, Chapter 6:Uncertainties, Section 606: Going Concern Problems
- Enhancing transparency of the audit committee auditor oversight process Archived June 2, 2013, at the Wayback Machine.. Ernst & Young.
- Section 204 -- Auditor Reports to Audit Committees Archived June 15, 2013, at the Wayback Machine.. Securities Lawyer's Deskbook.
- Audit Committee Reports Before and After Sarbanes-Oxley: A Study of Companies Listed on the NYSE The CPA Journal.
- Auditing Standard No. 16: Communications with Audit Committees. PCAOB.
- Hoffelder K. (2012). New Audit Standard Encourages More Talking. CFO Magazine.