An auditor’s report is a formal document issued by an auditor, expressing their opinion on whether a company’s financial statements align with generally accepted accounting principles (GAAP) and are devoid of substantial inaccuracies.
The independent and external audit report is usually presented alongside the company’s annual financial statements. This report holds significant importance as it grants banks and creditors the assurance needed before they extend loans or credit to the company.
Key Takeaways
- The auditor’s report articulates the auditor’s opinion on the compliance of a company’s financial statements with GAAP and their freedom from material misstatements.
- It is vital because banks, creditors, and regulators require audited financial statements for decision-making regarding the company.
- A clean (unqualified) report indicates compliance with accounting standards, while a qualified report signals potential errors.
- An adverse report suggests significant discrepancies in the financial statements, counter to GAAP guidelines.
The Functionality of an Auditor’s Report
An auditor’s report is a verifiable letter appended to a firm’s financial statements, indicating its adherence to standard accounting practices. Filing an auditor’s report is mandatory for public companies when reporting earnings to the Securities and Exchange Commission (SEC).
However, it’s crucial to note that an auditor’s report doesn’t assess whether a company is an appealing investment. Nor does it analyze the company’s earnings performance over a period. The report solely represents the reliability of the financial statements.
Components of an Auditor’s Report
An auditor’s letter adheres to a standard format delineated by generally accepted auditing standards (GAAS). Typically, a report has three paragraphs:
- First Paragraph: Describes the responsibilities of both the auditor and the directors.
- Second Paragraph: Specifies the scope, detailing that the standard accounting practices were followed.
- Third Paragraph: Enunciates the auditor’s opinion.
Additionally, there might be a paragraph elaborating on the outcomes of a separate audit conducted on another area of the entity. Investors generally focus on the opinion segment in the third paragraph.
The report type primarily depends on the auditor’s findings, and here are the most prevalent types:
Clean or Unqualified Report
A clean report denotes that the company’s financial records are free of any material misstatements and comply with GAAP policies. Typically, the majority of audits culminate in clean opinions.
Qualified Opinion
A qualified opinion arises in two scenarios: firstly, when financial statements contain non-pervasive material misstatements; secondly, when there’s inadequate appropriate audit evidence to form a basis. For example, there might be errors in calculating operating expenses. Auditors usually identify specific areas prompting the qualification, enabling the company to address them.
Adverse Opinion
An adverse opinion signals that the auditor has substantial evidence pointing to material misstatements that are pervasive. This outcome represents the most severe findings for a company, which could lead to rejection of its financial statements and potential legal consequences. Furthermore, any unlawful activity uncovered could result in criminal charges against corporate officers.
Disclaimer of Opinion
A disclaimer of opinion means the auditor can’t formulate a dependable opinion due to inadequate audit evidence, with potential material misstatements being both undetectable and pervasive. Instances could include lack of impartiality or restricted access to crucial financial information.
An Example of an Auditor’s Report
Here are some excerpts from an audit report conducted by a renowned auditing firm for a prominent company:
Paragraph 1: Opinion on the Financial Statements
“We have audited the accompanying consolidated balance sheets of [Company Name] and subsidiaries as of [Date 1], and [Date 2], alongside the flattened consolidated statements of earnings, comprehensive income, equity, and cash flows for each year in the period up to [Date 1], along with pertinent notes (collectively referred to as ‘financial statements’).
In our view, the financial statements accurately reflect, in all substantial aspects, the financial standing of [Company Name] as of [Date 1], and [Date 2], along with its operations and cash flows for the cited periods, adhering to the accounting principles generally accepted in the United States.”
Paragraph 2: Basis for Opinion
“Our audits were conducted in accordance with the Public Company Accounting Oversight Board (PCAOB) standards. These standards obligate us to plan and execute the audit to secure reasonable assurance about the absence of material misstatement resulting from errors or fraud. Audit Approaches included evaluating risk assessments of material misstatement in the financial statements and responding proactively. Comprehensive procedures involved on a test basis, verification of amount disclosures in financial statements, assessment of the accounting principles adopted, significant estimates by management, and an overall review of the financial statement presentation. We believe our audits afford a credible basis for our opinion.”
Related Terms: audit report types, qualified opinion, adverse opinion, unqualified opinion, financial compliance.
References
- U.S. Securities and Exchange Commission. “How to Read a 10-K/10-Q”.
- U.S. Securities and Exchange Commission. “Topic 4 - Independent Accountants’ Involvement”.
- Public Company Accounting Oversight Board. “AS 2405: Illegal Acts by Clients”.
- Starbucks Corporation. “Starbucks Fiscal 2019 Annual Report”, Page 84.
