What's in an Auditor’s Report: Opinions, Good and Bad
An auditor's report says that the business uses proper accounting methods and its financial report provides adequate disclosure — or not. When the auditor finds fault with the accounting or financial disclosure of the business, things can get messy. In the report, the auditor can render several opinions regarding the financial state of the business:
The unqualified, or clean, opinion
If the auditor finds no serious problems, the CPA firm gives the business’s financial statements an unqualified or clean opinion; that is, the auditor does not qualify or restrict his opinion regarding any significant matter. The standard audit report is rife with defensive, legalistic language .
The following summary cuts through the jargon and explains what the audit report really says:
|1st paragraph||We did an audit, but the financial statements are the responsibility of management; we just express an opinion of them.|
|2nd paragraph||We carried out audit procedures that provide us a reasonable basis for expressing our opinion, but we don’t necessarily catch everything.|
|3rd paragraph||The company’s financial statements conform to accounting and financial reporting standards and are not misleading.|
For large public companies, the auditor’s report must contain a paragraph explaining that the CPA audited the company’s internal controls over financial reporting, which expresses an opinion on the effectiveness of these controls. The business’s top management must also include a statement in the annual financial report giving their opinion on the company’s financial reporting internal controls.
The adverse opinion
At the other end of the spectrum, the auditor may state that the financial statements are misleading and should not be relied upon. This negative, disapproving audit report is called an adverse opinion. The threat of an adverse opinion almost always motivates a business to give way to the auditor and change its accounting or disclosure in order to avoid getting an adverse opinion.
An adverse audit opinion says that the financial statements of the business are misleading. The Securities and Exchange Commission (SEC) does not tolerate adverse opinions by auditors of public businesses; it would suspend trading in a company’s securities if the company received an adverse opinion from its CPA auditor.
Other kinds of audit opinions
An audit report that does not give a clean opinion may look very similar to a clean-opinion audit report to the untrained eye. Some investors see the name of a CPA firm next to the financial statements and assume that everything is okay.
How do you know when an auditor’s report may be something other than a straightforward, no-reservations clean opinion? Look for more language than just the standard three paragraphs that appear in an unqualified opinion. Additional language in an audit report is important to look for — it’s never good news.
The auditor’s report may point out a flaw in the company’s financial statements but not a fatal flaw that would require an adverse opinion. In this situation, the CPA issues a qualified opinion. The auditor includes a short explanation of the reasons for the qualification. You don’t see qualified audit opinions that often, but you should read the auditor’s report to be sure.
One modification to an auditor’s report is serious — when the CPA expresses doubts about the capability of the business to continue as a going concern. A going concern is a business that has sufficient financial wherewithal and momentum to continue its normal operations into the future and would be able to absorb a bad turn of events without having to default on its liabilities.
A going concern does not face an imminent financial crisis or any pressing financial emergency. A business could be under some financial distress but, overall, still be judged a going concern. Unless there is evidence to the contrary, the CPA auditor assumes that the business is a going concern.
But in some cases, the auditor may see unmistakable signs that a business is in deep financial waters and may not be able to convince its creditors and lenders to give it time to work itself out of its present financial difficulties. The creditors and lenders may force the business into involuntary bankruptcy, or the business may make a preemptive move and take itself into voluntary bankruptcy.
The equity owners (stockholders of a corporation) may end up holding an empty bag after the bankruptcy proceedings have concluded. (This is one of the risks that stockholders take.) If an auditor has serious concerns about whether the business is a going concern, these doubts are spelled out in the auditor’s report.