June 10, 2022 June 10, 2022/ Steven Bragg
An auditor’s opinion is a formal statement made by an auditor concerning a client’s financial statements. There are several types of audit opinions, which are noted below.
Unqualified Opinion
The unqualified opinion states that the financial statements fairly reflect the client’s financial results and financial position. This is the gold standard opinion that clients seek, since it provides a seal of approval to the client’s financial statements, making it easier to raise money from lenders and investors.
Qualified Opinion
The qualified opinion indicates any limitations on the scope of the audit and may describe certain information that could not be verified.
Adverse Opinion
The adverse opinion indicates significant problems with the client’s financial statements.
Disclaimer
Another possible outcome is the disclaimer, where the auditor states that no opinion can be given regarding the financial statements due to such factors as the absence of financial records or a lack of cooperation by the client’s management team.
June 10, 2022/ Steven Bragg/
Understanding Reservations in an Independent Auditor’s Report
There are two types of reservations:
1. GAAP departure
Situations where the financial statements deviate from the established accounting criteria. For example, a company that uses an incorrect accounting method faces a GAAP departure.
2. Scope limitation
Situations where the auditor is unable to obtain sufficient appropriate audit evidence to base the audit on. This presents a scope limitation.
In addition, the type of opinion, based on the reservation made, depends on two factors:
1. Materiality
Misstatements to the financial statements are considered material if the misstatements (individually or in aggregate), are expected to influence the decisions made by users who rely on the financial statements.
2. Pervasiveness
Misstatements to the financial statements are considered pervasive if the misstatements affect a substantial portion of the financial statements.
What is a Qualified Opinion?
A qualified opinion can be issued due to a GAAP departure or a scope limitation. In both cases, the misstatements are material but not pervasive. In other words, there is a material impact on the financial statements, but the misstatements are not widespread (do not affect a large number of accounts).
Example 1: Qualified opinion due to a GAAP departure
The auditor noticed that the inventory of ABC Company faces a write-down due to obsolescence. However, the company refuses to write down the inventory. In such a scenario, a GAAP departure reservation is made. Since only the inventory and cost of goods sold accounts are wrong, a qualified opinion due to a GAAP departure would be issued.
Example 2: Qualified opinion due to a scope limitation
The auditor wants to send out confirmation letters to customers for the accounts receivable balance as audit evidence. However, ABC Company does not want the auditor to do so. In such a scenario, a scope limitation reservation is made. Since the auditor has been unable to verify the accounts receivable, a qualified opinion due to a scope limitation would be issued.
What is an Adverse Opinion?
An adverse opinion can only be issued due to a GAAP departure. In such a case, the misstatements are both material and pervasive. In other words, there is a material impact on the financial statements, and the misstatements affect a large number of accounts.
Example: Adverse opinion due to a GAAP departure
The auditor believes ABC Company faces a going concern issue and is unable to survive another year. The company disagrees and prepares its financial statements on a historical cost basis instead of on a liquidation basis. In such a scenario, a GAAP departure reservation is made. Since ABC Company prepared its financial statements on a historical cost basis, the majority of the company’s accounts are incorrect. An adverse opinion due to a GAAP departure would be issued.
What is a Disclaimer of Opinion?
A disclaimer of opinion can only be issued due to a scope limitation. In this case, the misstatements are material and pervasive. In other words, the auditor is unable to collect sufficient appropriate audit evidence to base its audit on and, as a result, a large number of accounts are not verifiable.
Example: Disclaimer of opinion due to a scope limitation
The auditor is looking to review the company’s minutes book, which contains important information regarding the board of directors meeting and the audit committee. ABC Company does not permit the auditor to review the minutes book. In such a scenario, a disclaimer of opinion reservation is made. Since the auditor is unable to access the minutes book, a majority of the company’s accounts cannot be verified. A disclaimer of opinion due to a scope limitation would be issued.
Related Readings
Thank you for reading CFI’s guide to Auditor Opinions. To keep learning and advancing your career, the following CFI resources will be helpful:
A couple of things that make audit reports so complicated is that some of the information isn't readily available and some of the information is subjective in nature. Auditors have to make various judgmental assumptions in finalizing reports. The audit opinion is a very important part of the audit report because it makes a statement about a company's financial status to investors. The audit report provides a picture of a company's financial performance in a given fiscal year. Investors analyze audit reports and base much of their investment decisions on information contained in the audit reports. Investors are particularly interested in the audit opinion because it's a reflection of the integrity of the audit report and projects an image of the company. The audit opinion is based on such things as how available the data was to them, whether they had an opportunity to follow all due procedures, the level of materiality and other issues along those lines. All of these things are subjective in nature and depend on the auditor's opinion. An adverse audit opinion can deflate a company's status. In some cases, adverse audit opinions may lead to litigation. Regulatory bodies may also scrutinize the audit opinion and the audit report to verify the information for accuracy and any impact on taxation matters.
Board management software programs support the accountability and transparency of financial reporting to ensure that companies get the best auditor opinion letter. Governance Cloud by Diligent Corporation is a fully integrated platform of board management software solutions that will ensure that companies get through the audit process with flying colors. The platform assures confidentiality with its state-of-the-art security features. Boards can set granular permissions so that only authorized parties have access to various parts of the auditing process. Auditors form their opinions by making professional judgments and getting legal opinions. It's vital that companies have internal controls and financial policies in place and have them reviewed regularly by the company's internal audit team to ensure that everything is in order before the audit ensues.
>> Free Download: "How To Be Audit Ready" Whitepaper << Before the audit, management provides financial information to the audit committee. During the annual audit, the auditor has to review the processes and procedures that the company used to prepare the financial information. The auditors check to see whether the company uses GAAP or other applicable reporting frameworks in preparing the reports. Annual audits demonstrate transparency in corporate financial reporting, which is a positive step in establishing good relationships between companies and their investors, as well as the public. Auditors have the option of choosing among four different types of auditor opinion reports. An auditor opinion report is a letter that auditors attach to the statutory audit report that reflects their opinion of the audit. The four types of auditor opinions are:
- Unqualified opinion-clean report
- Qualified opinion-qualified report
- Disclaimer of opinion-disclaimer report
- Adverse opinion-adverse audit report
An unqualified opinion is considered a clean report. This is the type of report that auditors give most often. This is also the type of report that most companies expect to receive. An unqualified opinion doesn't have any kind of adverse comments and it doesn't include any disclaimers about any clauses or the audit process. This type of report indicates that the auditors are satisfied with the company's financial reporting. The auditor believes that the company's operations are in good compliance with governance principles and applicable laws. The company, the auditors, the investors and the public perceive such a report to be free from material misstatements.
Qualified Opinion-Qualified Report:
When an auditor isn't confident about any specific process or transaction that prevents them from issuing an unqualified, or clean, report, the auditor may choose to issue a qualified opinion. Investors don't find qualified opinions acceptable, as they project a negative opinion about a company's financial status. Auditors write up a qualified opinion in much the same way as an unqualified opinion, with the exception that they state the reasons they're not able to present an unqualified opinion.
A common for reason for auditors issuing a qualified opinion is that the company didn't present its records with GAAP.
Disclaimer of Opinion-Disclaimer Report:
When an auditor issues a disclaimer of opinion report, it means that they are distancing themselves from providing any opinion at all related to the financial statements. Some of the reasons that auditors may issue a disclaimer of opinion are because they felt like the company limited their ability to conduct a thorough audit or they couldn't get satisfactory explanations for their questions. They may not have been able to decipher the correct nature of some transactions or to secure enough evidence to support good financial reporting. Auditors that aren't allowed an opportunity to observe operational procedures or to review particular procedures may feel like they're not able to express a definite opinion, so they feel a disclaimer is necessary and in order. The general consensus is that a disclaimer of opinion constitutes a very harsh stance. As a result, it creates an adverse image of the company.
Adverse Opinion-Adverse Audit Report:
The final type of audit opinion is an adverse opinion. Auditors who aren't at all satisfied with the financial statements or who discover a high level of material misstatements or irregularities know that this creates a situation in which investors and the government will mistrust the company's financial reports.
An auditor's adverse opinion is a big red flag. An adverse audit report usually indicates that financial reports contain gross misstatements and have the potential for fraud. Adverse opinions send out a high alert that the company's records haven't been prepared according to GAAP. Financial institutions and investors take this opinion seriously and will reject doing any kind of business with the company.
Auditors use all types of qualified reports to alert the public as to the transparency, reliability and accountability of companies. Auditor opinions place pressure on companies to change their financial reporting processes and incorporate practices like ESG and cybersecurity healthcare governance so that they're clear and accurate. Companies, investors and the public highly value unqualified reports.
Free Download: "How To Be Audit Ready" Whitepaper