An audit report is a written opinion of an auditor regarding whether an entity’s financial statements are free of material misstatements and are presented fairly following the Generally Accepted Accounting Principles.
This is written in a standard format, as mandated by generally accepted auditing standards (GAAS).
It is the auditor’s formal means of communication to interested parties of a conclusion about the audited financial statement.
Lancaster has defined, “A report is a statement of collected and considered facts, so drawn up as to give clear and concise information to persons who are not already in possession of the full facts of the subject matter of the report.”
The auditor should send his report addressed to shareholders to the secretary or a responsible official or the company. The auditor’s report is to be read and discussed at the annual general meeting of shareholders.
Basic Elements of an Audit Report
A measure of uniformity in the form and content of the auditor’s report is desirable because it helps to promote the reader’s understanding and to identify unusual circumstances when they occur.
According to ISA 700, the auditor’s report includes the following basic elements, ordinarily in the following layout:
- Title: The title indicates the nature of the report. The title should be like “Auditor’s Report” or Branch Auditor’s Report”.
- Addressee: The auditor’s report should address the person to whom it is meant to be forwarded. Generally, the audit report is submitted to the board of directors or stockholders of an entity.
- Opening or Introductory Paragraph: The introductory paragraph should identify:
- types of service performed (‘We have audited’).
- financial statements audited.
- dates of statements.
- management’s responsibility for statements.
- auditor’s responsibility for opinion.
- Scope Paragraph: The scope paragraph specifies the work performed by the auditor. The scope paragraph should indicate that the auditor had planned and performed the audit to obtain reasonable assurance whether financial statements are free from material misstatement. Specifically, the scope paragraph describes the audit as including-
- examining evidence on a test basis,
- assessing accounting principles used and significant estimates made by management,
- evaluating the overall financial statement presentation.
- Opinion Paragraph: The opinion paragraph of the report should state the auditor’s opinion as to whether the financial statements give a true and fair view in conformity with the financial reporting framework and comply with the statutory disclosure requirements.
- Date of the report: The date of the report should be the date when the auditor has obtained sufficient appropriate evidence to support the opinion. It should not be earlier than the date when management approves the financial statements.
- Place of the report: The town in which the audit report is signed should be indicated.
- Auditor’s signature: The report should be signed the personal name of the auditor or in the name of an audit firm or both.
Characteristics of a Good Audit Report
In companies Act, Section 227 casts the duty on the auditor to make a report to shareholders.
In addition to this report, the auditor makes out a long-form audit report to the management. It contains detailed observation of auditors on various matters connected with the financial areas of the company.
It points out weaknesses, lapses and errors/frauds observed in the system.
It suggests corrective measures. A good report must at least meet the following characteristics:
- It should be based on factual information;
- It should be convincing;
- It should be forceful;
- It should be unbiased;
- It should point out mistakes;
- It should be constructive criticism and not be in reprimanding tone;
- It should offer constructive and timely suggestions to the management;
- It should be brief. If it is lengthy, the object of the report is defeated even if it is well written.
Kinds of Audit Report
There are five common types of auditor’s reports, each one presenting a different situation encountered during the auditor’s work.
They are discussed below:
Often called a clean opinion, an unqualified opinion is an audit report that is issued when an auditor determines that each of the financial records provided by the business is free of any misrepresentations.
Also, an unqualified opinion.
indicates that the financial records have been maintained following the standards known as Generally Accepted Accounting Principles (GAAP).
This is the best type of report a business can receive.
Typically, an unqualified report consists of a title that includes the word “independent.” This is done to illustrate that it was prepared by an unbiased third party. The title is followed by the main body.
Made up of three paragraphs, the main body highlights the responsibilities of the auditor, the purpose of the audit and the auditor’s findings. The auditor signs and dates the document, including his address.
Unqualified Opinion with an Explanatory Paragraph
An unqualified opinion with an explanatory paragraph is an audit report that is issued when the auditor determines that a complete audit took place with satisfactory results and financial statements are fairly presented, but the auditor believes that it is important or is required to provide additional information.
An opinion is said to be unqualified when the Auditor concludes that the Financial Statements give a true and fair view following 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.
This type of report is issued by an auditor when the financial statements presented are free of material misstatements and are represented fairly following 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 –
- The Financial Statements have been prepared using the Generally Accepted Accounting Principles which have been consistently applied;
- The Financial Statements comply with relevant statutory requirements and regulations;
- There is adequate disclosure of all material matters relevant to the proper presentation of the financial information subject to statutory requirements, where applicable;
- Any changes in the accounting principles or the method of their application and the effects thereof have been properly determined and disclosed in the Financial Statements.
In situations when a company’s financial records have not been maintained following GAAP but no misrepresentations are identified, an auditor will issue a qualified opinion.
The writing of qualified opinion is extremely similar to that of an unqualified opinion. A qualified opinion, however, will include an additional paragraph that highlights the reason why the audit report is not unqualified.
A qualified opinion should be expressed when the auditor concludes that an unqualified opinion cannot be expressed but that effect of disagreement with management is not so material and pervasive as to require an adverse opinion or the limitation on the scope is not so material and pervasive as to require a disclaimer of opinion.
A qualified opinion is expressed as being “subject to” or “except for” the effects of the matter to which the qualification relates.
The qualification should indicate the reasons for the qualification and the impact of the qualification in profit/losses and also on the financial position of the entity.
The following situation may occur in qualified opinion:
- Limitation on scope of audit– Nonavailability of confirmation of balances of major debtors, non-verification of stocks at the year-end, etc.
- Disagreement with management.
Accounting policy e.g providing retirement benefits on a cash basis without accrual accounting, non-provision of depreciation.
Wrong application of accounting e.g. Capitalizing interest expenditure on loan for the erection of machinery after installation.
Adequate disclosure -omitting to furnish quantitative details of purchases, sales, stock as per schedule VI requirements, omission to separately show the managerial remuneration, etc.
The worst type of financial report that can be issued to a business is an adverse Opinion. This indicates that the firm’s, financial records do not conform to GAAP.
Also, the financial records provided by the business have been grossly misrepresented.
Although this may occur by error, it is often an indication of fraud.
When this type of report is issued, a company must correct its financial statement and have it re-audited, as investors, lenders and other requesting parties will generally not accept it.
Disclaimer of Opinion
On some occasions, an auditor is unable to complete an accurate audit report. This may occur for a variety of reasons, such as an absence of appropriate financial records.
When this happens, file auditor issues a disclaimer of opinion, stating that an opinion of the firm’s financial status could not be determined.
Relationship of Materiality to Type of Opinion
|Materiality level||Significance in terms of reasonable users’ decisions||Type of opinion|
|Immaterial||Users’ decisions are unlikely to be affected.||Unqualified|
|Material||Users’ decisions are likely to be affected only if the information in question is important to the specific decisions being made. The overall financial statements are presented fairly.||Qualified|
|Highly material||Most of all users’ decisions based on the financial statements are likely to be significantly affected.||Disclaimer or Adverse|