The audit report is prepared and issued by auditors at the end of audit fieldwork. It’s directed to shareholders of the company where auditors give their remarks about accounting and bookkeeping carried out by the business. In technical terms, auditors give their opinion if the financial statement and accounting records of the business are free from material misstatement or if there is/are a material misstatement leading to a qualification of the audit report.
The audit report can be qualified or clean depending on the remarks made by auditors in their report. Let’s discuss related details.
Qualified audit report
If auditors conclude that there is some material misstatement in the financial statement, they issue a qualified audit report or the report with the audit findings that are material and might impact the decision of the financial statement user.
It’s important to note that auditors only need to issue a qualified audit report when a misstatement is a material – which may lead to impairment in the decision of the financial statement user.
Unqualified audit report/clean audit report
This type of audit report is issued when auditors conclude that nothing has come to their attention that suggests financial statements have not been prepared in compliance with the applicable framework. Similarly, there seems to be no material misstatement in the financial statement that might impact the decision of financial statement users. Hence, it’s a clean audit report that was not qualified.
Generally, stakeholders of the business like creditors, banks, lenders, and investors require the companies to provide them with audited financial statements, and the audit must be conducted by an independent firm of public accountants. The companies need to present a clean audit report to their stakeholders as they need to understand if the financial performance of the company is reported professionally, and whether they should work with the company or not,
It’s important to note that an audit report is not the same as a financial analysis and it does not suggest you should invest in the company. On the contrary, in audit report, auditors only express their opinion that a set of financial statements contain material misstatements or no.
Hence, the performance of external audit leads to an increase in the overall reliability of the financial statements prepared by the business.
Further, it’s important to note that the audit standard provides certain guidelines to prepare the audit report. Here are the given components for the audit report.
The first paragraph of the audit report
This paragraph is about the responsibilities of the company’s directors and auditors. For instance, directors of the business are responsible to prepare the financial statement. On the other hand, auditors are responsible to maintain independence, adequately assess the risk of material misstatement, and reporting on the set of financial statement. These responsibilities are mentioned in the paragraph.
The second paragraph is about the technical application of the auditing and accounting standards and the overall scope of the audit. For instance, this paragraph states that financial statements have been prepared in compliance with the USA GAAP.
The third paragraph of the audit report contains the audit opinion expressed by the auditors. If auditors have given clean audit report, it suggests to the users of the financial statement that it does not contain material misstatement as auditors have carried out a comprehensive review of the same.
The third paragraph is considered crucial because of the fact that it contains audit opinion. Further, audit opinion is not formed in the air. Instead, there is a certain basis that is used by the auditor to form an opinion. Let’s discuss the basis and how to audit opinion is formed.
Basis of forming audit opinion
The given chart illustrates how to audit opinion is formed.
|Audit opinion||When the risk of material misstatement is||Reason|
|Clean audit opinion||No material and no pervasive||There is no unresolved matter in the financial statement that is material/pervasive.|
|Qualified audit opinion||Material but not pervasive||The nature of the matter is material as verified by the auditor.|
|Qualified audit opinion||Material but not pervasive||Auditors are unable to obtain sufficient and appropriate audit evidence.|
|Adverse opinion||Material and pervasive||The financial statement contains material and pervasive misstatements as verified by the auditor.|
|Disclaimer of opinion||Material and pervasive||Auditors are unable to obtain sufficient and appropriate audit evidence.|
Pervasive – The nature of the misstatement is said to be pervasive when it’s related to the financial statement as a whole rather than some specific account balance. In other words, if the misstatement remains unresolved, it will impact the whole financial statement. For instance, if financial statements have not been prepared in compliance with the applicable accounting framework, it’s expected that this misstatement will lead to impairment on the overall financial statement. Hence, the matter is pervasive. So, if the matter is pervasive or not, it’s dependent on the auditor’s judgment.
By issuing adverse disclaimers of opinion, the auditors express that users should not make a decision on the basis of a financial statement that contains a pervasive matter.
Sometimes, auditors do not modify audit opinion but audit report. For instance, they might put emphasis of a matter paragraph and other matter paragraphs in the audit report. Let’s discuss what these paragraphs illustrate.
Emphasis of matter paragraph – (EOMP)
The emphasis of matter paragraph is when auditors place emphasis on some paragraph already given in the financial statement. In other words, auditors want the reader of the financial statement to go into the financial statement and read that specific paragraph. It’s because auditors think that paragraph is of utmost importance for the reader of the financial statement. Although, ISA-706 has described certain circumstances when the usage of EOMP is appropriate.
- When a paragraph contains some fact related to the future, and these facts are related to exceptional future events.
- When the company has adopted a new accounting standard.
- When there was some major catastrophe that had a severe impact on the financial position of a business.
It’s important to note that EOMP is given when referred paragraph (containing crucial facts that the auditor wants to emphasize) is already given in the financial statement. However, there can be a situation when that’s not the case. In this case, other matter paragraph is used. Let’s discuss related facts for the same.
Other matter paragraph
This paragraph is included in the audit report when the auditor believes there is some significant fact about the business (important for the reader of the financial statement) and these facts have not been included in the financial statement. So, auditors insert other matter paragraph in the audit report to enhance the usage of the financial statements.
There is one another usage of the other matter paragraph and that is,
When the auditor finds there is some inconsistency between the following,
- Audited financial statements.
- Some unaudited information in the annual report.
The audit report is issued by independent external auditors. The report contains three major paragraphs that include the auditor’s and directors’ responsibility, technical application of the applicable accounting framework and audit opinion respectively.
There are some bases for forming audit reports that include material misstatement, material and pervasive misstatement, and inability to obtain sufficient and appropriate audit evidence.
There are two important paragraphs that auditors might include in the financial statements. These paragraphs include an emphasis on the matter paragraph and other matter paragraph.
The emphasis of matter paragraph is when the auditor wants to place emphasis on some facts/paragraphs already given in the audit report. On the other hand, other matter paragraph is included in the audit report when the auditor wants to include some additional facts in the audit report that were not included in the financial statement.