The auditor's opinion is familiar to most people in business as a mandatory component of the Annual Report to Share holders. In fact, however, the financial accounting auditor's opinion is necessary whenever a firm presents its financial statements to potential investors, potential lenders, or potential business partners.
Four Names For the Opinion
Note that formal audit results may be called Auditor's Opinion, Report, or Statement. Or, they may also appear as Accountant's Opinion, Report, or Statements. These terms all mean almost the same thing.
- The Accountant's Opinion or Auditor's Opinion focuses on the actual opinion, one of the four possible outcomes described below.
- The terms Statement or Report imply that the text includes the opinion, but also:
- The responsibilities of auditors
- Responsibilities of directors and corporate officers
- The scope of cover
Four Possible Audit Outcomes
Sections below further define and explain financial reporting audits. This article explains the four primary audit outcomes:
- Unqualified opinion
- Qualified opinion
- Adverse opinion
- Disclaimer of opinion
- What is an auditor's opinion?
- Who performs the audit? And, who is responsible for the opinion?
- What are the four possible auditor's opinions? Which opinion is the best possible outcome?
- Example Auditors Statement by PricewaterhouseCoopers
- For more on the general nature of auditing, and other audit classes (internal audits, project audits, and management audits) see the article Audit.
- See Annual Report for more on the role of auditors opinions in reporting.
- The article Accountant describes the nature and background requirements for the accounting profession.
An audit examines a report. Its purpose is to assess report transparency and accuracy. Auditors perform these inspections and take personal responsibility for audit results.
In business, auditors may be accountants, financial specialists, project managers, line managers, technical experts, security experts, and others. The only universal requirement for working as an auditor is recognizable expertise in the area under audit. This recognition is crucial because the resulting opinion must speak with authority.
Two rules also apply universally for auditing:
- Firstly, the auditor does not report to the person under audit. The auditor, therefore, cannot receive discipline or reward from this person.
- Secondly, the auditor's pay does not depend on the audit outcome. The auditor, therefore, has no financial incentive to choose one opinion over another.
These rules, naturally, reinforce auditor impartiality.
Auditors serve as either internal or external auditors.
- Internal auditors report directly to very senior managers or directors.
- External auditors are outside the entity's management hierarchy. They qualify, therefore, as independent or third-party auditors.
Internal Financial Audits
Directors and officers in many firms rely on internal financial audits. As a result, corporate officers and boards of directors build internal financial audits into the firm's governance structure.
Investor-owned hotels, for example, run financial audits nightly. They do this because they must be sure that managers and other staff do not allow guests to build large outstanding balances. The industry even has job titles for this role, such as "Night Auditor" or "Night Accountant."
Similarly, internal auditors everywhere are always on the watch for such things as;
- Accounting fraud.
- Inventory leakage.
- Reimbursement abuse.
Internal auditors almost always report only to corporate officers or directors. Note that some organizations discourage their internal auditors from developing close personal ties, or social relationships with their colleagues—the people they audit.
Independent Third-Party Auditors
By contrast, independent third-party auditors, who write the formal opinions appearing below, are entirely outside the entity they audit. All parties therefore assume these people are free of influence from all levels of the group they are auditing.
Independent auditors are usually certified accountants or financial specialists, working for themselves or consulting firms. They are therefore responsible only to their managers, regulators, governments, and the law.
Note that third-party opinion is mandatory for financial results appearing in an Annual Report to Shareholders. And, this review is almost always mandatory when firms submit financial statements to regulators, governments, or lenders.
Formal opinions from independent auditors fall into four categories. (1) Unqualified Opinion, (2) Qualified Opinion, (3) Adverse Opinion, and (4) Disclaimer of Opinion.
Firstly, the unqualified opinion is the best possible audit outcome. And, it is also by far the outcome that auditors report most often. By contrast, the other three possible results appear rarely.
The term "unqualified" means that, in the auditor's opinion…
- Financial statements conform to Generally Accepted Accounting Principles (GAAP).
- And, statements represent the entity's financial accounts fairly.
Second Possible Auditor Opinion
Secondly, a qualified opinion means the auditor finds that reports conform to GAAP, except in just a few areas. For these areas, the auditor cannot assert conformance.
The qualified opinion may result because:
- The report misstates or misclassifies accounting entries.
For example, an expense that should appear above the gross profit line appears wrongly below it. This error can lead to misleading Gross profit figures.
- There are limits on audit scope.
In other words, auditors may not have had access to particular financial data.
- The auditor doubts the veracity of specific financial data.
- The auditor is not entirely confident that reports:
- Comply with GAAP
- Represent the entity's accounts fairly
In conclusion, auditors report the audit outcome as "qualified" when they are not comfortable calling it either "unqualified" or "adverse." With qualified opinions, auditors state specific reasons for their conclusions.
Thirdly, an "adverse" opinion means the auditor finds one or both of the following.
- Statements do not fairly represent the entity's accounts.
- The audited statements do not comply with GAAP.
Before publishing an adverse opinion, auditors advise the firm's accountants and officers of such problems. And, auditors then work with them to correct problems, insofar as they can. They do this hoping to describe the outcome as "unqualified" or "qualified" opinion, instead of "adverse," if possible.
When auditors do report an adverse opinion, they give specific reasons for the conclusion. As a result, auditors may point out specific accounting errors or departures from GAAP.
In any case, an adverse opinion has severe consequences for the reporting entity. At a minimum, the conclusion ensures that investors, regulators, lenders, and governments will reject the reports. Also, if the audit reveals illegalities, corporate officers may be held personally accountable.
Fourth Possible Audit Outcome: No Opinion
Disclaimer of Opinion
Fourthly, auditors may issue a disclaimer of opinion. Notice that disclaimer of opinion is not an opinion. Instead, it means that auditors choose not to render one.
Auditors may issue a disclaimer of opinion when:
- They believe they cannot audit impartially. With the disclaimer, therefore, auditors recuse themselves.
- There are limits to the auditor's scope. The auditor has limits in this way, for instance, when auditors cannot access particular financial data.
- Auditors have other doubts about the reports. For example:
- Financial statements may seem to violate accounting principles such as the matching concept or the conservatism principle.
- Auditors may question the classification of certain revenues and expenses.
- Some items that appear as capital items probably do not qualify as capital probably do not qualify for that designation.
- They may question the way the entity applies rules such as the Lower of Cost or Market rule, or LIFO and FIFO rules for inventory.
Auditors issue conclusions only when they are confident they can support the opinion. Otherwise, they submit a disclaimer of opinion.
Auditor opinions and statements are familiar to everyone who reads the Annual Report that public companies publish before their annual shareholder meeting. This report is mandatory, everywhere, because governments regulate the trading of ownership shares.
Annual reports have relatively few mandatory components, but foremost among them are (1) Financial statements for the reporting period, and (2) the written opinion of an independent 3rd-party auditor.
Auditors issue an "Auditor's Opinion" (or "Auditor's Statement," or "Auditor's Report") after they review the company's financial statements and—insofar as they are able—verify the accuracy of data and the judgments of the company accountants. The auditor's comments do not pass judgment on the company's financial performance or financial position. Even with the most favorable possible Auditor's opinion (an opinion of "Unqualified"), the report assures the public only that the auditor has examined the financial statements and is of the opinion that they present information fairly and in conformance with Generally Accepted Accounting Principles (GAAP).
For example, at the top of this section is the full text of the statement from PricewaterhousCoopers (PWC) to the IBM Annual Report for 2013 filed February 2014). This statement essentially states the "Unqualified" opinion in the opening lines:
"In our opinion, the accompanying Consolidated Financial Statements appearing on pages 78 through 146 present fairly, in all material respects, the financial position of International Business Machines Corporation and its subsidiaries at December 31, 2013 and 2012 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America."
Auditor's statements such as this typically appear on a report page of their own, close to the presentation of company financial statements. Here, PWC did not explicitly classify their judgment by name, but the statement by PWC essentially describes the highest and most favorable outcome for an audit, an unqualified opinion.
A favorable audit outcome is necessary for acceptance by regulatory authorities, lenders (banks, bondholders, and investors).