In financial reporting, an auditor's opinion is the outcome of an auditor's review of an organization's financial statements.
The auditor's opinion does not judge the financial position of the reporting entity. Nor does it otherwise interpret financial data. Instead, the opinion simply answers two questions:
- Firstly, do the statements conform to Generally Accepted Accounting Principles (GAAP)?
- And, secondly, do they fairly represent the entity's financial accounts?
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 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 coverage.
Four Possible Audit Outcomes
Sections below further define and explain financial reporting audits. Four kinds of outcomes are covered:
- 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?
- 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.
- See Generally Accepted Accounting Principles, for more on meaning of GAAP.
- The article Accountant describes the nature and background requirements for the accounting profession.
An audit examines a report. Its purpose is to assess report veracity and accuracy. And, audits are led by auditors who 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 recognized expertise in the area under audit. This is 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, obviously, reinforce auditor impartiality.
Auditors are classified 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 are therefore known also as independent or third party auditors.
Internal Financial Audits
Directors and officers in many firms rely on internal financial audits. As a result, coprorate 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 are almost always responsible 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 completely outside the entity they audit. They are therefore assumed free of influence from any level of the entity.
Independent auditors are usually certified accountants or financial specialists, working for themselves or for consulting firms. They are therefore responsible only to their own managers, regulators, governments, and the law.
Note especially that third party opinion is mandatory for financial results appearing in an Annual Report to Shareholders. And, third party opinion 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 outcomes below 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 leads to misleading gross profit figures.
- There are limits on audit scope. This can mean, for instance, that auditors did not have access to certain financial data.
- The auditor doubts the veracity of certain financial data.
- The auditor is not fully 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 the opinion.
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 opinion. As a result, auditors may point out specific accounting errors or departures from GAAP.
In any case, an Adverse opinion has serious consequences for the reporting entity. At a minimum, the opinion ensures that investors, regulators, lenders, and governments will reject the reports. In addition, 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. Note especially that this is not an opinion. Instead, it simply says that auditors chooses not to issue an opinion.
Auditors may issue a disclaimer of opinion when:
- They believe they cannot audit impartially. With the disclaimer, therefore, auditors recuse themselves.
- The auditor's scope is limited. This occurs, for instance, when auditors cannot access certain financial data.
- Auditors have other doubts about the reports. For example:
- Reports 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 capitalized items probably should not have been capitalized.
- They may question the way the entity applies rules such as the Lower of Cost or Marketrule, or LIFO and FIFO rules for inventory.
Auditors issue opinions only when they are confident the opinion is supportable. Otherwise, they issue a disclaimer of opinion.