Getting the make on audit reports.
Regardless of the reason, business and credit professionals often rely upon the output of the audit in managing specific functions within their business. However, a great deal of misunderstanding remains about the audit and its resulting report known as the "audit opinion."
Evaluating Financial Information
The audit process is a set of procedures used by an independent third party to assess the validity of financial information prepared by the management of a company. The process is governed by the Auditing Standards Board (ASB), a segment of The American Institute of Certified Public Accountants (AICPA). The Auditing Standards Board publishes documents known as Statements on Auditing Standards (SAS) that promulgate the generally accepted auditing standards used by the profession. Certified public accountants (CPAs) in practice are required to follow the policies and procedures outlined in these statements. Failure to do so can result in disciplinary action including the loss of the professional license.
Audit Opinion Defined
The audit report is a statement of opinions issued by the auditing firm. Such an opinion contains their conclusions about a company's financial statements based upon audit procedures performed. The audit report is the end result of an audit and is typically comprised of three paragraphs, known as the introductory, scope, and opinion paragraphs. Additional paragraphs are added as needed for explanatory or clarification, depending upon the circumstances.
The audit reports currently issued are a result of a change by the Auditing Standards Board in 1988 when it issued Statement on Auditing Standards (SAS) no. 58: "Reports on Audited Financial Statements." This change, effective for reports issued after Jan. 1, 1989, was largely in response to the misunderstandings that prevailed with respect to the meaning of the audit opinion. The SAS further highlighted that the audit report did not apply to unaudited financial statements.
Several practical points of interest should be emphasized. First, the audit opinion is now titled "Independent Auditor's Report." This identifies that it is conducted by those who are totally independent of company management, one of the most significant aspects of the audit.
Second, the audit report is normally addressed to someone other than management. According to an AICPA publication entitled Accounting Trends and Techniques, audit reports in 1991 were addressed to the board of directors and the stockholders in 581 out of the 600 companies surveyed. Third, it is important to understand what information is covered by the audit opinion, namely, the financial statements taken as a whole, including the footnote disclosures for a specific time period.
Finally, the audit opinion is dated as of the last day of field work, not the date the report is issued. Thus, the auditor's responsibility in the interim, from the last day of field work until the date the report is issued, is limited to "subsequent events." Subsequent events are usually defined as transactions that occur after year end but before the issuance of the audit report and that affect the information presented as of year end. If no subsequent events occur, the report date is the last day of field work.
If a subsequent event does occur, the audit report can show what is known as dual dating, where the original date of field work remains on the audit opinion, but is referenced by exception to the subsequent events disclosure, which will be dated as of the date the report is issued. Thus, the auditor's responsibility in the interim is restricted to the subsequent event, not all transactions that occur in the business during that time.
Audit Reports Come in Different Shapes and Sizes
Several types of audit reports are issued by certified public accountants. While the most common is known as the "standard report," there are other types of audit opinions that can be issued. For example, if certain circumstances are present, an auditor can issue a standard report with additional explanatory language, qualified or adverse opinions, or a disclaimer of opinion.
Standard Audit Report Is "Clean Opinion"
The standard audit report, known as an unqualified report, is also known as a "clean opinion." Many of the changes mandated by SAS no. 58 are reflected in the standard audit report. For example, the second and third sentences in the first paragraph now clearly identify that the financial statements belong to management and that the auditor's responsibility is to express an opinion on the information. This was a significant change from the audit reports issued prior to 1989. Although these statements are clear, there is still some degree of misunderstanding by the readers of financial statements and audit opinions as to responsibility for the financial statement data.
The second paragraph also represents a change from the pre-1989 reports because it makes specific reference to the definition of auditing standards as well as to auditing procedures used. The two important pieces of information from this paragraph that need to be highlighted are that the audit provides "reasonable assurance" that financial statements are "free from a material misstatement." The third paragraph reaffirms the financial statements conformity with generally accepted accounting principles (GAAP) and makes a statement as to the fairness of the financial statements, again with a materiality qualifier.
Although many read the unqualified or standard opinion noted above and comprehend what it means, there are some common myths about the standard report that need to be eliminated. The first myth is that the financial statements are free from all errors. They are not. Rather, they are free from errors that would materially alter the financial statement information or have a significant impact on the reported information causing a change in expectations or behavior.
A second myth is that all documents and information are verified. The opinion makes specific reference to an examination performed on a test basis.
The third myth is that an unqualified opinion provides 100 percent assurance. Instead, the auditor's report attests to the overall reasonableness of the information. Likewise, the myth that the information presented belongs to the auditors should be dispelled since the opinion now clearly states that the financial information belongs to management.
The last myth is that the audit covers all information contained in the annual report. In fact, the audit is always limited to the information identified in the first sentence of the introduction paragraph, usually the financial statements with related note disclosures.
There are circumstances when auditors will issue an unqualified audit opinion but additional information is presented. This event is usually caused by such items as uncertainties, doubt as to the ability of the company to continue in existence (going-concern issues), inconsistency of financial information recorded or presented, the need to highlight particular information, and several other events. When such an event occurs, the standard audit report is modified to identify the circumstances, usually in an additional paragraph following the opinion paragraph. The inclusion of such a paragraph indicates the auditor's agreement with the information unless it is specifically noted otherwise.
Departing from GAAP Principles
Qualified opinions are issued when the auditors determine that the client's financial presentations represent a departure from generally accepted accounting principles or that the auditor's ability to perform the audit procedures was limited in some way. If the results do not destroy the overall financial presentation when considered as a complete set of financial statements, a qualified opinion, which is still considered a positive opinion, will be issued. Although there is an issue raised by such deviation or limitation, the auditors believe that the financial information fairly presents the financial position and results of operations.
According to SAS no. 58, a qualified opinion contains the same information as the first and second paragraphs of the standard audit report, but includes a paragraph identifying the nature of the qualification and its impact on the financial statements. In addition, the concluding paragraph states the opinion while making reference to the effects of the explanatory paragraph, and states that "the financial statements do present fairly in all material respects flows in conformity with generally accepted accounting principles."
Casting Results in a Negative Light
Adverse opinions are issued when the results of the audit process indicate that the financial statements do not present fairly the results of operations, financial position, and cash flows for the company. Adverse opinions are in fact a negative statement, clearly advocating that the financial results do not represent a fair presentation. Normally such an opinion is the result of material deviations from GAAP.
According to SAS no. 58, an adverse audit opinion contains the same language in the introductory and scope paragraphs, followed by an explanatory paragraph describing the exceptions that caused an adverse opinion. The opinion paragraph must then clearly state that the financial statements do not present fairly in accordance with GAAP.
Sitting on the Fence
A disclaimer of opinion is a clear statement that no opinion is being rendered. Such an opinion is usually the result of the auditor's inability to perform standard audit procedures and tests due to other scope limitations on their work imposed by the client. Disclaimers of opinion are, in fact, no opinion at all.
Review and Other Reports
The previous discussions focused upon audit reports issued as a result of audit procedures. Accountants are often involved in issuing other types of reports, most commonly compilation or review reports. These reports are quite different from audit reports since the basis of the report is not one of positive assurance. Rather, a compilation is typically considered no more than an accounting service and provides no assurance as to the information presented. Review reports are a step beyond compilations in that limited procedures are performed by the report issued states that only limited assurance is being given.
Report Consumers Include Credit Professionals
In addition to the board of directors and stockholders, business and credit professionals can be considered consumers of the auditor's product--the audit report. Understanding the true meaning of the audit report as well as other reports issued by accountants will provide the credit professional with a sound basis for making business decisions.
Rose Marie L. Bukics is associate professor and head of the Department of Economics and Business, Lafayette College, Easton, Pa.
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|Title Annotation:||Credit Technique; analyzing the audit report|
|Author:||Bukics, Rose Marie L.|
|Date:||Jun 1, 1993|
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