Understanding audit reports

Auditors are required to give either an unmodified opinion (commonly referred to in business as a ‘clean’ opinion), or a modified opinion.

An unmodified opinion is provided where the auditor considers that the financial statements give a true and fair view of the company affairs at the balance sheet date and of its profit or loss for the accounting period.

In times of increasing UK and global economic uncertainty, we might reasonably expect to see more ‘modified’ audit opinions. The possible types of audit opinions that auditors may give are explained below.

A modified audit opinion can arise where there is an error, a disagreement over a particular matter or a lack of sufficient audit evidence in a particular area of the financial statements, including disclosures. How material or pervasive the impact is will determine the type of modification.

There are three types of modified audit opinion:

Qualified opinion - this could be because either:

• the auditor has been unable to obtain ‘sufficient appropriate audit evidence’ concerning a particular matter, but, except for the possible effects of this matter, the auditor is able to state that the financial statements give a true and fair view; or
• there is a particular material misstatement in the financial statements, ie, a misstatement that the auditor judges could impact the decisions of users of the financial statements, but except for the effects of this matter, the financial statements give a true and fair view.

The opinion section is headed up ‘Qualified opinion’.

Example 1: an auditor has been unable to attend a year-end inventory count of goods that are due to be sold by the company or to put in place suitable alternative measures to obtain the audit evidence considered necessary about the existence and condition of inventory. As a result the auditor has determined that this is a limitation in the scope of the auditor’s work, but in all other respects the financial statements give a true and fair view.

Example 2: a disagreement arises over the fair value of an item in the financial statements given the impact of recent volatility within the market. The auditor has determined that this misstatement could impact the decisions of users of the financial statements but that in all other respects the financial statements give a true and fair view.

Disclaimer of opinion - the auditor is unable to obtain ‘sufficient appropriate audit evidence’ and this is material and so pervasive that the auditor is unable to form a view as to whether the financial statements give a true and fair view. The opinion section will be headed up ‘Disclaimer of opinion’.

Example: there are a significant number of overseas subsidiaries that make up the majority of a group’s operations and as the auditor is unable to obtain evidence to audit the results of those overseas subsidiaries, an opinion on whether the financial statements give a true and fair view cannot be given by the auditor.

Adverse opinion - the auditor judges, having obtained sufficient evidence, that there is a material and pervasive misstatement in the financial statements and that, because of the significance of the matter, the financial statements do not give a true and fair view. The opinion section will be headed up ‘Adverse opinion’.

Example: revenue on long-term contracts has been significantly overstated as it has not been recognised in accordance with applicable accounting standards. This misstatement is considered by the auditor to be material and pervasive and because of the significance of this matter, the auditor has determined that the financial statements do not give a true and fair view.

Yes. These may include reference to material uncertainties in relation to going concern or to other specific matters in the financial statements that the auditors believe require specific emphasis (emphases of matter). These do not change the audit opinion and these sections will state specifically that the audit opinion is not modified in respect of these matters.

In addition, there may be potential modifications to other matters in the audit report, for example in relation to other matters prescribed by law, matters reported by exception (eg. in relation to the adequacy of accounting records) or regarding other information presented in the annual report that accompanies the financial statements.

A standard feature of audit reports for listed entities and other public interest entities are key audit matters (sometimes referred to as ‘KAMs’). These are intended to provide useful additional information to investors and other users. These are not material uncertainties or emphases of matter. In times of UK and global economic uncertainty, we may see more ‘key audit matters’ included by auditors in their reports in relation to the impact of these uncertainties.

A company is a going concern if it is able to remain in business for the foreseeable future. Unless management intends to liquidate the company or to cease trading, or has no realistic alternative but to do so, the financial statements will be prepared on a going concern basis. This does not mean, however, that there are no risks to future operations.

Auditors will evaluate management’s going concern assumptions for a minimum period of one year from the date of the audit report and will consider whether any material uncertainties exist which may cast significant doubt about the company’s ability to continue as a going concern.

This indicates that the auditor’s assessment of the company is that it is a going concern and that there are no material uncertainties.

No, the inclusion of such information does not mean that the company is not a going concern. It means that the directors have concluded that there is a material uncertainty about the company’s future operations, and that the auditors agree with that judgement. It also means, importantly, the directors have made clear, transparent disclosures in the financial statements regarding the nature and implications of the material uncertainty. If this section is included in the audit report it would replace ‘a conclusions relating to going concern’ paragraph.

External factors that create an uncertain or unstable economic environment are likely to make the inclusion of ‘material uncertainty relating to going concern’ paragraphs in audit reports more common. These paragraphs do not modify the audit opinion.

No, the inclusion of the material uncertainty in the audit report does not change the audit opinion.

Emphasis of matter paragraphs do not change the audit opinion. They are used by auditors to draw the attention of users to a matter that the auditor thinks is important to their understanding of the financial statements.

Example: an emphasis of matter paragraph might relate to property valuations where valuers specifically reference in their reports material uncertainty related to the uncertain economic environment and the directors have accordingly disclosed this in the financial statements. The inclusion of an emphasis of matter paragraph does not mean that the auditors believe that the valuation in the financial statements is inappropriate; the auditors are simply highlighting the disclosed material uncertainty as they believe that the information is important for users seeking to understand the financial statements. Reporting an emphasis of matter is not the only possible outcome in this situation; the impact on the auditor’s report will depend on the auditor’s assessment of the facts and circumstances in each case.

• FRC’s guidance on modifications of independent auditor’s opinions and reports 
• ICAEW Audit report wording guides