Understanding an Audit Report

The sole purpose of conducting an external audit is to make sure that the financial statements of the company express a true and fair view of its state of affairs and profitability. Understanding an audit report is essential for users of financial statements as they tend to make economic decisions based on it.

In this article, we will uncover various techniques for understanding an audit report and know what to read behind the numbers to make sound economic decisions based on it.

An independent auditor is appointed by the stakeholders so that he can carry out the audit in an unbiased manner. The auditor goes through vouchers, books, ledgers, registers, cash flow statements, balance sheets, profit and loss statements, etc. to express his opinion on the financial statements.

There are possibilities that there could be minor errors with no or minimum financial impact remaining undetected. However, fraud or material misstatements which affect the financial statement severely must be recognized, and information on them must be disclosed transparently and unambiguously.

The professional auditor then carries out his audit procedures and prepares his audit report based on the audited financials.

Using the unqualified audit report or qualified audit report, investors, stakeholders, and potential shareholders can provide a base to their decision regarding investing in the company.

Once the stakeholders start understanding an audit report of a company there are invested in, they can decide whether to stay invested or park their money elsewhere. Therefore, understanding an audit report will help to make better economic decisions.

Why is Understanding an Audit Report Important?

Benefits of Understanding an Audit Report

Consider you get access to the audited financials of the company. However, if you try to draw a conclusion purely based on audited financials, you will miss out on several things. You will not have access to the supporting documents and knowledge about the accounting policies and principles followed in the drafting of the financial statements. Even if you have access to everything, not everyone is skilled enough to have an auditor’s eye to draw conclusions and form an opinion.

An auditor will go through all the documents for you and summarize facts and figures for you to comprehend them properly. He applies the applicable financial reporting framework and evaluates if:

The significant accounting policies applied in the preparation of financial statements have been adequately disclosed. Further such policies are appropriate and consistent with the applicable financial reporting framework.
Accounting estimates made by the management are reasonable.
The financial statements provide adequate information, and such information is relevant, reliable, comparable, and understandable.
Adequate disclosures are provided for the effect of material transactions and events on the information conveyed in the financial statements.
The terminology and the titles used in the financial statements are appropriate.

Understanding an audit report will brief you about the scope of the audit, auditor’s responsibility, management’s responsibility, and auditor’s opinion. If you obtain a thorough understanding of audited reports, you can understand the financials of a company and hidden stories behind the numbers.

Elements of an Audit Report

Format of an Audit Report

An audit report has various elements, and each one is as important as another one. The auditor needs to prepare the audit report taking into consideration the audit report format and all the necessary elements.

We will discuss all the elements of an audit report in detail to make the task of understanding an audit report easier for you.

Title

The title of the audit report indicates that an independent auditor has prepared the audit report. It gives the assurance to the readers of an audit report that the auditor is unbiased in providing his opinion on the financial statements.

Addressee

An auditor mentions in his audit report that for whom the audit report is prepared. Generally, the auditor addresses the audit report to the shareholders or the board of directors of the company. The addressee may change as per the law of the country, terms, and circumstances of the engagement.

Auditor’s Opinion

This is an essential part of an audit report and provides an overview of whether the company’s financial statements provide a true and fair view of its state of affairs and profitability. The readers trying to understand an audit report must pay due attention to this section.

The opinion section of the auditor’s report:

Identifies the auditee and states that the financial statements have been audited
Identifies the title of each statement forming part of the financial statements
Refers to the notes on accounts and significant accounting policies
Specifies the date or period of each statement forming part of the financial statements

There are four types of audit reports issued by an auditor:

Unqualified Opinion

The auditor expresses an unqualified opinion when he finds financial statements of the company true and fair, and there is no need for any modification. It is also called an unmodified or clear opinion. An unqualified opinion creates a positive sentiment in the minds of stakeholders.

Qualified Opinion

The auditor gives away a qualified opinion when he concludes that he can not issue an unqualified opinion. Still, misstatements are not material enough to issue an adverse or disclaimer of opinion.

Adverse Opinion

The auditor expresses an adverse opinion when he finds significant misstatements in the company’s financial statements.

In case if an external auditor provides an adverse opinion, it may even lead to the shutting down of the company or a change of management. If any fraud is detected, the auditor is obliged to report this to government authorities.

Disclaimer of Opinion

The auditor expresses a Disclaimer of Opinion when the company doesn’t provide him all the required information. Because of this, he won’t be able to conclude, and thus, the exact picture of the company can’t be delivered.

Disclaimer of opinion harms the company’s reputation. Shareholders may not find it suitable to continue with the company as they can not ascertain the actual financial image of the company.

One of the crucial considerations in understanding an audit report is to check which opinion is provided by the auditor as it is an indicator of how much reliance you can place on the financial information provided by the company.

Basis of Opinion

This section follows the Opinion section, provides the context which strengthens the credibility of the report and helps the users in understanding an audit report. This section has a heading, “Basis of Opinion.” Key features of this section are as follows:

This section states that the audit was conducted according to the auditing standards.
Refers to the section that describes auditor’s responsibilities under the Standards on Auditing
It includes a statement that conveys that the auditor is independent of the entity and fulfills the relevant ethical requirements.
The auditor also mentions whether he believes that the audit evidence obtained is sufficient and appropriate.

Going Concern

Here the auditor reports if the organization is a Going Concern as per the applicable Standards on Auditing.

Key Audit Matters

There is a complete set of key audit matters which auditors communicate in this section of the audit report. The auditor may require adding the key audit matters of entities besides the listed entities if the law or regulations requires. This section provides additional information to the ones interested in understanding an audit report.

Responsibilities of Management for the Financial Statement

The management holds the responsibility for the preparation of the financial statements and presenting them to the auditor. Financial Statements should be free from errors and material misstatements. It is also the responsibility of the management to enforce internal controls and internal checks to achieve operational efficiencies. The external auditor clarifies this to aid in understanding an audit report.

Auditor’s Responsibilities as to the Audit of the Financial Statement

This section in an audit report explains what all responsibilities an auditor cover while conducting the audit and preparing the audit report.

The auditor mentions the objective of conducting the audit. The two objects which are necessary includes:
- Obtaining reasonable assurance that the audited financials are free from material misstatements or not.
- Issuing the audit report, which contains the opinion of the auditor about the financial statement.
The auditor ensures that the assurance provided is of high level. Still, it is not the guarantee that all material misstatements are detected.
It states that the misstatements can arise from fraud or error and provides a definition of the materiality as per the applicable financial reporting framework or describes that such misstatements are considered material if they are expected to influence the economic decisions of the users of the financial statements.
Audit Report states that the auditor has exercised professional judgment and maintained the professional skepticism while conducting the audit and describes his responsibilities.
He mentions that he has obtained an understanding of audit relevant internal controls. It is necessary as the audit procedure is designed as per the internal control and circumstances.
Auditor also holds the responsibility to communicate to the management the scope and time required for the audit. He adds in the audit report about the significant deficiencies in the internal control found during the audit.

Other Reporting Responsibilities

If the auditor addresses other responsibilities in addition to his responsibilities under Standards on Auditing, then such responsibilities he addresses in a separate section titled as ‘Report on Other Legal and Regulatory Requirements’ or otherwise as appropriate.

Signature of the Auditor and Auditor’s Address

The auditor signs the audit report in his name. He also signs the audit report in the name of the firm if an audit firm is appointed.

Place of Signature

The auditor also adds the name of a specific location where the audit report is signed.

Date of the Audit Report

The auditor puts a date on the audit report. It is the date when the auditor obtains sufficient and appropriate financial status evidence according to which he provides his opinion. The date of the audit report conveys that the auditor has taken into consideration all the effects of events and transactions that occurred on and before the date.

How to read an Audit Report

How to find hidden stories behind the numbers

Anyone knowing how to read an audit report will be able to make better economic decisions. Audit reports are lengthy, and without the complete knowledge of accounting policies, principles, and auditing standards, it is tough to comprehend the reports.

Understanding an audit report is in one’s own interest as decisions taken based on an audit report has financial consequences.

The main objective behind the auditor’s report is to make the users of financial statements draw meaningful conclusions and make economic decisions. Accordingly, an audit report provides reasonable assurance about the accuracy of financial statements and a true and fair view thereof.
The users of the audit report and financial statements will immensely benefit if they gain reasonable knowledge about the auditee in advance. The knowledge of business activities of the auditee will make the users known about the challenges and opportunities in the sector it operates and the regulatory requirements. It will also help in enhancing their abilities to understand an audit report.
The readers should know that financial statements and audit reports are prepared in accordance with the concept of materiality, meaning; the immaterial items may be grouped or presented in the way the auditor feels appropriate. This point must be considered while understanding an audit report.
The readers should also appreciate the fact that certain amounts in the financial statements are based on the judgment, estimate, and likely outcome of future events. So, there’s some amount of uncertainty involved.
Further, auditors’ report helps in placing a degree of confidence in the information presented in the financial statements. The audit report is not about the appropriateness of business strategies, its future viability, or a guarantee of a sound business.
The directors of the company comment on the solvency of the company, and the auditor also assesses if the organization is a going concern, but that is again not a guarantee for the future prospects of the company or the risks that could adversely impact a company’s fortune.
Readers of the audit report should also know the fact that a statutory audit is not an investigation to reveal all the frauds. On the other hand, the audit is likely to detect the instances of frauds that result in material misstatements as the auditor treats fraud risk as a significant risk and accordingly tests the auditee’s internal controls. However, there’s no guarantee that it will detect all the material frauds.
The readers will immensely benefit while understanding an audit report if they pay attention to scope and opinion sections of the audit report and the sections describing auditors’ and managements’ responsibilities.

FAQs: Understanding an Audit Report

1. What are the minimal elements of an audit report?

The basic elements of an audit report are as follows:
a) A title
b) An addressee
c) An opinion section
d) Basis of opinion
e) Going concern
f) Key audit matters
g) A description of management’s responsibilities
h) A description of auditor’s responsibilities
i) Other reporting responsibilities
j) The auditor’s signature and his address
k) Place of signature
l) The audit report’s date

2. What is the difference between a modified report and unmodified report?

An unmodified report is the one that doesn’t require any changes in the financial statement. According to this report, the company finances are true and fair. In this case, an auditor gives an unqualified opinion, which suggests that no changes are required.
In a modified report, the entity needs to make changes in its financial statement as per the opinion provided by the auditor. The qualified opinion, adverse opinion, and disclaimer of opinion come under this section. In this case, the company’s financial statement cannot be considered true and fair.

Source: https://nrdoshi.ae/understanding-an-audit-report/

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