Start-up and small business owners facing a first-time financial audit might feel like contestants on an episode of the cooking competition show Top Chef, sweating bullets as they await the judges’ decision regarding their culinary efforts. Understanding what goes into an auditor’s report can go a long way toward alleviating that stress.
An independent auditor’s examination and resulting report are designed to assure creditors, investors, and other users that they can rely on a company’s financial statements. These stakeholders often use financial statements to make decisions that can profoundly impact the company’s operations and growth. Thus, it is important for business owners to know what each “ingredient” of the audit report – the introduction, scope, and opinion – means to the reader.
Grasping the significance of each ingredient can help business owners prioritize the audit – one of our five tips for preparing for a financial statement audit.
Audit Report Ingredient #1: Introduction
The introduction states that an audit has been conducted for a set of financial statements that cover a specific period. This section also delineates management and auditor responsibilities. Management is responsible for preparing and fairly presenting the financial statements in accordance with both U.S. generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS). By contrast, the auditor is responsible for complying with generally accepted auditing standards (GAAS) throughout the engagement and for expressing an opinion based on the audit.
Audit Report Ingredient #2: Scope
The scope section describes the work the auditor has performed. It states that the auditor has:
- examined the company’s financial statements in accordance with GAAS, and
- obtained sufficient evidence to provide reasonable assurance as to whether the financial statements presented by management are free of material misstatement.
Audit Report Ingredient #3: Opinion
The main section, the opinion, states the auditor’s conclusion by either disclaiming an opinion or expressing one of the following three generally accepted opinions.
- Unqualified Opinion. An unqualified opinion, which is the most favorable, means that:
- management provided all necessary information,
- all auditing requirements were met, and
- the auditor can provide reasonable assurance that the financial statements presented are free of material misstatement and comply with GAAP.
An unqualified opinion may still include an explanatory paragraph to emphasize a matter, such as a change from one generally accepted accounting principle to another.
- Qualified Opinion. An auditor presents a qualified opinion when most of the information in the financial statements was fairly stated with one or two exceptions. The auditor names those exceptions in the report. For example, an auditor may issue a qualified opinion if there was a scope limitation – such as an inability to confirm the existence of an asset whose value is material, but not highly material.
- Adverse Opinion. An adverse opinion indicates that the financial statements are so materially misstated that they do not present the company’s financial position, results of operation, or cash flows in accordance with GAAP.
When an auditor presents a disclaimer, it usually means that management either was unable or refused to provide the necessary information for the auditor to form an opinion about the financial statements. For example, an auditor may use a disclaimer opinion if s/he could not observe or otherwise verify material physical inventory. A disclaimer is also used when the auditor’s independence has been compromised.
Auditor Quality: The “Secret Sauce” of a Comprehensive Audit Report
Financial statement users often place a high value on an external auditor’s opinion. Therefore, it is best to seek auditors who have extensive experience auditing small businesses in your industry and who encourage open communication throughout all steps of the audit process to minimize surprises.
Unlike Top Chef contestants, you can take the time to prepare for your financial audit – and CRI can help. Please contact us if you have questions about an upcoming audit. If you are unsure whether your company needs an audit, then we can also help you determine which service – audit, review, compilation, or financial statement preparation – best suits your needs.