Understanding Audit Report

The auditor’s report is the end product of each audit. Audit report is considered as an
important channel through which opinions of an auditor about the financial statements and
the findings of the company audited by him are expressed. The audit report summarizes the
outcome of the audit work done by the auditor. Hence it is an important part of the audit
process.

Auditor collects evidences about financial statements or other propositions covered by audit
through different methods. Gathered evidences are sifted and examined by the auditor with
due care, diligence, skill, etc. Finally, he drew appropriate conclusions and conveys them
through the audit report. The auditor should be careful about the language and the words,
which he uses, in the audit report because it is on them the auditor’s legal responsibility for
negligence or fraud rests.

The AAS 28 establishes standards on the form and content of the auditor’s report. The
Companies Act also lays down the requirement of an audit report. The auditor is expected to
prepare his audit report based on these standards and requirements. In this chapter, we shall
describe the form, contents and types of audit report.

Form and Contents of Audit Report

As per the AAS 28, the audit report should contain the following basic elements in it:

 Title of the Report.

 Addressee.
 Opening or Introductory Paragraph.
 Scope Paragraph.
 Opinion Paragraph.
 Signature.
 Place of Signature.
 Date of the Report.
1. Title of the Report

The title of the report should be appropriate i.e., Auditor’s Report, Cost Auditor’s Report, etc.
It enables the readers to identify the auditor’s report and also distinguish it from the reports of
others such as director’s report, accountant’s report, etc.

2. Addressee

The auditor’s report should be addressed to the person to whom it should be forwarded.
Generally, it is submitted to the person who appoints the auditor. Hence, the addressee is a
person who appoints the auditor and to whom the report is forwarded. In case of the statutory
audit of a company, it is the shareholders who are the addressee.

3. Opening or Introductory Paragraph

It consists of the identification of the following aspects:

 Financial Statements Audited: Financial statements are identified by name of the

company and the period covered by the financial statements.
 Clear Marking of Responsibility between the Management and the Auditor: It should
state clearly that the financial statements are the responsibility of the entity’s
management and that the responsibility of the auditor is to express an opinion thereon.

4. Scope Paragraph

The scope paragraph should specify the nature and scope of the work performed by the
auditor. It should state that the audit was conducted as per the auditing standards generally
accepted in India and that the audit was planned and performed to obtain assurance that the
financial statements are free of material misstatement.

Then it should specifically describe the audit as including — an examination, on a test basis,
of evidence supporting the financial statements, assessment of accounting principles followed
and of significant estimates made by the management, and overall evaluation of financial
statement presentation. Besides, it should also state that the audit provides a reasonable basis
for the auditor’s opinion.
5. Opinion Paragraph

The opinion paragraph of the auditor’s report should clearly specify the financial reporting
framework such as accounting principles generally accepted in India used to prepare the
financial statements and state the auditor’s opinion as to whether the financial statements give
a true and fair view in accordance with that financial reporting framework and whether they
comply with the statutory requirements.

6. Signature

The auditor in his personal name should sign the auditor’s report. The audit report should be
signed in the personal name of the auditor and also in the name of the audit firm if it was
appointed as the auditor. While signing the report, the membership number of the partner or
proprietor, assigned by ICAI should be mentioned.

7. Place of Signature

The report should specify the location, where the audit report is signed. That is the town or
city where the report is signed should be mentioned specifically here.

8. Date of the Report

The date of auditor’s report on financial statements indicates the date when the report is
signed by the auditor with his views and opinions about the financial statements of the
company he audited. This gives a clear picture that the auditor has considered the effect, on
the financial statements and on the audit report, of the events and transactions that occurred,
and of which the auditor became aware, up to that date. Further, the auditor report should not
predate than the date on which the financial statements are signed or approved by the
management.
What are the Types of Audit Opinions?

In the independent auditor’s report, an auditor can issue one of five different opinions:

 Clean (unqualified) opinion;

 Qualified opinion due to a GAAP departure;
 Qualified opinion due to a scope limitation;
 Adverse opinion due to a GAAP departure; and
 Disclaimer of opinion due to a scope limitation.

A clean (unqualified) opinion refers to financial statements that are “presented fairly, in all
material respects…”. Deviations from a clean opinion (where the financial statements are not
presented fairly) result in a reservation (modification) in the independent auditor’s report.

Understanding Reservations in an Independent Auditor’s Report

There are two types of reservations:

1. GAAP departure

Situations where the financial statements deviate from the established accounting criteria. For
example, a company that uses an incorrect accounting method faces a GAAP departure.

2. Scope limitation

Situations where the auditor is unable to obtain sufficient appropriate audit evidence to base
the audit on. This presents a scope limitation.
In addition, the type of opinion, based on the reservation made, depends on two factors:

1. Materiality

Misstatements to the financial statements are considered material if the misstatements

(individually or in aggregate), are expected to influence the decisions made by users who rely
on the financial statements.

2. Pervasiveness

Misstatements to the financial statements are considered pervasive if the misstatements affect
a substantial portion of the financial statements.
What is a Qualified Opinion?

A qualified opinion can be issued due to a GAAP departure or a scope limitation. In both
cases, the misstatements are material but not pervasive. In other words, there is a material
impact on the financial statements, but the misstatements are not widespread (do not affect a
large number of accounts).

Example 1: Qualified opinion due to a GAAP departure

The auditor noticed that the inventory of ABC Company faces a write-down due to
obsolescence. However, the company refuses to write down the inventory. In such a scenario,
a GAAP departure reservation is made. Since only the inventory and cost of goods sold
accounts are wrong, a qualified opinion due to a GAAP departure would be issued.

Example 2: Qualified opinion due to a scope limitation

The auditor wants to send out confirmation letters to customers for the accounts receivable
balance as audit evidence. However, ABC Company does not want the auditor to do so. In
such a scenario, a scope limitation reservation is made. Since the auditor has been unable to
verify the accounts receivable, a qualified opinion due to a scope limitation would be issued.

What is an Adverse Opinion?

An adverse opinion can only be issued due to a GAAP departure. In such a case, the
misstatements are both material and pervasive. In other words, there is a material impact on
the financial statements, and the misstatements affect a large number of accounts.

Example: Adverse opinion due to a GAAP departure

The auditor believes ABC Company faces a going concern issue and is unable to survive
another year. The company disagrees and prepares its financial statements on a historical cost
basis instead of on a liquidation basis. In such a scenario, a GAAP departure reservation is
made. Since ABC Company prepared its financial statements on a historical cost basis, the
majority of the company’s accounts are incorrect. An adverse opinion due to a GAAP
departure would be issued.
What is a Disclaimer of Opinion?

A disclaimer of opinion can only be issued due to a scope limitation. In this case, the
misstatements are material and pervasive. In other words, the auditor is unable to collect
sufficient appropriate audit evidence to base its audit on and, as a result, a large number of
accounts are not verifiable.

Example: Disclaimer of opinion due to a scope limitation

The auditor is looking to review the company’s minutes book, which contains important
information regarding the board of directors meeting and the audit committee. ABC
Company does not permit the auditor to review the minutes book. In such a scenario, a
disclaimer of opinion reservation is made. Since the auditor is unable to access the minutes
book, a majority of the company’s accounts cannot be verified. A disclaimer of opinion due
to a scope limitation would be issued.