Financial Reporting and Analysis I
Reading 19. Introduction to Financial Statement Analysis
Learning Outcome Statements
d. describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls;
CFA Curriculum, 2020, Volume 3
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Subject 4. Auditor's Reports
Though hired by the management, the auditor is supposed to be independent and to serve the stockholders and the other users of the financial statements.
An auditor's report (also called the auditor's opinion) is issued as part of a company's audited financial report. It tells the end-user the following:
- Whether the financial statements are presented in accordance with generally accepted accounting principles.
- It identifies those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period.
- Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report.
An auditor's report is considered an essential tool when reporting financial information to end-users, particularly in business. Since many third-party users prefer or even require financial information to be certified by an independent external auditor, many auditees rely on auditor reports to certify their information in order to attract investors, obtain loans, and improve public appearance. Some have even stated that financial information without an auditor's report is "essentially worthless" for investing purposes.
The Types of Audit Reports
There are four common types of auditor's reports, each one representing a different situation encountered during the auditor's work. The four reports are as follows:
- An unqualified opinion report is issued by an auditor when the financial statements presented are free of material misstatements and are in accordance with GAAP, which, in other words, means that the company's financial condition, position, and operations are fairly presented in the financial statements. It is the best type of report an auditee may receive from an external auditor. It is regarded by many as the equivalent of a "clean bill of health" to a patient, which has led many to call it the "clean opinion."
- A qualified opinion report is issued when the auditor encountered one or two situations that did not comply with generally accepted accounting principles; however, the rest of the financial statements are fairly presented. This type of opinion is very similar to an unqualified or "clean opinion," but the report states that the financial statements are fairly presented with a certain exception which is otherwise misstated.
- An adverse opinion is issued when the auditor determines that the financial statements of an auditee are materially misstated and generally do not comply with GAAP. It is considered the opposite of an unqualified or clean opinion, essentially stating that the information contained to assess the auditee's financial position and results of operations is materially incorrect, unreliable, and inaccurate.
- A disclaimer of opinion, commonly referred to simply as a disclaimer, is issued when the auditor could not form, and consequently refuses to present, an opinion on the financial statements. This type of report is issued when the auditor tried to audit a company but could not complete the work due to various reasons and does not issue an opinion.
Auditor's Report on Internal Controls
Following the enactment of the Sarbanes-Oxley Act of 2002, the Public Company Accounting Oversight Board (PCAOB) was established in order to monitor, regulate, inspect, and discipline audit and public accounting firms of public companies. The PCAOB Auditing Standards No. 2 now requires auditors of public companies to include an additional disclosure in the opinion report regarding the auditee's internal controls, and to opine about the company's and auditor's assessment of the company's internal controls over financial reporting. These new requirements are commonly referred to as the COSO Opinion.
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Who knows more on this COSO opinion?
Unqualified -> Clean report
Qualified -> Exceptions to Accounting principles
Adverse -> Not fair presentation
Disclaimer -> Unable to express an opinion.
what is "COSO"?
COSO stands for the Comittee of Sponsoring Organizations of the treadway commission. They established a new system of internal control strategies for companies, thus planting the seed for new broadly accepted standards of internal reporting and control within public companies. A quick Google gives you all the info if you're interested
Technically the auditors are hired by the board of directors, not management but whatever.
This phrase “Though hired by the managemen....” is not correct. In context, External Auditor is being spoken about here. External auditors are appointed and engaged by the shareholders mostly through audit committee.