Financial statements are generally required to be audited by an independent firm of auditors in accordance with applicable auditing standards who provide a written opinion, called audit report, which is included in the annual report. International Standards on Auditing (ISAs) are issued by the International Auditing and Assurance Standards Board (IAASB) and US auditing standards are promulgated by the Public Accounting Oversight Board (PCAOB).
The objective of an auditor is to obtain reasonable assurance (not absolute assurance) that the financial statements are free from material misstatement thereby enabling him to express an opinion on whether the financial statements are prepared in accordance with the applicable financial reporting framework.
Types of audit opinions
There are different types of audit opinions.
Unqualified opinion
An unqualified opinion (also called unmodified or clean opinion) states that the financial statements give a ‘true and fair view’ or are ‘fairly presented’.
Qualified opinion
A qualified opinion is an opinion in which there is some scope limitation or some exception to accounting standards (which must be explained in the audit report).
Adverse opinion
An adverse opinion is issued when the auditor determines that the financial statements are not fairly presented.
Disclaimer of opinion
A disclaimer of opinion occurs when the auditor is unable to issue an opinion, for example, due to scope limitation.
Key audit matters
The audit report describes the basis of auditor’s opinion, and for listed companies, includes a discussion of key audit matters (critical audit matters), a discussion of a critically important issue which in the opinion of the auditor requires significant management judgment or where the material misstatement is high.
Publicly traded companies may also be required to appoint an independent audit committee to oversee the audit process. Further, in the US, the Sarbanes-Oxley Act requires auditors to express an opinion on the company’s internal control systems (either as a separate opinion or as part of the audit report).
Even though the audit reports and attestations provide some assurance, an analyst still needs to employ a degree of healthy skepticism when analyzing financial statements.