What Is an Auditor's Report?
Let me explain what an auditor's report really is. It's a written letter from the auditor that gives their opinion on whether a company's financial statements follow generally accepted accounting principles (GAAP) and are free from any material misstatements.
You'll typically find this independent and external audit report published alongside the company's annual report. I want you to understand why it's crucial: banks and creditors insist on seeing an audit of the financial statements before they lend money.
Key Takeaways
Here's what you need to grasp: the auditor's report contains the auditor's opinion on GAAP compliance and the absence of material misstatements in the financial statements. It's vital because banks, creditors, and regulators demand these audits. A clean report indicates the company followed standards properly, while a qualified one suggests possible errors. An adverse report points to discrepancies, misrepresentations, and non-adherence to GAAP.
How an Auditor's Report Works
An auditor's report is essentially a letter attached to the financial statements, expressing the auditor's view on the company's adherence to standard accounting practices. If the company is public, this report must be filed with the financial statements when reporting earnings to the Securities and Exchange Commission (SEC).
Keep in mind, though, that this isn't an assessment of whether the company is a solid investment. It also doesn't analyze the earnings performance over the period. What it does is measure how reliable those financial statements are.
The Components of an Auditor's Report
The auditor's letter sticks to a standard format set by generally accepted auditing standards (GAAS). It usually has three paragraphs.
In the first paragraph, it outlines the responsibilities of the auditor and the directors. The second covers the scope, noting that standard accounting practices guided the audit. The third delivers the auditor's opinion.
Sometimes there's an extra paragraph about a separate audit on another part of the entity. You'll want to focus on that third paragraph where the opinion is stated.
The report type depends on what the auditor finds. I'll cover the common types next.
Clean or Unqualified Report
A clean report, or unqualified, means the financial records are free from material misstatements and align with GAAP guidelines. Most audits result in this type of opinion.
Qualified Opinion
You get a qualified opinion in two cases: if there are material misstatements that aren't widespread, or if the auditor couldn't get enough evidence, but any potential misstatements aren't pervasive. For instance, there might be an error in calculating operating expenses or profit. Auditors will point out the specific issues so the company can address them.
Adverse Opinion
An adverse opinion comes when the auditor has enough evidence to conclude that misstatements are both material and pervasive. This is the worst outcome for a company, leading to lasting impacts and possible legal issues if not fixed.
Regulators and investors will reject the financial statements after an adverse opinion. If there's illegal activity, corporate officers could face criminal charges.
Disclaimer of Opinion
A disclaimer means the auditor couldn't get sufficient evidence for an opinion, and any undetected misstatements could be material and pervasive. This might happen if the auditor can't remain impartial or isn't given access to key information.
Example of an Auditor's Report
Let me show you excerpts from Deloitte & Touche LLP's audit report for Starbucks Corporation, dated November 15, 2019.
In the first paragraph, on the opinion: 'We have audited the accompanying consolidated balance sheets of Starbucks Corporation and subsidiaries (the 'Company') as of September 29, 2019, and September 30, 2018, the related consolidated statements of earnings, comprehensive income, equity, and cash flows, for each of the three years in the period ended September 29, 2019, and the related notes (collectively referred to as the 'financial statements'). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 29, 2019, and September 30, 2018, and the results of its operations and its cash flows for each of the three years in the period ended September 29, 2019, in conformity with accounting principles generally accepted in the United States of America.'
The second paragraph, on the basis: 'We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (PCAOB). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.'
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