Audit Reports: The Auditor's Deliverable
The audit report is the final product of the audit engagement and the primary means by which the auditor communicates findings to financial statement users. The AUD section of the CPA exam heavily tests your knowledge of report types, modifications, and the specific language used. Under the current reporting framework (AU-C 700-706 for nonissuers, AS 3101 for issuers), the report structure and required elements differ between AICPA and PCAOB standards.
Standard Unmodified (Clean) Opinion
An unmodified opinion states that the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework (e.g., U.S. GAAP). Key elements of the unmodified report under AU-C 700 include:
- Title: Must include the word "independent" (e.g., "Independent Auditor's Report")
- Addressee: Typically the board of directors and shareholders
- Opinion section: Appears first, identifies the entity and financial statements audited, states the opinion
- Basis for Opinion: States the audit was conducted in accordance with GAAS, references the auditor's responsibilities
- Responsibilities of Management: Preparation and fair presentation, internal control, going concern assessment
- Auditor's Responsibilities: Obtain reasonable assurance, exercise professional judgment and skepticism, describe key audit procedures
For public company audits under PCAOB AS 3101, the report also includes Critical Audit Matters (CAMs) - matters communicated to the audit committee that relate to accounts or disclosures that are material and involved especially challenging, subjective, or complex auditor judgment.
Modified Opinions
When the auditor cannot issue an unmodified opinion, one of three modifications is required. The choice depends on the nature of the issue and whether its effects are material or both material and pervasive:
| Nature of Issue | Material but Not Pervasive | Material and Pervasive |
|---|---|---|
| Material misstatement | Qualified opinion ("except for") | Adverse opinion |
| Inability to obtain sufficient appropriate evidence | Qualified opinion ("except for") | Disclaimer of opinion |
Qualified Opinion
A qualified opinion is issued when the auditor concludes that misstatements are material but not pervasive, or when the auditor is unable to obtain sufficient evidence about a specific area but the possible effects are not pervasive. The opinion paragraph uses "except for" language - for example, "Except for the effects of the matter described in the Basis for Qualified Opinion section, the financial statements present fairly..."
Adverse Opinion
An adverse opinion is issued when misstatements are both material and pervasive to the financial statements. The opinion states that the financial statements "do not present fairly." This is the most severe opinion on the financial statements and is relatively rare in practice because management typically corrects identified misstatements before the report is issued.
Disclaimer of Opinion
A disclaimer is issued when the auditor is unable to obtain sufficient appropriate audit evidence and the possible effects are material and pervasive. The auditor states they "do not express an opinion." This may occur due to scope limitations imposed by the client, destruction of accounting records, or the auditor's inability to observe inventory or confirm receivables when alternative procedures are insufficient.
Emphasis-of-Matter and Other-Matter Paragraphs
Under AU-C 706, the auditor may add paragraphs to an unmodified report without modifying the opinion:
- Emphasis-of-Matter (EOM): Draws attention to a matter appropriately presented or disclosed in the financial statements that is of such importance that it is fundamental to users' understanding. Common examples include going concern uncertainty, significant related party transactions, important subsequent events, and adoption of a new accounting standard.
- Other-Matter: Refers to a matter not presented or disclosed in the financial statements that is relevant to users' understanding of the audit. Examples include alerting readers that the prior year statements were audited by another auditor or that supplementary information was not audited.
Going Concern
Under AU-C 570, if the auditor concludes there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time, the auditor evaluates whether the financial statements include adequate disclosure. If management's plans adequately mitigate the going concern doubt and appropriate disclosures are included, the auditor issues an unmodified opinion with an Emphasis-of-Matter paragraph. If disclosures are inadequate, a qualified or adverse opinion may be appropriate.
Comparative Financial Statements
When reporting on comparative statements, the auditor should update the opinion on prior-period statements. If a different opinion is warranted (e.g., a prior qualified opinion is resolved), the auditor includes an Other-Matter paragraph explaining the change. If the prior year was audited by a predecessor auditor, the current auditor may reissue or reference the predecessor's report.
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