The Structure of an Independent Auditor’s Report

Question: At the conclusion of an audit, a report is issued by the CPA that will be attached to the financial statements for all to read. Much of this report is boilerplate: the words are virtually identical from one company to the next. What information is conveyed by an independent auditor, and what should a decision maker look for when studying an audit report?

Answer: The audit report accompanying the 2009 and 2010 financial statements for The Procter & Gamble Company is shown next.

To understand the role of the independent audit within the financial reporting process, a considerable amount of information should be noted in the audit reportFormal written opinion issued by an independent auditor to communicate findings at the conclusion of an audit as to indicate whether a specific set of financial statements contains any material misstatements according to U.S. GAAP; if not, the statements are viewed as fairly presented. attached to the financial statements issued by Procter & Gamble.

1. The report is addressed to the board of directors (elected by the shareholders) and the shareholders. An audit is not performed for the direct benefit of the reporting company or its management but rather for any person or group studying the financial statements for decision-making purposes. The salutation stresses that external users (rather than the company itself) are the primary beneficiaries of the work carried out by the independent auditor.

   Interestingly, independent auditors are paid by the reporting company. The concern is raised periodically as to whether an auditor can remain properly independent of the organization that is providing payment for the services rendered. However, audit examinations can be quite expensive and no better method of remuneration has yet been devised.

2. To avoid any potential misunderstanding, the first (introductory) paragraph identifies the specific financial statements to which the report relates. In addition, both the responsibility of the management for those financial statements and the responsibility of the independent auditor for providing an opinion on those statements are clearly delineated. The statements are not created by the auditor; that is the job of management. The auditor examines the financial statements so that an expert opinion can be rendered.

3. The second (scope) paragraph provides information to explain the audit work. One key sentence in this paragraph is the second. It spells out the purpose of the audit by referring to the standards created by the PCAOB: “Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements.” This sentence clearly sets out the goal of an audit engagement and the level of assurance given by the auditor. No reader should expect absolute assurance.

   The remainder of the second paragraph describes in general terms the steps taken by the auditor, such as:

   • Examine evidence on a test basis to support reported amounts and disclosures.
   • Assess the accounting principles that were applied.
   • Assess significant estimations used in creating the statements.
   • Evaluate overall presentation.
4. The third (opinion) paragraph provides the auditor’s opinion of the financial statements. In this illustration, an unqualified opinionAn audit opinion informing the reader that attached financial statements are presented fairly, in all material respects, in accordance with U.S. GAAP; thus, the auditor is providing reasonable assurance that the statements contain no material misstatements according to U.S. GAAP and can be relied on by the reader in making financial decisions. is issued meaning that no problems worthy of note were discovered. The auditor provides the reader with reasonable assurance: “In our opinion, such consolidated financial statements present fairly, in all material respects…in conformity with accounting principles generally accepted in the United States of America.” Through this sentence, the independent auditor is adding credibility to the financial statements. The auditor believes readers can rely on these statements in making their financial decisions.
5. The fourth (explanatory) paragraph provides an additional opinion by the auditor, this time in connection with the company’s internal control. Such an assessment is required when an audit is performed on a company that is subject to the rules of the PCAOB. Not only is the auditor asserting that the financial statements are presented fairly in conformity with U.S. GAAP (paragraph 3) but also gives an unqualified opinion on the company’s internal control over its financial reporting (paragraph 4). This additional assurance provides the reader with another reason to place reliance on the accompanying financial statements.

Qualified Audit Opinions

Question: The audit report presented for Procter & Gamble is an unqualified opinion. The independent auditor is providing reasonable assurance to decision makers that the company’s financial statements are presented fairly, in all material respects, in conformity with U.S. GAAP. What can cause an independent auditor to issue an audit report that is less than an unqualified opinion and how is that report physically different?

Answer: An independent auditor renders an opinion that is not unqualified in two general situations:

• Lack of evidence. The auditor was not able to obtain sufficient evidence during the audit to justify an unqualified opinion. Perhaps the amount reported for a building or a liability could simply not be substantiated to the auditor’s satisfaction. The balance might well be fairly presented according to U.S. GAAP but evidence was not available to allow the auditor to make that assertion with reasonable assurance.
• Presence of a material misstatement. The auditor discovered the existence of a material misstatement in the financial statements, a balance or disclosure that does not conform to U.S. GAAP. Because of the potential damage to the credibility of the financial statements, reporting companies usually make any adjustments necessary to eliminate such misstatements. If not, though, the auditor must clearly warn readers of the reporting problems.

The physical changes made in the report depend on the type of problem that is involved and its magnitude. The key method of warning is that a new paragraph is added between the scope and the opinion paragraphs to describe the auditor’s concern. Decision makers often scan the audit report solely to see if such a paragraph is contained. If present, a careful reading of its contents (as well as related changes found in the wording of the opinion paragraph) should be made to determine the possible ramifications. Whether evidence was lacking or a material misstatement was uncovered, the auditor is responsible for letting the reader know. The presence of an added paragraph—prior to the opinion paragraph—always draws attention.