Understanding the audit opinion - A guide for non-auditors

The purpose of an audit of financial statements are two-fold:

• To provide an opinion on the financial statements, and
• To express clearly the audit opinion through a written audit report.

Audit opinions are therefore crucial for understanding the financial health and integrity of an organisation. For non-auditors, the terminology and implications of these opinions can seem complex and confusing. This article will assist in clarifying the purpose of an audit and the differences between the types of audit opinions, particularly those outlined in the International Standards on Auditing.

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What is an Audit Opinion?

An audit opinion is a statement provided by an independent auditor after examining an organisation's financial statements. The audit report reflects the auditor's assessment of whether the financial statements are free from material misstatement and whether they present a true and fair view of the organisation's financial position. The auditor would express an opinion following a series of audit procedures carried out to understand the entity and its operations, including relevant tests (both substantive and controls testing where possible) to obtain sufficient appropriate audit evidence that the financial statements are free from material misstatement, whether due to fraud or error.  The level of assurance obtained by the auditor is referred to as ‘reasonable assurance’ and this indicates a level of assurance that is not absolute assurance (therefore not based on 100% testing), but nonetheless a high level of assurance.  

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Types of Audit Opinions

In the event that the auditor concludes that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework, then an unmodified opinion is expressed. This can also be referred to as a ‘clean’ audit opinion. Such opinion therefore indicates to the reader that the financial statements as a whole are free from material misstatement and that sufficient appropriate audit evidence has been obtained during the audit.

Alternatively, should the auditor conclude that the financial statements as a whole are not free from material misstatement, or the auditor is unable to obtain sufficient appropriate audit evidence, then the auditor would need to modify the audit opinion.

Modified audit opinions expressed by auditors would include one of the following:

• Qualified opinions
• Adverse opinions
• Disclaimer of opinions

The decision on which audit conclusion is reached by the auditor depends largely on:

• whether a material misstatement is present within the financial statements and
• whether sufficient and appropriate audit evidence has been obtained by the auditor

A material misstatement present within the financial statements (without such misstatement being pervasive to the financial statements), will result in a qualified audit opinion. Furthermore, if the auditor is unable to obtain sufficient appropriate audit evidence (but this is not pervasive to the financial statements), then this will also result in a qualified audit opinion.

Meanwhile, an additional factor considered in arriving at the audit conclusion also depends on the pervasiveness of the matter. For the sake of clarity, the term pervasive, in line with ISA 705, is ‘used to describe the effects on the financial statements of misstatements or the possible effects on the financial statements of misstatements that are undetected due to an inability to obtain sufficient appropriate audit evidence.’ Therefore, something is pervasive if it is not confined to specific elements, accounts or items in the financial statements, or if confined, would represent a significant portion of the financial statements’.  

If the misstatement identified within the financial statements is both material and pervasive, then the auditor will provide an adverse opinion.

Conversely, if the auditor is unable to obtain sufficient and appropriate audit evidence, and this is pervasive to the financial statements, then the auditor will need to disclaim his opinion.

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1. Qualified Opinion

As noted above, a qualified opinion would be used when:

• the auditor, having obtained sufficient appropriate audit evidence, concludes that the financial statements include misstatements that are material but not pervasive, or
• the auditor is unable to obtain sufficient appropriate audit evidence on which to base his audit opinion, with such effects being material but not pervasive to the financial statements.

A typical example of this could include a situation where the auditor is unable to verify the accuracy of inventory due to insufficient evidence, the amount of which is material but not pervasive to the financial statements. The audit opinion issued will therefore include a qualified opinion stating: ‘except for the matter noted with respect to inventory, the financial statements are true and fair’.

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2. Adverse Opinion

An adverse opinion is issued when the auditor concludes that the financial statements are materially misstated, with such misstatement being both material and pervasive to the financial statements.

An instance of this could include where the auditor finds that the financial statements are significantly overstating revenue and may thereby issue an adverse opinion stating that the financial statements do not present fairly the Company’s  financial position, financial performance and cash flow for the year then ended, where applicable.

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3. Disclaimer of Opinion

A disclaimer of opinion is issued when the auditor is unable to obtain sufficient appropriate audit evidence to form an opinion on the financial statements, this being both material and pervasive to the financial statements. This opinion indicates that the auditor cannot form an opinion due to limitations in the audit process.

One such example could include where the auditor is unable to access key financial records due to restrictions imposed by the organisation and may therefore issue a disclaimer of opinion stating that they cannot form an opinion on the financial statements.

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‍Communicating with Those Charged with Governance

ISA 706, Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report, outlines the auditor’s responsibility to communicate key issues to those charged with governance during a financial statement audit. This communication is conveyed through the inclusion of emphasis of matter and other matter paragraphs in the auditor’s report.‍

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1. Emphasis of Matter

An Emphasis of Matter paragraph is included in the auditor’s report to draw users’ attention to a matter that is appropriately presented or disclosed in the financial statements and is, in the auditor’s judgment, of such importance that it is fundamental to users’ understanding of the financial statements. Its purpose is to highlight a matter that, while appropriately presented or disclosed, is of such significance that it warrants special attention. This communication does not modify the auditor’s opinion.

One such example could include drawing the users’ attention to the fact that a company has been placed into liquidation.

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2. Other Matter

An Other Matter paragraph refers to a matter other than those presented or disclosed in the financial statements that, in the auditor’s judgment, is relevant to users’ understanding of the audit, the auditor’s responsibilities, or the auditor’s report. This paragraph is used to communicate matters that are not presented or disclosed in the financial statements but are important for users to understand the audit context or the auditor’s responsibilities. This communication does not modify the auditor’s opinion.

For example, in the case where the prior year financial statements have been audited by another auditor, this would be disclosed in the other matter paragraph.

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Conclusion

Understanding the different types of audit opinions is essential for interpreting an auditor's report and assessing an organisation’s financial health. By familiarising oneself with the terminology and implications of these opinions, the reader can gain a clearer understanding of the audited results and the reliability of the financial statements.