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What is an Auditor's Report?

 An auditor's report is a document where the auditor expresses their view on whether a company's financial statements align with generally accepted accounting principles (GAAP) and are devoid of significant errors. 

An auditor's report holds significance as it is a written confirmation that a company's financial records are in compliance with established accounting standards. It serves as a crucial document, especially for financial institutions like banks and creditors, who require assurance before engaging with a company.

 Key Takeaways 

• Auditing Evaluation: The auditor's report provides an evaluation on whether a company's financial statements adhere to GAAP and are free from major errors.
• Financial Compliance: It underscores the importance of financial compliance as mandated by banks, creditors, and regulatory bodies.
• Clear vs. Unqualified Report: A clear audit report indicates that the company followed accounting norms, while an unqualified report suggests potential errors.
• Adverse Findings: An adverse report implies discrepancies in financial statements, potential misrepresentations, and a failure to meet GAAP standards.

How an Auditor's Report Works

Definition of Auditor's Report

• An auditor's report is a formal document accompanying a company's financial statements. It offers the auditor's opinion on the company's adherence to accounting standards.

Purpose of Auditor's Report

• An auditor's report is mandatory for public companies when submitting financial results to the SEC. It assesses the reliability of the financial statements, not the company's investment potential.

Not an Investment Evaluation

• The report does not evaluate the company's suitability as an investment. It solely focuses on the financial statement's trustworthiness.

The Components of an Auditor's Report

When an auditor prepares a report, it typically consists of three main paragraphs, each serving a distinct purpose.

• The first paragraph outlines the responsibilities of both the auditor and the company's directors.
• The second paragraph details the scope of the audit, indicating that standard accounting practices were adhered to during the assessment.
• The third paragraph presents the auditor's opinion on the financial statements of the company.

In some cases, an additional paragraph might be included to communicate the outcomes of a separate audit conducted on a different aspect of the business. Investors often pay close attention to the third paragraph, where the auditor's opinion is explicitly stated.

The nature of the report issued is determined by the auditor's findings. There are several common types of reports that auditors may issue for companies, with the two primary ones outlined below.

Clean or Unqualified Report

A clean or unqualified report signifies that the company's financial records are accurate, free from significant errors, and comply with Generally Accepted Accounting Principles (GAAP). In most cases, audits culminate in unqualified opinions, indicating a clean bill of financial health for the company.

Qualified Opinion

A qualified opinion is issued under specific circumstances. Firstly, it may arise when the financial statements contain material errors that are limited in scope. Secondly, it can be issued when the auditor lacks sufficient appropriate evidence to form an opinion, although the potential impact of any errors is not widespread. For instance, a miscalculation in operating expenses or profits could lead to a qualified opinion. Auditors usually outline the precise reasons and areas where issues exist, enabling the company to address and rectify them.

Adverse Opinion

• An adverse opinion indicates that the auditor has gathered enough audit evidence to determine that there are significant and widespread errors in the financial statements. This type of opinion is highly detrimental to a company, carrying severe consequences and potential legal implications if not rectified.
• Regulators and investors typically refuse to accept a company's financial statements when an adverse opinion is issued by the auditor. Moreover, in cases involving illegal activities, corporate officers may face criminal charges.

Disclaimer of Opinion

• A disclaimer of opinion occurs when the auditor is unable to acquire adequate audit evidence to form an opinion due to various reasons. This situation may lead to significant and widespread impact on the financial statements from undetected errors, if any. For instance, this could happen if the auditor lacks impartiality or is denied access to crucial financial data.

Example of an Auditor's Report

Here are excerpts from the audit report issued by Deloitte & Touche LLP for Starbucks Corporation, dated November 15, 2019.

Paragraph 1: Opinion on the Financial Statements

• "We have audited the accompanying consolidated balance sheets of Starbucks Corporation and its subsidiaries (the 'Company') as of September 29, 2019, and September 30, 2018, along with the related consolidated statements of earnings, comprehensive income, equity, and cash flows for each of the three years ending September 29, 2019, and the related notes (collectively referred to as the 'financial statements').
• In our opinion, the financial statements fairly present, in all material respects, the financial position of the Company as of September 29, 2019, and September 30, 2018, as well as the results of its operations and its cash flows for each of the three years ending September 29, 2019, in accordance with accounting principles generally accepted in the United States of America."

Paragraph 2: Basis for Opinion

• "We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (PCAOB). These standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from 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 address 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."