Education

How to read an audit report

Harinderjit Singh | Updated on November 15, 2017 Published on June 03, 2012

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A better understanding of audit reports will lead to better economic decisions, giving the reader the benefit of an independent opinion on a company's financial statements.

Imagine wading through pages of information to understand a company's financial position – and without any knowledge of the nuances of financial reporting! The independent auditor's report is here to help understand financial statements better. It summarises the scope of the audit, the management and auditors' responsibilities, and the true and fair view of financial statements to name a few.

Before looking at an audit report, readers should be aware of certain myths associated with it and its inherent limitations.

It is believed that an audit is a guarantee for the management's efficiency in running the company's affairs. It is also seen as a guarantee for the company's future viability. Another common myth is that an unqualified opinion means the company has sound financial health. Further, many people think the objective of an audit is to detect fraud and error, and that it includes commenting on the company's policy decisions and use of resources. Many also think the auditor decides the accounting policies of the company and prepares its financial statements.

However, the reality is different and there are inherent limitations. For instance, audits are designed to provide only reasonable assurance, not absolute assurance. Examining all the company's transactions is neither practical nor possible. Moreover, the audit opinion is based on the collected evidence for the amounts and disclosures in the financial statements. Much of the audit evidence is persuasive rather than conclusive in nature. Also, unless the examination reveals evidence of fraud, the auditor is entitled to accept the representations as truthful, and the records and documents as genuine. Further, the auditor's opinion is based on audit evidence obtained and the existence of an effective internal control system. Undetected factors could result in misstatement.

Readers must pay special attention to certain elements in an audit report, namely the introductory paragraph — especially the managements' and auditors' responsibilities, scope paragraph and opinion paragraph.

Management's responsibility

Contrary to popular perception, only the company's management is responsible for preparing and presenting its financial statements. This includes selecting accounting policies, exercising judgement in the use of estimates, and preparation and presentation of the financial statements according to the relevant reporting framework. The management is also responsible for designing, implementing and maintaining internal control. It has to ensure that the financial statements give a true and fair view in accordance with the financial reporting framework.

As auditors cannot provide absolute assurance on the financial statements, they plan and perform the audit to obtain reasonable assurance that there is no material misstatement. For this they examine, on a test basis, the evidence supporting the amounts and disclosures in the financial statements.

An auditor also assesses the accounting principles used, the significant estimates made and the management's overall presentation of the financial statements. The evidence for the amounts and disclosures in the financial statements is the basis for the audito's opinion.

Auditing standards

The auditing standards issued by the Institute of Chartered Accountants of India contain basic principles, essential procedures and related guidance for carrying out an audit. Departure from these requirements is allowed only under certain circumstances.

Opinion paragraph

An unqualified audit opinion is an independent reasonable assurance that the financial statements give a true and fair view in conformity with the relevant financial reporting framework.

The auditor may modify the report for the effects, or possible effects of

any misstatement that is either material or pervasive or both; or

the auditor's inability to obtain sufficient and appropriate audit evidence, which could lead to misstatement that is material or pervasive or both.

A better understanding of audit reports will lead to better economic decisions, with the reader ultimately reaping the benefit of an independent opinion on a company's financial statements.



Harinderjit Singh is Partner, Price Waterhouse

Published on June 03, 2012
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