The auditor's report

In simple terms

Every year, a company's financial statements are checked by an independent firm of chartered accountants, the statutory auditor. The auditor's report, placed with each set of statements in the annual report, gives the auditor's opinion: whether the statements give a true and fair view in line with the accounting standards.

An audit gives reasonable assurance, which is a high level of assurance but not a guarantee. Auditors test samples rather than every transaction, rely partly on management's explanations and judgements, and focus on material misstatements, ones large enough to change a reader's decisions.

The four kinds of opinion

Auditing standards set out when an auditor must change ("modify") the opinion:

Key audit matters

For listed companies, the auditor must also describe key audit matters: the areas of the audit that needed the most attention, usually because they involve the biggest judgements or risks. Typical examples are revenue on long contracts, impairment of goodwill, provisions for legal cases and the valuation of loans in a bank.

Key audit matters are not criticisms; a clean report on a listed company normally includes several, and if the auditor finds none to report it must say so. But they are a map of where the accounts are most uncertain, written by someone who has seen the details. They often point to the notes worth reading first.

Emphasis of matter and going concern

An emphasis of matter paragraph draws attention to something already disclosed in the statements that the auditor considers fundamental to understanding them, such as a major lawsuit or a significant uncertainty. It does not change a clean opinion, but it tells you where to look.

A material uncertainty related to going concern is the most important of these warnings. It means there is significant doubt about whether the company can keep operating and meet its obligations over the coming period, for example because it may not be able to repay or refinance its debt.

Warning signs around the audit

Beyond the opinion itself:

• The auditor resigns in the middle of its term, or the company changes auditors often.
• The same issue is qualified year after year without being resolved.
• Results are published late, or the audit takes unusually long.
• Large subsidiaries are audited by other firms whose work the main auditor relies on, especially if those subsidiaries hold much of the business.

Changes of auditor are announced to the stock exchanges, so they appear in a company's exchange filings as well as in the annual report.

Why it matters

The auditor is the only outsider who sees inside the company's books in detail. A modified opinion or a going concern warning is one of the strongest signals an investor can get, and it is public. Many collapses were preceded by such signals; others happened despite clean reports, which is why an audit opinion is a minimum requirement, not a seal of quality.

Limitations

• Audits are designed to detect material misstatement, not every error, and carefully concealed fraud, especially involving collusion, can go undetected.
• The auditor is paid by the company it audits, a conflict the rules on independence try to manage.
• A clean opinion says the statements follow the accounting rules. It says nothing about whether the business is good or the share is fairly priced.

Common mistakes

• Treating a clean audit as a guarantee against fraud or failure.
• Not reading the opinion at all, or reading only the first paragraph.
• Skipping key audit matters because the opinion is clean.
• Missing a going concern paragraph or an auditor's resignation.

Try it yourself

1. Open the independent auditor's report on the consolidated statements in any listed company's annual report. What kind of opinion is it?
2. List the key audit matters. Find the note for each and read how the company explains it.
3. Search the report for "emphasis of matter", "material uncertainty" and "qualified". If any appear, what are they about?
4. Check the company's exchange filings for any change of auditor in the last five years.