The independent auditor's report states his or her opinion regarding the audited financial statements. It is the culmination of a thorough examination of each of the financial statements and the data underlying them. An unmodified (clean) opinion is issued when the auditor is satisfied with the financial statements as a whole and they are presented in accordance with U.S. GAAP.
A clean opinion provides the highest level of assurance that in all “material” (significant) respects (1) the Statement of Financial Position fairly presents the organization's financial position; (2) the Statement of Activities fairly presents the results of the organization's operations; and (3) the Statement of Cash Flows fairly presents its cash flows. The reader of these statements can be confident that appropriate accounting principles have been followed and that appropriate accounting principles have been used consistently to maintain comparability of financial statements from period to period. The reader can also be confident that any significant matters not shown on the face of the financial statements are adequately disclosed in the footnotes.
However, the reader should not look to the audited financial statements for perfect accuracy. Based on auditing standards generally accepted in the United States of America (GAAS), when conducting an audit of financial statements, the auditor must obtain reasonable assurance about whether the audited financial statements are free from material misstatement. Based on GAAS, reasonable assurance is a high, but not absolute, level of assurance. The independent auditor's report also does not comment on immaterial matters, and audited financial statements are frequently the end result of many judgment calls regarding what is material (significant) and what is not.
The independent auditor's report does not deliver an opinion on the organization's financial condition. To the extent that the audited financial statements present fairly the organization's financial condition, however, the reader obtains sufficient information for forming such an opinion. Another caveat about the independent auditor's opinion is that it does not discuss the competence, skills, or knowledge of the organization's management. You must look elsewhere to obtain that information. Oftentimes external auditors will prepare a management letter that may discuss such issues that were noted during the audit of the organization.
If the auditor has concerns about whether the entity can continue operations that cannot be alleviated by looking at future operations or other pertinent information, he or she may add an Emphasis of a Matter paragraph that discusses the fact that he or she is concerned with the ability of the entity to continue operations. If this is necessary, the auditor will include an additional paragraph that discusses this issue and draws the reader's attention to a specific footnote that will contain additional information. This scenario can become more common in negative economic climates.
Financial statement readers rely heavily on an auditor's opinion. CPAs almost always use the same language and format to express an unmodified opinion so that this type of opinion can be readily identified. Every time you read an audited financial statement, look for the following information in the independent auditor's report.
The first paragraph of the independent auditor's report tells you the names and dates or time periods of the audited financial statements. This first paragraph will include all financial statements audited and the periods covered. The second paragraph explains management's responsibility for the financial statements. The third through fifth paragraphs explain the independent auditor's responsibility and the nature of audit procedures and that the auditors have performed their work according to established professional guidelines. The sixth paragraph, the opinion paragraph, states the auditor's opinion that the financial statements are “present[ed] fairly, in all material respects…[and] in accordance with accounting principles generally accepted in the United States of America.”
When these paragraphs are present, you can be confident that the independent auditor's report is clean and rely on the financial statements accordingly. An unmodified opinion sometimes includes an additional paragraph that draws the reader's attention to a particular matter. This additional paragraph does not reduce the level of assurance the independent auditor is expressing. It simply provides disclosure of additional information in the audited financial statements, or an additional important matter. For example, a seventh or eighth paragraph might indicate that the information is presented in a different fashion from in the previous year or discuss an unusual or important subsequent event.
These additional paragraphs are referred to as either an “Emphasis of a Matter” or “Other Matter” paragraph and will be labeled as such in the independent auditor's report. An Emphasis of a Matter paragraph is included in the independent auditor's report to refer to a matter appropriately presented or disclosed in the audited financial statements that is relevant to the users' understanding of the financial statements. Some common examples of topics addressed in an Emphasis of a Matter paragraph include when an auditor reports on an incomplete presentation but one that is otherwise in accordance with GAAP (that is, an entity presents the statement of activities by type of net asset in a columnar format for the current year but only presents a total column for the prior year), a change in accounting principle, or a correction of a misstatement.
An other matter paragraph is included in the independent auditor's report and refers to a matter other than those appropriately presented and disclosed in the audited financial statements that is relevant to the users' understanding of the audit, the auditor's responsibility, or the auditor's report. Some common examples of topics addressed in an other matter paragraph include the independent auditor's report on supplemental information accompanying the audited financial statements and prior period financial statements not being audited.