How to read an Audit Report

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 the audit evidence obtained and the existence of an effective internal control system. Undetected factors could result in a misstatement.

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