What is Audit Report ?
Meaning of Audit Report
An auditor is appointed by the shareholders of a company to audit its accounts and, as such, he makes a report to them about the affairs of the company. An auditor's report provides an opinion of the validity and reliability of a company or organization's financial statements. The goal of an auditor's report is ultimate to document reasonable assurance that a company's financial statements are free from material error.
Definition of Audit Report
Under Section 227(2) of the Companies Act, 1956, the auditor is required to make a report to the members of the company on the accounts examined by him and on every balance sheet and profit and loss account and on every other document declared by the Act to be annexed to the balance sheet or profit and loss account which are laid before the company in general meeting during his tenure of office. Such a report is known as the Auditor's Report.
According to Joseph Lancaster, audit report is, "Report is a statement of collected and considered facts, so drawn up as to give clear and concise information to persons who are not already in possession of the full facts of the subject matter of the report".
Features of Audit Report
The features of audit report are as follows :
- Statement of facts collected by auditor.
- Serves as medium to convey auditor's opinion.
- Final product of audit.
- Based on facts and information relating to company.
- Essential for shareholders.
- Report may be short or long.
- May be clear/qualified/foul report.
- May be in the form of letter or mere statement.
- Duly signed by auditor and attached to balance sheet.
Importance of Audit Report
Audit report is important for all those persons and parties which are related to the organization. The audit report gives a time picture of the state of the organization. The main parties which benefit from an audit report are as follows :
1) Investor :
It is human nature that while making an investment the investor wants maximum safety and return for his investment. The audit report helps increasing the confidence of the investors in the organization and it on the basis of the audit report only that the investors decide to invest in an organization.
2) Shareholders :
They are the actual owners of a company, but they are usually very far from the place of business. They are large in member also as a result of which they cannot directly take part in the management of the company. Therefore, the company is managed by a group of representatives selected by the shareholders known as the Board of Directors. In this way, there is a separation of ownership and management in a company. Therefore, the correct information about the work done by directors is available to the shareholders from the audit report only.
The audit report gives the shareholders information about the completeness of the ledger and accounts, their accuracy and their adherence to the correct principles. Information about the propriety of the items disclosed in the balance sheet and the profit or loss disclosed by the profit and loss account can be obtained from the audit report. The rights of the shareholders are safeguarded by the audit report. The report also discloses the honesty and capability of the directors. Therefore, it is said that the audit report is an important document for the shareholders. Keeping the importance of the audit report in mind the Companies Act has, made it mandatory for the companies to get their accounts audited.
3) Directors :
It is possible for the Directors of a company to fore-see all the activities of the company themselves. The main job of the directors is to formulate the policies of the company, on the basis of which work is done, by the employee. In such a situation the directors also want to know the extent t which the employees have done their work according to the policies of the company and their level of honesty and commitment towards their job. Such information can be obtained by them from the audit report.
4) Creditors :
The creditors of any organization are always eager to find-out about the financial position of the company to know whether their money is safe or not. Therefore, the creditors rely on the audit report to find-out about the financial situation of the organization/company. They can find-out from the audit report if their money is safe and whether the organization is in a position to return it or not.
5) Government :
Business and government have a direct relationship. The growth of business, industry, and finance plays an important role in the growth of the country. Erosion in the capital of the country, embezzlement of capital, discouragement to investments are such issues for which the participation of government is essential. The government also invests its funds in government companies. The government also give loans and financial assistance to other businesses and industries. Therefore, the government also wants to know whether its money is safe or not. Such information can be obtained from the audit report.
6) Taxation Officer :
Various officers such as income tax officers, sales tax officers, excise officers also rely on the audited accounts and take a decision on the basis of the report without doing much verification. This helps them in increasing the amount of tax. Such tax is an important source of revenue for the government therefore the audit report is also very important for the tax officer.
The parties interested in evaluation of a company's performance would require the accounting audit report to form an opinion. With the help of this report, they can decide whether or not to invest into the shares of a particular company. Moreover, bigger organizations could decide if a specific company is a profitable purchase or not.
Essentials of Audit Report
Essentials of audit report are as follows :
1) Title :
An auditor report must have appropriate title, such as "Auditor's Report". It is helpful for the reader to identify the auditor's report. It is easy to distinguish it from other reports, As management can issue any report about the business performance so the title to the report is essential.
2) Addressee :
The addressee may be shareholder or Board of Director of a company. The auditor can audit financial statements of any business unit as per agreement. The report should be appropriately addressed as required by engagement letter and legal requirements. The report is usually addresses to the shareholders or the Board of Directors.
3) Identification :
The audit report should identify the financial statement that have audited. The financial statement may include trading accounts and profit and loss accounts, balance sheet and statement of changes in financial position and sources and application of frauds statement. The report should include the name of the entity. Moreover the data and period covered by the financial statement are also stated in it.
4) Reference to Auditing Standards :
The audit report should indicate the auditing standard or practice followed in conducting the audit. The international auditing guidelines need assurance that the audit has been conducted as per set standards.
5) Opinion :
The auditor's report should clearly state the auditor's opinion on the presentation in the financial statement of the entity's financial position and the result of its operations. The statement give a true and fair view is an auditor's opinion. This opinion is usually based on national standard or international accounting standards.
6) Signature :
The audit report should be signed in the name of the audit firm, the personal name of the auditor or both as appropriate.
7) Auditor's Address :
The address of auditor is stated in the audit report. The name of city is stated in the report for information of the readers.
8) Date of Report :
The report should be dated. It informs the reader that the auditor considered the effect on the financial statements and in his report of events or transactions about which he become aware the occurred up to that date.
Provisions of Companies Act, 1956 for Audit Report
Section 227 of the Companies Act deals with the auditors' report and provides as under :
1) The auditor shall make a report to the members of the company on the accounts examined by him, and on every balance sheet and profit and loss account and on every other document, which is to be part of or annexed to the balance sheet or profit and loss account.
2) The report shall state whether, in his opinion and to the best of his information and according to the explanations given to him the said accounts :
- Give the information required by the Companies Act in the manner so required, and
- Give a true and fair view :
- In the case of the balance sheet, the state of the company's affairs as at the end of its financial year, and
- In the case of the profit and loss account, the profit or loss for that financial year.
Contents of Audit Report
As per the provisions of Section 227 of the Companies Act 1956, the following matters are required in be included in the auditors report of a company :
- Whether the financial information, disclosed in financial statements, has been prepared by using acceptable accounting policies:
- Whether the said policies are consistently applied year after year:
- Whether the financial information complies with relevant regulations and statutory requirements.
- Whether the view presented by the financial information as a whole, is consistent with the auditor's knowledge of the business of the entity; and
- Whether there is adequate disclosure of all material matters relevant to the proper presentation of the financial information.
Thus, the overall conclusion of auditor concerns itself with the adherence to accounting policies, consistency in application of accounting policies, compliance to the provisions of statutes, truth and fairness of financial information and proper disclosure. The overall conclusion of the auditor in this regard, is reduced to clear written expression of opinion and expression of facts. The audit report contains these expressions.
In this connection, it is pertinent to understand the matters required to be reported by company auditor as per Section 227(2) and 227(3) of the Act.
Under Section 227(3) of the Act, the audit report shall state :
- Whether the auditor has obtained all the information and explanations which to the best of his knowledge and belief were necessary for the purpose of his audit.
- Whether in his opinion, proper books of account as required by law have been kept by the company so far as appears from his examination of those books and proper returns adequate for the purposes of his audit I have been received from branches not visited by him.
- Whether the report on the accounts of any branch office audited under Section 228 by the person other than the company auditor has been forwarded to him and how the auditor has dealt with the same in preparing his final report.
- Whether the company's balance sheet and profit and loss account dealt with by report are in agreement with the books of account and returns.
- Whether, in his opinion, the profit and loss account and the balance sheet comply with the accounting standards referred to in sub-section (3C) of Section 211.
- In thick type, or in italics, the observations or comments of the auditor which have any adverse effect on the functioning of the company.
- Whether any director is disqualified from being appointed as director under clause (g) of sub-section (1) of Section 274.
Companies (Auditors Report) Order (CARO), 2003
This order came into effect on 1 July 2003 replacing the manufacturing and other Companies (Auditor's Report) Order (MAOCARO). This new order has placed increased responsibility on auditors and calls for greater corporate disclosures, According to chartered accountants: the propriety concept has made greater inroads in the new reporting order.
For example, the auditor will now have to look at whether a term loan has been used for the purpose it was taken. In other words, the end use of funds will have to be correctly assessed. The auditor is also expected to state if funds raised for short-term purposes are being used for long-term investments.
Keeping in mind the increasing number of corporate frauds coming to light, nationally and internationally, CARO requires auditors to report whether any fraud on or by a company has been noticed or reported during the year under audit.
If yes, the nature and amount involved has to be indicated. Thus, the burden of identifying fraud has now shifted from a company's directors to its statutory auditors.
CARO requires auditors to report defaults in repayment of dues to banks, FIs or debenture-holders. The period and amount will have to be reported. Additionally, CARO requires auditors to provide sufficient reason for offering unfavorable or qualified opinion a case of transactions, which they feel do not follow the general accepted principles of accounting.
The auditors would be further required to state whether the company is regular in depositing undisputed statutory dues pertaining to Investor Education and Protection Fund or not. The audit report should certify whether the management has disclosed on the end use of money raised by public issues and the same has been verified.
The report should also comment whether a company which has been registered for a period of not less than 5 years, has accumulated losses at the end of the year that are not less than 50 per cent of its net-worth and whether such company has incurred cash losses in such financial year and in the year immediately preceding such financial year.
The auditor has also to certify that whether a company has made any preferential allotment of shares to parties and companies covered in the register maintained under Section 301 of the Companies Act 1956.
Types of Audit Report
Following are the types of audit report :
1) Standard/Clean/Unqualified Report :
If no defect, illegal act, frauds are detected during the verification of the accounts of the company and if profit and loss account in the annual account of the company presents. true and fair profit or loss and balance sheet shows true and fair economic condition as of the date and auditor presents whatever report are called clean report. Clean report is also called report without defect or routine report or regular report.
A clean audit report is one which is issued by the auditor when he does not have any reservation with regard to the matters contained in the financial statements. In such a case, the audit report may state that the financial statements give a true and fair view of the state of affairs and profit and loss account for the period. The audit report should contain a clear written expression of opinion on the financial information and if the form or content of the report is laid down in or prescribed under any agreement or statute or regulation, the audit report should comply with such requirements. An unqualified opinion indicates the auditor's satisfaction in all material respects with the matters dealt with below or as may be laid down or prescribed under the relevant agreement or statute or regulation, as the case may be.
Under the following/circumstances an auditor is justified in issuing a clean report.
- The financial information has been prepared using acceptable accounting policies, which have been consistently applied.
- The financial information complies with relevant regulations and statutory requirements.
- There is adequate disclosure of all material matters relevant to the proper presentation of the financial information, subject to statutory requirements, where applicable.
2) Adverse Opinion Report :
Audit report containing an adverse opinion is also called adverse report. The auditor shall express an adverse opinion when the auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are both material and pervasive to the financial statements.
3) Disclaimer of Opinion Report :
Audit report containing a disclaimer of opinion is also called disclaimer report. The auditor shall disclaim an opinion when the auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, and the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive.
4) Piecemeal Report :
Auditor's opinion in his report may not be on the entire financial statements. Such opinion may relate to some of the items contained in the statements on which only he can satisfactorily express opinion after audit. Such an opinion as a part of the financial statement is a piecemeal opinion and the auditor's report containing such opinion is called a piecemeal report.
5) Qualified Report :
During the verification of the accounts of the company, any defect, illegal act, frauds, breach of provision of law is detected and the profit loss account does not show true and reasonable profit or loss of the concluding year and balance sheet does not show the true and fair economic condition as of that date, when auditor gives report about it is called qualified audit report. This type of audit is also called improved report or limited report.
Qualified audit report is one in which the auditor does not give clean report about the truthfulness and fairness of financial statement but makes certain reservations. While qualifying the audit report, it has to be seen that the subject matter of qualification is material but not so much as to affect the overall true and fair view of accounts. Where an auditor fails to obtain sufficient information to warrant an expression of opinion, then he is unable to form an opinion and, thus, he makes a disclaimer of opinion.
Accordingly, the auditor may state that he is unable to express an opinion because he has not been able to obtain sufficient and appropriate audit evidence to form an opinion. The necessity of a disclaimer of opinion may arise due to many reasons such as restriction on scope of examination or in certain circumstances the auditor may not e access to all the books of account for certain reasons, e.g., books are seized by excise authorities or destroyed in fire, etc. It is but natural that the event or must make all forts to verify and substantiate the events. in case he is unable to obtain audit evidence even from alternative sources, then the auditor can only state that a unable to forth an opinion. Therefore, an auditor is required to exercise judgement as to circumstances which may cause modification in the audit report. The following are some of the circumstances when qualified audit report is warranted :
- If the auditor is unable to obtain all the information and explanations which he considers necessary for the purpose of his audit.
- If proper books of account have not been kept by the company in accordance with the law.
- If the Balance Sheet and Profit and Loss Account are not in agreement with the books of account and returns.
- If information required by law is not furnished.
- If the profit and loss account and balance sheet do not comply, with the accounting standards referred to in sub-section (3c) of Section 211 of the Companies Act, 1956.
- If there is contravention of the provision of the Companies Act, 1956 having a bearing on the accounts and transactions of the company.
The aforesaid circumstances have to be carefully evaluated by the auditor having regard to materiality to see whether the circumstance require disclaimer of opinion or adverse opinion.
The Statement on Qualifications in Auditor's Report apart from giving the circumstances necessitating qualifications in the auditor's report also lays down the principles as to the manner of qualification of the audit report.
Types of Qualifications in Qualified Report :
There are several types of qualifications. These include the following :
1) Limitation of Scope :
It means a limitation of scope of the auditors' work that prevents them from obtaining sufficient evidence to express an unqualified opinion. Consider the following examples :
- A limitation imposed on the auditor - e.g., if he were not permitted to carry out an audit procedure considered necessary. The directors may not permit a debtors' circulation or may not allow the auditor to attend a stock take.
- A limitation outside the control of both the auditors and the directors. Perhaps necessary records existed but have been destroyed by fire or the auditor was prevented from attending stock take by a break down.
2) Disagreement :
It means that the auditors do not agree with the accounting treatment or disclosure of some em in the accounts. The financial statements may have an accounting policy, e.g., inclusion of overheads in finished goods stock on a global percentage of overheads to prime cost, when the auditor considers that a more complex apportionment is essential for true and fair view.
3) Material and Pervasive :
This term applies when the possible effect of the limitation of scope is so material or pervasive that the auditors are unable to express an opinion on the financial statements. Similarly when the matter giving rise to the disagreement is so material and pervasive that the financial statements are seriously misleading.
4) Less Material :
It means when the effect of the limitation is not so material or pervasive as to require a disclaimer. Similarly when the disagreement is not so material or pervasive as to require an adverse opinion.
5) Adverse Opinion :
An adverse opinion is one where the auditors state that the financial statements do nor give a true and fair view.
6) Disclaimer :
A disclaimer of opinion occurs when the auditors conclude that they have not been able in obtain sufficient evidence to support, and accordingly are unable to express, an opinion on the financial statements.
7) Possible Adjustments :
The wording of the opinion should indicate that it is qualified as to the possible adjustments to the financial statements that might have been determined to be necessary had the limitation not existed.
8) Exclusion of Certain Points :
The opinion is qualified by stating that the financial statements give a true and fair view except for the effects of any adjustments that might have been found necessary, had the limitation not affected the evidence available to the auditors.
An auditor makes a standard or clean or unqualified report when he is satisfied with various matters, such as follows :
- He has got reasonable evidence in support of all material transactions.
- All entries have been passed according to generally accepted accounting principles.
- The financial statements correspond to the books of accounts.
- All relevant information has been disclosed.