What an auditor actually does
Not a guarantee that the numbers are right. A professional opinion, with a defined scope, delivered by a firm the company pays.
Every set of published accounts carries an auditor's report. Almost nobody reads it, partly because it is written in careful professional language and partly because people assume they already know what it says.
What is being asserted
The standard opinion states that the financial statements give a true and fair view, or present fairly in all material respects, in accordance with the applicable framework. Three constraints are built into that sentence: reasonable rather than absolute, material rather than exact, and in accordance with a framework rather than in some objective sense.
Auditors test samples, not every transaction. They evaluate estimates for reasonableness rather than correctness, because the future outcome is unknown to everyone. And they assess compliance with accounting standards, which permit a range of defensible treatments.
The forms of opinion
- Unqualified (clean) — the overwhelming majority. No material problems found within the audit's scope.
- Qualified — a specific issue, otherwise fine. Rare, and worth reading in full when it appears.
- Adverse — the statements do not present fairly. Extremely rare and extremely serious.
- Disclaimer — the auditor could not obtain enough evidence to form an opinion. In practice this is as bad as adverse.
The parts investors should read
Since reforms following a series of corporate failures, audit reports include key audit matters — the areas the auditor judged to involve the greatest risk of material misstatement, and what they did about them.
Revenue recognition timing, goodwill impairment assumptions, inventory valuation, litigation provisions. These are the places where the accounts depend most heavily on management's estimates. A professional with full access to the books has told you where to look, in a public document, for free.
The going concern section is the other one to read. A material uncertainty disclosed there is a direct statement that the company's ability to continue operating for the next year depends on events not yet settled.
The structural problem
The company pays the auditor, and the audit partner's firm frequently earns additional fees for other services. That is a conflict, it is well documented, and it is managed rather than eliminated — through partner rotation, independence rules, audit committees and caps on non-audit work.
It follows that an audit is not designed to detect determined, collusive fraud by senior management. Auditors are required to consider fraud risk, and most large accounting scandals were nevertheless signed off as clean beforehand. That is not primarily a failure of diligence; it is the boundary of what sampling and reasonable assurance can achieve.
What to take from the report
- A clean opinion is a floor, not a recommendation. Nearly every listed company has one.
- Read the key audit matters — they are short and specific.
- Note a change of auditor, especially outside the normal rotation cycle, and read the reason.
- Note non-audit fees relative to audit fees, disclosed in the annual report.
- A qualification, a going-concern uncertainty, or a late filing are all serious, in that order of escalation.