Audit Reports Under US GAAS: Unmodified vs Modified Opinions

What an audit opinion is

An audit opinion is the auditor's conclusion on whether the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework (such as US generally accepted accounting principles, or GAAP). For private companies the rules are in AU-C 700 and AU-C 705 of the AICPA's auditing standards; for public companies, the Public Company Accounting Oversight Board (PCAOB) standards AS 3101 and AS 3105 apply.

The four opinions

• Unmodified opinion — the "clean" opinion. The auditor obtained sufficient appropriate evidence and found no uncorrected material misstatement.
• Qualified opinion — fair "except for the effects of" a specific matter. Used when a misstatement, or an inability to obtain evidence, is material but confined to one area.
• Adverse opinion — the financial statements are not presented fairly because misstatements are material and pervasive.
• Disclaimer of opinion — the auditor does not express an opinion because it couldn't obtain enough evidence, and the possible effects of undetected misstatements could be both material and pervasive.

The decision table

Nature of the problem	Material, not pervasive	Material and pervasive
Financial statements are materially misstated	Qualified	Adverse
Unable to obtain sufficient appropriate evidence (scope limitation)	Qualified	Disclaimer

Pervasive means the effects aren't confined to specific elements, or, if they are, they represent a substantial part of the financial statements, or they concern disclosures that are fundamental to users' understanding.

Structure of the auditor's report (AU-C 700)

Since SAS No. 134, the opinion comes first. An unmodified report for a private company contains, in this order:

1. Title — including the word "independent".
2. Addressee — usually the board or shareholders.
3. Opinion — identifies the entity and the statements audited, and states that they present fairly, in all material respects, in accordance with the framework.
4. Basis for Opinion — states that the audit was conducted under generally accepted auditing standards (GAAS), that the auditor is independent and has met other ethical responsibilities, and that the evidence obtained is sufficient and appropriate.
5. Where applicable: Substantial Doubt About Going Concern, Key Audit Matters, Emphasis of Matter or Other Matter sections.
6. Responsibilities of Management for the financial statements, including the going concern evaluation.
7. Auditor's Responsibilities for the audit — reasonable assurance, professional judgement and scepticism, risk assessment, internal control, and communication with those charged with governance.
8. Other information included in an annual report, where applicable.
9. Signature, city and state, and date — no earlier than the date sufficient appropriate evidence was obtained.

PCAOB reports for public companies follow AS 3101 and also include the auditor's tenure and any critical audit matters.

What changes in a modified report

• The Opinion section heading changes to "Qualified Opinion", "Adverse Opinion" or "Disclaimer of Opinion".
• A Basis for Qualified (or Adverse, or Disclaimer of) Opinion section describes the matter and, where practicable, quantifies its effect.
• In a disclaimer, the auditor does not say it obtained sufficient appropriate evidence, and the description of the auditor's responsibilities is amended.

Scope limitations imposed by management

If management refuses to let the auditor perform a procedure (for example, confirming receivables) and alternative procedures can't fill the gap, the auditor communicates with those charged with governance. If the possible effects are material and pervasive, the auditor either disclaims or withdraws from the engagement where withdrawal is possible under law.

Study the full reporting rules, including report elements and other-information requirements, in our AUD audit reports notes. For the paragraphs that don't modify an opinion, see emphasis-of-matter vs other-matter paragraphs.

Sources

• AICPA & CIMA — Statements on Auditing Standards (AU-C sections) currently effective
• PCAOB — AS 3101, The Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion
• PCAOB — AS 3105, Departures from Unqualified Opinions and Other Reporting Circumstances