Audits of Financial Statements

Annual reports present financial statements that have been audited by an independent accounting firm. Auditing of financial statements is an important function that is performed under specified auditing standards and which may be required by law, regulation, or some form of contractual agreement.

Objectives of an Audit

The two primary objectives of an audit are:

• to provide reasonable (not absolute) assurance that financial statements are free from material misstatement. This, in essence, enables the independent auditor to express an opinion on whether or not the preparation of financial statements complied with a specified set of accounting standards; and
• to report on the financial statements following the auditor’s findings as required by the International Standards for Auditing.

Types of Audit Reports

When an independent auditor provides a written opinion on a company’s financial statements, it is called an audit report.

The standard independent audit report usually has several paragraphs. To begin with, the first or “introductory” paragraph describes the financial statements and the responsibilities of management and the auditor. The second or “scope” paragraph describes the nature of the audit process and gives the basis for the auditor’s expression about reasonable assurance. Lastly, the third or “opinion” paragraph expresses the auditor’s opinion on the fairness of the financial statements.

The audit opinion can take any one of the following forms:

• the unqualified audit opinion indicates that the financial statements are fairly presented under the accounting standards;
• the qualified audit opinion indicates that there is some amount of limitation to the scope of the audit or that there is an exception to the accounting standards;
• the adverse audit opinion indicates that the independent auditor has determined that the financial statements materially depart from accounting standards and are not fairly presented; and
• the disclaimer of opinion indicates that the auditor is unable to issue an audit opinion for one reason or another.

Importance of Effective Internal Controls

Effective internal controls help to ensure that a company’s process for financial reporting is sound.

Having effective internal controls has become increasingly important. Under the Sarbanes-Oxley Act, the securities regulators in the United States now require the management of publicly traded companies to accept responsibility for the effectiveness of internal control processes, evaluate their effectiveness, have supporting evidence for the evaluation, and provide a report on internal controls.

Question

Which paragraph in the standard independent audit report describes the nature of the audit process and gives the basis for the auditor’s expression of reasonable assurance on the fairness of the financial statements?

1. Scope paragraph.
2. Opinion paragraph.
3. Introductory paragraph.

Solution

The correct answer is A.

The second or scope paragraph describes the nature of the audit process and gives the basis for the auditor’s expression about reasonable assurance.

B is incorrect. The opinion paragraph expresses the auditor’s opinion about the fairness of the financial statements.

C is incorrect. The introductory paragraph describes the financial statements and the responsibilities of management and the auditor.